INTERNATIONAL TRADEA. GAINS FROM TRADEInternational trade refers to the interchange of goods and services between and among countries. It also be defined as the trade that takes place between two or more countries. It is essentially the exchange of commodities on global scale. International trade arises because of the following reasons:i) The production of different types of goods requires different kinds of resources. Such

resources. Such resources may not all be found in a countryii) Different countries are endowed with different resources. Different regions of the world are

agricultural goods because of good climate and soils while other produce mineral resources. Since agricultural countries need machinery to run their firms and process goods, such machinery can be imported from industrialized nations.

iii) Competitive forces and the exercise of choice.iv) Some goods cannot be produced efficiently as elsewhere and thus it makes more sense to

import it.v) It may be better for the country to give up the production of a commodity and import it

instead, in order to specialise in something else.vi) Shortage-at a time of high domestic demand for particular goods production may be unable to meet this demand. In such a situation goods are imported to overcome the shortages.

Bilateral Trade- This is the exchange of commodities between any two countries e.g. Kenya and Britain. It is necessitated by differences technology and resources endowments existing between to countries. Multilateral Trade- This is the situation where a country conducts trade with more than one country. In reality, international trade is carried out on the basis of multilateral arrangements rather than bilateral.Visible trade - this refers to the exchange of tangible goods between two or more countriesInvisible trade- this is the exchange of intangible goods i.e. services such as tourism between two or more countries.Exports- refers to the goods and services sold by a country to another country.Imports- refers to the goods and services bought by a country from another country.Advantages/Importance of International Trade(a) Better Supply of Goods through importationThrough international trade, a country may obtain goods which it does not produce through importation from countries with surplus production or from where they can be produced at a cheaper costs, eg, less developed countries find it to produce capital goods thus importing them from the industrialized countries. This increases variety of goods available for consumers widening their choice and increasing their satisfaction.(b) Lower CostsA country can obtain goods which it could not grow or produce itself, and it can also obtain goods which it could grow or produce – but only at higher cost than in other countries.c) Widens/expands market for goods and services International trade, by opening up the whole world for trading purposes, increases the size of the markets for various goods. Foreign markets can be fully exploited to strengthen and widen a country’s market. Production on a larger scale is then possible, allowing full advantage to be taken of economies of scale such as increased efficiency in managerial skills, technological advancement, financial economies and research economies to achieve greater output for the expanded foreign markets. (c) Supply of commodities during calamities/Famines can be Prevented- international trade makes it possible to provide urgently required goods and services to countries which may experience calamities as drought, floods, earthquakes, or strikes. Commodities such As food and medicine can be rushed to the areas affected, thus alleviating the problem. World trade reduces the likelihood of famine and of other

results of shortages of supply, since it is possible to offset temporary domestic shortages by getting additional supplies from abroad.(d) A Curb on MonopolyInternational trade is an obstacle to the development of monopolies. Even if monopolies exist in a country, their control over prices will be limited by the threat of foreign competition in form of large multinational companies. Such companies tend to limit world competition by agreements between themselves, and by their own power to absorb competitors.(e) Encouragement of International Cooperation, peace and understandingInternational trade leads to a greater degree of interdependence between sovereign states, and this should be a factor making for international peace and friendly cooperation between nations. Trading countries develop social, cultural, political and economical relationships. This leads to international peace necessary for social co-existence, mutual understanding and strengthening of relationships.(f)Exportation of commodities leads to full utilisation of resources-surplus commodities can be exported to countries where they are not adequately available and where such surpluses are demanded. This enables countries to exploit their resources fully because of increased market, e.g., Kenya produces surplus tea which she exports to countries such as Britain(g)Foreign exchange earnings- when surplus commodities are produced and exported, foreign exchange is earned. Surplus production which is not exported might go to waste. Thus, exporting of such goods earns a country the much needed foreign exchange.(h)Specialisation- international trade brings about specialization in the production of different commodities which leads to lower costs of production. In this way, the world output of goods and services increases.(i)Economic development- international trade promotes economic development as it stimulates less developed countries to compete with industrialised nations in the production of commodities.(j)Improved standards of living- through international trade a country is able to wide import a wide variety of goods and services. This gives a wide choice to the people which will raise the living standards.(j)Mobility of factors of production- International trade makes it possible for the mobilization of factors of production such as land, labour capital as well as raw materials tp produce the most needed commodities according to the market forces of demand and supply thus leading to optimal location of resources.(k)Improved transport- international trade helps to improve transport facilities. This leads to an increase in the volume of trade and variety of commodities traded, e.g. , physical barriers as aero planes, trains and ship can be used . Communication facilities such as telephones, telex, fax are today used to facilitate trade, so orders can be placed through these facilities then commodity imported or exported as required.(l)Improved balance of payment- due to export of goods and services, countries earn foreign exchange which may be used to finance a deficit in the balance of payment(m)Increased government revenue- duties and taxes such as customs duties increase government revenue which can be used to promote economic and social activities such as building schools, hospitals, roads and dams.Disadvantages of International Tradea) Over reliance on imported commodities : Over reliance on imported commodities can prove harmful if the relationship between the trading nations goes sour. During times of war trade is disrupted, thus the supply of goods which were once relied upon no longer reach the country relying on them.b) Exhaustion of resources- Non-renewable resources such as mineral deposits become depleted as more and more of them are being exploited, eg, Zambia relies on export of copper. If copper deposits are exhausted, then Zambia’s economy will be affected. c) Hampers growth of infant industries- international trade brings about stiff competition among trading countries, therefore, infant industries find it difficult to compete with internationally well

established industries. Stiff competition in the international market tend to discourage newly established industries which might end up closing down all together. d) Importation of harmful products- through international trade some harmful products might find their way into a country eg, some harmful drugs such as banned pesticides, cocaine, mandrax and bad literature might get into a country.e) Importation of inflation- standards of living of people depend on the level of inflation, when inflation is low, the prices of commodities go down to the benefit of many people. This is because their purchasing power for goods and services increase. However, due to importation of commodities from countries already suffering from inflation the cost of imported goods and services increase. This may cause hardships to people who may find it difficult to buy commodities due to high prices, hence low standards of living.f) Capital ‘flight’ – foreign investments involve the movement of massive capital to produce goods and services in a foreign country. The money which would have otherwise been used to invest in home country is thus invested outside the country. If there is a decreased foreign investment from home country.g) Repatriation of profits- investment by foreigners in a home country is a healthy economic activity since it promotes economic development in the country due to either economic or political reasons, then there will be slowed economic development in the home country.h) Political blackmail- a country that over-relies on international trade may be forced to adopt economic, political and social policies that may be in conflict with its aspirations.B. FREE TRADE AND PROTECTIONFree trade refers to trade that is free from imposed restrictions suchas tariffs, quotas, total ban e.t.c. The principle of comparative advantage shows that free trade and specialisation brings gains to the participating countries. So long as a country has a comparative advantage in producing something it can benefit from specialising in its production, and trading the surplus over home consumption for other materials and products from abroad.Advantages of Free Trade1. Countries can specialise and increase production safe in the knowledge that they canexport their surplus2. Resources are allocated efficiently3. Countries can export surpluses and import what they need4. Countries gain economies of scale from access to the world market5. Competition from imports increases efficiency and limits the creation of monopolies6. Free movement of capital allows countries to develop their industries. Free trade overcomes the immobility of factors: it permits the free movement of the product of immobile factors so that countries worldwide can benefit from an abundant factor endowment in any place.7. Political links develop between countries.8. Access to the global market is essential for developing countries if they are to achieve economic growth. Trade with the developed economies would give the developing nations a large market for their goods and the opportunity to import new technology.9. Firms could gain economies of scale and new techniques; competition would increase efficiency; monopolies are avoided. 10. Production for export helps to diversify the economy: it reduces dependence on what is often a single crop subject to disasters, like sudden frosts which halve the output of coffee.ProtectionAll trading nations engage in some form of trade protection, as governments have to face political pressures from powerful domestic interest groups. At the same time they are often

reluctant to admit that they are imposing barriers, so they may avoid the formal measuresthat would invite retaliation and invite censure from the World Trade Organisation (WTO).Instead they make use of a variety of devices to delay imports or make them more expensive. These include cumbersome import procedures with complicated documentation or "safety measures" with a dubious safety value.At the same time the more formal measures still survive, and are employed by individualcountries and regional groups such as the European Union. The main such measures are:

import tariffs, also known as customs duties, which are taxes imposed on goods whenthey enter a country or one of a group of countries such as the EU, which contrast with

import quotas, which are quantitative restrictions on the import of goods.The belief that free trade (trade free from imposed restrictions) should be encouraged asmuch as possible is linked closely to the theory of comparative cost advantage. ARGUMENTS IN FAVOUR OF THE USE OF PROTECTIONIST MEASURES/REASONS FOR RESTRICTING IMPORTSi) To correct balance of payments deficit- when a countries payment exceed her receipts in the

international transactions, the result is a balance of payments deficit. This means that more money goes out of the country than it receives. Tariffs , quotas, total ban and other restrictive measures are used to discourage imports and promote exports thus correcting a deficit balance of payment.NB Balance of payments is not only concerned with imports but also with exports, and the government will have to consider what effect the imposition of protectionist measures by a country will have on that country's exports.

ii) To protect ‘infant’ industries- These are those industries which are being introduced/established industries in a country where the industry has not previously been present. "Infant" industries need protection from foreign competition to prevent them from collapse. The absence of external economies makes the costs of production high for new industries. Such industries cannot withstand competition from well established foreign industries, if these industries are not protected from international competition, they may end up closing down

iii) To promote employment of resources- Import restrictions measures, such as tariffs tend to shift demand away from imports to the home produced goods. Income is directed away from foreign exports and towards domestic producers. As the demand for home produced goods increases, more resources will be employed to produce them. On the other hand, if there is already full employment at home, such measures will tend to be inflationary in their effects.

iv) To protect key industries for National SecurityKey industries, such as agriculture and those producing goods which are important for the defence of the country, must be maintained for security reasons. Diversity of industries is important to a country, as it makes it independent of foreign supplies which may be jeopardized in the event of war.

v) To diversify industrial growth- Industrial diversification for economic growth, development and stability of a country. If new and diversified industries producing different commodities cannot come up due to international trade, it would meant hat one country will rely on one or a few key industries. This is not desirable for economic growth development

vi) To protect key industries are well established and strategic industries for a country. Such industries promote faster economic growth and development and lead to establishment of other industries. They may also promote agricultural, banking, transport and tourism, therefore, they should be protected from closing down

vii) To protect declining industries- certain industries in Kenya, such as the textile industry is on the decline. They are faced with stiff competition from second-hand clothes imported from developed countries, hence, there is need for the Kenyan government to levy taxes on second hand clothes. Any other country participating in international trade can protect her industries in the same way

viii) Protection against dumping- Foreign industries may choose to dump their inferior or sub-standard goods in a country. Dumping implies selling in a foreign market at prices below what is charged at home. Protection measures are needed to protect a country against the dumping of cheap and inferior foreign goods. "Dumping" means the application to international trade of the methods of a discriminating monopoly whereby goods are sold abroad at a lower price than at home. This is done in order to avoid swamping the home market with a surfeit of goods which would bring down home prices, and to kill off foreign competition by undercutting it on its own markets. Dumping is an unfair trading practice, and for that reason industries fearing competition from dumped goods ask for tariff protection. Many industrialists begin to complain if they have to face competition from foreign goods which are cheaper than their own. The home producers may simply be inefficient. Also, when dumping takes place, the imposition of protective duties may be too slow a weapon, since by the time the new duties have been introduced, the dumped goods may already be in the country.

ix) Improvement of the Terms of TradeThe imposition of import duties may lead to an improvement in the terms of trade, particularly where the goods taxed are in inelastic supply and elastic demand.

Dangers of Trade Protection/DisadvantagesThe case against import controls is based on the following factors.(a) Benefits of Free Trade Based on Comparative Cost AdvantageIt can be argued that multinational enterprise, unemployment and specialized production represent modifications and imperfections only, and do not change the fundamental truth and importance of the benefits to be derived from international specialization and trade. Efforts should be made to reduce the harmful effects of these – including efforts to reduce the monopoly power of large multinationals – and to increase trade, not to interfere with it.(b) Possible International RetaliationWhen a country imposes restrictions on imports from other countries, the other countries can react by similarly imposing restrictions on imports from the former country. If all countries sought to reduce, and impose barriers against, imports, total trade and production would fall, and unemployment would increase in all countries. The spread of protectionism would increase unemployment instead of reducing it.(c) Reduction in Industrial Efficiency and production of low quality goodsCompetition is the main incentive to business efficiency. Protecting domestic industry against foreign competition would make firms less able to compete in world markets. The longer controls lasted, the more they would be needed, and the country would lose the variety of products provided by imported goods. Its standard of living would fall with this loss of choice, as increasingly inefficient firms required more and more resources to produce less and less. The protected local industries may end up producing low quality commodities due to lack of competition. The local consumer is therefore denied the chance of enjoying high quality goods which might otherwise come from the other countries.d) High prices for Locally Produced Commodities The protected infant local industries may not enjoy economies of scale due to their small sizes, they therefore incur high production costs for their products. The high production costs lead to high prices for their commoditiese) Possible Emergence of Monopolies- Protectionism may lead to emergence of monopolies, this may give rise to problems associated with monopolies, and these include being insensitive to the customer demands, overcharging and provision of low quality products.g) Danger of the Need for Perpetual Protection- The protected infant industries have a tendency of remaining young, this means that these industries remain calling for continued protection with all its inherent problems.h) Less Consumer Choice- Trade restrictions implies that there would be fewer goods and services that consumers can choose from, this in turn leads to low standards of living for such consumers.C. METHODS OF PROTECTION

A country can restrict the freedom of international trade by using the following methods: 1. Tariffs/custom dutiesTariffs are taxes on imported goods and so of course they raise money for the government. The object is to raise the cost of the imported goods so that importers have to raise prices or accept reduced profits. The imports thus suffer a competitive disadvantage compared with home produced substitutes. The tariff raises the price paid for the imported good by the domestic consumer and reduces the quantity purchased. Thus domestic producers supply more to the market, and foreign suppliers provide less than if there were no tariff. Customs duties may be imposed by a specific duty of so much per item or per tonne or ad valorem (by value). Specific duties work best for goods of low value and high weight, such as iron. Ad valorem duties obviously have more impact as goods increase in value, so they are best applied to items like jewellery and those whose prices change often. 2. QuotasQuotas are restrictions on the quantity of a product which can be imported. While the purpose of protective customs duties is to restrict the import of goods by making them more expensive to the home consumer, import quotas lay down the exact quantity of a commodity which may be imported in a given period of time. Import quotas may, but need not, be accompanied by customs duties. If they are, it means that the limited amount of goods which may be imported is subject to the duty as well. 3. Embargoes/Total banAn embargo is a total ban on imports or exports, usually applied for political reasons. An example is the UN embargo on exports of armaments to Iraq and on oil exports from Iraq.4. Export Subsidies and BountiesThese can be of the visible type, where a bounty is paid to exporters by the governmentaccording to how much they send abroad. WTO rules generally forbid bounties, so hiddensubsidies tend to be provided instead. For example, exporters get government insuranceagainst political and commercial risks at very low rates, tax concessions on equipment usedfor making exports and help with borrowing to finance export production.5. Non-tariff Barriers or administrative restrictionsThis refers to multitude of measures applied to restrict imports, especially where countries cannot use tariffs and quotas because they belong to WTO or a free trade area. They include oppressive safety measures, like the USA requirement for destructive car tests, which would require the whole annual output of a small specialist manufacturer to be crashed. The term is also applied in trade liberalization to refer to all restrictive measures except tariffs. This is because tariffs are the only measure to be visible and measurable with accuracy. Agreements to reduce tariffs are pointless if duties are replaced by other measures which are difficult to police.6. Exchange ControlControl is enforced in many countries by requiring all buying and selling of foreign exchange to be done through the central bank. The government can then allocate foreign exchange to whichever activities it considers should have priority. This is effectively the same as a quota and is subject to the same dangers. Governments can avoid some of the problems by auctioningoff foreign exchange, as was done in Nigeria. The amount released to auction is determinedby the state of the balance of payments. Exchange and capital controls, however may cause economic damage and may also be ineffective in achieving what they were intended to achieve, and abolished them either completely or in part. TERMS OF TRADETerms of trade can be defined as the rate at which a country’s goods (exports) exchanges against those of other countries (imports). To calculate terms of trade, index of average prices of goods exported from a country in a particular year is taken as base year and expressed as 100. Then the average prices of goods exported in subsequent years are worked out as the percentage of the average prices dating the base year. This may be computed using exported price index and import price Index as shown in the following in the following equation:

Terms of trade= price index exports Price index of imports

ORTerms of trade = export price index Import price indexThe total of a country’s export earnings depends on both volume and the prices of such exports. Incase the price of the export decline, the country may have to increase the quantities exported in order to at least retain the earnings at the same level. Equally the total amount spent on imports depends both on the quantities and price of such imports, a country may have to increase the volume of her exports in order to get the same volume of imported goods as she was getting before. There is therefore a relationship between what a country exports and what she exports. The relationship may be expressed by what is referred to as terms of trade.IMPORTANCE OF TERMS OF TRADEIf the prices of a country’s exports rise, while those of her imports are constant, or declining, terms of trade are said to be favourable or improving. This is a healthy situation because a country obtains more foreign exchange in exports than it pays for her importsFavourable terms in trade imply that:

i) A country can get more imports with the same quantity of exportsii) There is an increase in national income in the country and hence, high standards of livingiii) There is an improvement in balance of payments

On the other hand, if prices of a country’s exports decline, or remain constant, while those of her imports are rising, terms of trade are said to be unfavourable or deteriorating. This is an unhealthy situation because a country obtains less foreign exchange from exports than it pays for imports Unfavourable trade implies:

i) A given volume of exports will now exchange for smaller volume of importsii) There is less foreign exchange earnings from exports, leading to reduced domestic earningsiii) There will be balance of payments problems (deficit)

Balanced Terms Of TradeIf the ratio of terms of trade equals one (1) it means that the average prices of import commodities is equal to average prices of commodities. A country which experiences balances terms of trade has its domestic prices of goods and services competing at equal price level with foreign goods and services. However, this situation is a rare one since different countries of the world have different levels of natural and man made resources CAUSES OF CHANGES IN TERMS OF TRADEDepending on the prices and volume of exports, and imports traded, a country’s terms of trade can either be favourable or unfavourable. Thus, terms of trade may fluctuate upwards or downwardsFactors leading to unfavourable terms of trade

i) Increase in supply of exports will decrease their prices, this will cause unfavourable terms of trade in the exporting industry

ii) A fall in demand for a country’s export will lead to a fall I export prices, causing unfavourable terms of trade in the exporting countries

iii) An increase in demand for imports will lead to an increase in price of those imports, leading to unfavourable terms of trade in importing countries

iv) Political instability may affect the production of exports, leadingv) to a fall in volume of exports hence, unfavourable terms of trade.

Factors leading to Favourable terms of tradei) Decrease in supply of exports will lead to an increase in their prices, this will lead to an

improvement in terms of trade in lead to a fall in their prices, in the exporting countryii) An increase in demand for a country’s exports will led to an increase in the price of those

exports, this will lead to favourable terms in terms of trade in the exporting countries

iii) A fall in demand for imports, may lead to a fall in their prices, hence bringing about an improvement of trade in the exporting country’s trade

iv) A high supply of imported goods leads to a fall in their price, leading to favourable terms of trade in the importing country.

A country may experience favourable remain constant or increase terms of trade if a) prices of imports decline while those of exports either remain constant or increase b) prices of imports decline while those of exports increase c) price of imports decline while those of exports increase d) Price of imports remain constant while those exports increaseConversely, a country’s terms of trade would be unfavourable if:

a) prices of imports increase while those of exports declineb) prices of exports decline while those of imports increasec) prices of imports remain constant while those of exports declined) prices of exports remain constant while those of imports increase

Reasons for differences in the terms of trade between countriesThere are a number of reasons that account for differences in terns of trade between countries. Some of these reasons are discussed below:

a) Nature of commodity being exportedNormally, the price of primary products tends to be lower to those of manufactured goods. A country whose main export is raw materials such as unprocessed agricultural products is likely to experience unfavourable terms of trade.

b) Nature of the commodity being importedSome commodities such as manufactured goods higher prices compared to others in the world market. A country imports such expensive goods may experience adverse terms of trade while one that imports cheap raw materials may experience favorable terms of trade. c) Demand for a country’s exportsWhere there is an increase in demand for a country’s exports in the world market, such as a country to experience favourable terms of the world, such a country is likely to export to experience favourable terms of trade. On the other hand, if demand for a country’s exports decline, she may experience unfavourable terms of trade. d) Existing world economic orderDue to their strong bargaining power, industrialized countries tend to dominate the decision making in t he international market. International prices therefore tend to favour products from these countries. As a result of this, they may have favourable terms of trade while the less dev eloped countries may have deteriorating terms of trade. e) Total quality suppliedIn a situation where a commodity is supplied by many countries into the world market, its supply may be very high and this may tend to depress its price. A country relying on exportation of such a product may experience unfavourable terms of trade. On the other hand a country that relies on exportation of a commodity that is in short supply in the world market may experience favourable terms of trade.BALANCE OF TRADEBalance of trade is the difference between the value of visible imports. Balance of trade is also referred to as balance of visible trade(X -M)If the value of visible exports exceeds the value of visible exports, balanced of trade is said to be favourableeg, if a country’s total visible exports amounted to Sh. 35 billion while the value of her total imports are Sh. 26 billion then the country’s favourable balance of trade can be obtained as followsBalance of trade = Exports (visible)- imports (visible)

=35,000,000,000- 26,000,000,000surplus = Shs = 9,000,000,000

If the value of visible imports exceeds the value of visible exports balance of trade is said to be unfavourableeg, if a country’s total visible imports amounted to Shs. 31 billion while her visible exports amounted to Shs. 26 billion, then the country’s unfavourable balance of trade can be obtained as followsBalance of trade = exports (visible)- imports(visible)=26,000,000,000-31,000,000,000Deficit = 5,000,000,000Balance of paymentsBalance of payment touches on all economic transactions that take place between one country and the rest of the world over a period of one year. Balance of payments is the difference between all the receipts(inflow) of foreign currency and payment (outflows) of foreign currencyThe balance of payments of a country is the systematic record of all its receipts and payments in international transactions in a given year. The balance of payments account is structured into two parts

i) The current accountIn the current account of balance of payments, the following transactions are recorded. The difference between visible and invisible imports, The difference between invisible imports and invisible export (trade in service)

ii) The capital accountIn the capital account of balance of payments, the following transaction are recordedNet short-term private inflows, Net long-term private inflows, Net short- term government (official) capital inflows, Net long term government capital inflows If the sum of the four transactions above is positive (+), then capital account is said to have a surplus. Conversely, if the sum of the four transactions is negative (-), then capital account is said to be in deficit.N/B: In developing countries like Kenya, current account in most cases has a deficit, while capital account is in surplus. If surplus in the capital account exceeds the deficits in deficit account, the balance of payments is said to be in surplus. Conversely, if the surplus in the account is less is said to be to be a deficit (-) The balance of payments account has the debit side and the credit side. The principal items on the credit side include:

1. Visible exports(receipts from exports of goods)2. Invisible exports(receipts from exports of services e.g tourism banking, insurance)3. Transfer receipts in the form of gifts received from foreigners.4. Borrowings from abroad and investments foreigners in the country5. Official sale of reserve assets including gold to foreign countries and international institutions.

The principal items on the debit side include:1. Visible imports(payments for imports of goods)2. Invisible imports(payments for imports of services)3. Transfer payments to foreigners in the form of gifts 4. Loans to foreign countries, investments by residents in foreign countries and debt repayments to

foreign countries.6. Official purchase of reserve assets including gold from foreign countries and international

institutions.If total receipts from foreigners on the credit side exceed total payments to foreigners on the debit side, the balance of payments is said to be favourable. On the other hand if total payments to foreigners on the debit side exceed total receipts from foreigners on the credit side, the balance of payments is said to be

unfavourable.DISEQUILIBRIUM IN BALANCE OF PAYMENTSA disequilibrium in the BOP of a country may be either a deficit or surplus. A deficit or surplus in BOP of a country appears when its autonomous receipts (credits) do not match its autonomous payments (debits). If autonomous credit receipts exceed autonomous debit payments, there is a surplus in the BOP and the disequilibrium is said to be favourable. On the other hand, if autonomous debit payments exceed autonomous credit receipts, there is a deficit in the BOP and disequilibrium is said to be unfavourable or adverse.CAUSES OF DISEQUILIBRIUM IN THE BALANCE OF PAYMENTSThere are many factors that may lead to a BOP deficit or surplus:1. Temporary/seasonal Changes (or Disequilibrium). There may be a temporary disequilibrium caused by random variations in trade, seasonal fluctuations, the effects of weather on agricultural production, etc. Deficits or surpluses arising from such temporary causes are expected to correct themselves within a short time.2. Fundamental Disequilibrium: Fundamental disequilibrium refers to a persistent and long-run BOP disequilibrium of a country. It is a chronic BOP deficit, according to IMF. It is caused by such dynamic factors as: (i)Changes in consumer tastes within the country or abroad which reduce the country's exports and increase its imports. (ii)Continuous fall in the country's foreign exchange reserves due to supply inelasticities of exports and excessive demand for foreign goods and services. (iii)Excessive capital outflows due to massive imports of capital goods, raw materials, essential consumer goods, technology and external indebtedness. (iv)Low competitive strength in world markets which adversely affects exports. (v)Inflationary pressures within the economy which make exports dearer.3. Structural Changes (or Disequilibrium). Structural changes bring about disequilibrium in BOP over the long run. They may result from the following factors: (a)Technological changes in methods of production of products in domestic industries or in the industries of other countries may lead to changes in costs, prices and quality of products. (b)Import restrictions of all kinds bring about disequilibrium in BOP. (c)Deficit in BOP also arises when a country suffers from deficiency of resources which it is required to import from other countries. (d)Disequilibrium in BOP may also be caused by changes in the supply or direction of long-term capital flows. More and regular flow of long-term capital may lead to BOP surplus, while an irregular and short supply of capital brings BOP deficit.4. Changes in Exchange Rates in the form of over-valuation of foreign currency. When the value of currency is higher in relation to other currencies, it is said to be overvalued. On the other hand when the value of currency is lower in relation to other currencies, it is said to be undervalued currency. Overvaluation of the domestic currency makes foreign goods cheaper and exports dearer in foreign countries. As a result, the country imports more and exports less of goods. There is also outflow of capital. This leads to unfavourable BOP. On the contrary, undervaluation of the currency makes BOP favourable for the country by encouraging exports and inflow of capital and reducing imports.5. Cyclical Fluctuation (or Disequilibrium) in business activity. When there is depression in a country, volumes of both exports fall drastically in relation to other countries. But the fall in exports may be more than that of imports due to decline in domestic production. Therefore, there is an adverse BOP situation.

On the other hand, when there is boom in a country in relation to other countries, both exports and imports may increase. But there can be either a surplus or deficit in BOP situation depending upon whether the country exports more than imports or imports more than exports. In both the cases, there will be disequilibrium in BOP.6. Changes in National Income. If the national income increases, it will lead to an increase in imports thereby creating a deficit in its balance of payments, other things remaining the same. If the country is already at full employment level, an increase in income will lead to inflationary rise in prices which may increase its imports and thus bring disequilibrium in the balance of payments.7. Price Changes(Inflation or Deflation). If there is inflation in the country, prices of exports increase. As a result, exports fall. At the same time, the demand for imports increases. Thus increase in export prices leading to decline in exports and rise in imports results in adverse balance of payments.8. Stage of a Country’s Economic Development. If a country is developing, it will have a deficit in its balance of payments because it imports raw materials, machinery, capital equipment, and services associated with the development process and exports primary products. The country has to pay more for costly imports and get less for its cheap exports. This leads to disequilibrium in its balance of payments.9. Capital Movements. Borrowing and lending or movements capital by countries also result in disequilibrium in BOP. A country which gives loans and grants on a large scale to other countries has a deficit in its BOP on capital account. If it is also importing more, as is the case with the USA, it will have chronic deficit. On the other hand, a developing country borrowing large funds from other countries and international institutions may have a favourable BOP. But such as possibility is remote because these countries usually import huge quantities of food, raw materials, capital goods, etc and export primary products. Such borrowings simply help in reducing BOP deficit.10. Political Conditions of a country. Political instability in a country creates uncertainty among foreign investors which leads to the outflow of capital and retards its inflow. This causes disequilibrium in BOP of the country. Disequilibrium in BOP also occurs in the event of war or fear of war with some other country.IMPLICATIONS OF A DISEQUILIBRIUM IN THE BALANCE OF PAYMENTS TO THE ECONOMY ( WHETHER A DEFICIT OR SURPLUS)

A deficit in the combined current and capital accounts is regarded as undesirable for the country because the deficit has to be covered by borrowing from abroad or attracting foreign exchange or capital from abroad. This may require paying high interest rates. There is also the danger of withdrawing money by foreigners. An alternative may be to draw on the reserves on the reserves of the country which may also lead to a financial crisis. Moreover the reserves of a country being limited, they can be used to pay for BOP deficit up to a limit.

However, it is beneficial for a country to have a current account deficit even if it equals capital account surplus in BOP. In the short-run, the country may benefit from a higher level of consumption through import of goods and consequently a higher standard of living. But the excess of imports over exports may be financed by foreign investments in the country. These may lead to increased production, employment and income in the country. In the long-run, foreign investors may purchase large assets in the country and thus adversely affect domestic industry as is the case with MNCs (multinational corporations).

The current account deficit in BOP of a country may have either good or bad effects depending on the nature of an economy.

a) In a country where domestic industries are rapidly growing and it has current account BOP deficit. These industries offer a high rate of return on their investment. This would, in return, attract foreign investments. As a result, the country would have a capital account surplus due to the inflow of capital and a current account deficit. This current account deficit is good for the economy. No doubt the external debt of the country increases, but this debt is being utilized to finance the rapid growth of the economy. The real burden of this debt will be very low because it can be rapid out of higher income in the future.

b) On the contrary, a country having an inefficient and unproductive domestic industry will be adversely affected by its current account BOP deficit. The country borrows from abroad to finance the excess of spending over consumption. To attract foreign borrowings, the country will have to pay high interest rates. These will increase the money burden of the debt. The real burden of the debt will also increase because of the low productive capacity of domestic industries. If the current consumption is being financed by foreign borrowings, the wealth of the economy will decline. This, in turn will lead to either a reduction in domestic expenditure or a change in government policy so as to control the rising debt.

On the other hand, if foreign borrowings are being used to finance real investment, the current account BOP deficit will be beneficial for the economy. A higher rate of return on real investment than the interest on foreign borrowings would increase the country's wealth over time through rise in its national income. Thus a current account BOP deficit is not always undesirable for a country.MEASURES TO CORRECT DEFICIT IN BALANCE OF PAYMENTSWhen there is a deficit in the balance of payments of a country, adjustment is brought about automatically through price and income changes or by adopting certain policy measures like export promotion, monetary and fiscal policies, devaluation and direct controls.1.Adjustment through Exchange Depreciation (Price Effect) Under flexible exchange rates, the disequilibrium in the balance of payments is automatically solved by the forces of demand and supply for foreign exchange. An exchange rate is the price of a currency which is determined, like any other commodity, by demand and supply. “The exchange rate varies with varying supply and demand conditions, but it is always possible to find an equilibrium exchange rate which clears the foreign exchange market and creates external equilibrium.” This is automatically achieved by depreciation of a country's currency in case of deficit in its balance of payments. Depreciation of a currency means that its relative value decreases. Depreciation has the effect of encouraging exports and discouraging imports. When exchange depreciation takes place, foreign prices are translated into domestic prices. Suppose the dollar depreciates in relation to the pound. It means that the price of dollar falls in relation to the pound in foreign exchange market. This leads to lowering of the prices of U.S exports in Britain and raising of prices of British imports in the U.S. When import prices are higher in the U.S the Americans will purchase less goods from the British. On the other hand, lower prices of U.S exports will increase exports and diminish imports, thereby bringing equilibrium in the balance of payments.2.Devaluation of currency or Expenditure-Switching Policy A government may devalue her currency in order to make her exports cheaper and competitive with the world market. This therefore will lead to conservation (savings) of foreign exchange and increase earnings of foreign exchange. Devaluation raises the domestic price of imports and reduces the foreign price of exports of a country devaluing its currency in relation to the currency of another country. Devaluation is referred to as expenditure switching policy because it switches expenditure from imported to domestic goods and services. When a country devalues its currency, the price of foreign currency increases which makes imports dearer and exports cheaper. This causes expenditures to be switched from

foreign to domestic goods as the country's exports rise and the country produces more to meet the domestic and foreign demand for goods with reduction in imports thus correcting balance of payments deficit.3. Restriction of imports / Direct Controls aimed at limiting the volume of imports. A country may take measures such as imposing heavy import duties/tariffs, fixing import quotas and imposing total ban to restrict the import of undesirable or unimportant items. At the same time, it may allow imports of essential goods duty free or lower import duties, or fix liberal import quotas for them. For instance, the government may allow free entry of capital goods, but impose heavy import duties on luxuries. Import quotas are also fixed and the importers are required to take license from the authorities in order to import certain essential commodities in fixed quantities. In these ways, imports are reduced in order to correct an adverse balance of payments. The government also imposes exchange controls. Exchange controls have a dual purpose. They restrict imports and also control and regulate the foreign exchange. With reduction in imports and control of foreign exchange, visible and invisible imports are reduced. Consequently, an adverse balance of payments is corrected.4.Adjustment through Capital Movements A country can use capital imports to correct a deficit in its balance of payments. A deficit can be financed by capital inflows. When capital is perfectly mobile within countries, a small rise in the domestic rate of interest brings a large inflow of capital. The balance of payments is said to be in equilibrium when the domestic interest rate equals the world rate. If the domestic interest rate is higher than the world rate, there will be capital inflows and the balance of payments deficit is corrected.5.Adjustment through Income Changes Given the foreign exchange rate and prices in a country, an increase in the value of exports, causes an increase in the incomes of all persons associated with the export industries. These, in turn, create demand for other goods and services within the country. This will raise the incomes of persons engaged in the latter industries and services. This process will continue and the national income increases by the value of the multiplier.6. Export Promotion and Import substitution A country may promote her exports through measure such as producing quality products, by reducing exports through increased production and productivity, and by better marketing, giving to export producers export compensation and reducing taxes on exports. They can also be increased by a policy of import substitution. It means that the country produces those goods which it imports. In the beginning, imports are reduced but in the long run exports of such goods start. An increase in exports causes the national income to rise by many times through the operation of the foreign trade multiplier. The foreign trade multiplier expresses the change in income caused by a change in exports. Ultimately, the deficit in the balance of payments is removed when exports rise faster than imports.7.Expenditure-Reducing policies A deficit in the balance of payments implies an excess of expenditure over income. To correct it, expenditure and income should be brought into equality. For this expenditure reducing monetary and fiscal policies are used. A contractionary or tight monetary policy relates to cut in interest rates to reduce money supply and a contractionary fiscal policy relates to reduction in government expenditure and or increase in taxes. Thus expenditure reducing policies reduce aggregate demand through higher taxes and interest rates, thereby reducing expenditure and output. The reduction in expenditure and output, in turn, reduces the domestic price level. This gives rise to switching of expenditure from foreign to domestic goods. Consequently, the country's imports are reduced and the balance of payments deficit is corrected.8.Seeking financial assistance internationally A government may seek financial institutions (IMF, World bank) which may come in form of loans, grants or aid. Such funds may be used to finance the deficit in the balance of payments

9. Utilization of a country’s foreign reserves A country may use the accumulated foreign exchange reserves to correct her balance of payments deficit.