International Trade — Practice Q&A
Q: Why does comparative advantage justify trade even between a highly productive and a less productive economy?
A: Comparative advantage is about relative opportunity cost, not absolute efficiency — a country benefits from specializing in producing goods where its opportunity cost (what it gives up to produce that good, in terms of other goods) is relatively lower, even if it's less efficient in absolute terms at producing everything compared to its trading partner. Both countries can gain from trade by specializing according to comparative advantage and trading, which absolute-advantage reasoning (simply comparing raw productivity) doesn't fully explain.
Q: What's the accounting relationship between a country's current account and capital account, and what does it mean practically?
A: The current account and capital/financial account must balance together by construction — a current account deficit (importing more than exporting, in the broad current-account sense) must be financed by a net capital account inflow (net foreign investment) or a drawdown of foreign exchange reserves. Practically, this means a country running a persistent current account deficit needs sustained, healthy capital inflows (FDI, FII, or borrowing) to avoid depleting its reserves over time.
Q: Why might trade protection (tariffs, quotas) persist politically even when the aggregate economic case favors free trade?
A: This reflects a political-economy dynamic around how trade's costs and benefits are distributed — consumers broadly benefit from cheaper imports, but this benefit is diffuse and small per person, while domestic producers competing with imports bear concentrated costs like job losses in specific industries. Concentrated costs tend to generate more organized, vocal political pressure than diffuse benefits do, which helps explain why trade liberalization often faces political resistance even when it would improve aggregate economic efficiency.
Q: What's the key practical difference between FDI and FII/FPI from a policy-risk perspective?
A: FDI represents longer-term, harder-to-reverse investment (like building a factory or acquiring significant ownership stakes), making it a relatively stable, "sticky" form of capital. FII/FPI represents investment in financial assets like stocks and bonds, which is far more liquid and can exit rapidly in response to shifting market sentiment or global conditions. This is why large, rapid FII outflows can meaningfully pressure a country's currency and asset prices in a way FDI typically doesn't — the liquidity difference translates directly into a volatility difference.
Q: What does most-favored-nation (MFN) treatment mean under WTO rules, and why does it matter?
A: MFN treatment requires a WTO member country to generally extend the same trade terms it gives its most-favored trading partner to all other WTO members equally, preventing discriminatory bilateral trade deals outside specific WTO-sanctioned exceptions like regional trade agreements. This matters because it's the WTO's core organizing principle for preventing a fragmented system of preferential bilateral deals that would undermine the goal of a more open, non-discriminatory multilateral trading system.
Q: How does a weaker domestic currency affect trade competitiveness, and is the effect immediate?
A: A weaker (depreciated) currency makes exports cheaper for foreign buyers and imports more expensive domestically, generally improving trade competitiveness over time. The effect isn't necessarily immediate, however — the J-curve concept describes how a currency depreciation can initially worsen the trade balance before improving it, since import and export volumes typically adjust more slowly to price changes than the exchange rate itself moves.