Gains from International Trade and Investment digg The major gain of international trade is that it has brought

about increased prosperity by allowing nations to specialize in producing those goods and services at which they are relatively efficient. The relative efficiency of a country in producing a particular product can be described in terms of the amounts of other, alternative products that could be produced by the same inputs. When considered this way, relative efficiencies are described as the comparative advantages. All nations can do simultaneously gain from exploiting their comparative advantages, as well as from the large-scale production and broader choice of products that are made possible by the international trade. Suppose that Japan is relatively more efficient in producing steel than food and the United States is relatively more efficient in producing food than steel. So we can expect food to be cheap relative to steel in United States, and steel to be cheap relative to food in Japan. This suggests that by exporting foods to Japan, the United States can receive a relatively large amount of steel in return. Similarly, by exporting steel to United States, Japan can receive a relatively large amount of food. Therefore, via exchange of products through trade, both countries can be better off. This gain is pure exchange gain and would be enjoyed even without specialization of production. Here we implicitly assumed constant returns to scale, that is, the number of people required to produce the food and steel are same. However, if there is increasing returns to scale, it will take fewer people to produce a given quantity of output for which the country has a comparative advantage. In this case economies of scale is the further gain from international trade. Another gain from trade comes in the form of an increased product variety. In addition, international trade can make a brooder range of inputs and technology available and thereby increase economic growth. Among the gains of international investment has been improvement in the global allocation of capital and an enhanced ability to diversify investment portfolios. The gain from the better allocation of capital arises from the fact that international investment reduces the extent to which investment opportunities with high returns in some countries are forgone for want of available capital, while low-return investment opportunities in other countries with abundant capital receive funding. The flow of capital between countries moves rates of return in different locations closer together, thereby offering investors overall better returns. There is an additional gain from increased international capital flows enjoyed via an enhanced ability to smooth consumption over time by lending and borrowing. Trends in International Trade and Cross Border Financial Flows digg When a firm operates only in the domestic market, both for procuring inputs as well as selling its output, it needs to deal only in the domestic currency. As companies try to increase their international presence, either by undertaking international trade or by establishing operations in foreign countries, they start dealing with people and firms in various nations. Since different countries have different domestic currencies, the question arises as to which currency should the trade be settled in. The settlement currency may either be the domestic currency of one of the

parties to the trade, or may be an internationally accepted currency. This gives rise to the problem of dealing with a number of currencies. The mechanism by which the exchange rate between these currencies (i.e., the value of one currency in terms of another) is determined, along with the level and the variability of the exchange rates can have a profound effect on the sales, costs and profits of a firm. Globalization of the financial markets also results in increased opportunities and risks on account of the possibility of overseas borrowing and investments by the firm. Again, the exchange rates have a great impact on the various financial decisions and their movements can alter the profitability of these decisions. In this increasingly globalize scenario, companies need to be globally competitive in order to survive. Knowledge and understanding of different countries economies and their markets is a must for establishing oneself as a global player. Studying international finance helps a finance manager to understand the complexities of the various economies. It can help him understand as to how the various events taking place the world over are going to affect the operations of his firm. It also helps him to identify and exploit opportunities, while preventing the harmful effects of international events. A thorough understanding of international finance will also assist the finance manager in anticipating international events and analyzing their possible effects on his firm. He would thus get a chance to maximize profits from opportunities and minimize losses from events which are likely to affect his firms operations adversely. Companies having international operations are not the only ones, which need to be aware of the complexities of international finance. Even companies operating domestically need to understand the issues involved. Though they may be operating domestically, some of their inputs (raw materials, machinery, technological know-how, capital, etc.) may be imported from other countries, thus exposing them to the risks involved in dealing with foreign currencies. Even if they do not source anything from outside their own country, they may have foreign companies competing with them in the domestic market. In order to understand their competitors strengths and weaknesses, awareness and understanding of international events again gains importance. What about the companies operating only in the domestic markets, using only domestically available inputs and neither having, nor expecting to have any foreign competitors in the foreseeable future? Do they need to understand international finance? The answer is in the affirmative. Globalization and deregulation have resulted in the various markets becoming interlinked. Any event occurring in, say Japan, is likely to affect not only the Japanese stock markets, but also the stock markets and money markets the world over. For e.g., the forex and money markets in India have become totally interlinked now. As market players try to profit from the arbitrage opportunities arising in these markets, the events affecting one market also end up affecting the other market indirectly. Thus, in case of occurrence of an event which has a direct effect on the forex markets only, the above mentioned domestic firm would also feel its indirect effects through the money markets. The same holds good for international events, thus, the need for studying international finance. Globalization essentially involves the various markets getting integrated across geographical boundaries. Integration of financial markets involves the freedom and opportunity to raise funds from and to invest anywhere in the world, through any type of instrument. Though the degree of freedom differs from country to country, the trend is towards having a reducing control over

these markets. As a result of this freedom, anything affecting the financial markets in one part of the world automatically and quickly affects the rest of the world also. This is what we may call the Transmission Effect. Higher the integration, greater is the transmission effect. Financial markets were not always as integrated as they are today. A number of factors are behind this change. The most important reason is the remarkable development of technology for transfer of money and information, making the same possible at an extremely fast speed and at considerably reduced cost. This has made possible the co-ordination of activities in various centers, even across national boundaries. Another significant development was the sudden increase in the inflation levels of various industrial countries which resulted in the price of various financial assets changing widely in response to the changes in the domestic inflation rates and the interest rates in different countries. These developments led to some others, which contributed all the more to the process of globalization. They are:

The development of new financial instruments: For example, instruments of the eurodollar market, interest rate swap, currency swap, futures contracts, forward contracts, options, etc. Liberalization of regulations governing the financial markets: Though the extent and direction of liberalization has been different in different countries, based on the domestic compulsions and the local perspective, it has been substantial enough to make operations in foreign markets a lucrative affair. Increased cross penetration of foreign ownership: This has helped in the countries developing an international perspective while deciding on various factors influencing the process of globalization.

The function of the financial system is to efficiently transfer resources from the surplus units to the deficit units. Greater integration of the financial markets helps in performing this function in a better manner. Just like natural resources are distributed unequally among various countries, some countries are capital-rich, while others are capital-poor. Capital-rich countries generally enjoy a lower return on capital than the capital-poor countries. Let us imagine the scenario where there is no capital flows between these two sets of countries. In the absence of adequate capital, the capital-poor countries will have to either forego or postpone some of the high-yielding investments. On the other hand, capital-rich countries will be investing in some of the lowyielding investments due to lack of better opportunities. When capital flows are allowed to take place, investors from the capital-rich countries would invest in the high-yielding projects available in the capital-poor countries. This would benefit both the countries. The residents of the capital-rich country will benefit by earning a higher return on their investments, and the cashpoor country will benefit by earning profits on the project, which they would otherwise have had to forego. Integration of financial markets thus results in a more efficient allocation of capital and a better working financial system.