The Foreign Connection

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No nation is an island unto itself. All nations participate in the world economy and are linked together through trade and finance.

The trade linkages of imports and exports of goods and services are seen when the United States imports cars from Japan or exports computers to Mexico.

Financial linkages come when the United States borrows from Japan to finance its budget deficit or when American pension funds diversify their portfolios by investing in emerging markets in Asia or Latin America.

Nations keep a close watch on their foreign-trade flows. One particularly important index is net exports, which is the numerical difference between the value of exports and the value of imports. When exports exceed imports, the difference is a surplus, while a negative net-export balance is a deficit.

The goal of expanding international trade has become increasingly important, as the nations of the globe have seen that foreign trade spurs efficiency and promotes economic growth. As the costs of transportation and communication have declined, international linkages have become tighter ...
... than they were a generation ago.

International trade has replaced empire building and military conquest as the surest road to national wealth and influence. Some economies today trade over half their output,One of the major developments of the 1980s was the changing pattern of U. S. international trade.

For most of this century, the United States had a surplus in its foreign trade, exporting more than it imported. But in the 1980s, net exports reached a deficit of almost $150 billion, or about 3 percent of GDP.

As the deficits piled up, the United States by 1996 owed almost $800 billion to foreigners. Many Americans are concerned about the future impact of a large foreign debt.As economies become more closely linked, policymakers devote increasing attention to international economic policy.

International trade is not an end in itself. Rather, nations are properly concerned about international trade because trade serves the ultimate goal of improving living standards. The major areas of concern are trade policies and international financial management. Trade policies consist of tariffs, quotas, and other regulations that restrict or encourage imports and exports.

Most trade policies have little effect on macroeconomic performance, but from time to time, as was the case in the 1930s, restrictions on international trade are so severe that they cause major economic dislocations, inflations, or recessions.

A second set of policies specifically aimed at the foreign sector is international financial management. A country's international trade is influenced by its foreign exchange rate, which represents the price of its own currency in terms of the currencies of other nations. As part of their monetary policies, nations adopt different systems to regulate their foreign exchange markets.

Some systems allow exchange rates to be determined purely by supply and demand; others set a fixed exchange rate against other currencies. The United States today is in the first category, generally allowing the dollar's exchange rates to be determined by market forces.

The international economy is an intricate web of trading and financial connections among countries. When the international economic system runs smoothly, it contributes to rapid economic growth; when trading systems break down, production and incomes suffer throughout the world. Countries therefore must monitor their international economic linkages through trade policies and international financial management.