Lecture 2: Features of International Trade

Econ 2203 | International Trade and Policy in Agriculture

Nithin M

Department of Development Economics

2026-05-02

Recap: Lecture 1

Three things to remember from last week

1. International trade = cross-border exchange of goods, services, and capital; driven by differences in resource endowments, technology, and opportunity costs

2. India’s position: 18th-largest merchandise exporter; agricultural exports ~$43.7B (FY2024); structural trade surplus in agriculture of ~$15.5B

3. Agricultural trade is special — food security concerns, perishability, seasonality, and powerful political economy shape how governments intervene

Today’s agenda

• What distinguishes international trade from domestic trade?
• How open is India to global trade — and how has this changed over time?
• Advantages and risks of participating in global markets

India’s Growing Trade Openness

library(ggplot2)

openness <- data.frame(
  year = c(1990, 1995, 2000, 2005, 2010, 2015, 2020, 2024),
  trade_gdp = c(14, 22, 27, 35, 48, 42, 38, 44)
)

ggplot(openness, aes(x=year, y=trade_gdp)) +
  geom_line(color="#012169", linewidth=1.5) +
  geom_point(color="#012169", size=3) +
  geom_area(fill="#012169", alpha=0.1) +
  geom_vline(xintercept=1991, linetype="dashed", color="red", linewidth=0.8) +
  annotate("text", x=1993, y=16, label="1991\nLiberalisation", color="red", size=3) +
  labs(title="India's Trade Openness: (Exports + Imports) / GDP",
       subtitle="India has become significantly more open since 1991 liberalisation",
       x=NULL, y="Trade / GDP (%)") +
  scale_x_continuous(breaks=c(1990,1995,2000,2005,2010,2015,2020,2024)) +
  theme_minimal(base_size=11)

Figure 1: India: Trade Openness (Exports + Imports as % of GDP) Source: World Bank, World Development Indicators (WDI).

Trade/GDP rose from 14% (1990) to 44% (2024) — India is significantly more integrated into the global economy post-liberalisation.

Features That Make International Trade Distinct

International trade is not simply domestic trade “at a larger scale.” Six features create unique challenges:

(a) Geographical separation — Long distances → higher transport costs, insurance, cold-chain requirements, longer lead times

(b) Different currencies — Each transaction requires currency conversion; exchange rate fluctuations create financial risk

(c) Factor immobility — Labour and capital cannot move freely across borders — immigration controls, capital account restrictions

(d) Multiple political jurisdictions — Each country sets its own trade policy — tariffs, quotas, export bans; no single governing authority

(e) Different legal systems & culture — Food labelling laws, packaging standards, contract enforcement vary widely

(f) Greater risk and uncertainty — Combination of all above → higher commercial, political, and exchange-rate risk than domestic commerce. Indian spice exporters must comply with EU pesticide MRL standards.

Feature 1: Factor Immobility

Why factors don’t move freely

• Labour: Visa restrictions, language barriers, immigration quotas
  • India sends ~8 million workers to Gulf countries — under strict bilateral agreements, not free movement
• Capital: FDI restrictions, capital account controls, regulatory hurdles
  • India maintains partial capital account convertibility (RBI-regulated)
• Land: Completely immobile by definition

India case: Gulf remittances — Indian workers (largely from Kerala, UP, Bihar) work in UAE, Saudi Arabia, Kuwait — sending back ~$120 billion in remittances (FY2024), making India the world’s largest remittance recipient.

Feature 1: Factor Immobility (cont.)

Why this matters for trade theory

• Classical models (Ricardo, H-O) assume factor immobility across borders
• This is what makes trade in goods a substitute for factor flows
• If labour moved freely, there would be less need to trade goods

Feature 2: Currency and Exchange Risk

The exchange rate problem

• Indian exporters price in USD (world standard for commodities)
• Their costs are in Indian Rupees (INR)
• If INR appreciates (e.g., ₹80 → ₹75 per USD), the same USD revenue converts to fewer rupees → profit squeezed
• If INR depreciates (₹80 → ₹85), exporters gain; importers lose

Year	INR/USD		Year	INR/USD
2000	45		2020	75
2010	46		2024	83–84
2015	65

Agricultural export example: A Punjab wheat exporter quotes $250/tonne FOB Mumbai. At ₹80/USD → realises ₹20,000/tonne; at ₹75/USD → only ₹18,750/tonne. A 5% INR appreciation = 6.25% reduction in rupee revenue — potentially wiping out margins. Hedging tools: Forward contracts, futures on NSE/BSE, ECGC insurance.

Internal vs International Trade: Key Differences

Dimension	Internal (Domestic) Trade	International Trade
Factor mobility	Labour and capital move freely	Highly restricted — visas, FDI rules
Currency	Single national currency	Multiple currencies; exchange rate risk
Political jurisdiction	One government, one legal system	Multiple governments, international law
Trade barriers	None within India (post-GST)	Tariffs, quotas, SPS, NTBs
Transport costs	Relatively low	Higher — ocean freight, insurance, customs
Documentation	Invoice, transport document	B/L, L/C, Certificate of Origin, SPS certificate
Market size	Limited to one country	Global — 195 countries
Dispute resolution	Domestic courts	WTO DSM, bilateral/regional bodies

Key insight: India’s internal trade was itself fragmented before GST (2017) — state-level taxes created internal barriers. International trade faces all these barriers and more.

The Gravity Model of Trade

Inspired by Newton’s law of gravitation:

\[T_{ij} = G \cdot \frac{Y_i \cdot Y_j}{D_{ij}^2}\]

Where \(T_{ij}\) = trade between \(i\) and \(j\); \(Y_i, Y_j\) = GDP; \(D_{ij}\) = distance.

Interpretation: Trade is proportional to economic size and inversely proportional to distance.

Partner	GDP	Distance	Trade rank
USA	Very large	Far	#1 export dest.
China	Very large	Medium	#1 import source
UAE	Medium	Close	#2 export dest.
Bangladesh	Small	Very close	#5 export dest.

UAE ranks highly despite moderate GDP: it is a regional trade hub + large Indian diaspora creates demand for Indian food products.

Advantages of International Trade for India

For producers and the economy

1. Wider market — Indian basmati rice sold in 150+ countries; domestic market alone could not absorb export volumes
2. Access to unavailable inputs — India imports potash fertiliser (not produced domestically in sufficient quantity)
3. Technology transfer — FDI brings modern food processing technology
4. Employment generation — Marine product sector employs ~1.5 million workers, mostly coastal women
5. Foreign exchange earnings — Agricultural exports earn $43.7B; crucial for financing oil imports

Rice example: India is the world’s largest rice exporter (~22 million tonnes in 2022). Exports earn ~$10B forex and support 30 million paddy farmers.

Additional advantages of international trade for India:

6. Economic growth — Export-led growth: every $1B of agri exports generates ~$1.5–2B in backward linkages
7. Better utilisation of resources — India’s abundant agricultural land and labour efficiently deployed through exports

Disadvantages and Risks of International Trade

Economic risks

1. Import dependence — India’s edible oil dependence (60–65% imported) exposes inflation to global price shocks
2. Dumping risk — China dumped cheap steel and tomato paste in India; domestic industries harmed
3. BoP strain — India’s merchandise deficit ~$241B (FY2024); requires large capital inflows to finance
4. Domestic industry harm — Cheap palm oil lowered demand for domestic groundnut oil

Policy lesson: The goal is not to maximise trade at all costs, but to manage trade so its gains exceed its disruption costs.

Political and structural risks: 5. Economic dependency — Over-specialisation creates vulnerability (e.g., countries heavily dependent on single commodity exports) 6. Trade disputes — India has faced WTO challenges on sugar subsidies, poultry import bans 7. Structural unemployment — Import competition can displace workers; adjustment is slow

Case Study: India’s Edible Oil Import Dependence

The structural problem

• India consumes ~24–25 million tonnes of edible oil per year
• Domestic production: ~9–10 million tonnes
• Import requirement: ~14–15 million tonnes (60–65% of need)
• Cost: ~$12–14 billion per year (FY2024)

Oil type	Source	Share
Palm oil	Indonesia, Malaysia	~65%
Soybean oil	Argentina, Brazil	~15%
Sunflower oil	Ukraine, Russia	~15%

Lesson: Import dependence in a strategic food commodity creates price transmission vulnerability. PM KISAN Oilseeds Mission (2023) aims to double domestic production by 2030.

The 2021–22 price shock: - Russia-Ukraine war → sunflower oil disruption - Palm oil export ban by Indonesia (April–May 2022) - Global edible oil prices rose 50–80% in 6 months - India’s retail edible oil inflation peaked at ~20% mid-2022 - Government response: cut import duties, banned futures trading

Case Study: India’s Rice Export Ban (2023)

What happened:

• India banned non-basmati white rice exports in August 2023
• Rationale: control domestic food inflation, protect consumers
• India is the world’s largest rice exporter — ~22 million tonnes/year

Who gained: Urban consumers (domestic prices stabilised); RBI’s CPI inflation target

Who lost: Paddy farmers (domestic price fell); rice millers and exporters (contracts cancelled); Bangladesh and West Africa (supply shortage; global prices rose +20%)

The ban caused a global rice price spike of ~20% — demonstrating India’s market power as the world’s dominant rice exporter. India partially reversed the ban for specific grades in early 2024 under WTO member pressure.

This is a classic domestic policy vs. trade commitment conflict — a recurring theme in agricultural trade policy.

Government Policy in Agricultural Trade

Price support and export competitiveness

• MSP: Raises domestic price above world price → may make exports uncompetitive without subsidy
• Export bans: Rice ban (non-basmati) August 2023; wheat ban (May 2022) — protect domestic prices, hurt exporters
• Import duties on pulses and oilseeds: Reduced to zero during 2021–22 price shock; raised again when harvest recovered
• TRQs: Limited quantities at low duty; higher duty beyond the quota

Core tension: India’s domestic farm support policies often conflict with WTO commitments on export subsidies and import duties — the AoA bindings create real constraints (Lecture 12).

• Export subsidies: Previously used for sugar (challenged at WTO); now replaced by transport/marketing assistance
• PLI scheme for food processing: Incentivise value-added food exports

Trade Finance and Documentation

Key trade documents

• Bill of Lading (B/L): Shipping company’s receipt; title document for goods
• Letter of Credit (L/C): Bank’s guarantee of payment; protects both parties
• Certificate of Origin: Proves provenance; needed for preferential duty under FTAs
• Phytosanitary Certificate: Certifies plants/plant products are pest-free
• SPS Compliance Certificate: Confirms pesticide residues, aflatoxin levels meet standards

Why small agri-exporters struggle: Indian rice exporters to EU must meet Maximum Residue Levels (MRLs) for 300+ pesticides. Failure → entire consignment rejected at port. L/C requires strong banking relationships. ECGC provides credit insurance — covers non-payment risk for Indian exporters.

Summary and Key Takeaways

What we covered today

• International trade has 6 key features distinguishing it from domestic trade: geographic separation, currency risk, factor immobility, multiple jurisdictions, cultural/legal differences, and greater uncertainty
• India’s trade openness rose from 14% of GDP (1990) to 44% (2024) — driven by 1991 liberalisation
• Factor immobility is the fundamental reason countries trade goods rather than simply moving workers
• Currency risk directly affects agricultural export profitability — a 5% INR appreciation can wipe out export margins
• Edible oil dependence is India’s most significant agricultural import vulnerability: $12–14B/year

• Gravity model predicts India trades most with large (USA, China) and close (UAE, Bangladesh) economies

Discussion Question

“India has a comparative advantage in rice. Bangladesh also exports rice. How can both export the same commodity?”

Think through:

• Is India’s advantage in all varieties of rice?
• Can a country export and import the same good? (Intra-industry trade)
• How do quality differentiation, variety, and destination markets matter?
• What does the rice export ban tell us about the limits of comparative advantage as a policy guide?

Answer preview: Intra-industry trade, quality segmentation (basmati vs parboiled), and market access geography all allow two countries to simultaneously export similar products. We formalise this in Lecture 6.

Next Lecture: Lecture 3

Theories of International Trade I — Mercantilism and Absolute Advantage (May 12, 2026)

We will cover:

• Mercantilism (1500–1750): wealth = gold, maximise exports, minimise imports — and why it is fundamentally flawed
• Colonial trade: India’s experience under British mercantilism — the “drain of wealth” thesis (Dadabhai Naoroji)
• Adam Smith (1776): Absolute advantage — trade based on genuine productivity differences
• Numerical example: India vs Bangladesh in rice and jute
• Limitations of absolute advantage — setting up for Ricardo

Suggested reading

• Krugman, Obstfeld & Melitz, International Economics, Ch. 2
• Adam Smith, Wealth of Nations, Book IV, Ch. 1 (excerpt)

To think about:

If every country has absolute advantage in something, does that mean every country should trade? What about a country that has absolute advantage in nothing?

Appendix

Additional Resources

Further Reading

• International Economics — Salvatore (Ch. 1)
• International Economics — Appleyard & Field (Ch. 1)
• RBI/DGCI&S/APEDA databases for latest data

Key Data Sources

• DGCI&S: India’s merchandise trade
• RBI: Balance of payments data
  
• APEDA: Agricultural export statistics
• WTO: Tariff and trade databases