Principles of International Trade (Import-Export): The First Step Toward Globalization

CHAPTER I

Introduction To International Trade

No country is completely self-sufficient. No country can produce all products it needs, nor is blessed with all natural resources necessary to maintain its economic growth. The resulting interdependence of nations is becoming more important as the world economy is being globalized and businesses are expanding their markets beyond their countries’ borders.

Import is a business activity that brings foreign goods and services into the country where the business is located. On the other hand, export is a business activity sending goods and services beyond a nation’s border. Import and export are also called international trade or foreign trade.

1. Classical Theories of International Trade

(1) Mercantilism

Mercantilism advocates more exports and fewer imports. A nation becomes richer and more powerful when it exports more than it imports. The trade balance between imports and exports is settled by precious metals such as gold and silver. The more precious metals a country accumulates, the more prosperous it becomes. However, not all nations can have a trade surplus for the same time period, since a nation’s surplus is another nation’s deficit. This theory was popular among European countries during the sixteenth to eighteenth century. While promoting exports, countries raised trade barriers to discourage imports that resulted in reduced international trade after all.

(2) Absolute Advantage

In 1776 Adam Smith of Great Britain published the book entitled An Inquiry into the Nature and Causes of the Wealth of Nations. In this book, he proclaimed that a country’s wealth consists of the goods and services available to its citizens rather than gold and silver. He denounced mercantilism and advocated free trade.

To increase the wealth of nations, instead of producing all items a country needs, it should produce and export goods at an absolute advantage, and import goods at an absolute disadvantage. The international specialization in production would result in more outputs to all trading partners.

Some countries have a ‘Natural Advantage’ at some products due to climate and natural resources such as Saudi Arabia in petroleum. Other countries have an ‘Acquired Advantage’ at other products due to product and process technology such as Japan in electronic goods.

Let’s assume that the countries of Mexico and the U.S.A. each have 100 resources available for producing tomatoes and beans. In producing 1 ton of tomatoes, Mexico uses 4 units of resource and the U.S.A. uses 10 units of resource. In producing 1 ton of beans, Mexico uses 20 units of resource and the U.S.A. uses 2 units of resource.

Mexico USA

Resources available 100 100

To produce 1 ton of tomatoes 4 10

To produce 1 ton of beans 20 2

When each uses half of its resources (50) per product without trade

Mexico USA Total

Tomato production 12.5 5 = 17.5 tons

Bean production 2.5 25 = 27.5 tons

When each uses all its resources (100) only for product at an absolute advantage

Mexico USA Total

Tomato production 25 0 = 25 tons

Bean production 0 50 = 50 tons

It is more beneficial that the USA produces only beans at an absolute advantage using all 100 resources, while Mexico produces only tomatoes at an absolute advantage using all 100 resources. Then, one country exports a product it produces and imports a product it does not produce.

(3) Comparative Advantage

In 1817 David Ricardo expanded the Absolute Advantage Theory of Adam Smith. He declared that even if a country does not have an absolute advantage on all products, trade gains can occur if the country specializes in the production and export of those products in which its advantage is greater than other products, and imports products in which its advantage is less. The reason is that a country must give up less efficient outputs to produce more efficient ones due to limited resources.

Mexico USA

Resources available 100 100

To produce 1 ton of tomatoes 2 10

To produce 1 ton of beans 4 8

When each uses half of resources (50) per product without trade

Mexico USA Total

Tomato production 25.00 5.00 = 30.00 tons

Bean production 12.50 6.25 = 18.75 tons

When Mexico produces tomatoes and USA beans only and trade

Mexico USA Total

Tomato production 50.00 0.00 = 50.00 tons

Bean production 0.00 12.50 = 12.50 tons

In this situation, USA and Mexico together produce more tomatoes by 20 tons (50 tons-30 tons) but less beans by 6.25 tons (12.50 tons-18.75 tons). The advantage cannot be compared at this stage, because the result is more production in one product and less production in another product.

Therefore, to make a comparison easier, let’s assume that the USA produces 12.50 tons of beans using all 100 resources (100 / 8), while Mexico produces 30 tons of tomatoes by using 60 resources (60 / 2). Then, Mexico can produce 10 tons of beans with the remaining 40 resources (40 / 4).

Mexico USA Total

Tomato production 30.00 0.00 = 30.00 tons

Bean production 10.00 12.50 = 22.50 tons

In this case, the USA and Mexico produce 30 tons of tomatoes and 22.50 tons of beans together. The result is that the production of beans is increased by 3.75 tons (22.50 -18.75).

For more analysis, let’s assume once again that the USA produces the same 12.50 tons of beans using all 100 resources and Mexico produces 6.25 tons of beans by using 25 resources (25 / 4) to make the total production of beans by two countries 18.75 tons. Mexico can use the remaining 75 resources in producing 37.50 tons of tomatoes (75 / 2).

Mexico USA Total

Tomato production 37.50 0.00 = 37.50 tons

Bean production 6.25 12.50 = 18.75 tons

In this assumption, USA and Mexico can produce more tomatoes by 7.50 tons (37.50-30.00), while producing the same 18.75 tons of beans.

Therefore, in order to increase overall production of tomatoes and beans, it is more beneficial that the USA produces only beans at which it has a comparative advantage and Mexico produces only tomatoes at which it has a comparative advantage, even though Mexico has absolute advantages at both tomatoes and beans. Then, each country exports the product it produces and imports the product it does not produce.

Ricardo’s Law of Comparative Advantage was developed under the assumption that (1) a country has limited resources so that it must allocate its resources, (2) transportation cost of products from one country to another is not considered, and (3) there is no mobility of resources between countries.

2. Interactions between an Exporter and an Importer

An importer who wants to import a product sends an inquiry to an overseas supplier. The letter of inquiry usually consists of a short introduction of the inquirer, the name and quantity of the product an importer wants to import, and the time of shipment he desires. The importer also inquires an exporter about the price, the terms of trade, the terms of payment required, and sometimes the minimum quantity the exporter is willing to accept.

If an importer responds to an exporter’s advertisement or sales letter, or is referred to the exporter by an important person or organization, it is beneficial to mention this. In any case, an importer must have a specific inquiry about the products he wants to import. Too general an inquiry on any or all products a manufacturer exports will not receive special attention and as a result, the importer might not get even a reply from the exporter.

When an exporter receives an inquiry from a potential importer, the exporter sends his offer to the overseas importer. An offer usually consists of a description of the product, price with terms of trade, quantity, the time of shipment, and terms of payment. The exporter answers all the questions raised by the importer. An offer with a validity date is called a firm offer. When a firm offer is accepted by an importer, the exporter must comply with all the terms and conditions he proposed.

When an importer receives an offer from his overseas exporter, the importer first must determine if the price and other trade terms are acceptable to him. It is common for an importer to ask for discount or change in the trade terms. Sometimes an importer sends an exporter a counter-offer that contains the terms and conditions an importer is willing to accept. After several negotiations, the importer sends his acceptance of the exporter’s offer and a written purchase order to the exporter.

Unless the transaction is between related parties or firms of a long-standing relationship, an exporter usually will not fulfill the purchase order without an assurance of the payment for the products he will ship. In international trade, unlike in a domestic transaction, a letter of credit (L/C) opened by the importer’s bank is usually required by the exporter. Most manufacturers in developing countries are reluctant even to start the manufacturing processes until a letter of credit is received. Therefore, a letter of credit needs to open not when the product is ready to ship, but when the purchase order is placed and the manufacturing process begins.

When the product an importer ordered is shipped on the vessel, an ocean bill of lading (B/L) is issued to the exporter. The bill of lading carries the title to the products. The shipping lines do not release the cargo without an original bill of lading at the port of importation. An exporter obtains the bill of lading from the shipping company after shipment of the ordered goods and prepares other shipping documents required by his buyer in the letter of credit. The exporter then presents the shipping documents to his bank for payment for the products he has shipped.

The bank that receives the shipping documents first forwards the documents to the opening bank for payment. After payment for shipment is received, the exporter’s bank pays the exporter. Depending on the reimbursement condition of the letter of credit, sometimes the exporter’s bank first pays the exporter and forwards the shipping documents to the opening bank and gets reimbursed. In this case, the interest for the period between payment to the exporter and reimbursement is charged to the exporter. When an exporter gets paid for the product he has shipped, the international transaction is completed between an exporter and an importer.

However, an importer must wait for the vessel to arrive at the port of importation, even if the payment for his import has been made earlier against the shipping documents specified in the letter of credit. After the cargo arrives at his port, the importer’s customs broker clears the goods through customs and get the shipment released by the carrier upon presentation of the bill of lading.

After customs clearance, the imported cargo goes through a distribution channel. The cargo is shipped to the importer’s domestic buyers or importer’s warehouse for future distribution. An importer’s work is not complete until he sells his imported goods to domestic buyers and receives payment.

Exporter Importer

Overseas U.S.A.

Inquiry ———————————

Offer (Quotation) ———————————

Acceptance ———————————

Order ———————————

Letter of Credit ———————————

Shipping Docs ———————————

Payment ———————————

Customs Clearance X

Distribution X

CHAPTER II

Establishing An Import Business

1. Reasons for Importation

Import is a business where profit is a major reason for existence. When a businessman finds products overseas which are not available in his country, he may import them for resale in his country. For example, the fruits of South America and Australia/New Zealand are imported into the United States during the winter season. Ethnic foods and specialty products are also imported into the United States when they are not available in the United States.

When a businessperson is interested in products which are available overseas and in his own country, overseas prices of similar quality should be cheaper than domestic prices for importation to be profitable. Many consumer goods imported from developing countries belong to this category. Although their quality is not equal to U.S. products, due to the cheaper prices, they are able to capture the U.S. consumer markets.

Even though prices of imported goods are higher than domestic products, if imported goods’ quality is better than domestic products, importing makes sense. Luxury items catering to high-income buyers come under this category. For instance, European luxury automobiles and Japanese electronic products are in big demand because of their better quality.

In the case of high priced machinery or a factory project that requires large capital, the availability of financing plays a more important role. Foreign governments that want to promote their exports are willing to provide much better financing to importers of their products than domestic sources. Similar to the United States, most countries have an Export-Import Bank whose major function is to finance their major exports.

2. Requirements for a Successful Import Business

Like any other business, without buyers of imported goods, the import business cannot exist. Selling ability by an importer himself or his salesmen is the backbone of a successful import business. Sell first, import later should be a motto for all beginning importers. No matter how attractive the foreign products appear to an importer, he should find buyers first before importing them.

After sales are made, an importer must deliver the goods to his buyers on time. He must have reliable suppliers who provide goods on time in accordance to the specifications. Incorrect merchandise and late deliveries can easily ruin an importer’s business.

In the import business, an importer pays his supplier before receiving the goods through a bank’s letter of credit, but only gets paid after delivering the goods to domestic buyers. Without a good financing ability, an import business cannot be successful.

An import business is conducted by two parties located far away from each other and with different business practices. All imports are subject to customs regulations and other governmental controls depending on the nature of the goods. Knowledge of import procedures and regulations is vital for an importer to avoid pitfalls. Importing is not an easy business nor does it yield a quick result. It is not expected to be successful in one trial or two. It requires persistence and perseverance even after several failures.

Business transactions even within the same country, require clear communication between parties. Important matters must be in writing. In importing business, clear communication is further required between an importer and exporter of different countries using different languages.

An importer is a go-between. He must build trust with both buyers and suppliers. He must deliver the goods to the buyers on time and in strict compliance with the specifications. In order to succeed, he must have good reliable suppliers. He must perform duties promised to the suppliers such as opening a letter of credit on a timely basis. Building trust with buyers and suppliers leads to a lasting success.

3. Legal Forms of a Business

An import business can be conducted as sole proprietorship, partnership, corporation or limited liability company (LLC).

(1) Sole proprietorship

A businessman can conduct his import business as a sole owner. All that is legally required is a business license issued by the local city government where the business is located. If the businessman wants to use a business name other than his legal name, then the fictitious name must be registered with the county government and advertised three times in the local newspaper. A newspaper usually registers the fictitious name with the county on behalf of the applicant for a business license, if he buys advertisements from the same newspaper.

As to the business tax, some cities charge a fixed amount per employee, while other cities levy a percentage of the gross sales amount. The individual has unlimited liability for his business activities. Federal and state income taxes for business income are paid as the owner’s individual income.

(2) Partnership

When more than one legal entity forms a business, it becomes a partnership. A partnership is also required to register its fictitious name with the county government. There are two kinds of partnership:

a. General partnership

All partners are general partners who have unlimited liability for the business activities like a sole proprietorship.

b. Limited partnership

A limited partnership must have one general partner and one or more limited partners who are liable up to their investment and do not participate in the management of the partnership.

(3) Corporation

A corporation is a legal entity. It acts like a living person in conducting a business, but the stockholders, that is, the owners of the corporation have a limited liability up to their investments. A corporation must register with the state government. There are two types of corporation based on how a corporate income tax is paid, that is, a C corporation and an S corporation¹.

a. C Corporation

A C corporation is one that is taxed under Subchapter C of Chapter 1 of the Internal Revenue Code. It pays its own federal and state income taxes. When a corporation’s net income is distributed to stockholders as a dividend, stockholders must pay income tax on the dividend again resulting in double taxation on the same income.

b. S Corporation

An S corporation is one that elects to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. Like a partnership, it does not pay a corporate income tax, while stockholders enjoy the limited liability like a regular C corporation. The S corporation’s income is allocated to its shareholders whether distribution of dividends occurs or not, and each stockholder pays federal and state income taxes on pro-rata share of the corporate income. In this corporation, the double taxation of the same income is avoided. Several restrictions apply to an S corporation, such as a maximum number of stockholders. The maximum number of stockholders was increased to 100 from 75 by the American Job Creation Act of 2004 (AJCA) and family members may elect to be treated as a single shareholder.

Unlike domestic products, the product liability stops at the importer of the products instead of going to actual foreign manufacturers. An importer should incorporate his import business, especially if he imports products susceptible to liability such as medicines, cosmetics, toys and other products used by children.

(4) Limited Liability Company (LLC)

An LLC is a company that enjoys both a limited liability like a corporation and no double taxation like a partnership. Owners of an LLC are called members. There is no maximum number of members and most states also allow single member LLCs. Members may include individuals, corporations, other LLCs, and foreign entities.

LLCs are created under state statutes, and therefore are not uniform. For example, California adopted its LLC in September 1994². LLCs are now available for all 50 States and Washington, D.C.

The LLC articles of organization must be filed with the Secretary of State to form an LLC and the LLC members must enter into a verbal or written operating agreement. A formal written agreement is advisable. The articles of organization usually contain who will manage the LLC.

An LLC does not issue stock and is not required to hold annual meetings or keep written minutes, which a corporation must do in order to preserve the liability shield for its owner. An LLC’s life is perpetual, unless members agree to a date or events of dissolution.

4. Import Organizations

There are no clear distinctions among various import organizations. An importer can even belong to several categories depending on the product and the transaction volume.

(1) Import Agents (Commission Agents)

Import agents or commission agents do not assume title to the merchandise. They receive commission from their overseas exporters as a sales agent. They carry catalogs and samples of exporters to solicit business from buyers. Import agents have very few employees — usually less than 10. They are not directly involved in financing imports or customs clearance.

(2) Import Dealers

Import dealers usually match a specific import with a specific purchase order from a domestic buyer. They take title to the goods. They import the goods under their own name and risk. They usually do not carry inventory. They deliver imported goods to their domestic buyers directly from the dock at a port of importation upon customs clearance. They finance their imports and are responsible for all import activities.

(3) Import Distributors

Import distributors carry stock of imported goods in a warehouse. They seldom deliver imported goods directly from the port of importation to their domestic buyers. They also carry parts and components for after-sales service. They advertise and promote their products. Many import distributors are owned by foreign manufacturers. They have larger staff and larger inventory than import dealers.

(4) International Trading Companies

International trading companies are global corporations that operate in several countries such as Japanese general trading firms (Sogoshosha). They have a worldwide network and conduct both import and export business internationally. Due to their excellent marketing and financing ability, they have competitive advantage in high volume transactions. In many cases, they also control manufacturing and distribution networks. By so doing, they accomplish the vertical integration of the product movements. International trading companies are the largest organizations in international trade.

(5) Manufacturers

When manufacturers find importing foreign raw materials or components more advantageous than buying from domestic suppliers, they also turn to importing in order to expand their supply sources. Today’s manufacturing success largely depends on outsourcing. Manufacturers do not make all components internally, but acquire them from outside suppliers if outsourcing is more advantageous. It is getting more difficult to determine the nationality of products that use domestic and foreign components.

CHAPTER III

Locating Products To Import

1. Import Sources

After an importer decides upon the products he wants to import, then he has to check all available import sources to find the right exporter-supplier-manufacturer that brings him the best deal.

(1) Foreign Trade Offices or Foreign Consulates

Most trading partners of the United States have their trade offices in major U.S. cities in order to promote exports of their countries’ products.

More than a few foreign trade offices in the major U.S. cities are Argentine Trade Office, Chilean Trade Bureau, Commercial Office of Spain, Brazilian Trade Center, CCNAA (Taiwan Trade Center), Hong Kong Trade Office, Italian Trade Commissioner, Japan Trade Center (JETRO), Korea Trade Center (KOTRA), Malaysian Trade Commission, Mexican Trade Commission, New Zealand Trade Development Board, Peoples Republic of China’s Trade Office, Singapore Trade Development Board, and Thai Trade Center.

If foreign trade offices are not located nearby, an importer can consult with the foreign consulates in major cities or the commercial attachés at foreign embassies in Washington, D.C. They are eager to help importers of their products.

(2) World Trade Centers Association

There are world trade centers in the major cities throughout the world. World trade centers such as the New York World Trade Center and the Los Angeles Area World Trade Center in Long Beach can provide importers with information needed for selecting uppliers. An importer may contact the World Trade Centers Association (WTCA) (http://www.wtca.org) for information on a nearby World Trade Center. The WTCA is an organization of nearly 300 World Trade Centers in almost 100 countries.

(3) Foreign Chambers of Commerce

Chambers of Commerce in foreign countries provide overseas importers with information regarding suppliers, manufacturers, and exporters of their products of interest. Most countries have a Chamber of Commerce composed of the major businesses within their country.

(4) Trade Magazines and Websites

Trade magazines and their websites published overseas are excellent import sources. A few sample websites are as follows:

• www.globalsources.com

• www.alibama.com

• www.europe.bloombiz.com

• www.ec21.com

(5) Information Brokers

There are several information brokers who do market or product research on an hourly or project fee basis.

For example, Port Import Export Reporting Service³ provides comprehensive statistics on global cargo movements transiting seaports in the U.S. and Latin America.

A list of information brokers can be obtained from the Association of Independent Information Professionals⁴.

2. Unsolicited Offers from Foreign Suppliers

When an importer receives unsolicited offers from foreign suppliers, or is approached by foreign suppliers through family or friends to import their products, the following points should be considered before the importer proceeds further:

(1) Check if the product is new or unique.

If the product is not new or unique, it might be difficult to get a buyer’s attention, there might be competition for that product, or the product may have been unsuccessful in the importer’s market.

(2) Check if the quality is good.

The perceived quality of a product varies depending on to whom the question is asked. The quality standard of buyers in developed countries is usually higher than that of those in developing countries. What counts is the quality not from the manufacturer’s point of view, but from the buyer’s viewpoint.

(3) Check if the suggested retail price is workable.

In general, an importer sells to a wholesaler who, in turn, sells to a retailer. The retailer sells to the public. The retail price acceptable to U.S. consumers should be at a minimum 4 times the Free-on-Board (FOB) price at a port of exportation. As a rule of thumb, if the retail price of the imported good is less than 4 times the FOB price, the import price is too high. If the price is not workable, check if the distribution channel can be shortened to eliminate middleman’s profits. An FOB price is a price of the goods on board a shipping vessel at a port of exportation.

(4) Get a small number of samples for testing.

A novice should not import a large quantity before testing the market. The safest motto for a beginner is Sell first, Import later, which means that an importer imports only the quantity he has presold. At the beginning, never import without a firm order or a domestic letter of credit from a buyer.

3. Inquiries from Domestic Buyers

Domestic buyers are always looking for new or better suppliers. When a domestic buyer requests an importer to offer the best deal for a certain product, the following are recommended:

(1) Check if the product can be imported from the tariff preference countries.

Many products under the special tariff treatment programs of the United States can be imported duty-free such as Generalized System of Preferences (GSP), Caribbean Basin Initiative (CBI), Andean Trade Preference Act (ATPA), African Growth and Opportunity Act (AGOA), and many Free Trade Agreements

(2) Make a decision based on the combination of quality and price of the product, and delivery ability and accountability of the exporter.

Do not make a decision on price alone. Settling international disputes costs a lot of time and money. An importer must have a reliable supplier who is willing to honor reasonable product claims.

4. Selection of Products to Import

There are several thousand products internationally traded these days. Among them, which products should an importer select?

(1) Specialization

Instead of spreading oneself thin, it is recommended to concentrate on a few specialized items which can meet the demand of the market segment. It is impractical and unprofitable to serve it all.

(2) Marketability

An importer should select a product that is easily marketable based on his/her knowledge, experience, capability, and financial strength.

(3) Supplier’s support

An importer should import products that are backed by a strong supplier’s support.

(4) Enjoyment of selling

An importer should also select a product he enjoys selling.

(5) Familiarity

An importer should select a product he knows very well in all respects. He must visit the factory and learn the manufacturing process from raw material to export packaging.

5. Selection of Foreign Suppliers

When an importer has decided upon the products he wants to import, which foreign supplier should he choose?

(1) A supplier in a country with a good legal system

In import business, the suppliers are usually located in a foreign country where business customs and the legal system are quite different from the importer’s country. If the import-export transaction is conducted under the letter of credit of a bank, exporters get paid upon shipment of the goods before the importer has a chance to examine the goods after importation.

Product claims against the exporter occur quite often. If the supplier is from a country with a good legal system, it is much easier to get the importer’s claims honored through that country’s legal system; otherwise, it is almost impossible.

(2) A supplier in a country which is granted a lower duty rate

If the quality, price, and delivery are the same, it brings more profit to the importer, if he imports from a country which is granted a lower duty rate or duty-free by the United States. Many items from countries under the special tariff preference programs of the United States and free trade agreements with the United States are importable at a lower rate or duty-free into the United States.

(3) A supplier who is eager to work with an importer

Most imports are custom-made to specifications provided by the importer. The supplier who is not cooperative in changing specifications and does not accept a small sample order for market testing should be avoided.

(4) A supplier who is competent and honest

A supplier who is not competent may not make products in strict accordance with your specifications and deliver on time. A dishonest supplier may ship incorrect or inferior merchandise on purpose, but get paid by presenting right documents under the letter of credit. The supplier may not honor any product claims from the importer later.

(5) A supplier who is financially stable

A financially unstable supplier usually will have a difficulty meeting the delivery and tends to become dishonest specifically in dealing with foreign buyers.

(6) A supplier with good business references

The best tool, even if not perfect, in finding out the capability and honesty of the foreign supplier is to check his business references in the United States.

(7) A supplier who is willing to accept a reasonable product claim from an importer:

In international business, it is not uncommon to file product claims against the foreign supplier. The most frequent product claims are shortage of shipments, wrong merchandise, wrong color, wrong size, wrong assortment, inferior quality and late shipments. If the foreign supplier is unwilling to accept reasonable product claims from the importer, it would cost too much money and time to settle them legally.

CHAPTER IV

Special Tariff Treatment Programs

Originally under the leadership of the General Agreement on Tariffs and Trade (GATT) and later under the World Trade Organization (WTO), major developed countries have tariff concession programs for imports from the developing countries. The United States also grants tariff concessions for a wide range of products from developing countries as follows:

1. Generalized System of Preferences (GSP)

The Generalized System of Preferences (GSP)⁵ is a program that grants duty-free entry for specified products imported from designated developing countries and territories. The United States and roughly 25 other industrialized countries maintain their own GSP programs in order to promote economic growth of the beneficiary developing countries.

In the United States, the GSP was authorized under the Trade Act of 1974 and took effect on January 1, 1976 for a 10-year period. Since then, the GSP has expired and been renewed retroactively several times. The current status of the GSP is available from the U.S. Trade Representative.

The GSP designation is unilaterally granted by the United States to a beneficiary developing country. It is not a trade agreement between the United States and the beneficiary country.

There were about 4,400 products eligible for duty-free entry under the GSP from more than 140 countries in 1994.