1.

THE ROLE OF FOREIGN TRADE IN THE ECONOMIC

DEVELOPMENT OF THE STATE

Objective of the chapter: The objective of the chapter is to introduce the students
into the problems of international trade. It is necessary to define the basic terms, explain the
importance of foreign trade and its functions. The objective of this chapter is also to
characterize the principal directions of the foreign-trade policy and its advantages or
disadvantages. The students shall also get acquainted with the evolution of theoretical
approaches concerning the importance of foreign trade.

1.1 Basic definitions

International trade is a social discipline, which is based on three fundamental

sources: philosophy (the development of the society as a whole), economics and law. It
concerns the mutual foreign trade activities among the states; therefore it is a term of wider
comprehension than the foreign trade.

Foreign trade represents the commercial relations of a certain country with foreign
countries. It is influenced above all by the foreign-trade policy, which the given country
practises.

Foreign-trade policy could be characterized as a summary of activities, by means of

which the state influences purposefully its foreign trade.

International trading policy is then a summary of foreign-trade policies of the states,

their mutual relationships and dependencies. Therefore it concerns a set of principles and
means, by which it is possible to influence and regulate the economic relations among the
states each other.

Closed economy (autarkical) is an economy without any external economic relations.

Open economy is an economy, which has the external economic relations, that means
it is linked with the world by means of the trade in goods and services, capital flows, etc.

1.2 Importance of foreign trade

1
 Within the last decades a large development of the international trade has happened,
which at the present represents the most dynamic element of the world economy
development. We can observe the dynamics of the international trade not only from the
quantitative point of view, but also from the qualitative point of view. Not only the volume of
the foreign-trade exchange among the states has been increasing, but we can also observe the
changes in its structure. Therefore the international trade has been gradually becoming one of
the critical factors influencing the worldwide economic growth.

The foreign trade is an important factor of the economic development of each

advanced country as well. However, the importance of the foreign trade for the economy of
the state is influenced by the size of the given economy. The small economies tend more to
participate in the foreign-trade exchange than the states of large economic size. It is in virtue
of the limitation of their sources and at the same time in virtue of the limited domestic market,
all of which can be overcome just by the help of the foreign trade. If we compare the states of
the equal economic size, a state with an advanced economy has usually a larger extent of the
foreign-trade exchange.

There are methods, which can help us to characterize more precisely, what is the role
of the foreign trade in the economy of a certain state:

• the comparison of the social product produced (the total volume of what
was produced in the country) with the social product used (the volume of the
consumption) within the period under consideration; the social product used
consists of the social product produced increased by the import and reduced by the
value of the export,

• the quantification of the foreign trade volume,

• the ability of the export to cover the import requirements of the country,

• the relation of the import to the foreign-exchange reserves, respectively

how the foreign-exchange reserves are able to cover the import requirements,

• the ratio of the import to the debt service; the debt service represents the
sum of instalments and interests on foreign loans, the export should be able to
cover the debt service.

1.3 Functions of the foreign trade

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 The professional literature1 generally distinguishes the following basic functions of the
foreign trade:

• transformation function

• growth function

• barrier of growth

functions of the foreign

trade

transformation
growth function barier of growth
function

Transformation function of the foreign trade means its impact on the formation of
the status of internal economic equilibrium; it represents the original sense of the foreign-
trade relations. That is the foreign trade changes, transforms the structure of the domestic
sources, domestic production into the desirable structure. It results from the information already said
about the influence of the economy size on the participation of the country in the international trade, that the
transformation function is usually more distinctive at the small economies. Such countries have to import in
order to overcome their limits given by the natural conditions (for example insufficient raw material basis,
climatic and soil conditions), but also by the economic conditions (above all the size of the domestic market,
which does not allow taking advantage of the benefits of the extension and so producing more effectively).

The transformation function represents not only the original sense of the foreign-trade relations, but it is
also very important at the present time, when the economic advance of the countries has been gradually
increasing. The differentiation of the needs is also connected therewith, which leads to the expansion of the
assortment of the consumption. However, the more is the country advanced, the more the production
specialization occurs and the following narrowing of the assortment produced occurs. It is possible to “bridge
over” by means of the import this discrepancy between the expansions of the consumption assortment on the one
hand, and the narrowing assortment of the production on the other hand.

If we expand the sphere of the foreign-trade relations into the external economic relations as a whole,
the transformation activity means also for example the utilization of the foreign workforce, foreign credits, etc.,
so it concerns actually the transformation of the production factors themselves.

1
For example: KUBIŠTA, V. and composite authors International Economic Relations. Prague: HZ Editio,
1999. ISBN 8086009-29-7.
ČERNOHLÁVKOVÁ, E.; PLCHOVÁ, B. and composite authors Foreign Trade. 3rd edition,
Prague: Banking Institute, 2005. ISBN 80-7265-074-2.

3
 We also speak on the higher type of the transformation acting on the economy of a state, which is the
so-called transmission function. It concerns the transmission of “the information, criteria and stimuli from the
external environment to the domestic economy for the purpose of utilization in the decision-making processes of
the domestic subjects”2.

Growth function is connected with the saving of the national work, which occurs if
the country participates in the international trade.

The domestic production is partially substituted by the import, the domestic sources are substituted by
the utilisation of the foreign sources; namely in such a way, which leads to the saving of the national work. That
is at the participation in the international trade, the country can specialize, and it can target only some special
types of the production, namely such types, which are economically effective for this country. The ineffective
production is then replaced by the import. The free sources can be so utilized for the expansion of the effective
production, which can be realized – under the conditions of the open economy – not only on the domestic
markets, but also on the foreign markets. In this way the foreign trade acts favourably on the economic growth of
the given country. However, it is obviously necessary that the domestic production should be able to compete on
the foreign markets.

Barrier of growth means that the foreign trade may - under certain circumstances -
act also as a factor of the backwardness of the domestic economy. It concerns for example the
situation, where the foreign demand does not correspond to the export supply of a certain
country. However, the most often mentioned examples of the countries, where the foreign
trade rather obstructs the economic growth, are as follows:

• underdeveloped countries

• centrally planned economies

The underdeveloped countries represent a typical “immature” economy, which is

unable to face the foreign competition; in addition they have an unsuitable structure of the
export, in which the raw materials generally prevail. All of it leads to the situation, where the
foreign trade becomes a factor of the economic backwardness of the underdeveloped country
rather than a factor of its economic growth. It is obvious then that a certain extent of the
protectionism is more advantageous for such a country than the free trade without any
barriers.

2
ČERNOHLÁVKOVÁ, E.; PLCHOVÁ, B. and composite authors Foreign Trade. 3rd edition, Prague: Banking
Institute, 2005. ISBN 80-7265-074-2, page 11.

4
 The centrally planned economies wrestle with rather different problems. In contrast to
the external environment, with which they come into contact through the foreign trade, there
do not function any market relations here. The usual high growth rates, which mean increased
requirements for the import, are determined by the central plan regardless of the foreign
demand for the domestic production. However, the export must be realized to cover the
abovementioned import requirements, which leads on one hand to the deterioration of the
export values or to the export of ineffective products, on the other hand it leads then to the
endeavour to substitute the import by the domestic production, which is however less
effective. The result is again the economic backwardness of the country.

1.4 The principal directions of the foreign-trade policy

As for the foreign-trade policy of the states, respectively the international trading
policy, we can distinguish the two principal directions

• liberalism (free trade)

• protectionism

Liberalism means that the restraints of the foreign trade are eliminated, whether they
are represented by the tariff measures or by the non-tariff measures.

Protectionism is based on the contrary on the application of various measures heading

for the protection of the domestic production against the foreign competition.

The practical foreign-trade policy of the states nowadays moves between the
principles of liberalism and principles of protectionism.

It is also often based on the situation on the world market and on the position of the
respective state in this market. We can say that in practice neither the purely liberal, nor the
purely protective policies exist. Some countries are heading more for the liberalism, other
countries apply rather the protective policy; however, in no case it concerns the extreme trend.

In the historical evolution of the foreign-trade relations we can find the eras,
when the protectionism tendencies had prevailed, but also the eras, which had favoured
the liberalism.

For example the era of the mercantilist economic thoughts (the 16th century up to the
1st half of the 18th century) represents an era of a strong protectionism. The protectionism was

5
also the result of the Second World War, which dramatically influenced the economies of a
range of states. These states endeavoured then to protect their economies by means of various
business policy instruments, especially by means of a high level of the customs tariffs. On the
contrary the classical economic doctrine already contained the liberalism (the second half of
the 18th century up to the 1st half of the 19th century); the intensive post-war protectionism
was later replaced by the endeavour to remove the barriers in the international trade, and
therefore by the effort at the more liberal approaches in the foreign-trade policies of the
particular countries.

Both types of the foreign-trade policy have obviously their advantages and
disadvantages. Whether or not the advantages or disadvantages of the respective direction
prevail, it depends for example on the economic advance of the country, but also on the time
period, within which the business policy is being just pursued.

Advantages of the liberalism:

• lower prices on the domestic market, which result from the pressure of
the foreign competition and which mean the advantage for the consumers,

• enhancement of the price stability within the domestic economy,

• enlargement of the assortment of the supply on the market by the

imported goods,

• possibility of a higher specialization of the production,

• expansion of the markets and a possibility to realize the benefits from

the large size connected therewith,

Advantages of the protectionism:

• protection of the domestic manufacturers, which are not so endangered

by the foreign competition,

• lower dependence on the imports,

• easier check of the quality of goods on the market,

• strengthening of the stability of the domestic economy, because the

possible access to the less stable international markets is limited,

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 • reduction of the transfer effect, that means of the transfer of negative
phenomena among the particular economies.

1.5 Importance of foreign trade from the point of view of the theoretical
approaches

In order to sketch in the importance of the foreign trade for the economy of a state it is
also necessary to remind the evolution of the theoretical approaches connected with these
problems. These approaches document, how the view on the advantageousness of the foreign-
trade exchange had been changing within the particular historical stages, as well as the view
on the grounds, on which this advantageousness had been based.

Classical economic
theory

Mercantilists
Theory of occasional
costs

Theory of availability
of the production

The mercantilists asserted for example that in the case of two countries trading
mutually with each other, only one of these countries could benefit from the foreign trade,
namely that country, which had an active balance of trade. Their doctrine was based on the
statement that the fortune accrued from the foreign trade, which had to bring the money into
the country. A strong protectionism resulted from this statement, because the import
represented the outflow of money abroad. Therefore various measures were used to restrict
the import, starting with the high customs, through the support of such branches, which were
able to replace the imports, up to the absolute veto on the import of some sorts of goods. At
the same time the export was markedly promoted. However, the supporters of this doctrine
were not fully conscious of the importance of the foreign trade yet.

The classical economic theory refused the mercantilists’ statement that only some
countries could benefit from the foreign trade. On the contrary this theory brought an idea that
the foreign trade was advantageous for every country provided that the country specialized

7
appropriately. At first the specialization was based on the principle of the absolute
advantages, where it was recommended that a country should target the production and next
the export of such products, which it was able to produce with the absolute lowest costs, i.e.
for cheaper than the other countries. However, this principle did not resolve the situation
when the country did not have any such unique advantage as for the costs; therefore the
principle of the comparative advantages was gradually adopted. On the basis of this principle
a less effective country should specialize on such products, in which its disadvantage as for
the absolute costs was minimal. It is necessary to add that the classical theory considered only
the costs of work.

Theory of availability of the production factors, which belongs to the

neoclassic school, considers the different availability of the production factors in different
countries as the basis for their specialization. Namely the cost of the production factor, which
is available in a sufficient quantity in the country is low, on the contrary the cost of the
shortage production factor is high. If the country targets then the production of such products,
which require (need) the highly available production factor, it will be able to produce such
products for cheaper. The result is that the country may have a comparative advantage on the
foreign markets.

Theory of occasional costs forms also a part of the neoclassic school; however it is
based on the marginal approach to the costs. It concerns the so-called “costs of the sacrificed
occasion”, so the ratio between the increase in the production of one product kind by a unit
and the evoked decrease in the production of another product. This ratio determines the price
as well, which then determines the advantageousness or disadvantageousness of the exchange
on the foreign markets.

On the other hand there also exist the theories based on the positions of the
underdeveloped countries, which show that the foreign trade does not need to be always
advantageous for these countries. However, the fact remains that the more advanced countries
may benefit from their participation in the international trade and that they can be moved
forward above the limits of their own possibilities.

Summary:

The foreign trade represents an important element of the world economy and has a
significant impact on the economies of the particular states. Some countries prefer more open

8
economy, other countries may be more closed, and i.e. their external economic relations are
rather limited. The smaller and more advanced economies tend more to the openness.

We distinguish the following functions of the foreign trade:

- the transformation function of the foreign trade means the transformation of structure

of the domestic sources and domestic production intro such structure, which is

desirable

- the growth function is connected with the saving of the national work

- however, in the case of economies of the underdeveloped countries or centrally

planned economies the foreign trade may also act negatively and may rather obstruct

their further development.

The state regulates its commercial relations with the foreign countries by means of the
foreign-trade policy. In this connection we can distinguish the following two terms: liberalism
and protectionism. The liberalism means the support of free trade; the protectionism means on
the contrary the protection of the domestic market of the given country by means of various
measures, which embarrass the trade.

The evolution of economic theories documents, how the view on the importance of the
foreign trade for the economy of a state had been changing, as well as the view on the
grounds, on which the advantageousness of the foreign-trade exchange had been based. The
base principle remains, even from the today’s point of view of understanding of the foreign
trade, the classical economic theory and its principle of the comparative advantages.

The terms to be remembered:

• international trade

• foreign trade

• foreign-trade policy

• international trading policy

• closed economy

• open economy

9
 • liberalism

• protectionism

International trade is a social discipline, which is based on three fundamental

sources: philosophy (the development of the society as a whole), economics and law. It
concerns the mutual foreign trade activities among the states; therefore it is a term of wider
comprehension than the foreign trade.

Foreign trade represents the commercial relations of a certain country with foreign
countries. It is influenced above all by the foreign-trade policy, which the given country
practises.

Foreign-trade policy could be characterized as a summary of activities, by means of

which the state influences purposefully its foreign trade

International trading policy is then a summary of foreign-trade policies of the states,

their mutual relationships and dependencies. Therefore it concerns a set of principles and
means, by which it is possible to influence and regulate the economic relations among the
states each other.

Closed economy (autarkical) is an economy without any external economic relations.

Open economy is an economy, which has the external economic relations, that means
it is linked with the world by means of the trade in goods and services, capital flows, etc.

Liberalism means that the restraints of the foreign trade are eliminated, whether they
are represented by the tariff measures or by the non-tariff measures.

Protectionism is based on the contrary on the application of various measures heading

for the protection of the domestic production against the foreign competition.

Check questions and tasks:

• Explain the terms of foreign-trade policy and international trading

policy.

• What are the functions of the foreign trade?

• What are the principal directions of the international trading policy?

10
2. FORMS OF THE INTERNATIONALISATION OF THE
ECONOMIC ACTIVITIES

Objective of the chapter: the objective of the chapter is to make the students
acquainted with the forms of strategic approaches to the international business and with the
forms of entry of the companies in the international markets. These forms have most often the
following character:

- the export and import operations

- the forms of entry, which are not capital investment-intensive

- the forms of entry, which are capital investment-intensive

The students shall get acquainted with the particular business approaches within the
abovementioned forms.

The experts in the foreign trade theory state that the most frequent forms of the
internationalisation of the economic activities include the following:

• irregular export activity

• export by means of the independent agents (intermediaries)

• establishment of one or more selling affiliated companies

• building of the production facilities abroad

The above-mentioned steps may form the particular stages of the evolution, which the
company may pass through, or on any of which the company may remain.

Before the company enters the foreign market, it must make several fundamental
decisions:

• decision on whether or not to expand abroad

• decision, which markets should be entered

• decision on the way of entering the market

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 There exist several factors, which may force the company to enter the international
markets:

• the worldwide companies offer better products or they can compete

with the domestic companies in lower process

• the company may achieve a higher profit on some foreign markets than
on the domestic market

• the company needs a larger customers’ segment to be able to reach a

certain economic extent of the production

• the company wishes to reduce its dependency on a sole market and

thereby reduce the risks

On the other hand the company must also consider carefully the following risks:

• the company may underestimate the foreign legislation or it can incur

unexpected expenses

• the company does not understand the foreign culture of business or it is

not able to cooperate efficiently with the foreign countries

• any foreign country may change its legislation on the business, devalue
its currency or a political crisis may spring into existence here

• the company may not be able to understand the preferences of the

foreign customers and it is not able to offer them any competitively attractive product.

2.1 Strategies of the approach to the international business

The international trade experiences at the present time an intensive development.

It is the result of the influence of a range of the currently running processes, such as the
liberalization, internationalization and globalization of the world economy, development and
use of the information technologies. These processes create for the companies many new
opportunities for the business; however at the same time they increase the competition on the
global market.

12
 The decision on the participation of a company in the international activities
belongs to the key strategic decisions. The practical realization of the international activities is
connected with the application of the international marketing. Many companies of different
sizes, different economic conditions and with different enterprise objectives are participating
in the sphere of the international business. They use different strategic approaches in doing so.
The best known approaches are as follows:

a) Strategy of market leader

the aim is to achieve and to maintain the dominant position on a target segment of
the world market. This can be achieved especially by means of the permanent innovation
of products and services, by the coverage of all market segments with a large supply, by a
close and intensive cooperation with the distribution chains, by the reduction of costs and
achieving savings due to the extent, by an intensive international marketing
communication, acquisition and merger.

b) Strategy of challenger

the aim is to weaken the market position of the market leader and in final
consequence to reach for his position. For this purpose the challenger makes use above all
of the weaknesses of the competitor (weaker positions in a certain region, in a certain
market segment) and the marketing mix (lower prices, more favourable terms of payment,
more suitable forms of communication activities, introduction of innovations into the
international market, etc.).

c) Strategy of emulator

this position is usually occupied by the small and middle-sized companies, the aim
of which is to maintain the position on the market and to acquire loyal customers. The
supply of their products must be of high-quality and with reasonable prices. The company
image and brand do not play any important role in this case. The emulators usually keep
away from the direct concurrence with the leading firm on the market.

d) Strategy of niche of the market

it consists in the company’s targeting a small special niche, in which the large
companies are not interested. The strategy is based on the better understanding and
knowledge of the customers’ needs and requirements, on the direct contacts with the
customers and on the offer of specialized services. The companies achieve lower prices in

13
 their activities and are able to offer competitive prices. Such companies do not represent
mostly any competition for the large companies. The assertion of these companies even in
the international milieu enhances their competitive advantage in many directions.

Other strategies regarding the forms of penetrating into the foreign market:

Strategies

Strategy of wide Strategy of Strategy of narrow

penetration differentiation specialization

Strategy of wide penetration is used by the large manufacturing corporations and

distribution chains. It is based on the mass production, low costs and competitive prices.
On the basis of these characteristics the companies achieve large coverage of the market
segments.

Strategy of differentiation is based on the differentiation of the supply. The

companies endeavour to differentiate their supply from the competition on the basis of the
characteristics of the products, scope of the services provided together with the products,
on the basis of personnel and price. The application of the above-mentioned strategy is
suitable for the technologically-demanding products, brand-name consumer goods and
services.

Strategy of narrow specialization it is suitable for the small and middle-sized

companies. These companies may specialize in certain products and services, thereby
reaching for a special position in the international trade. The specialization may relate
both to the products and to the market segments.

2.2 Forms of the companies’ entry in the international markets

The companies may choose a range of forms of the entries in the international
markets. The choice of a concrete form is influenced by several factors: investment intensity
of the entry, sources and possibilities of the company, market potential of the target segment,

14
possibility of control of the business activities, competitiveness of the company in the
international milieu and risks of the international business.

The decision on the internationalization of the company activities depends to a

great extent on the corporate culture, shared corporate values and on the management’s style.
The experts specializing in the foreign trade theory divide the forms of the entries in the
international markets into three groups:

- the export and import operations

- the forms of the entry, which are not capital investment-intensive

- and capital inputs

2.2.1 The export and import operations

The export is considered as a traditional form of the company’s entry in the

foreign market. If the company desires to succeed in this activity, it should pay great attention
to the international marketing and adapt itself to the conditions of the foreign market.
According to the needs the company must adapt the product, price, distribution as well as the
marketing communication. The companies may use various trade practices, which are realized
on the basis of the contractual relations with the business partners.

Intermediary relations – it is a very frequent form, where the intermediary purchases

the products in his own name

on his own account and carries business at his own risk. The intermediaries have
various names. Especially the small and middle-sized companies use the services of the
intermediaries, possibly the companies, which orientate themselves to a special production
and whose sphere of the foreign trading is ensured by the specialized intermediaries.

Exclusive sale (dealing) contract – is one of the ways through which the company
may quickly enter the foreign market. In the contract the company undertakes that it shall not
deliver the goods mentioned in the contract to any other person in a certain region, but to the
exclusive dealer (agent). The exclusive sale is often considered as a benchmark test of the
ascertainment of the demand for the goods supplied. On the basis of this “test” the company
may decide on its further business activities. The exclusive sale contract ensures a sufficient
control over the distribution of the products.

15
 Commercial representation – in the contract on the commercial representation the
commercial representative (business agent) undertakes to conclude and to do businesses on a
long-term basis, on behalf of the represented company and on its account. The forms of the
representation may vary. The representatives of the company must respect in theirs activities
the conditions of the represented company. In addition to the intermediation of the businesses
the representative performs other functions as well (for example the care of customers, the
“bearer” of marketing information, etc.).

The exclusive commercial representation represents a special type of the contract on

the commercial representation. In this case the represented company is obliged not to use any
other commercial representative on a determined territory and for a determined range of
businesses, and the exclusive representative is obliged not to represent any other companies in
the determined region. The contract on the exclusive representation creates closer contacts
and attachments between both parties.

There exist some spheres of the international trade, where the conclusion of such
contract may arise both from the side of the representative and from the side of the
represented company.

Commission and mandate relations – in the contract with a commission agent the
commission agent undertakes that he shall arrange for the committer in his own name and on
his account a concrete commercial transaction, and the committer undertakes to pay for that
performance to the commission agent. The use of this method has an advantage, namely that
the committer can control the price of the goods sold and may use the distribution channels of
the commission agentAccording to the mandate contract the mandatary acts on behalf of the
mandator. The mandate contract is being closed between the entrepreneurs and it has some
common features with the contract with a commission agent. In the contract there must be
precisely determined the subject of the commercial transaction being arranged for the
mandatory.

Piggyback - represents a cooperation of several companies from the same sphere of

business, at which the largest and best-known company usually provides its distribution
channels to the other companies for the payment. It represents a great advantage for the small
companies because they can use the image and the experiences of the large firm, as well as its
marketing and logistics services. This method of cooperation is also being used by the large
companies as a form of the inter-company cooperation. In this way they achieve the costs
saving resulting from the shared utilization and financing of the sales network, and from the

16
shared providing of services on the foreign market. The cooperating companies enter the
foreign market under their own brand-name; they can apply their own marketing strategy and
keep their own control over the pricing policy.

Direct export – it represents a direct business way from the manufacturer to the
customer. It is usually applied in the sphere of industrial markets at the export of machines,
manufacturing equipment, vehicles and investment equipment. It is necessary to provide a lot
of accompanying services connected directly with the sale of the abovementioned goods,
which requires the presence of the manufacturer at the foreign market. This method of
realization of the international activities requires a thorough analysis of advantages and
disadvantages, weak and strong points of the company, possible risks of the international
business activities, etc.

Export alliance – it is in fact an association of the small and middle-sized companies

established for the purpose of a common approach to the resolution of problems connected
with the export. It concerns usually an association of the exporters from the same sphere of
business, the supplies of which may appropriately complete each other. The legal form of the
association may vary. The scope of its activity is formed by the research of the foreign
markets, processing of offers, handling of orders, ensuring of the international marketing and
logistics, representation of its members abroad, intermediating the participation in the foreign
trade fairs and exhibitions, etc.

The main benefits from the common proceeding of the association’s members include
the saving of costs of the foreign business activity, possibility of decrease in risks, better
negotiating position, possibility of creation of an improved image, etc. The abovementioned
form of the access to the international markets is supported in all advanced states and forms
an integral part of the pro-export policy.

2.2.2 Forms of the entry in the foreign markets, which are not capital
investment-intensive

The companies use these forms of entry in the foreign markets in such cases, when
they want to present - within the international business activities - their products on the
foreign markets in another way than through the export operations. The best-known forms of
the entries of the above-mentioned category include:

17
 Licence, franchising, contracts on management, refinement operations and the
production cooperation
Forms of entry

Licence Contracts on Production

management cooperation

Franchising
Refinement
operations

Licence – belongs to the frequently applied forms of the entry of a company in the
foreign markets. It is a form of consent to the utilization of an incorporeal good by another
person. The consent is granted by the entity, which has an absolute title to the use of the
incorporeal good.

Franchising – represents a contractual relationship between the partners, in which the

franchiser entitles and obliges the particular franchisees to use the business name or the trade-
mark, and the right to use the subject of enterprise of the company. This form of business is
being applied in various areas, most frequently in the sphere of the commercial enterprise.

There occurs the development of business within the frame of the franchising. Both
the sources of the franchise grantor and the sources of the franchise grantee contribute to that.
These sources are associated and the results are synergetic effects in the business activity.

The development of the franchising occurs because it is advantageous both for the
large and for the small companies. As for the large companies, it brings them a fast
internationalization of business activities and a decrease in risks resulting from these
activities. As for the small companies, it also brings them a decrease in business risks thanks
to their participation in the franchising chains.

18
 Contracts on management – the subject of such contract is the providing of
managerial methods and techniques, as well as of managers on the contractual basis. It is in
fact a managerial know – how. The subject of contract may be the management of a
manufacturing factory, a factory providing services or an advisory activity. The contracts on
management are frequently being used by the advanced companies for the management of
companies in the underdeveloped countries. It is in fact a transfer of the approved method of
management abroad.

Refinement (improvement) operations – represent a process of processing or

reprocessing of materials, raw materials or half-finished products into a higher degree of
finality or finished products. The reasons for the realization of this approach are as follows:
lower costs of this process abroad, possibly a less strict legislation in the sphere of ecology
and labour-law relations. In the sphere of the refinement operations it is necessary to take into
consideration the customs regulations (active refinement operations).

Production cooperation – within the international scale they are based on the division
of the manufacturing programme among the manufacturers from various countries without
any capital link. At the international production cooperation the contractual partners may use
the advantages resulting from the difference in the costs’, sources’ and prices’ parameters in
either of the contractual parties. In addition to the production sphere the cooperation between
the contractual parties may be practised also at other levels, too.

As for the objects of the industrial property we distinguish the following licences
for the use of:

• patents – inventions

• industrial designs (external get-up of the product)

• utility designs (engineering solution of the product)

• protective marking (trade-mark, business name of the company)

• know - how (pseudo-licence)

As for the licence business, the company may decide

1. either on the sale of licence or

2. on its purchase

19
 The first case – it is usually when the company has no possibility of introduction of the
production, or the production can be introduced only to a limited extent, the company has
already a better progressive solution, there exist various barriers on the side of the export and
the sale of licence is connected with advantageous cooperation relations.

The second case – it is usually when the company has no possibility of development of
its own Research and Development, and its own original design is not realistic. The licences
may - in some cases - form a part of the intangible deposit at the joint venture. The companies
manufacturing the consumer goods consider the licences as an important source of income.
The licences may be also considered as a frequent form of the inter-company cooperation
among the significant worldwide companies.

2.2.3 Capital inputs of the companies in the foreign markets

This form of the entry of companies in the foreign markets is the highest level of the
internationalization of the enterprise activities. It is being used above all by the large
companies. Most frequently they have a form of the direct or portfolio investments. The direct
foreign investments may have a form of the contributions of capital (tangible and intangibles
investments) or of intra-plant (in-house) loans or reinvested profit. The portfolio investments
represent a purchase of shares or other securities.

The decision-making of the company on the capital entry in the foreign market is
influenced by several factors, which can be divided into the following basic groups:
marketing, costs, business policy and investment.

The direct foreign investments can have the following forms: acquisition, merger,
green field investment, joint venture or strategic alliance.

a) Acquisition (takeover) – represents a takeover of a functioning company or a part

thereof, which can have a form of friendly takeover (with a view to strengthen the position of
the company) or unfriendly takeover (with the aim of liquidation of the competition).

b) Merger – may have a form of the amalgamation or consolidation. The

amalgamation represents a joinder of companies, at which the merged company ceases to
exist without liquidation of assets and liabilities. The consolidation represents a joinder of two
companies, at which the consolidated companies cease to exist and a new legal subject
originates.

20
 c) Green field investments – represent newly established and newly built companies.
They usually bring to the country more capital, more up-to-date technologies, they create new
job vacancies and enhance the competition on the market.

d) Joint venture – it represents a consolidation of the resources of two or more

subjects into a joint ownership. It can have a form of contractual joint ventures or joint
ventures based on the capital investments (equity joint ventures).

The joint ventures are usually characterized by the following common features:

• Long-term character of the interrelationships

• Joint ownership of the invested funds, sharing the profit, possibly

sharing the losses and costs of the company’s operation

• Joint management of the company and possibility of control according

to the amount of the invested funds.

The capital interest of the foreign companies may be minority interest, parity interest,
majority interest or interest with 100%. In some states the limitation of the investment amount
of the foreign investor can be applied.

e) Strategic alliance – it concerns a partnership of large, capital-powerful companies

from the advanced countries. They were initially established in the branches connected with
the scientific and technical development (telecommunications, information technologies, and
aircraft industry); however at the present time they are being established even in other
branches. Large companies also establish the alliances in the sphere of services (for example
joint distribution services). They can have a form of contractual joint ventures without any
mutual capital linkage or with the capital participation.

Summary

When making decision on the possibilities of entry in the international markets, the
company’s management must analyze the benefits and risks, which result from this decision.
The decision on the participation of a company in the international activities belongs to the
key strategic decisions. The strategy of approach of the company depends on its competitive
position on the market. The best known approaches are as follows: strategy of market leader,
strategy of market challenger, strategy of market emulator and the strategy of niche of the
market. From the point of view of forms of the penetration into the foreign markets we can

21
distinguish the strategy of wide penetration, the strategy of differentiation and the strategy of
narrow specialization.

The companies may choose from several forms of entry in the international markets.
The basic forms of entry include:

- the export and import operations

- the forms of entry, which are not capital investment-intensive

- the forms of entry, which are capital investment-intensive

The choice of a concrete form is influenced by a rage of factors such as: investment
intensity of the entry, sources and possibilities of the company, possibility of control of the
business activities and risks of the international business.

The terms to be remembered:

• strategy of market leader

• strategy of challenger

• strategy of emulator

• strategy of niche of the market

• direct export

• export alliance

• licence

• franchising

• refinement (improvement) operations

• strategic alliance

The aim is to achieve and to maintain the dominant position on a target segment of the
world market. This can be achieved especially by means of the permanent innovation of
products and services, by the coverage of all market segments with a large supply, by a close
and intensive cooperation with the distribution chains, by the reduction of costs and achieving
savings due to the extent, by an intensive international marketing communication, acquisition
and merger.

22
 The aim is to weaken the market position of the market leader and in final
consequence to reach for his position. For this purpose the challenger makes use above all of
the weaknesses of the competitor (weaker positions in a certain region, in a certain market
segment) and the marketing mix (lower prices, more favourable terms of payment, more
suitable forms of communication activities, introduction of innovations into the international
market, etc.).

This position is usually occupied by the small and middle-sized companies, the aim of
which is to maintain the position on the market and to acquire loyal customers. The supply of
their products must be of high-quality and with reasonable prices. The company image and
brand do not play any important role in this case. The emulators usually keep away from the
direct concurrence with the leading firm on the market.

It consists in the company’s targeting a small special niche, in which the large
companies are not interested. The strategy is based on the better understanding and
knowledge of the customers’ needs and requirements, on the direct contacts with the
customers and on the offer of specialized services. The companies achieve lower prices in
their activities and are able to offer competitive prices. Such companies do not represent
mostly any competition for the large companies. The assertion of these companies even in the
international milieu enhances their competitive advantage in many directions.

It is necessary to provide a lot of accompanying services connected directly with the

sale of the abovementioned goods, which requires the presence of the manufacturer at the
foreign market. This method of realization of the international activities requires a thorough
analysis of advantages and disadvantages, weak and strong points of the company, possible
risks of the international business activities, etc.

Export alliance – it is an association of the small and middle-sized companies

established for the purpose of a common approach to the resolution of problems connected
with the export. It concerns usually an association of the exporters from the same sphere of
business, the supplies of which may appropriately complete each other.

Licence – belongs to the frequently applied forms of the entry of a company in the
foreign markets. It is a form of consent to the utilization of an incorporeal good by another
person. The consent is granted by the entity, which has an absolute title to the use of the
incorporeal good.

23
 Franchising – represents a contractual relationship between the partners, in which the
franchiser entitles and obliges the particular franchisees to use the business name or the trade-
mark, and the right to use the subject of enterprise of the company. This form of business is
being applied in various areas, most frequently in the sphere of the commercial enterprise.

There occurs the development of business within the frame of the franchising. Both
the sources of the franchise grantor and the sources of the franchise grantee contribute to that.
These sources are associated and the results are synergetic effects in the business activity.

The development of the franchising occurs because it is advantageous both for the
large and for the small companies. As for the large companies, it brings them a fast
internationalization of business activities and a decrease in risks resulting from these
activities. As for the small companies, it also brings them a decrease in business risks thanks
to their participation in the franchising chains.

Refinement (improvement) operations – represent a process of processing or

reprocessing of materials, raw materials or half-finished products into a higher degree of
finality or finished products. The reasons for the realization of this approach are as follows:
lower costs of this process abroad, possibly a less strict legislation in the sphere of ecology
and labour-law relations. In the sphere of the refinement operations it is necessary to take into
consideration the customs regulations (active refinement operations).

Strategic alliance – it concerns a partnership of large, capital-powerful companies

from the advanced countries. They were initially established in the branches connected with
the scientific and technical development (telecommunications, information technologies, and
aircraft industry); however at the present time they are being established even in other
branches. Large companies also establish the alliances in the sphere of services (for example
joint distribution services). They can have a form of contractual joint ventures without any
mutual capital linkage or with the capital participation.

Check questions and tasks:

• What does force the companies to enter the international markets?

• What strategies may the companies choose at entering the international

markets depending on their positions on the market?

• What trade practices may the companies use in the international trade?

24
 • What best-known forms of entry in the international markets do you
know as for the forms, which are not capital investment-intensive?

• What are the forms of capital inputs in the foreign markets?

• Characterize the following form of entry in the foreign markets – the

refinement (improvement) operations

• What decisions must the company’s management make before entering

the foreign markets?

25
3. ORGANIZATIONAL FORMS OF THE
INTERNATIONAL EXCHANGE

Objective of the chapter: the objective of the chapter is to make the students
acquainted with the organizational forms of international exchange of goods and services. It is
based on the sales methods, which are used by the largest domestic and foreign competitors,
on the character and properties of the products, their prices and requirements of customers.
The method of organization is divided into two groups: direct trade practices and indirect
trade practices.

At the present time most of the industrial enterprises cannot exist without the export.
The export means for the company to produce in larger series, to achieve a higher profitability
of the production process, a service ability of a product on the world markets and the world-
famousness of the company. The product, which won recognition on the world markets, is
better saleable even on the domestic market. To win recognition abroad, it needs a great effort
within the particular business activities. In addition to the quality and functionality the
product must have a right design, package and label. To win recognition on the market and to
keep this position – it is the greatest motivation factor, which moves the manufacturer
forward. This factor applies also to the businessman – to overcome all the obstructions to the
satisfaction of the customers’ needs.

Each business, either foreign or domestic business, means a certain risk, which must
be reduced or removed. The more the product is complicated, the more this process is
demanding and longer. Before the process of export itself the manufacturer (the exporter)
must obtain a lot of information, by means of which it is possible to decrease the risks or to
eliminate them. One of the ways how to obtain this information is the marketing research.

The subjects of such research are usually as follows:

• International business milieu (economical, political, technical,

ecological, legislative and cultural)

• Acting and strategy of the competition (number of competitors and their

behaviour)

26
 • Determination of the potential of the target foreign markets

• Application and efficiency of the marketing strategy

• Prices

• Forms of the trade promotions

• Distribution channels

• Trade and sales practices

In addition to the information obtained by means of the marketing research, it is

possible to use a range of reliable domestic and foreign electronic information sources, which
are obtainable with relatively low costs, respectively quite free of charge.

3.1 Trade and sales practices

On the basis of the analysis and evaluation of the available information the
businessman decides on the most appropriate method of sale for the given products. His
decision-making is also based on the sales method, which is used by the largest domestic and
foreign competitors.

In principle we divide the trade practices into two groups:

direct methods and

indirect methods

a direct market channel exists between the manufacturer or the exporter and the
customer

a lot of agents exist between the manufacturer, exporter and customer

A number of factors decide on the method of the trade way used, such as the type and
characteristics of the product, financial analysis of the estimated expenses and revenues,
assessment of all risks, tradition and economic condition of the exporter and competition.

Powerful companies prefer the building of their own market channels

and they establish their own affiliated companies on the key markets. The trade
network at the indirect sales method is formed by the intermediaries (they are trading in their

27
own names and on their own accounts) and by the agents (they are trading in somebody else’
name and on somebody else’ account).

The character of the product belongs to the significant factors of the decision-making
on the form of entry in the international market.

As for the consumer goods, a tendency to use the indirect forms of sale prevails,
whereas in the trade network there are several businesses interlinks. These can be the
specialized companies of foreign trade, international commercial chains, wholesales and other
enterprises dealing with the international trade.

As for the industrial goods, a tendency to the direct export prevails.

That is in the concrete region there is usually required the provision of a number of
professional services, the quality of which is a condition of the success on the international
market and influences the decision-making of the customers.

3.1.1 Direct trade practise

This sales method is being realized in specific business transactions. These

transactions include especially:

• Offer and sale within the so-called public tenders - “tenders”. It

concerns above all the government contracts, and contracts of the public or half-
private sector. The public tenders take place under pre-determined conditions. The
intermediary organizations may represent the state only in exceptional cases.

• In dealing with the countries having the foreign trade monopoly of

some commodities (petroleum, pharmaceuticals, and weapons). However, even in
these cases the function of an intermediary is admitted – a consultant.

• In the cases, where the exporter’s goods proved sufficiently good on the
concrete market and therefore it does not need to use any services of the intermediary.
It concerns usually the neighbouring accessible markets.

28
 In addition to the abovementioned specific cases, the direct trade practises are being
used especially by large companies at the export of manufacturing equipment and complete
industrial plants or technologically-complicated and expensive products. The use of the
abovementioned method requires a perfect knowledge of the technology and business
problems. From the point of view of the international exchange organization it is necessary –
in this case – to build one’s own enterprise section (Export Department), which is a very
expensive matter.

The advantages are as follows: the possibility of control over the product, achieving of
higher price and profit, and the use of one’s own marketing strategy. The direct business
relationships may contribute to their stability and increase the loyalty of customers.

The education and training of the foreign trade specialists is time-consuming, as well
as finance-consuming. Therefore the decision-making on the establishment of one’s own
distribution channels must form an integral part of the enterprise strategic management.

3.1.2 Indirect trade practise

This method represents the sale of products by means of the intermediaries, who can
be independent or the company may create its own foreign network on the basis of the
distributors or representatives. The term “distributor” may indicate a seller, wholesale
merchant, importer or an import house. The most frequent cases are the wholesale merchants,
who further distribute the purchased goods into the retail network.

The distributor imports the products on his own account and sells them also in his own
name.

The distribution may be

- exclusive or

- non-exclusive

The intermediary may be:

• one-time

• exclusive

• non-exclusive

29
 The exclusive distributor is the sole person authorized to sell exclusively on the
market a certain product of a certain firm. The exclusivity may have a territorial character or a
professional character.

The non-exclusive distribution represents a relationship, which can be realized on the

basis of a general contract, which includes such circumstances that the exporter or the seller
consider being important. The intermediaries form a further link of the indirect trade channel.
This term indicates the salesmen, agents, representatives of the company, who act in
somebody else name and on somebody else account.

The one-time intermediary is being used in specific business cases, such as the
delivery of a complete industrial plant. The one-time contract is advantageous for the
verification of the relationship and a later pass on the more permanent representative
relationship.

The exclusivity means in this case that the intermediary represents the company on a
certain territory. The exclusivity may also relate to a certain product or an assortment of
products.

The non-exclusivity means that the company may cooperate on the market with more
intermediaries. It can have a territorial character or a commodity character.

The company may have built its own foreign sales network, which may have various
characters:

• capital participation of the manufacturer (exporter)

• representative office

• other form corresponding to the legal and business conditions of the

local market

The capital participation may have a form of the branch or affiliated company. The
branch is owned on 100% by a foreign subject, whereas as for the affiliated company, it can
be a mixed ownership (usually 49% is owned by the foreign subject). The capital participation
may function as the intermediary or the agent. Only capital-powerful parent companies may
afford to build their own foreign network, because the establishment of such entrepreneurial
subject requires a detailed analysis of the legislative, tax and labour-law conditions.

30
 Another possibility of the use of the indirect trade channel is represented by the

- foreign trade organizations

- trade companies

Every exporting company gets offers for provision of services from various marketing
agencies. These agencies formally declare the support of business; however their own goal is
the support of export from their own country. In addition to the abovementioned there are a
lot of private agencies, which operate both for the importers and the exporters.

which have built a foreign network. Their employees cope with the technique and
economy of the foreign trade and are proficient at languages. Especially small and middle-
sized companies seek these special companies.

The so-called casual intermediaries represent a certain possibility at the realization of

the business relationships. The company’s managers usually come into contact with them at
some actions other than business actions. They have common characteristics – go-aheadness
and contacts, which they attempt to use at any opportunity.

3.1.3 Management of the representative network

The management of the representative network represents the process of selection of

countries and forms of the business activity by a concrete company. It includes the method of
addressing, tactic of approach, work with partner and the communication with him. This is not
just the matter of the authorized contact employee, but the matter of a whole team of
employees, who come into contact with the customer.

The above-mentioned area of the company activities must form an integral part of the
conceptual activity of the company.

The quality of the foreign representative network influences “the value” of company.
The building of a high-quality representative network is a long-term task and it is a “never-
ending” process.

In connection with the management of the company’s foreign trade it is necessary to

pay attention to the world’s trends in the area of the international economic cooperation.

31
 This approach means that all the key information about the partners’ network are
concentrated within one section at one competent employee. He should be responsible for the
acquisition, analysis and evaluation of information in connection with the development of the
turnover on the particular markets.

The foreign trade is not any longer the sole form of this cooperation. New non-
traditional forms of business have been developed. The firms from the economically advanced
countries began to export the capital instead of the goods (financial capital, manufacturing
capital and knowledge capital). Thereby a process began, when the manufacture has been
moved from these countries to the countries, which dispose of cheap workforce and potential
effective demand. This process took effect even in the application of new business methods.

The basic forms of capital inputs in the foreign markets are as follows:

- the investment portfolio (purchase of shares or other securities) and

- the direct foreign investments.

The direct capital investments abroad are most often realized in the form of mergers
and acquisitions, newly established companies, in the form of joint ventures and strategic
alliances.

Summary

The organizational forms of the international exchange are influenced by a range of

factors, such as the sales method of the largest domestic and foreign competitors, the
investment intensity of the entry to foreign markets, the properties of products, their prices,
the risks of international business, the sources and possibilities of the company.

These forms unwind from the basic methods of sale – direct sale and indirect sale.

The direct method of sale is being realized in specific business transactions and at the
industrial goods. From the point of view of organization of this method it is necessary to build
one’s own enterprise section (Export Department).

The indirect method of sale is usually realized at the consumer goods and is provided
by means of the intermediaries, who can be independent or the company may create its own
foreign network on the basis of the distributors or representatives. The quality of this network
influences “the value” of company.

32
 An important sphere of the enterprise’s activities is represented by the management of
the representative network. This is not just the matter of the authorized contact employee, but
the matter of a whole team of employees, who come into contact with the customer.

The terms to be remembered:

• direct forms of sale

• indirect forms of sale

• specific business transactions

• intermediary

• exclusive distribution

• foreign trade organizations (trade companies)

• branch and affiliated company

• management of the representative network

Offer and sale within the so-called public tenders - “tenders”. It concerns above all
the government contracts, and contracts of the public or half-private sector. The public tenders
take place under pre-determined conditions. The intermediary organizations may represent the
state only in exceptional cases.

In dealing with the countries having the foreign trade monopoly of some
commodities (petroleum, pharmaceuticals, and weapons). However, even in these cases the
function of an intermediary is admitted – a consultant.

In the cases, where the exporter’s goods proved sufficiently good on the concrete
market and therefore it does not need to use any services of the intermediary. It concerns
usually the neighbouring accessible markets.

This method represents the sale of products by means of the intermediaries, who can
be independent or the company may create its own foreign network on the basis of the
distributors or representatives. The term “distributor” may indicate a seller, wholesale
merchant, importer or an import house. The most frequent cases are the wholesale merchants,
who further distribute the purchased goods into the retail network.

33
 The one-time intermediary is being used in specific business cases, such as the
delivery of a complete industrial plant. The one-time contract is advantageous for the
verification of the relationship and a later pass on the more permanent representative
relationship.

The intermediary may be:

- one-time

- exclusive

- non-exclusive

The exclusive distributor is the sole person authorized to sell exclusively on the
market a certain product of a certain firm. The exclusivity may have a territorial character or a
professional character.

The non-exclusivity means that the company may cooperate on the market with more
intermediaries. It can have a territorial character or a commodity character.

trade companies which have built a foreign network. Their employees cope with the
technique and economy of the foreign trade and are proficient at languages. Especially small
and middle-sized companies seek these special companies.

The capital participation may have a form of the branch or affiliated company. The
branch is owned on 100% by a foreign subject, whereas as for the affiliated company, it can
be a mixed ownership (usually 49% is owned by the foreign subject). The capital participation
may function as the intermediary or the agent. Only capital-powerful parent companies may
afford to build their own foreign network, because the establishment of such entrepreneurial
subject requires a detailed analysis of the legislative, tax and labour-law conditions.

The management of the representative network represents the process of selection of

countries and forms of the business activity by a concrete company.

Check questions and tasks:

• What is the principal division of the trade practices?

• How can we organize the management of the representative network?

• Advantages and disadvantages of one’s own Export Department

34
 • Advantages and disadvantages of indirect forms of export

• What can be the position of the intermediary in the process of

distribution?

35
4. SYSTEMS OF REGULATION OF THE
IMPORT
Objective of the chapter: The objective of this chapter is to present a summary of
instruments of the trading policy and to explain their basic classification. The students shall
subsequently get acquainted with the autonomous instruments of the trading policy, which are
aimed at the regulation of import, namely with the non-tariff instruments. In the following
text there will be also described the contractual instruments, by means of which it is also
possible to regulate the import.

In the first chapter there were explained some important terms, among others the term
of foreign trade policy and international trading policy. In both cases it concerns a set of
instruments, by means of which a state (respectively states) regulates its economic relations
with other countries.

The instruments of trading policy may serve both for the limitation of the import and
for the promotion of the export, however they may arrange the foreign-trade relationships
even in another way. In the following text there is a summary of instruments of the trading
policy, the parts of which will be described in more details below, not only in this chapter but
also in the next chapters.

4.1 Instruments of trading policy

We can divide the instruments of the trading policy into two main groups. It concerns

- the autonomous instruments and

- the contractual instruments.

The autonomous instruments of the trading policy are historically older and we can
indicate them as primary instruments. The state applies these instruments independently on
other states, i.e. autonomously.

The contractual instruments did not originate before a certain stage of the evolution
of the international economic relationships, they are derived from the autonomous instruments
and therefore they are secondary instruments. By means of these instruments the states
regulate the use of autonomous instruments.

36
 However, at the present time the contractual instruments of the trading policy are
getting more and more foreground, which causes that the autonomous instruments are not any
more as autonomous as they used to be. It is given by the fact that most of the autonomous
instruments are bound by various international treaties and conventions; therefore its usage is
enabled only with regard to these international treaties.

4.1.1 Autonomous instruments

We can divide the autonomous instruments of the trading policy into two parts,
namely the instruments for limitation of the import and the instruments for promotion of the
export.

Instruments for limitation of the import:

• Tariff

• non-tariff

- customs

- other provisions in the form of fees

- quantitative restrictions

- auto-limitation agreements

- minimal price

- foreign currency restrictions

- technical obstructions to the business

- prohibitions (embargo) on import

- automatic licensing

- security and other licences

- import surcharge

- import deposit

- national trade companies

Instruments for promotion of the export:

37
 • export subventions

• government export credits

• export crediting

• government guarantees on credit

• devaluation of currency

• institutions supporting the export

• promotion

• other means

4.1.2 Contractual instruments

We can divide the contractual instruments of the trading policy into two groups,
namely bilateral and multilateral instruments.

Bilateral instruments:

• treaties of commerce

• trade agreements

• payment agreements

• barter trades

Multilateral instruments:

• international agreements and treaties

• integration coalitions

• activity of international organizations

4.2 Instruments for limitation of the import

As it results from the summary of the trading policy instruments, the import can be
limited either by means of tariff instruments or by means of non-tariff instruments. The tariff
instruments of the trading policy include above all the customs, which will be characterized in
more details in a separate chapter, and some other provisions in the form of fees.

38
 As for the non-tariff instruments, there exist a number of possibilities. However it is
necessary to note that the professional source-books somewhat vary as for the classification of
some trading policy instruments. Such trading policy provisions, which are not quite
unambiguous, we can find so in one source-book among the tariff instruments, whereas in
another source-book we can find them among the non-tariff instruments.

The states apply most frequently the following trading policy provisions:

4.2.1 Quantitative restrictions

The quantitative restrictions (limitations on quantity) determine the maximal quantity

of a certain sort of goods, which is allowed to be imported into a certain country. This
quantity has the form of an import quota, which is divided among the domestic importers of
the relevant sort of goods.

Within the licence system the import permits are being allocated to the particular
importers. The import permits authorize the importers to import the abovementioned goods.
The licences are allocated according to the following aspects:

• there are preferred the importers, which have applied earlier for
the licence

• or there are preferred the importers, which already traded with

the relevant sort of goods in former times

The licence system may discourage the importers from the import, because
it is usually connected with various administrative delays or other problems; even
the illicit trade with the licences or an abuse of the licence system for the purpose
of competitors’ fight among the companies may occur.

However, on the other hand the quantitative restrictions have their

advantages. Namely, as soon as the import quota is fulfilled, any further goods cannot be
imported any more. The quantitative restrictions so represent a reliable protection against the
undesirable imports.

However, by means of the quantitative restrictions the states may not only restrict the
import, respectively export of certain sorts of goods, but at the same time - by means of these
restrictions - the states can also advantage, respectively discriminate some countries in a
differentiated way.

39
 4.2.2 Auto-limitation agreements

The auto-limitation agreements are agreements on the voluntary limitation of export.

However in fact it concerns a covert form of protectionism, because it does not

concern the voluntary limitation of export to all intents and purposes, but it takes place under
certain pressure. The country, which has some problems with the imports from another
country, forces this country to “voluntarily” limit the export; otherwise the forcing country
threatens for example with the quantitative restrictions.

In former times the agreements on the voluntary limitation of export were frequently
used for example by the European Union or by the United States of America for the purpose
of protection of the “sensitive” sectors, such as textile industry, metallurgy, agriculture, etc.

4.2.3 Minimal price

The minimal price is a provision, which should prevent from the dumping imports, i.e.
the imports of goods for an uneconomically low price. There is namely administratively
determined the lowest reasonable price, for which it is possible to import a certain sort of
goods.

In the event that the minimal price is not kept, the importing country may adopt an
appropriate provision in accordance with its rules, for example to introduce additional
customs or quantitative restrictions.

4.2.4 Foreign currency restrictions

The foreign currency restrictions represent such trading policy instruments, where the
state intervenes in the management of means of payment.

The exporters must compulsory levy the obtained foreign currency means, and on the
contrary the importers must apply for the allocation of the foreign currency means on the
planned imports. The foreign currency restrictions are frequently used by the states, which
don’t have enough convertible currency or which have some problems with the adverse
balance of payments.

4.2.5 Technical obstructions to the business

The technical obstructions to the business arise because sometimes, in different states,
there are different legal regulations and national technical standards, which determine the
requirements for the characteristics of products and the methods of determination whether the

40
products introduced to the market meet these requirements or not. The different technical,
health, sanitary, environmental and other standards

may also represent the obstructions to the international trade. If the goods don’t meet
the legal regulations or standards of the country, in which they should be imported, then they
are not admitted into this country and so the business doesn’t take place.

4.2.6 Prohibitions (embargo) on import

In the extreme case there can be even used the total prohibition (embargo) on the
import of certain goods into a concrete country, however this provision is being used only
rarely with regard to its strong protectionist character.

Usually it is not used by the economic reasons, but rather by political reasons.
However, it is used most frequently in the cases, when the health or even the lives of citizens
of the importing state are endangered.

As the examples from the last years we can mention the prohibitions on the import of
beef or poultry, which many countries applied in connection with the dissemination of the
Creutzfeld-Jacob (mad cow) disease and the bird’s flu.

4.2.7 Automatic licensing

The automatic licensing means also the allocation of licences on the import of certain
sort of goods, however these licences are being allocated automatically, because there is not
determined any import quota. In this case the licence system serves for the control of the
imported goods’ volume, rather than for its limitation. It is being used in the case of imports,
which could threaten any of the domestic sectors and therefore they must be monitored. The
state would proceed to certain protective measures only at the moment of proving that the
imports really threatened the domestic production.

4.2.8 Security and other licences

In addition to the licences, which are issued within the allocation of the import quota
or just for the control purposes, there exist also other licences, by means of which the state
protects not only its business interests, but also its political and security interests.

These licences permit the import, as well as the export of the goods, such as for
example military materials, weapons, ammunition, explosive substance or the goods

41
and technologies, which are subject to the international control regimes with regard to their
sensitiveness.

In the latter case it concerns the subjects of double use, including software and
technologies, which can be used for the civil and military purposes, namely both for the
production of un-explosive substances, and for any form of support of the production of
nuclear armament, chemical weapons and biological weapons.

The states usually strictly control even the import of pharmaceuticals, drugs, as well as
some products, which are in violation of the general public morals or religion.

4.2.9 Import surcharge

The import surcharge is included in the non-tariff measures; it concerns an amount,

which is levied at the import of goods. It is determined by a percentage of its value for
customs purposes.

4.2.10 Import deposit

The import deposit represents a certain amount, which must be deposited - at the
import - with a selected banking institution, free of interest and for a fixed time period. After
expiration of this time period the amount is returned. Even in this case the amount is
determined by a percentage of the goods’ value for customs purposes.

4.2.11 National trade companies

The non-tariff trading policy measures are also represented by the trade companies
established or maintained by the state, which are granted such privileges that cause serious
obstructions to the business.

4.3 Contractual instruments

The foreign trade can be influenced not only by means of the autonomous instruments
of the trading policy, but also by instruments of contractual character, which are nowadays
getting more and more foreground, as was said before. Therefore it is also necessary to
mention them in connection with the regulation of import.

The states regulate the application of the contractual instruments of the trading policy
partly on the bilateral basis, especially by means of various treaties of commerce and trade

42
agreements. Furthermore the bilateral instruments regulating the mutual business relationships
between the states include also for example the payment agreements or the barter trades.

Multilateral instruments of the trading policy represent another important means of

influencing the international business, which include various international agreements and
treaties, integration coalitions and the activity of international organizations.

As for the international agreements, we can mention for example the agreements on
raw materials, which are concluded between the producers, possibly between the producers
and consumers of a certain mineral raw material or a crop with a view to stabilize their prices.
The textile agreements regulating the exports of textile from the underdeveloped countries to
the advanced markets may represent another example.

The most important agreement in the sphere of international trade, which has
significantly influenced the whole post-war evolution, is the General Agreement on Tariffs
and Trade, known under abbreviation GATT. This agreement will be characterized in the
following text.

Also the integration coalitions significantly influence the regulation of the trade
relationships. We distinguish several degrees of the economical integration:

• zone of free trade

• customs union

• common market

• economic and monetary union

• activity of international organizations

Zone of free trade means that the member-states of the integration coalition will
cancel – in the mutual trade relationship - the customs, possibly other obstructions to the
trade, however every state will preserve its own customs tariffs and trading policy towards the
third countries.

Customs union has similar characters as the zone of free trade, which means it
eliminates the obstructions in the mutual trade; however the states use a unified customs tariff
towards the third countries, so a part of the decision-making on the trading policy issues
passes on the supranational level.

43
 Common market represents not only free movement of goods, but also other
production factors, i.e. work and capital.

Economic and monetary union is the highest degree of the economic integration,
where the states of integration collation apply common economic policy, and in its highest
form even the common monetary policy including the single currency.

Activity of international organizations is also ranked among the multilateral

contractual instruments of the trading policy, because these organizations are being
established on the basis of contracts between the interested countries and their activity has in
fact a character of multilateral treaties.

There are many international organizations and institutions influencing the sphere of
international economic relationships and international trade. It is above all the United Nations
Organization (UNO) and a number of other organizations associated with it, as well as other
organizations ad institutions operating outside the scope of UNO.

The organizations associated with the United Nations Organization (UNO) are for
example as follows:

International Monetary Fund (IMF), International Bank for Reconstruction and

Development (IBRD), World Intellectual Property Organization (WIPO), United Nations
Industrial Development Organization (UNIDO), etc. Within the United Nations Organization
(UNO) also the United Nations Conference on Trade and Development operates, which is
rather known under the abbreviation UNCTAD.

As for the organizations and institutions operating outside the scope of United Nations
Organization (UNO), we can mention for example the Organization for Economic
Cooperation and Development (OECD), Bank for International Settlements (BIS) or the
International Chamber of Commerce.

All the above-mentioned organizations or institutions relate to the sphere of

international trade and influence it by some means. However, for a long time no organization
has existed, which would focus directly on the problems of the international trading
relationships and which would fully address these problems, although the demand for such
organization has been discussed since the end of Second World War. Only in the middle of

44
the nineties of the Twentieth Century it was succeeded in the international sphere to reach an
agreement on the establishment of World Trade Organization, which is indicated by the
abbreviation WTO and which will also be characterized in details in the following text.

4.3.1 GATT

General Agreement on Tariffs and Trade was signed in 1947, with effect from 1st
January 1948. Its main purpose was to reduce barriers to international trade, which were
considerable after Second World War. Especially the high level of customs tariffs meant a
considerable obstruction to the development of trade relationships.

Originally, after the war the GATT was supposed to become an International Trade
Organization, however its establishment did not take place in the end. The fundamental
requirement for the regulation of rules of the world trade resulted at least in the creation of
GATT agreement. A part of the International Trade Organization Chart (so-called Havana
Chart) became its basis, which concerned the general trading policy together with the treaties
on customs tariffs reduction that were agreed upon within the preparation of the Organization.
Although the GATT agreement was originally intended as a certain provisional arrangement,
it has remained in a provisional function for almost fifty years.

The agreement was first signed by 23 states; however the number of contractual
parties has been enlarging gradually up to more than 120 countries in 1994. The negotiations
took place on so-called customs tariffs’ conferences, which were later named “rounds”. At
first these negotiations targeted above all the reduction of customs tariffs, later on the states
focused also on the non-tariff obstructions and on other measures causing problems in the
international trade.

The GATT agreement is featured by the reciprocity principle, provision of reciprocal

advantages and endeavours to resolve the problems by means of compromise acceptable for
all participating parties. The agreement was based on the principle of the Most-Favoured-
Nation Clause. This means that the conditions applied to the most favoured nation apply
automatically to all trading nations within GATT. Exception to the rule is formed by the so-
called codes, which are the documents approved as for the individual particular problems.
These codes applied only to the states, which accepted them, the other contractual parties
were bound by the generally effective wording of the GATT agreement.

So the GATT agreement incorporated the co-called framework agreement and

collection of documents of customs advantages. As for the framework agreement, it was

45
related to the principles of trading policy, which should be maintained by all the contracting
parties to GATT in the mutual trading. These basic principles include the already mentioned
non-discriminating treatment and obviously the reduction of customs tariffs or elimination of
other obstructions to the trade.

First section of GATT agreement regulated the mutual provision of the Most Favoured
Nation Treatment and at the same time it meant the obligation of the particular contractual
parties not to increase the existing customs tariffs.

Second section concerned for example the free transit, antidumping and compensatory
duties, export subventions, issues concerning the determination of the goods’ value for
customs purposes, etc. It concerned the provisions, which applied conditionally, that means if
they did not oppose the internal regulations of the particular contractual parties. Furthermore
the section contains the provisions concerning the quantitative restrictions, its elimination and
at the same time the elimination of the discriminating treatment connected with them. We can
also find here the so-called escape clauses, which enabled to change or even to withdraw the
customs concessions already agreed upon, possibly to introduce certain limitations on
quantity in such situation, when the import caused or threatened to cause a serious damage to
the domestic production sector, or the provisions for protection of the balance of payments.

Third section concerned the territorial activity, frontier traffic, protocol regulations,
etc. The contractual parties were permitted to create the zones of free trade or customs union,
which were excluded from the scope of the Most Favoured Nation Treatment. However, these
coalitions could not apply any higher than existing protectionist measures, or new
protectionist measures, towards the third countries, which were contractual parties to the
GATT agreement.

46
 Fourth section was added to the agreement later, in 1965, namely on request of the
underdeveloped countries, the role of which became more important in the sixtieth of the
Twentieth Century. This section focused on the position of the underdeveloped countries; an
important movement was represented by the fact that the advanced states had abandoned the
reciprocity in relation to these countries, i.e. at the elimination of the barriers to trade the
reciprocity had not been further expected from them.

GATT agreement can be evaluated as very successful, as by means of GATT there

were created the rules of the world trade and reduced the level of customs tariffs in a
significant way. GATT text was gradually changed and amended with regard to the agreed
rules. GATT agreement in the wording from the year 1994 became then one of the
multilateral agreements, which form an integral part of the system of World Trade
Organization.

4.3.2 WTO

Agreement on establishment of the World Trade Organization was signed in April

1994 in Marrakech, Morocco, whereby at the same time the last round of GATT negotiations,
known as Uruguay Round, was formally terminated. The agreement on WTO establishment
entered into force on January 1, 1995.

World Trade Organization has its headquarters in Geneva and as per December 15th,
2005 it had already 150 member-states. The basic objectives of this organization include
common goals, such as increase in living standard, achievement of full employment,
furthermore of course the support of free trade with goods as well as with services; the
objectives of the organization also include the ideas of permanently sustainable economic
development or the environmental protection. A considerable attention is also paid to the
underdeveloped countries, there is emphasized the necessity to develop the efforts, which
would lead to a higher participation of these countries in the development of international
trade.

These objectives should be realized by means of agreements focused on further

reduction of customs tariffs and elimination of other barriers to the trade, on elimination of
the discriminating treatment in the international trade relationships.

In WTO there applies the so-called “principle of sole obligation”, which means that
the member-states must accept all the obligations resulting from the Agreement on WTO
Establishment, as well as all the multilateral trade agreements. They are obligatory for all

47
members of the organization. An exception is represented only by several so-called
multilateral agreements that are binding only for such states, which admitted them.

The multilateral trade agreements include above all Agreement GATT 1994,
furthermore the General Agreement on Trade in Services (GATS), Trade-Related Aspects of
Intellectual Property Rights Agreement (TRIPS) and a number of further agreements, for
example the Agreement on Agriculture (AoA), Agreement on Textile and Clothing,
Agreement on Technical Barriers to Trade (TBT), Agreement on Compensatory Measures,
etc.

The multilateral agreements representing en exception to the “principle of sole

obligation” include for example the Agreement on Trade in Airliners, Agreement on
Government Contracts, and International Agreement on Trade in Dairy Products and
International Agreement on Trade in Beef.

World Trade Organization provides space for the business negotiations of member-
countries, assists at out-of-court settlements of possible disputes, possibly interprets the
provisions of agreements. At the same time it provides its member-countries with technical
assistance and professional training and cooperates with other international organizations or
institutions.

In WTO the particular decisions are taken on the principle of unanimity rule. That
means that a general consensus must be reached, when no negotiating party opposes the
proposed solution. Should it be impossible to reach such consensus, the decision has to be
voted through.

In conclusion it is necessary to say that the General Agreement on Tariffs and Trade
and subsequently the World Trade Organization represent fundamental pillars of the
multilateral trading system.

“The essence of the multilateral trading system resulting from the General Agreement
on Tariffs and Trade consists in the process of gradual liberalization of trade by way of
elimination of tariffs’ and non-tariffs’ obstructions to the trade. It takes place by means of
multilateral business negotiations, the results of which – agreed concessions – are then
granted on the basis of treatment according to the Most Favoured Nation Clause, or according

48
to contract, to all other contractual parties. After passing the frontier the discrimination with
domestic products is excluded, too.”3

4.4 Regulation of import within European Union

European Union applies for the regulation of import both tariff instruments and non-
tariff instruments; it regulates its foreign trade relationships even by means of a number of
contractual instruments.

The problems of customs, as it was said before, will be described in a separate chapter.
As for the non-tariff instruments, the European Union applies a range of provisions, especially
various quantitative restrictions.

The non-tariff instruments in the international trading policy started getting more and
more foreground from the middle of seventies of the Twentieth Century; it was even
compared to a new wave of protectionism. On the one hand it was the result of reduction of
customs tariffs within the GATT negotiations and on the other hand it was the result of need
to protect certain industrial branches. That is why many advanced countries proceeded to
application of various non-tariffs instruments, among others the states of the European
Community.

Still at the beginning of the nineties the states of the Community limited the import of
many industrial products, mostly from Asian countries. Since then the extent of quantitative
restrictions has been reduced considerably; the limitations remain especially at products, such
as fruits, vegetables or consumer electronics.

Above all the agricultural policy belongs to the

protectionist policies of EU, which applies both customs
tariffs, and various quotas, possibly tariffs quotas, minimal
import prices or import surcharges.

In the extreme cases the EU also applies in the

trading policy for example the embargo, depending on the
politically motivated restrictions of United Nations
Organization (UNO), which the EU observes.

3
DVOŘÁK, P. Basic principles of international trading policy. Prague: School of Economics in Prague, 1999.
ISBN 80-7079-658-8. Page 51.

49
 European Union has also a common community system of import controls or
prohibitions, which is based on the environmental, health, hygienic, sanitary or security
requirements.

As for the protectionist provisions applied in compliance with the escape clause
according to the GATT agreement, they are being used from the side of EU most frequently
for the agricultural or fishing products.

It concerns temporary provisions that are being used only rarely. EU applies them in
the cases, when the imports endanger the health of citizens, the imported goods has an
extremely low price or in the cases, when a sudden and extreme increase of import occurs. In
these cases the protectionist provisions have mostly a form of minimal import price, import
quota or individual licence on the imports.

Further provisions are applied in compliance with the agreements concluded between
EU and third countries. These agreements usually include the provisions enabling to take
measures, which were mutually agreed upon, in case that the imports from one country into
another country would cause a threat.

A specific instrument of trading policy serving for the protection against undesirable
imports for uneconomically low prices (dumping prices) is represented by the antidumping
customs. Some professional source-books classify this instrument as tariffs instruments of
trading policy, other source-books classify it as non-tariffs instruments, with regard to the fact
that it concerns an additional duty, which serves for the compensation of difference between
the export value and current value of the relevant sort of goods.

Antidumping measures

European Union applies the antidumping measures against third countries quite often.
In the past these measures were aimed most frequently against the imports from the area of
Central and Eastern Europe, other Asia, from the area of Pacific, and against the imports from

50
China and Japan. The antidumping measures are being applied above all to the chemicals,
metallurgical products and textile.

However, in the European Union itself an opinion prevails that its antidumping
practices are relatively liberal, with regard to the fact that:

• the volume of the antidumping customs imposed is mostly lower

than the dumping profit,

• a large number of antidumping proceedings end with the consent

to the change of price,

• in the case of determination that the dumping causes damage to

the domestic sector, it must be examined, whether it is in the public interest to
introduce the protective measures,

• all the antidumping measures expire after five years, if it does

not lead again to the damage to the domestic production or to the threat of its
damage.4

Summary:

We can divide the instruments of the trading policy into two main groups: the
autonomous instruments and the contractual instruments. The state applies these instruments
independently on other states; on the contrary the contractual instruments are the results of
negotiations between the particular states and regulate the use of autonomous instruments.

We can divide the autonomous instruments of the trading policy into two parts,
namely the instruments for limitation of the import and the instruments for promotion of the
export; the contractual instruments can be also divided into two groups, namely bilateral and
multilateral instruments.

The instruments for limitation of the import include: the tariff instruments, which are
represented above all by the customs, and the non-tariff instruments, such as the quantitative
restrictions, auto-limitation agreements, minimal price, foreign currency restrictions, technical
obstructions to the business, prohibitions (embargo) on import, automatic licensing, security
and other licences, import surcharge, import deposit or national trade companies.

4
PLCHOVÁ, B.; LUKÁŠ, Z.; HRADOVÁ, M. Czech Republic and European Union: selected chapters. Prague:
School of Economics in Prague, Oeconomica, 2005. ISBN 80-245-0452-9.

51
 The import can be also regulated by means of the contractual instruments. The
multilateral contractual instruments include various international agreements and treaties,
integration coalitions, and activity of international organizations.

The most important agreement, which has significantly influenced the whole post-war
evolution in the sphere of international trade, is without question the General Agreement on
Tariffs and Trade, known under abbreviation GATT. Its role was assumed in the middle of the
ninetieth of the Twentieth Century by the newly established World Trade Organization,
referred to as the WTO, which was aimed directly at the problems of international trade.

The terms to be remembered:

• autonomous instruments of the trading policy

• contractual instruments of the trading policy

• tariff instruments for limitation of the import

• non-tariff instruments for limitation of the import

• integration coalitions

• GATT

• WTO

The autonomous instruments of the trading policy are historically older and we can
indicate them as primary instruments. The state applies these instruments independently on
other states, i.e. autonomously.

The contractual instruments did not originate before a certain stage of the evolution
of the international economic relationships, they are derived from the autonomous instruments
and therefore they are secondary instruments. By means of these instruments the states
regulate the use of autonomous instruments.

Tariff instruments for limitation of the import:

- customs

- other provisions in the form of fees

Non-tariff instruments for limitation of the import:

52
 - quantitative restrictions

- auto-limitation agreements

- minimal price

- foreign currency restrictions

- technical obstructions to the business

- prohibitions (embargo) on import

- automatic licensing

- security and other licences

- import surcharge

- import deposit

- national trade companies

Also the integration coalitions significantly influence the regulation of the trade
relationships. We distinguish several degrees of the economical integration:

• zone of free trade

• customs union

• common market

• economic and monetary union

• activity of international organizations

General Agreement on Tariffs and Trade was signed in 1947, with effect from 1st
January 1948. Its main purpose was to reduce barriers to international trade, which were
considerable after Second World War. Especially the high level of customs tariffs meant a
considerable obstruction to the development of trade relationships.

Agreement on establishment of the World Trade Organization was signed in April

1994 in Marrakech, Morocco, whereby at the same time the last round of GATT negotiations,
known as Uruguay Round, was formally terminated. The agreement on WTO establishment
entered into force on January 1, 1995.

53
Check questions and tasks:

• What is the basic classification of the instruments of trading policy?

• Characterize the non-tariff instruments for limitation of the import.

• What are the degrees of the economical integration?

• Name several examples of the international agreements and

organizations influencing the international business.

• What were the reasons for the establishment of the GATT agreement?

• What are the main objectives of WTO?

54
5. POLICY OF PROMOTION OF THE EXPORT

Objective of the chapter: The objective of the chapter is to explain the importance of
promotion of the export for the improvement of competitiveness of domestic firms on the
foreign markets and at the same time to make the students acquainted with the possibilities
how to execute this pro-export policy. Within this chapter there will be characterized the
particular instruments of the trading policy for promotion of the export. At the end of this
chapter the application of various instruments of the pro-export policy shall be demonstrated
on the example of European Union.

5.1 Instruments for promotion of the export

Export plays an important role in the economy of each state. That is why the states try
to promote it by all means. There exist a number of possibilities how to execute this
promotion, however it is necessary to take into consideration the WTO provisions in order not
to violate the ethics of international trade.

Instruments for promotion of the export belong to the autonomous instruments of the
foreign trade policy. They are also indicated as active means.

Instruments of trading policy for promotion of the export include:

• export subventions

• government export credits

• export crediting

• government guarantees on credit

• devaluation of currency

• institutions supporting the export

• promotion

• other means

55
 It the case of export subvention it concerns the state contribution to the exporter, the
purpose of which is to improve the competitive position of the exported product on the
foreign markets.

The government export credit is such a credit, which the state grants to another state;
however under a condition that the debtor country will use these means for the purchase of
goods and services in the creditor country.

The competitive milieu on the current international markets requires that the exporters
should be able to grant a commercial credit to the customers abroad. However, this often
represents a high risk for the exporting company, especially because many countries belong to
the so-called risky countries.

In addition to a direct financial promotion of the export in the form of a granted credit
the state may also help to the exporters by granting them a guarantee on their credits to the
foreign customers.

Devaluation of currency means its depreciation; it concerns an official change in the

central rate of exchange, which executes the central bank of state in the system of fixed
exchange rates. In the system of floating exchange rates the modification of exchange rate
takes place spontaneously, in dependence on the currency market, in this case we speak about
the depreciation.

For the purpose of supporting the export, the states frequently establish specialized
institutions, various pro-export agencies, which endeavour to promote the domestic products
on the foreign markets.

The state may help to its exporters with the publicity of their products abroad, which
represents another possibility of how the state may promote the export. The states organize for
example various prestige exhibitions, in which participate only selected companies.

It concerns for example assistance to the exporters with creation of distribution

network abroad that sometimes represents a big problem for small and middle-sized
companies, which do not have enough financial resources for such a costly matter.

5.1.1 Export subventions

56
 It the case of export subvention it concerns the state contribution to the exporter, the
purpose of which is to improve the competitive position of the exported product on the
foreign markets. The subvention may be either director or indirect.

1. Direct subvention means that the state provides the exporter directly with a certain
amount of funds. It can be for example the export premium in the amount of a certain
percentage from the export volume.

However, just the direct export promotions are inconsistent with the WTO provisions,
therefore at the present time there are applied rather the indirect promotions.

2. Indirect subvention is executed by means of various relieves for the exporter, for
example by reductions in prices of the electric energy, gas, etc.

3. We can also consider as an indirect export subvention such situation, when to the
exporter is returned a duty paid before, for example the customs, which was levied at the
import of materials or components necessary for the export production, or a certain tax. In
such cases we speak about a customs or tax restitution.

Indirect subventions can even have a form of various competitions organized by the
state institutions, such as the best exporting company competition, the best export product
competition, possibly the best package competition, etc.

4. The state promotes the exporters also by means of contributions to the scientific and
technical research and development, or it enables them the access to the results of research
and development, which are being financed by the state funds.

5.1.2 Government export credits

The government export credit is such a credit, which the state grants to another state;
however under a condition that the debtor country will use these means for the purchase of
goods and services in the creditor country. In this way the creditor country endeavours to
promote the sales of its products abroad. It has a disadvantage, namely that problems with the
back-payment repayment may occur.

On the contrary the debtor country obtains necessary financial resources, usually under
favourable terms of credit, such as the longer term of expiration or lower interest rates.
However it must choose the suppliers from the creditor country, which means for this country
a certain limitation.

57
 5.1.3 Export crediting

The competitive milieu on the current international markets requires that the exporters
should be able to grant a commercial credit to the customers abroad. However, this often
represents a high risk for the exporting company, especially because many countries belong to
the so-called risky countries.

We can divide the risks into two groups: territorial risks and commercial risks. The
territorial risks are connected with the credibility of the country; they result from its political,
financial and macroeconomic situation. The commercial risks result directly from the
economic and financial situation of the business partner; therefore they are connected with the
credibility of a concrete foreign customer.

The state, which endeavours after the promotion of export, and at the same time it is
interested in exporting into certain countries – with regard to the concluded international
(interstate) agreements, must help to its exporters with financing such exports. For similar
purposes the states establish various institutions, which execute the financing. The granting of
credit is of course conditioned by the fulfilment of severe criteria. However the exporter,
which meets these criteria, has a considerable advantage, because these credits have low
interest rates and furthermore the state itself takes in fact the risks connected with the
business. Therefore it is possible to obtain the credit for the export of complete industrial
plants rather than for the export of consumer goods.

5.1.4 Government guarantees on credit

In addition to a direct financial promotion of the export in the form of a granted credit
the state may also help to the exporters by granting them a guarantee on their credits to the
foreign customers. The exporter can then afford to assume higher credit risks and in this way
gain a competitive advantage on the foreign markets. In the case that the credit is so
guaranteed by the state, the exporter has a certainty not to lose his money even if it is not paid
from abroad.

The insurance of export is usually executed by the national or half-national

organizations, which the particular states establish for these purposes. The amount of the
settlement granted to the exporter in the event that the foreign customer does not pay the due
amount, may reach up to 90 % of its value. This insurance enables the exporters to conclude

58
even such businesses with foreign subjects that would otherwise represent a high risk for
them, and therefore they would not probably realize them at all.

5.1.5 Devaluation of currency

Devaluation of currency means its depreciation; it concerns an official change in the

central rate of exchange, which executes the central bank of state in the system of fixed
exchange rates. In the system of floating exchange rates the modification of exchange rate
takes place spontaneously, in dependence on the currency market, in this case we speak about
the depreciation.

The depreciation of currency has double effect on the foreign trade. On the one hand it
promotes the export; on the other hand, however, it also limits the import. That is the
domestic goods become - in conversion - cheaper for the foreign customer, on the contrary the
foreign goods become more expensive on the domestic market.

Devaluation of currency is a pro-export provision, which should positively influence –

at the same time with the effect on limitation of import - the trade balance of the country, in
which the devaluation was executed. However, a danger consists in that the devaluation raises
generally the prices of all imports, including the imported inputs for the domestic production.
Thereby is simultaneously reduced the competitiveness of the domestic products, which are
just being produced by means of the foreign inputs, and if these products are determined for
the export at the same time, the impact on the trade balance might be zero or even negative.

5.1.6 Institutions supporting the export

For the purpose of supporting the export, the states frequently establish specialized
institutions, various pro-export agencies, which endeavour to promote the domestic products
on the foreign markets. Such institutions are mostly financed by the state, possibly by the
special-interest associations or firms. They often have branch offices abroad and their activity
is focused above all on provision of information, promotion of domestic products,
intermediation of contacts or various business missions into the countries, which are
prospective for the export of the relevant state.

59
 The export can be promoted even by the representative offices abroad, which provide -
by means of their trade-economical departments - the economic news services and process the
analyses of business opportunities for the firms from their country.

The employees, which are sent by the state for this purpose abroad, are carefully
selected and duly trained for the work in foreign countries. It is necessary that they should
have not only the language knowledge required, but also professional qualification, and last
but not least they should be able to establish commerce contacts in the country of their
activity.

5.1.7 Promotion

The state may help to its exporters with the publicity of their products abroad, which
represents another possibility of how the state may promote the export. The states organize for
example various prestige exhibitions, in which participate only selected companies. In this
way these companies may not only effectively represent themselves abroad, as similar actions
are usually monitored by media, but at the same time the state pays a lot of expenses
connected with this publicity, which is for these companies very advantageous.

The states often support even less important actions, which are organized for example
by representative offices or by the individual commercial agents and distributors. Various
digital publications processed by the particular economic Ministries may also serve as an
advertising medium. However, it does not concern only advertising media, the publicity of the
country and its products must be taken into account even at the parties connected with certain
foreign-trade activities. Typically Czech food and drinks, and appropriate atmosphere should
be selected for these parties, possibly accompanying actions.

5.1.8 Other means

The instruments of trading policy serving for the promotion of export have a lot of
forms. In addition to the above-mentioned main instruments we can also mention some others
instruments.

It concerns for example assistance to the exporters with creation of distribution

network abroad that sometimes represents a big problem for small and middle-sized
companies, which do not have enough financial resources for such a costly matter.

60
 In some cases the export may be facilitated even by the state export monopoly,
especially in case of agricultural crops or primary commodities.

The states purchase some agricultural crops or primary commodities for fixed
determined prices, which is advantageous for their producers, and then the states export these
commodities by means of monopoly organizations. It concerns usually such commodities,
which play an important role in the economy of the relevant states. In this way the states have
control over their national wealth and at the same time they are able to negotiate better trading
conditions than the individual small exporters would be able to do.

The competitiveness of products on foreign markets is also influenced by their quality,

sanitary perfectness or safety. However the quality must be proved and the foreign customer
must be assured of it. That is why the states establish various institutions, which guarantee the
quality and which must be independent in order to perfectly perform their own control
function.

The state’s support to the export may also have a form of certain contributions to the
goods’ transport, but it may also concern assistance at the education of experts and specialists
for the sphere of foreign trade.

5.2 Pro-export policy of European Union

The pro-export policy within European Union is not much united; the particular
member-states have considerable liberty at the application of their own instruments and
measures. However, all the states aim to provide complex services, which would make it
possible to the domestic firms to use the state’s help in each phase of the export. The pro-
export policy is understood as a very important means to the support of competitiveness of the
domestic firms on foreign markets.

Despite of considerable disunity in the applied instruments, it is possible to observe in

the pro-export policy of European Union the following main common features:

• regional policy,

• support to scientific and technical development,

• attention to small companies,

• endeavour after the efficiency of state assistances,

61
 • support to prospective sectors and reduction of non-prospective
sectors

The most frequently used instruments of the pro-export policy within European Union
are as follows5:

• financial support to the exporters,

• technical assistance,

• information and advisory services for the exporters,

• education of workers for the foreign-trade activity,

• acknowledgement of the most efficient exporters

Financial support to the exporters is executed above all by means of crediting the
export or granting state’s export guarantees (insurance of export).

It concerns above all the granting of more advantageous bridge loans for the time
period between the origin and maturity of the foreign assets. However this sphere is regulated
by the agreement on admissible terms of export credits with the government support, which
the OECD member-states concluded. The agreement sets forth the limits for granting the
credits, the lowest interest rates, the longest terms of maturity; it also deals with the amounts
of instalments, their scheduling, etc.

Exporters may more easily obtain credits even from the private sources, if the state
guarantees the credit. The EU commission endeavours indeed to harmonize the conditions of
insurance of the long-term export credits; however the institutions performing this insurance
in the particular countries do not still proceed equally, which results from the difference in
their statutes and approaches to the evaluation of credit risks.

Technical assistance to the exporters consists in obtaining information about the

foreign regulations, standards, and technical requirements, in providing professional technical
translations or consultations. The state may help with the approving of domestic products
abroad, with building the sales network, and with organizing the export projects.

5
PLCHOVÁ, B.; LUKÁŠ, Z.; HRADOVÁ, M. Czech Republic and European Union: selected chapters. Prague:
School of Economics in Prague, Oeconomica, 2005. ISBN 80-245-0452-9.

62
 Information and advisory services for the exporters becomes more and more
important instrument of the pro-export policy with regard to the growing requirements for the
competitiveness of the products.

Commercial departments at representative offices, mixed commercial chambers,

national or half-national information and advisory institutions for the exporting companies,
regional industrial and commercial chambers, independent private export advisers or state
authorities are being used for this activity.

The pro-export climate is also supported by the education of workers for the foreign-
trade activity, by evaluation of the exporting firms and acknowledgement of the most efficient
exporters. The evaluation is being performed for example on the basis of export proportion in
the overall turnover of the company, according to dynamics of growth of export revenues,
penetration to the new markets, etc. The states more and more frequently subsidize, possibly
organize various exhibitions or trade fairs, conference activity and other publicity activities.

Thanks to common efforts of member-states, the EU unified electronic information

system for small and middle-sized companies was successfully created, there are coordinated
the programmes of education for the economic workers, etc. Even the EU Commission itself
endeavours to support the member-states’ export, for example by means of various promotion
activities, marketing studies of foreign markets, etc. However the focus of support to export is
still remaining in the particular member-states.

Summary:

The promotion of export represents an important and integral part of the foreign trade
policy of each state. The pro-export policy uses various instruments that include for example
the export subventions, which can be either direct subventions or indirect subventions;
furthermore the government export credits, the crediting of the export itself or the government
guarantees on credit. By means of these instruments the state endeavours to help directly to
the exporters or to reduce the risks connected with the foreign trade.

For the purposes of promotion of the export it is also possible to use the devaluation of
the state’s own currency, which cheapens the domestic goods for the foreign customers. The
states also establish various institutions supporting the export; the states also organize or at
least promote the exhibitions or other advertising actions, and utilize other means. It may
concern for example assistance to the exporters with creation of distribution network abroad,

63
the state export monopoly, the establishment of various institutions, which guarantee the
quality, etc.

As for the European Union, the pro-export policy is also understood here as a very
important means to the support of competitiveness of the domestic goods on foreign markets,
although the particular member-states have considerable liberty at the application of their own
instruments and measures supporting the export. The most frequently used instruments of the
pro-export policy within European Union are as follows: financial support to the exporters,
technical assistance, information and advisory services for the exporters, education of workers
for the foreign-trade activity or acknowledgement of the most efficient exporters.

The terms to be remembered:

• pro-export policy

• export subventions

• government export credits

• export crediting

• territorial risks

• commercial risks

• government guarantees on credit

• devaluation of currency

Export plays an important role in the economy of each state. That is why the states try
to promote it by all means. There exist a number of possibilities how to execute this
promotion, however it is necessary to take into consideration the WTO provisions in order not
to violate the ethics of international trade.Instruments for promotion of the export belong to
the autonomous instruments of the foreign trade policy. They are also indicated as active
means.

It the case of export subvention it concerns the state contribution to the exporter, the
purpose of which is to improve the competitive position of the exported product on the
foreign markets.

64
 The government export credit is such a credit, which the state grants to another state;
however under a condition that the debtor country will use these means for the purchase of
goods and services in the creditor country.

The competitive milieu on the current international markets requires that the exporters
should be able to grant a commercial credit to the customers abroad. However, this often
represents a high risk for the exporting company, especially because many countries belong to
the so-called risky countries.

The territorial risks are connected with the credibility of the country; they result from
its political, financial and macroeconomic situation.

The commercial risks result directly from the economic and financial situation of the
business partner; therefore they are connected with the credibility of a concrete foreign
customer.

In addition to a direct financial promotion of the export in the form of a granted credit
the state may also help to the exporters by granting them a guarantee on their credits to the
foreign customers. The exporter can then afford to assume higher credit risks and in this way
gain a competitive advantage on the foreign markets. In the case that the credit is so
guaranteed by the state, the exporter has a certainty not to lose his money even if it is not paid
from abroad.

Devaluation of currency means its depreciation; it concerns an official change in the

central rate of exchange, which executes the central bank of state in the system of fixed
exchange rates. In the system of floating exchange rates the modification of exchange rate
takes place spontaneously, in dependence on the currency market, in this case we speak about
the depreciation.

Check questions and tasks:

1. What are the risks connected with the export?

2. What is the importance of the insurance of export?

3. In which manner the exchange rate may influence the foreign

trade?

65
6. INSTRUMENTS OF CUSTOMS POLICY

Objective of the chapter: The objective of this chapter is to explain the importance of
customs in the foreign-trade policy of a state, to define the customs and what are the effects of
customs. The customs shall be subdivided according to three basic aspects, and the particular
types of customs shall be also characterized. The students shall also get acquainted with the
terms of customs operation and customs tariff.

6.1 Customs and its history

We can divide the autonomous instruments of trading policy for limitation of the
import into two groups. It concerns the non-tariff instruments, which were described in the
fourth chapter, and the tariff instruments. The tariff instruments for limitation of the import
include above all the customs, in addition to various fees.

We can define the customs as a certain monetary duty levied upon the passage of
goods through the customs frontier. Nevertheless the customs frontier does not need to be
identical with the geographical frontier.

Customs is the oldest instrument of trading policy; we can find its traces already in the
antiquity.

In the history the customs were used above all for fiscal reasons, only later they started
fulfilling also a protective function. It concerned originally certain fees connected with the
trading and with the transit associated with it, for example the fees for use of roads, bridges,
ports or fees for the protection of merchants. The customs were unified approximately in the
middle of 19th century in the European states.

In addition to the fiscal and protective functions the customs can be also used for the
regulation of commodity and territorial structure of the goods’ exchange. As for the protective
function, it concerns above all the protection of domestic producers; however we can also see
the customs imposed for example in the interest of environmental protection. That is, in this
way it is possible to prevent the import of primary commodities, materials, possibly products,
the processing of which or utilization of which deteriorate the environment.

66
 However, the significance of customs has been gradually lowering, at the present time
the non-tariff instruments of trading policy are rather preferred.

That is the customs is evidently a protectionist measure and moreover its reliability, as
a means for protection of the domestic production, is debatable. The foreign producer may
namely response to the imposed customs by reducing his costs and subsequently his price, so
the expected protective effect does not need occur. Furthermore there exist a number of
international agreements regulating the rules for the customs’ utilization, so the introduction
of this trading policy instrument is not as autonomous as it used to be, and that is why its
application is embarrassed.

6.2 Effects of customs

As for the effects of customs on the economy, it is necessary to target above all the
following impacts:

• Impact on the domestic producers

– they are protected by the customs against foreign competition, their competitiveness
on the domestic market is increased, they achieve higher turnover and also have possibly a
space rise in their prices and enlargement of their production; however a long-term protection
may lead to the backwardness in domestic production as the firms are not forced to face the
pressure of competition from abroad, and are losing the motivation for costs reduction or
financing their further development.

• Impact on the consumer

- in this case the customs take rather negative effect, the imported goods become more
expensive, which is not advantageous for the domestic consumers, moreover a limitation of
assortment takes place, if a certain goods cease to be imported completely because of the loss
of competitiveness.

• Impacts on the state budget

– the revenues from customs represent an item of revenue of the state budget, although
their portion is gradually dropping; the amount of revenues depends not only on the level of
customs tariffs but of course also on the volume of import.

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 • Impact on the real rate of exchange

– the import duty has a favourable effect on the real rate of exchange (the ratio of
export price index to import price index), because a pressure on the reduction of import prices
occurs, thereby the foreign exporters try to eliminate the increase in price caused by the
imposed customs.

• Impact on the balance of payments

– the customs is an instrument for limitation of the import, which positively influences
the balance of payments of state; at the same time the balance of payments is also favourably
influenced by the fact that domestic producers have a better competitive position, because if
they are at the same time exporting, they could use a possible rise in price on the domestic
market for the reduction of export price, and thereby improve their competitive position
abroad, which can lead to the increase of export. However at the decision-making on the
customs imposition on certain imports, especially imports of primary commodities, materials
or semi-finished products, it is necessary to proceed in spirit of the so-called effective
protectionism, which means that the prices of inputs into export production should not be
preferably raised, otherwise it can happen that the customs do not improve the balance of
payments, but they can even worsen this balance.

6.3 Classification of customs

The customs can be subdivided in various ways; however we use most frequently the
following three basic aspects. The customs are usually subdivided according to:

• purpose

• direction of movement of the goods

• method of calculation

6.3.1 Customs according to the purpose

We can subdivide the customs according to the purpose, to which they serve, as
follows:

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 • financial (fiscal)

• protective (protectionist)

The financial customs are imposed for the purpose of gaining financial means for the
treasury. It can concern both import customs and export customs.

The protective customs is a means of protection of the domestic market against

undesirable imports, they can possibly protect against undesirable exports.

The imported goods are more expensive after adding the customs, so it becomes less
competitive on the inside market of the importing country, in the extreme case even un-
saleable. The increase in price of the exported goods by means of customs again reduces the
competitiveness of domestic goods on foreign markets, which is being used for the purpose of
preventing the export of certain primary commodities or products.

The protective customs can be further subdivided according to its character:

• preferential

• differential

• countervailing

• compensating

• anti-dumping

• retaliatory

Preferential duties are used in the relation to certain countries; it usually concerns the
support of underdeveloped countries (frequently in relationship of the linkage between former
colonies and their metropolises) or preferences within integration coalitions.

Differential duties concern the sea transport. They are imposed on the goods, which
are transported by foreign ships; thereby the domestic shippers are advantaged.

Countervailing duties compensate certain advantages, which were granted to the

goods in the exporting country, for example the export premium or subvention. Due to the
duty the imported goods becomes more expensive so that its price would get on the level of
the domestic price.

Anti-dumping duties serve as the protection against cheap imports, which cause
problems to the domestic economy. The dumping is defined in various ways, for example as

69
an import for lower price than is its costs price, possibly than is the common price on the
domestic market of the exporting country or common price on the domestic market. It is quite
difficult to prove the dumping and moreover it must be also documented that such import
causes any damage to the domestic manufacturing sector.

Retaliatory or retorsionary duties are used in the foreign-trading policy mostly as a

reaction to a certain discrimination measure of another state, and if the countries do not agree
in time, such duties could even result in an economic war, which does not contribute to the
mutual business in any case.

6.3.2 Duties according to the direction of movement of the goods

We can subdivide the customs according to the direction, in which they pass the
frontier, as follows:

• import duty

• export duty

• transit duty

Import duty Export duty Transit duty

and at the same time they represent the most typical instrument for the protection of
domestic market. However, they are also the most frequent subject of international regulation,
i.e. its usage is bound by the international agreements.

Export duties are used less frequently as every state endeavours rather to promote the
export; however there are certain situations, when the export is disadvantageous for the
relevant country. It concerns for example the exports of primary commodities, which could be
processed at home and subsequently exported as finished products or at least as semi-finished
products with a certain level of processing, thereby containing more added value, and so they
could be sold for higher prices at the markets. Moreover, by processing the primary
commodities at home, the domestic production is being developed, which at the same time
promotes the increase in the employment rate. By imposing the export duty the state also aims
to prevent the lack of a certain product on the domestic market.

Transit duties today do not occur in the advanced countries any more. They served
above all for the fiscal purposes. Today the states prevent the transit through their territory by

70
means of other measures, for example by means of various fees, which however do not have
the character of customs.

6.3.3 Customs according to the method of calculation

We can subdivide the customs according to the method, by which they are calculated,
as follows:

• valoric

• specific

• differentiated

• compound

Valoric duties are calculated as a certain percentage from the value of goods. Its
advantage is that the cheap and more expensive sorts of goods are charged equally. However
a problem often occurs, namely determining the base, from which the duty will be calculated.
It often happens that the declared value of goods does not correspond to its actual value.

Specific duties are not problematic from the point of view of determining the base for
the duty’s calculation as they are determined by a fixed amount for a certain physical unit.
However they charge more the cheaper sorts of goods; the duty charge is dropping with the
increase of the foreign price.

Differentiated duties attempt to eliminate the problematic aspects of two previous

methods of calculation. There exist differentiated valoric duties and differentiated specific
duties. In the first case it concerns the calculation of duty by means of a graded percentage for
different prices of the same goods. The second type of differentiated duties is based on the
rates per unit, but also graded for different prices of goods.

Compound duties, which are also indicated as combined or sliding scale of duties,
represent then various combinations of valoric and specific duties.

6.4 Customs operation

All the goods passing through the frontier must go through the customs operation. The
customs operation has various modifications in various countries; however its rules are

71
contained in the appropriate tariff law. The result of a customs operation is the release of
goods into any of the customs procedures, which are as follows:

• free circulation

• customs entry

The release into free circulation means that the imported goods is cleared according
to the defined rules and can be freely traded on domestic market of the importing country.

In the case of customs entry the duty is not assessed, but the goods cannot be freely
traded on domestic market of the importing country. It is supposed that such goods would be
subsequently exported back into the exporting country, possibly into any third country. It
concerns for example the goods, which is imported for the purpose of presentation on an
exhibition or trade fair. As another example we can mention the so-called improvement trade,
which has two variants. In case of active improvement trade there are imported primary
commodities, semi-finished products, etc., which are further processed in the importing
country and exported back abroad. Passive improvement trade means then the export of
domestic products abroad, where they are processed and imported back into the original
country. At the import on “customs entry” it might also concern a temporary usage, after
termination of which the goods are returned back abroad in unchanged condition. However
the goods remain in the ownership of the exporter during the whole time.

6.5 Customs tariff

The customs tariff is

a systematic arrangement of the rates of duty for all the sorts of goods, which has
usually the form of an Act. Each sort of goods is assigned a numeric indication and an
appropriate rate of duty at the same time. The numeric code is assigned most frequently on the
basis of the International Convention on harmonized System of Description and Numeric
Indication of Goods. European Union and a number of other countries use furthermore the so-
called combined nomenclature of goods for the purpose of better code specification.

In Customs Tariff there are usually the following types of rates of duty:

• general

• conventional

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 • preferential

General or autonomous rates of duty are the highest rates and are being used towards
the countries, with which the trading relationships are not contractually regulated at all. With
regard to the fact that at the present time most countries have concluded contractual
relationships, these rates are used by the countries only rarely. Another reason for the
application of general rate of duty may be represented by the situation, when it is impossible
to evidence the provenance of goods.

Conventional rates are usually lower than the general rates and are being used
towards the countries, with which the trading relationships are contractually regulated, for
example by means of Most Favoured Nation Treatment.

Preferential rates of duty are low, possibly zero, in comparison with the other rates.
The rules of their application are determined by the appropriate bilateral or multilateral
treaties. The preferential rates may be provided also unilaterally, namely to underdeveloped
countries or to the least developed countries within the General System of Preferences.

6.6 Customs tariff system of EU

The main characteristics of the customs tariff system of EU include6:

• most of customs tariffs are determined on the value base, the

number of exceptions is relatively low,

• relatively low level of average customs tariffs (already before

the Uruguay Round),

• high portion of mutually interconnected customs tariffs on

industrial products,

• marked graduation of import tariffs at fish, tobacco, leather,

rubber, textile or metals,

As for the food products and the main agricultural crops grown within EU, at the
import there are moreover applied various additional fees.

6
PLCHOVÁ, B.; LUKÁŠ, Z.; HRADOVÁ, M. Czech Republic and European Union: selected chapters. Prague:
School of Economics in Prague, Oeconomica, 2005. ISBN 80-245-0452-9.

73
 Summary:

The customs are ranked among the autonomous instruments of the trading policy,
namely among the tariff instruments for limitation of the import. It concerns the monetary
duties levied upon the passage of goods through the customs frontier. The customs are the
historically oldest trading policy instrument; however the significance of customs has been
gradually lowering.

The effects of imposition of the customs are shown in several spheres. The customs
protect above all the domestic producers against foreign competition, however due to the
customs the imported goods become more expensive for the domestic consumers. The
customs also represent the revenues of the state budget, although the fiscal significance of
customs has been gradually lowering, especially in the advanced economies. The customs
also influence the real rate of exchange and the balance of payments of a state.

The customs are usually subdivided according to the purpose, according to the
direction of movement of the goods or according to the method of calculation. All the goods
passing through the customs frontier of the state must go through the customs operation, and
are subsequently released into any of the customs procedures. The rates of duty required for
the determination of the customs’ amount are systematically arranged in the Customs Tariff.

The terms to be remembered:

• customs

• effective protectionism

• customs operation

• customs procedure

• customs tariff

• rate of duty

We can define the customs as a certain monetary duty levied upon the passage of
goods through the customs frontier. Nevertheless the customs frontier does not need to be
identical with the geographical frontier.

74
 The customs is an instrument for limitation of the import, which positively influences
the balance of payments of state. However at the decision-making on the customs imposition
on certain imports, especially imports of primary commodities, materials or semi-finished
products, it is necessary to proceed in spirit of the so-called effective protectionism, which
means that the prices of inputs into export production should not be preferably raised,
otherwise it can happen that the customs do not improve the balance of payments, but they
can even worsen this balance.

All the goods passing through the frontier must go through the customs operation. The
customs operation has various modifications in various countries; however its rules are
contained in the appropriate tariff law.

The result of a customs operation is the release of goods into any of the customs
procedures, which are as follows:

• free circulation

• customs entry

The customs tariff is a systematic arrangement of the rates of duty for all the sorts of
goods, which has usually the form of an Act. Each sort of goods is assigned a numeric
indication and an appropriate rate of duty at the same time.

The customs tariff is a systematic arrangement of the rates of duty for all the sorts of
goods, which has usually the form of an Act. Each sort of goods is assigned a numeric
indication and an appropriate rate of duty at the same time. In Customs Tariff there are
usually general, conventional or preferential types of rates of duty:

Check questions and tasks:

• What are the effects of customs?

• How can we subdivide the customs?

• What are the types of customs procedures?

75
7. TRANSACTIONS IN FOREIGN TRADE

Objective of the chapter: The objective of the chapter is to make the students
acquainted with the activities and operations in the international trade, with the particular
steps of the business transactions and with the particular terms of purchase contract, which
include the subject of purchase contract, price, term of delivery, place, terms of payment by
the buyer and others.

7.1 Nature of operations and activities in economic relations

The term operation in the external economic relations means the final phases of
activities within the particular sections of these relations, which lead to creation of certain
contracts related to foreign subjects. The nature of these operations is defined by the
following basic features:

• contractual determinability and determinateness,

• determination of contractual parties,

• definition of the subject of relation and its terms,

• rise of the foreign exchange receivables or obligations,

• place in the balance of trade and in the balance of payments.

7.2 Main types of operations and activities in external economic

relations

The activities and operations in the international trade can be classified according to
the following aspects:

• subject – it is the most frequent aspect of division and the operations are
then divided into two groups: operations with tangible products and operations
with incorporeal goods,

• territories – it is possible to distinguish the operations with partners in

industrially advanced countries, EU countries, countries of Eastern Block, etc.,

76
 • type of contract – according to this aspect we can distinguish the
business transactions, intermediary transactions, transport transactions, etc.,

• movement of goods – on the basis of various movements of goods it is

possible to distinguish the export, import, transit and re-export transactions,

• relation to the process of reproduction – according to this very

frequently used aspect the operations are divided into the following groups: sphere
of research and development, sphere of production, exchange, accompanying
services and separate services, which are further divided as follows:

o transactions in the sphere of research and development

licence transactions, cross-licensing, scientific and technical assistance, direct

scientific-research-development cooperation with foreign companies

o transactions in the sphere of production

improvement operations, reprocessing operations, research and development activity,

licensing production, manufacturing specialization, co-production, joint projecting, joint
investing, subcontracting, entrepreneurial deliveries of complete industrial plants, joint
ventures, co-partnership in production

o transactions in the sphere of exchange

traditional business transactions, barter trades and blocked transactions, re-exports,

general transactions, exchange businesses and auction transactions, switch, transit operations,
arbitrations of exchange

o transactions in the sphere of accompanying services

forwarding, transport, storage, mediator, intermediary, insurance, reinsurance and

control operations

o transactions in the sphere of separate services

consultancy, supply, individual engineering, geological services, engineering and

technological service, advertising services, information services, leasing and rental, factoring
and forfeiting, and others

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 7.3 Methods of export and import

There are many possibilities of performing the connection between the producer and
consumer at the export or import of goods. This way can be ensured by various numbers of
economic subjects. The variants, which can take place, are as follows:

• according to a direct agreement the producer shall ensure the movement

of goods to the place of final consumption, including storage, insurance and
control of goods,

• the consumer shall ensure all the movements of goods to the place of
consumption, which reduces the individual selling price,

• on the basis of mutual agreement the producer and consumer shall

ensure a certain part of the goods’ way; then they share proportionally the costs on
transport, reloading of goods, package, storage, insurance, etc.,

• a third economic subject, which functions as a mediator, enters between

the producer and consumer at the exchange, and ensures the movement of goods,

• more economic subjects enter between the producer and consumer, and
ensure the transport of goods.

The basic possibilities of the connection between the producer and the ultimate
consumer in the international trade are generally the same as in the intrastate commerce, but
we can observe in the international trade the following additional differences:

• the movement of goods from the producer to the consumer passes through the
frontiers of states,

• the number of economic subjects participating in the exchange is usually higher

than in the intrastate commerce,

• the legal aspects, which influence the choice and application of the trade method,
are more complicated than in the intrastate commerce,

• even the transport of goods is more complicated, namely because of longer

distances and because of problems connected with the preservation of the use value of goods
in the course of transportation,

• a flexibility is needed with regard to the changes in business conditions and terms,
which are more frequent in the international trade than in intrastate commerce.

78
 7.4 Contractual safeguarding of market channels and purchase
channels

At the safeguarding of sale and purchase of tangible goods, but also at trading with
services, there are used the brokerage contracts, contracts with a commission agent and
contracts on exclusive taking delivery.

The nature of the intermediation is an activity, which targets the conclusion and
performance of a business. It concerns the situation, when the intermediary procures for the
interested party an opportunity for conclusion of a transaction with the third party, or he
himself concludes the transaction in the interest of one (or both) parties.

The relationship between the interested party and the intermediary is determined by
the brokerage contract, in which there are set forth the basic rights and obligations of both
partners. The intermediary undertakes to pursue an activity targeting the conclusion of a
certain agreement between the interested party and the third party. If the agreed result is
achieved (the transaction takes place), the intermediary has a claim to brokerage
(commission).

The intermediaries in international trade are indicated with various names, such as
agent, stockjobber, negotiator, broker, dealer, commercial representative, seller, etc. Some of
them can specialize to a certain area and work independently for various interested parties;
others may be bound by a one-time contract to one contractor.

A specific type of intermediation is represented by the commercial representation. It is

such an activity, when the intermediary pursues for the represented party a permanent activity
targeting the securing of the sale or purchase on a certain market, and receives a commission
for this activity.

This relationship is determined by the contract on representation, in which there are

specified the subject of representation (sort of goods or services, to which the intermediation
relates) and the contractual area (in which the representative will act). In this contract there
are also specified the obligations of both parties. The obligations of the representative include
to permanently intermediating the transactions, to connect business relations with such
partners, which are expected to fulfil the undertaken obligations, to inform the represented
party about the situation on the market, to keep the business and professional secrets, etc. The
obligations of the represented party include above all the payment of commission to the
representative.

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 Another type of contracts, which may occur in the international trade, is represented
by the contracts with a commission agent. The commission agent concludes the businesses in
his own name, on the account of the order party (committer).

When concluding the agreements, the commission agent has to follow the conditions
determined by the committer. These conditions may include the price limits, terms of
payment, etc. The contract with a commission agent has many similar features with the
representation contract, because the commission agent does not guarantee the fulfilment of
purchase contract by consumer, and obtains a commission (similar to the representative), if
the contract is fulfilled.

Exclusive sale (dealing) contracts are such contracts, which contain an obligation of
the supplier, that he will be selling the agreed goods only to the relevant contractual partner
on the contractual territory.

This type of contract is different from the brokerage contract and contract with a
commission agent, because the exclusive dealer purchases the goods from the producer in his
own name, on his own account and at his own risk, and sells them to the customers in his
country. By means of this contract the producer creates – through the exclusive dealer - a
contact with market. The exclusive dealer does not receive any commission for his activity;
his “commission” is the right to keep the profit resulting from the executed transactions.

Contracts on exclusive taking delivery contain an obligation of the customer, that he

will be taking delivery of the agreed goods exclusively from a certain supplier. This
obligation is usually compensated by certain obligations of the supplier, such as regular
supplies, guarantee of terms of the business for a longer time, etc.

7.5 Operations in the sphere of trade

Each business transaction has a certain specific course, which is influenced above all
by the sort of goods, by the character of the relevant market, by trading-policy situation and
by selected business method. The course of the operation itself can be then influenced also by
fortuitous events, which may occur in various phases of the operation.

The applied trading-policy means influencing the business transactions include the
traditional means, such as treaties of commerce, trade agreements and payment and credit
agreements, and various interstate agreements.

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 7.5.1 Treaties of commerce

These general treaties regulate the economic relationships between the contractual
states in the broadest sense of the word, they regulate the mutual position of physical and
legal entities between the contractual states, determine the basic tax, customs’ and legal
issues. These treaties form such a frame for other trading-policy agreements, which are based
on the above-mentioned treaties and which are aimed more concretely.

7.5.2 Trade agreements

The trade agreements are usually based on the treaties of commerce and their
effectiveness is usually three years, five years or more. These agreements ensure the exchange
of goods between the contractual states and enable to overcome the unfavourable
consequences of some autonomous measure. They can also relate to the sphere of services,
namely the directions of transport, choice of carrier, insurance issues, etc.

7.5.3 Payment agreements

If the regulation of payment system is not included in the trade agreement, the
particular states conclude separate treaties, which are called payment agreements. These
agreements relate to the system of payments, which is effected in free convertible currencies
or on the basis of bilateral or multilateral clearing of receivables and obligations.

7.5.4 Other bilateral interstate agreements

Other agreements, which may be concluded, include credit and investment

agreements, interstate agreements on industrial cooperation, on economic cooperation,
agreements on protection of the investment, agreements on exclusion of double taxation, etc.

7.5.5 Multilateral treaties, conventions and institutions

One of the main multilateral treaties applicable in the international trade is the GATT
(General Agreement on Tariffs and Trade). The purpose of this agreement is the reduction of
customs tariffs and liberalization of international trade. An important role is also played by
international agreements on primary commodities, which influence the quantity of the
production offered, prices and other terms and conditions of the trade.

7.6 Course of business transaction

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 With regard to the fact that especially in trading policy it is necessary to create
favourable conditions for execution of a business transaction by means of permanent
promotion, service activity, etc., the choice of trade method is very important as it has long-
term effects on the relevant market and on the relevant group of goods. The trade method
influences the distribution channels, the method of provision of accompanying services in
import and export, etc. That is why long-term treaties are frequently being concluded both
with the intermediaries, and with the agents and subjects providing services.

7.6.1 Export

a) The business transaction in export begins with sending of an offer. This offer can be
sent from initiative of the exporter or as a reply to the demand of the buyer. Offer should be
formulated and sent off in such a way that it contained all the terms and conditions of a
purchase contract, by acceptance of which this contract could be concluded.

b) Therefore before sending the offer, a preliminary calculation should be executed,

which should include the particularities of the relevant transaction, financial position of the
partner, currency situation, etc.

c) Before the conclusion of a purchase contract, there take place frequent additional
negotiations, which specify or modify the terms and conditions contained in the offer,
respectively in the purchase contract. After unreserved acceptance of the proposal by both
contracting parties the purchase contract comes into existence.

d) After conclusion of the purchase contract the delivery must be ensured in the
manufacture, if it does not concern a delivery from stock.

e) Upon the conclusion of the purchase contract and ensuring the delivery, other
phases occur, such as: the provision of transport of goods, insurance, control of goods and
other obligations resulting from the purchase contract. If the goods are dispatched, the
exporter advises the customer of this fact, invoices the delivery and hands over the documents
in accordance with the relevant terms of payment.

f) The transaction is concluded, when the customer takes delivery of the goods and
pays the purchase price.

g) However, in some cases the obligations of the supplier do not end thereby. Namely
just then, if the supplier warrants for the defects of goods within the warranty periods, if he
undertook to provide some services to the customer, etc.

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 7.6.2 Import

The business transaction in import is initiated by the domestic customer, which takes
the imported goods. On the basis of offers the appropriate importer (which can be a
production or business company) carries out a survey of the supply possibilities of the foreign
suppliers, and afterwards he makes decision on the most advantageous offer. If the importer
accepts bindingly the offer of the foreign supplier or confirms the order with the foreign
partner, the contract comes into existence.

Before delivery the foreign supplier must fulfil all the obligations resulting from the
purchase contract (for example delivery of technical documentation, provision of transport of
goods, etc.). If the customer has any obligations resulting from the purchase contract (for
example opening of a letter of credit, etc.), he must also fulfil them.

The transaction is concluded, when the supplier delivers the goods in accordance with
the concluded contract and the customer pays for it.

The final result of the business transaction can be determined after fulfilment of all
obligations of the supplier and buyer, possibly after fulfilment of obligations, which result
from the connected arrangements with forwarders, carriers, intermediaries, banks, etc.

7.7 Creation of purchase contract

Purchase contract is a legally binding arrangement, in which the seller undertakes to

deliver to the buyer the subject of purchase and enable him to acquire the property right to this
subject, and the buyer undertakes to take delivery of the subject of purchase and to pay the
purchase price. From the purchase contract there result the terms and conditions, under which
the transaction takes place.

The form, contents and method of conclusion of purchase contracts are influenced by
the particularities of character of the traded goods, by commercial usage of the particular
countries and business sector, as well as by economic and legal position of the contractual
parties.

When concluding a purchase contract, it is necessary to pay attention, from the legal
point of view, to that the conditions of validity of the legal act of both contracting parties
would be met. They may include due manifestation of will of the acting person, observance of

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the form and contents of contract, conformity of the content of legal act with the law,
performability of obligation, etc.

If both parties agree upon essential terms, the purchase contract comes into existence.
These terms may be determined by law or they can result from the will of contracting
partners. The contract comes into effect upon signature by both parties on one original
document, which can happen if all signing persons are present, or by written contact.

The most frequent cases of origin of the contract are as follows:

• a binding offer and its acceptance by the buyer provided that the
offer can be drawn up also as a pro-forma invoice,

• an order and its confirmation by the seller.

7.8 Contents of classic purchase contracts

Each purchase contract includes an introduction part, containing the name of

document, its number, place and date of issue, determination of the seller and buyer with
exact names of firms and their addresses, introductory sentences expressing the conclusion of
contract and reference to general conditions.

A further content of the particular contracts is individual as it is influenced by the

particularities of subject of trade, by character of the market, by business methods and scope
of obligations of the contractual partners.

Besides the essential terms, such as the subject of purchase and price, the significant
terms of the contract in international trade include: the terms of delivery, terms of payment,
method of carriage and delivery parity. The purchase contract may also include the provision
concerning the consequences of breach of contract, lodging a claim, etc.

Most of conditions have a direct impact on the price; however the relations may even
exist among other conditions respectively.

So most of the purchase contracts include the following terms:

• subject of purchase contract,

• price,

• term of delivery,

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 • terms of payment,

• delivery parity,

• method of carriage,

• other terms.

7.8.1 Subject of purchase contract

The subject of purchase contract plays the main role among the others conditions and
is a starting point for further terms and conditions. It can be specified individually or by the
sort and quality, or by quantity of goods.

The sort and quality of goods may be specified in various ways, which include the
description of goods, indication of brand (mark), indication of production type, reference to
previous delivery, application of technical norms and standards, chemical composition,
specific gravity, etc. The particular methods of specification are often combined, so that the
specification of sort and quality of goods would be as precise as possible.

The quantity of goods may be qualified in various units of measure (pieces, units of
length, units of mass, etc.). It is also possible to use in the international trade the quantity unit
specific for a relevant sort of goods, which became the usances, such as the barrels, or
bushels. As for the finished goods, the quantity is specified accurately, as for the bulk cargo, it
is usual to determine the quantity only approximately with a certain tolerance, which can be
agreed upon explicitly.

The method of packing is agreed upon together with the subject of purchase, namely
in case that the nature of goods does not allow to deliver the goods in bulk. In the contract
there is then determined the kind of package, quality, dimensions and methods of settlement.
The main function of package is above all protective, especially during the transport; however
the package also influences the possibilities of handling, the level of costs of circulation and it
can also have a promotional significance. Each package must be indicated with a sign, which
is then mentioned on all accompanying documents.

7.8.2 Price

According to most legal orders the price belongs to the essential terms of purchase
contract. The price can be agreed upon as a flexible price depending on various factors, or a

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method is just mentioned how to determine the price in the future, but the price is most
frequently determined as a fixed price.

In purchase contract the price is expressed in relation to a certain unit of measure

(price per 1 piece, per 1 kilogram ……..) and is expressed in units of a certain currency. The
type of currency may be predetermined by trading-policy conditions or it depends on
agreement between the parties.

In the international trade there are used a lot of various price adjustments, such as
rebate, bonus, premium, etc. The rebate can be a price discount, i.e. a reduction in price
defined in the price list, or a quantity discount, which means a discount connected with taking
delivery of a certain quantity of products.

In order to reduce the exchange rate risk, the exporters and importers may use in most
cases the non-contractual methods, such as forward operations on exchange markets,
insurance of exchange rate risk or the sale of claim within factoring or forfeiting.

7.8.3 Term of delivery

The term of delivery represents an important means of competitors fight and it is

agreed upon explicitly in most purchase contracts. When negotiating the term of delivery, the
seller usually endeavours to meet the requirements of the buyer, who is interested in as short
terms of delivery as possible.

The term of delivery may be agreed as an exact date of delivery, performance of

delivery, or as a certain period after performance of an important fact (for example granting of
an import licence or opening of a letter of credit). As for large contracts, it is usual to agree
the term of delivery as a successive term, when in the contract there are determined fixed
terms of delivery for the particular part deliveries.

It is also possible to use the so-called “term of delivery on call”, which means for the
seller that he must be ready – within this term – to deliver the particular parts at any time on
request of the buyer.

The term of delivery JIT (“just in time”) is another possibility meeting the
requirements of the buyer. In this way the suppliers help to optimise the production process of
customer by delivering him the goods on such place and at such time, which are most suitable
for the customer.

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 7.8.4 Terms of payment

The term of payment determines the place, time and method of payment of the
purchase price by the buyer. It considerably influences the effectiveness of trade transactions
and predetermines their financing. The most frequently used instruments of payment and
reinsurance in the countries with market economy include:

• bills of exchange,

• cheques,

• advance payment,

• documentary letter of credit,

• documentary collection,

• payment against delivery of goods,

• payment immediately on receipt of goods,

• payment within a certain period after the delivery.

Bill of exchange is an instrument to order, which is determined by essential terms that

are set forth peremptorily in law. This security may serve as a payment instrument, when by
means of bill of exchange a debt is paid to the credit of a concrete creditor’s account; as a
credit instrument in case that the supplier or bank grant to the costumer a credit covered by
bill of exchange; a securing instrument, if the customer’s debt was not paid at the agreed due
date, or as an instrument of the creditor’s own refinancing before due date in the form of
discount or in the form of forfeit.

We can divide the bills of exchange into two groups: foreign bills and promissory
notes. The foreign bill is an unconditional payment order of the drawer to the drawee to pay to
an entitled person, indicated in the bill of exchange, a certain amount on a certain place and at
a certain time. The promissory note is an unconditional promise of the promisor to pay to an
entitled person, indicated in the bill of exchange, a certain amount on a certain place and at a
certain time.

Cheque is a security, which serves at the same time as a payment instrument, by

which the drawer of cheque orders to his bank (so-called chequer) to pay to the holder of
cheque the relevant amount. If the exporter decides on the terms of payment and selects the
cheque, it is necessary to request a bank cheque, because it is the most qualitative kind of

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cheque. The risks at bank cheque are minimal for the payee and can be eliminated by a
consistent and careful check of all terms.

Advance payment is the payment of a part of the purchase price in advance. The
purpose of this method of payment is to reduce the risks of supplier resulting from a possible
customer’s avoidance of a contract and to provide a certain amount of means for the financing
of production of goods. From the point of view of the customer this method has all risks of the
credit relationships and therefore it usually requires a bank guarantee.

Documentary letter of credit is a contractual documentary payment instrument. It

concerns an instrument, which has been used for a long time and therefore it is a well
developed, but expensive instrument.

The supplier has certainty that if he fulfils the L/C conditions, i.e. if he submits the
required documents, he will be paid, even in the case that the customer would not or could not
take delivery of the goods and would not pay for them. On the contrary, the customer has
certainty that the supplier will not be paid before delivering and submitting the appropriate
documents evidencing the delivery. The bank authorized to payment may, if required by the
opening bank, confirm the L/C; thereby it enters in the same obligation towards the
beneficiary as the opening bank. The authorized bank must then pay the L/C after fulfilment
of the L/C conditions, even if the opening bank goes meanwhile bankrupt or is otherwise
unable to pay its obligation. Thereby even the risk of financial insolvency of the buyer’s bank
is covered, possibly of the territory, if it concerns the foreign trade.

Participants in the transaction in the simplest form:

• applicant for the letter of credit (order party, buyer, importer),

• bank opening the letter of credit,

• beneficiary (seller, exporter).

However, the beneficiary usually does not know well the standing of the bank opening
the L/C, which has usually its seat in the country of importer, often very far. That is why
when negotiating the L/C, the beneficiary may request that a corresponding bank (advising
bank, confirming bank) would enter in this transaction, which has its seat in his country,
possibly even in his city. This bank may reliably estimate the standing of the issuing bank and
may quickly and reliably communicate with it (for example by means of SWIFT).

The documents, which are usually required by the letter of credit, include:

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 shipping document in accordance with the method of transport (bill of lading,
forwarder’s receipt, duplicate copy of railroad bill of lading, the third original of air waybill,
postal receipt, etc.),

• bill of exchange,

• signed commercial invoice,

• consular invoice or customs invoice,

• insurance policy or certificate of insurance,

• other documents (certificate on

provenance of goods, certificate of inspection,
etc.).

Documentary letters of credit, which are being used

in the commercial relations with abroad, can be export or
import documentary letters of credit.

The letter of credit covering the export of goods is

being sent by the foreign bank to the bank of the exporter
(beneficiary) with a request for its advising or confirming,
and on the contrary the letter of credit covering the import of
goods is being opened by the importer in favour of its
foreign supplier.

Documentary collection is a non-contractual documentary payment instrument,

which is connected with the handing over of documents covering the delivery of goods. A
well functioning documentary collection includes the documents representing the goods,
respectively the documents, without which the customer cannot dispose of the goods.
Sometimes the acceptance of bills of exchange is required instead of payment (if it concerns
the credit). The documentary collection provides a certainty to the supplier that the customer
will not obtain the documents (in the case of documents of title that he will neither obtain the
goods) before paying respectively before accepting the bill of exchange. However, it does not
protect him against the unwillingness of the customer to take delivery of the contracted goods.

The collection receivables are receivables of the order party (seller), not of the banks,
to which the documents for provision of collection are entrusted. Neither the sending nor the

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submitting bank has any possibility to force the buyer to fulfil his obligation arising from the
contract.

The export documentary collection is a form of payment relations with abroad, at

which the delivery of documents and thereby of the goods, is conditioned by payment,
acceptance of bill of exchange or by fulfilment of other conditions.

The application of the export documentary collection is suitable in the cases, where the
exporter is not willing to deliver the goods against the settlement by smooth payment, but he
does not need any securing instrument, such as the documentary letter of credit.

So the use of this instrument is suitable in the following situations:

• the exporter has no doubts on the willingness and ability of the importer
to pay,

• the political, economic and legal milieu of the country of importer is

considered as stable,

• the country of importer did not issue any restrictions on the import of
goods.

The documentary collection as an instrument of payment relations in import represents

a bank’s disposal of the documents on the basis of accepted instructions from the foreign
order party (i.e. the foreign bank or the supplier). By the contract on the banking documentary
collection the domestic bank then undertakes to deliver to the debtor the documents
authorizing him to dispose of goods or other documents, which were entrusted to the bank by
the order party, if the debtor pays the agreed amount at the delivery of the documents, or if he
performs another collection transaction. So the foreign exporter has the disposal of the goods,
which is secured until the moment of fulfilment of the conditions predetermined in the
documentary collection.

The foreign exporter (order party) shall hand over the order to perform the collection
to its banking connection (the sending bank) or he will send it directly to the domestic (the
submitting bank). The collection order is accompanied by a various combination of
accompanying documents – collecting, transport, storage, insurance and auxiliary documents.

Payment against delivery of goods may take place as “cash on delivery” of the
carrier, i.e. the carrier shall deliver the goods to the receiver only against payment. Another
possibility is to perform the collection by means of the forwarder.

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 It is possible to apply the payment term payment immediately on receipt of goods
towards the most reliable customers, which is performed by a simple settlement. An
advantage of this method is the fact that it is connected with very low expenses. However, a
disadvantage of this method is the danger that deferred payment from the side of buyer will
cause an uncovered credit of supplier.

Payment within a certain period after the delivery is enabled at almost all kinds of
goods. Short-term supplier credits up to one year are granted for the deliveries of consumer
goods, long-term supplier credits are granted for the deliveries of big machines, equipment
and complete industrial plants.

7.8.5 Delivery parity

This term (delivery parity) defines in the purchase contract some obligations of the
contracting parties, which are connected with the provision and taking delivery of goods. It
concerns above all:

• place of delivery of goods by the supplier at the disposal of the

consumer,

• place and time of transfer of costs settlement connected with the

delivery, from the seller to the buyer,

• place and time of transfer of risks of loss or of damage to the goods,

from the seller to the buyer,

• additional duties and obligations of the contracting parties at the

provision of carriage, accompanying documents, control operations, insurance,
packing of the goods, etc.

In 1936 the International Chamber of Commerce (ICC) published the INCOTERMS

(International Commercial Terms), which are the most commonly used trade terms unifying
the interpretation of the delivery parities. These terms have no character of legal norm,
however, if the contracting parties incorporate them in the purchase contract and refer to
them, they become binding.

The terms are divided into several groups:

E – 1 term concerning the provision of goods (EXW),

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 F – main freight is not paid by the seller (FCA, FAS, and FOB),

C – main freight is paid by the seller, there is a different moment of transfer of risks

and division of costs (CRR, CIF, CPT, CIP),

D – terms of delivery (DAF, DES, DEQ, DDU, and DDP).

EXW - Ex Works (... named place)

“Ex works” means that the seller delivers when he places the goods at the disposal of
the buyer at the seller’s premises or another named place not cleared for export and not loaded
on any collecting vehicle. This term thus represents the minimum obligation for the seller.

The buyer has to bear all costs and risks involved in taking the goods from the seller’s
premises or from another named place. This term should not be used when the buyer cannot
carry out the export formalities directly or indirectly.

FCA - Free Carrier (... named place)

“Free Carrier” means that the seller delivers the goods, cleared for export, to the
carrier nominated by the buyer at the named place. The seller must obtain at his own risk and
expense any export licence or other official authorization and carry out, where applicable, all
customs formalities necessary for the export of the goods. The chosen place of delivery has an
impact on the obligations of loading and unloading the goods at that place.

If delivery occurs at the seller’s premises, the seller is responsible for loading on the
vehicle. If delivery occurs at any other place, the seller is not responsible for unloading of the
goods, i.e. he fulfils his obligation of delivery by placing the goods at the disposal of the
carrier (nominated by the buyer) on the means of transport not unloaded.

FAS - Free Alongside Ship (... named port of shipment)

“Free Alongside Ship” means that the seller delivers when the goods are placed
alongside the ship nominated by the buyer at the named port of shipment, on the date or
within the time period set forth in the purchase contract and in the manner customary at the
port. The seller must carry out at his own risk and expense all export and customs formalities.

The buyer has to bear all costs and risks of loss of or damage to the goods from the
moment of delivery of goods.

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 FOB - Free On Board (... named port of shipment)

“Free On Board” means that the seller delivers when the goods pass the rail of ship
nominated by the buyer at the named port of shipment on the date or within the time period
set forth in the purchase contract. The seller must also carry out at his own risk and expense
all export and customs formalities.

The buyer has to bear all costs and risks of loss of or damage to the goods from the
moment of delivery of goods on the board of ship.

CFR - Cost and Freight (... named port of destination)

“Cost and Freight” means that the seller delivers when the goods pass the rail of ship
nominated by the buyer at the named port of shipment on the date or within the time period
set forth in the purchase contract. The seller must pay the costs and freight necessary to bring
the goods to the named port of destination, but the risk of loss of or damage to the goods are
transferred from the seller to the buyer from the time the goods have passed the ship’s rail at
the port of shipment. The seller must clear the goods for export.

CIF - Cost, Insurance and Freight (... named port of destination)

This term “Cost, Insurance and Freight” is identical with the term CFR, as for the
rights and obligations of the seller and of the buyer. However, the seller also has to procure
marine insurance against the buyer’s risk of loss of or damage to the goods during the
carriage. Consequently, the seller contracts for insurance and pays the insurance premium.
This insurance is only on minimum cover, which means the minimum insurance shall cover
the price provided in the contract plus ten per cent (i.e. 110%) and shall be provided in the
currency of the contract.

CPT - Carriage Paid To (... named place of destination)

“Carriage Paid To ……” means that the seller delivers the goods to the carrier
nominated by him but the seller must in addition pay the cost of carriage necessary to bring
the goods to the named destination. The risks of loss of or damage to the goods are transferred
from the seller to the buyer from the time they have been delivered to the carrier. The seller
must also clear the goods for export.

If subsequent carriers are used for the carriage to the agreed destination, the risks of
loss of or damage to the goods pass to the buyer when the goods have been delivered to the
first carrier. “Carrier” means any person who, in a contract of carriage, undertakes to perform

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or to procure the performance of transport of the goods, by rail, road, air, sea, inland
waterway or by a combination of such modes.

CIP - Carriage and Insurance Paid to (... named place of destination)

According to this term “Carriage and Insurance paid to …….. ” the seller has the same
obligations as with the term CPT, but the seller also has to procure insurance against the
buyer’s risk of loss of or damage to the goods during the carriage. Consequently, the seller
contracts for insurance and pays the insurance premium, the same way as with the CIF term.

DAF - Delivered At Frontier (... named place)

“Delivered At Frontier” means that the seller delivers when the goods are placed at the
disposal of the buyer on the arriving means of transport not unloaded, at the named point and
place at the frontier, but before the customs border of the adjoining country.

The term “frontier” may be used for any frontier including that of the country of
export. Therefore, it is of vital importance that the frontier in question be defined precisely by
always naming the point and place in the term.

The seller must also obtain at his own risk and expense any export licence or other
official authorization and carry out all customs formalities necessary for the export of the
goods to the named place of delivery at the frontier and for their transit through any country.

The term is suitable especially for the rail and road transport.

DES - Delivered Ex Ship (... named port of destination)

“Delivered Ex Ship” means that the seller delivers when the goods are placed at the
disposal of the buyer on board the ship not cleared for import at the named port of destination.
The seller has to bear all the costs and risks involved in bringing the goods to the named port
of destination before discharging.

The buyer must obtain any import licence or other official authorization and carry out
all customs formalities necessary for the import of the goods and must pay the costs of
customs formalities as well as all duties, taxes and other charges payable upon import of the
goods.

DEQ - Delivered Ex Quay (... named port of destination)

“Delivered Ex Quay” means that the seller delivers when the goods are placed at the
disposal of the buyer not cleared for import on the quay (wharf) at the named port of

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destination. The seller has to bear all the costs and risks involved in bringing the goods to the
named port of destination and discharging the goods on the quay (wharf).

The buyer must obtain any import licence or other official authorization and carry out
all customs formalities necessary for the import of the goods and must pay the costs of
customs formalities as well as all duties, taxes and other charges payable upon import of the
goods.

DDU - Delivered Duty Unpaid (... named place of destination)

“Delivered Duty Unpaid” means that the seller delivers when the goods are placed at
the disposal of the buyer on the arriving means of transport not unloaded, at the named place
of destination in the country of import. The seller has to bear the costs and risks involved in
bringing the goods to the named place of destination.

The buyer must in time clear the goods for import.

DDP - Delivered Duty Paid (... named place of destination)

This term “Delivered Duty Paid” represents the maximum obligation for the seller. So
it is a contrary to the term EXW. The seller delivers the goods to the buyer, cleared for
import, and not unloaded from any arriving means of transport at the named place of
destination in the country of import. The seller has to bear all the costs and risks involved in
bringing the goods to that place including, where applicable, any “duty” (which term includes
the responsibility for and the risks of the carrying out of customs formalities and the payment
of formalities, customs duties, taxes and other charges) for import in the country of
destination. If the seller is unable to obtain directly or indirectly the import licence this term
should not be used.

If the parties wish the buyer to bear some of the costs payable upon import of the
goods (such as value-added tax = VAT), this should be made clear by adding explicit wording
to this effect in the purchase contract.

7.8.6 Method of carriage

In purchase contract there is usually agreed the vehicle and way of transport. The
method of carriage must be selected with regard to the nature of goods, the way of packing,
the distance between the place of dispatch and place of destination, the term of delivery, the
amount and structure of costs of carriage, conditions of the particular carriers, etc.

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 Depending on the delivery parity there can be also agreed the buyer’s obligation to
send the traffic instructions to the seller within a certain period before the agreed term of
delivery, in some cases the buyer is also advised that the goods are ready for delivery, and
after dispatching the seller advises the delivery by announcing the time and place of dispatch.

7.8.7 Other terms of purchase contracts

Further terms and conditions, which are usually incorporated in the purchase contract,
include the terms of legal character, such as provisions on the applicable law, agreement on
jurisdiction, competence of court, which would settle any possible disputes arising from the
contract, the seller’s guarantee for quality of the goods delivered, etc.

7.9 Performance of trade contracts

The final phase of the business transaction is usually the performance of purchase
contracts. This is the most frequent way of expiration of obligations resulting from the
contract. However, there exist also other ways of expiration of the obligations. For example
the contracting parties may agree upon any changes to the contract or they can agree the
withdrawal from the contract; or the contract is not performed due to later accidental
impossibility of performance, etc.

The seller fulfils the purchase contract by delivering the goods to the buyer and by
performing all the acts enabling the buyer to acquire the property rights to the goods in
accordance with the purchase contract. The buyer fulfils the contract by taking delivery of the
goods and by paying the purchase price for that. So the fulfilment of the obligations arising
from the purchase contract is reciprocal. If either of the contracting parties does not fulfil its
obligations, neither the other party needs to fulfil.

7.10 Contractual fine

In the international business relations it is possible to guarantee the fulfilment of

contractual obligations by means of a contractual fine. Such fine means a certain amount of
money, or another non-monetary fulfilment, which the debtor must provide to the creditor in
case the debtor does not fulfil his obligations. The function of contractual fine is above all
safeguarding, and it is usual that a contractual fine for breach of contractual obligations of

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both parties is set forth in contract. The payment of this contractual fine by the debtor does
not release him from the duty to fulfil his obligations covered by this contractual fine.

7.11 Control of goods

With regard to the fact that quality has been recently becoming more and more
important, the check of taken goods is also an important aspect of transactions within the
international trade. Its main function is to verify and confirm that the subject of purchase
contract is identical with the agreed specification. This check can be performed by control
organizations on the basis of a contract on control activity, and these organizations state the
results on the so-called control testimony or certificate. In the aforesaid contract the inspector
undertakes to perform an impartial determination of the condition of a certain thing or
verification of a result of a certain activity and to produce a control certificate concerning that
fact, and the client ordering the check undertakes to pay to the inspector for this activity.

7.12 Service and technical assistance

As for the machines and equipment, the determination of the guarantee period forms
an integral part of the contract. If the guarantee period is not set forth in the contract
explicitly, the legal periods valid in the relevant customer’s country relate to both contracting
parties. As a heavy competition exists among the suppliers, the producers usually give the
guarantee periods and free guarantee service, which are longer than the legal ones.

Summary:

The operations in international trade include such activities, which lead to the
conclusion of contracts with foreign subjects. They can be classified according to the subject
of trading, territory, type of contract, movement of goods, etc.

In the sphere of trade all the operations can be influenced by the sort of goods and by
selected business method, but also by the trading-policy means, which are used by the
governments of the particular countries. These means include above all the treaties of
commerce, trade agreements, payment and credit agreements, and various interstate
agreements.

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 The business transactions are legally treated by means of a purchase contract, which is
a legally binding arrangement. It is possible to say simply that in the purchase contract the
seller undertakes to deliver to the buyer the subject of purchase, and the buyer undertakes to
take delivery of the subject of purchase and to pay the purchase price for it. The purchase
contract includes the subject of purchase contract, price, term of delivery, and terms of
payment, delivery parity and method of carriage. The final phase of the business transaction is
usually the performance of purchase contracts. So the fulfilment of the obligations arising
from the purchase contract is reciprocal. If either of the contracting parties does not fulfil its
obligations, neither the other party needs to fulfil. It is also possible to guarantee the
fulfilment of contractual obligations by means of a contractual fine.

The terms to be remembered:

• brokerage contract

• contract with a commission agent

• contract on exclusive taking delivery

• term of delivery

• terms of payment

• bill of exchange

• cheque

• advance payment

• documentary collection

• delivery parity

The relationship between the interested party and the intermediary is determined by
the brokerage contract, in which there are set forth the basic rights and obligations of both
partners. The intermediary undertakes to pursue an activity targeting the conclusion of a
certain agreement between the interested party and the third party. If the agreed result is
achieved (the transaction takes place), the intermediary has a claim to brokerage
(commission).

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 Another type of contracts, which may occur in the international trade, is represented
by the contracts with a commission agent. The commission agent concludes the businesses in
his own name, on the account of the order party (committer). When concluding the
agreements, the commission agent has to follow the conditions determined by the committer.
These conditions may include the price limits, terms of payment, etc. The contract with a
commission agent has many similar features with the representation contract, because the
commission agent does not guarantee the fulfilment of purchase contract by consumer, and
obtains a commission (similar to the representative), if the contract is fulfilled.

Contracts on exclusive taking delivery contain an obligation of the customer, that he

will be taking delivery of the agreed goods exclusively from a certain supplier. This
obligation is usually compensated by certain obligations of the supplier, such as regular
supplies, guarantee of terms of the business for a longer time, etc.

The term of delivery represents an important means of competitors fight and it is

agreed upon explicitly in most purchase contracts. When negotiating the term of delivery, the
seller usually endeavours to meet the requirements of the buyer, who is interested in as short
terms of delivery as possible.

The term of payment determines the place, time and method of payment of the
purchase price by the buyer. It considerably influences the effectiveness of trade transactions
and predetermines their financing.

Bill of exchange is an instrument to order, which is determined by essential terms that

are set forth peremptorily in law. This security may serve as a payment instrument, when by
means of bill of exchange a debt is paid to the credit of a concrete creditor’s account; as a
credit instrument in case that the supplier or bank grant to the costumer a credit covered by
bill of exchange; a securing instrument, if the customer’s debt was not paid at the agreed due
date, or as an instrument of the creditor’s own refinancing before due date in the form of
discount or in the form of forfeit.

Cheque is a security, which serves at the same time as a payment instrument, by which
the drawer of cheque orders to his bank (so-called chequer) to pay to the holder of cheque the
relevant amount.

Advance payment is the payment of a part of the purchase price in advance. The
purpose of this method of payment is to reduce the risks of supplier resulting from a possible
customer’s avoidance of a contract and to provide a certain amount of means for the financing

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of production of goods. From the point of view of the customer this method has all risks of the
credit relationships and therefore it usually requires a bank guarantee.

Documentary collection is a non-contractual documentary payment instrument, which

is connected with the handing over of documents covering the delivery of goods. A well
functioning documentary collection includes the documents representing the goods,
respectively the documents, without which the customer cannot dispose of the goods.

This term (delivery parity) defines in the purchase contract some obligations of the
contracting parties, which are connected with the provision and taking delivery of goods. It
concerns above all:

• place of delivery of goods by the supplier at the disposal of the consumer,

• place and time of transfer of costs settlement connected with the delivery, from the
seller to the buyer,

• place and time of transfer of risks of loss or of damage to the goods, from the seller to
the buyer,

• additional duties and obligations of the contracting parties at the provision of carriage,
accompanying documents, control operations, insurance, packing of the goods, etc.

Check questions and tasks:

• What is the classification of the operations in the international trade according to the
movement of goods?

• What are the differences between the possibilities of the connection between the
producer and the ultimate consumer in the international trade and in the intrastate commerce?

• What is the nature of the commercial representation as a specific type of the

intermediation?

• What agreements are ranked among the other bilateral interstate agreements?

• What are the most frequent cases of origin of the purchase contract?

• In what form may be agreed upon the term of delivery in the purchase contract?

• What is the advance payment?

• Who is the beneficiary and at which instrument does he occur?

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• What are the groups of the INCOTERMS terms?

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8. INTERNATIONAL TRADING RULES

Objective of the chapter: The chapter is focused on the trading rules, or usances,
which are observed at the conclusion of business transactions, and on the differences, which
are typical for different countries. The chapter also describes the conditions of Intraterms,
which is a set of standard conditions for the sale of goods.

Trading rules (usances)

The trading rules (usances), which have a special significance at the conclusion of
purchase contracts, are certain rules known and observed in the business circles. During the
last centuries they were created in the international commerce as special means or rules,
which had to and still have to aim to overcome the differences between the particular legal
systems and eliminate a certain uncertainty, which is connected especially with the conflict
resolution of certain issues. With regard to the fact that it does not concern any direct norms,
these rules are not generally binding legal norms. However, they create a legal regulation
between the contracting parties, which incorporated these means into their contractual
relationships, i.e. if the parties explicitly referred to these rules, or if it results from the
circumstances of the case that the parties kept in mind these rules at the conclusion of a
concrete contract.

Any departure from the trading rules is being considered as an exception. These means
may become a supporting source for the interpretation of rights and obligations of the parties
resulting from the concluded contract. The usances may relate - in the international trade – to
the relationships between the seller and the buyer, the forwarder and the order party, between
the consignor and the carrier, the bank and its client, etc.

The international trading rules developed separately in the particular sectors of the
international trade and at the present time they become more and more important. Different
rules are valid in the trade with certain primary commodities (for example with petroleum),
different rules apply in the trade with agricultural products (the hops, etc.), with military
materials. A special group of rules can be also represented by the utilization of various
abbreviations or specific terms, which can be used both in the contracts, and in other legal
relations.

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 The rules important for the international purchase contracts are especially as follows:

• the rules in connection with the interpretation of some terms and

conditions of the purchase contracts, for example:

o delivery parities,

o terms of payment,

o terms of delivery, etc.,

• the usances for the trade with certain commodities,

• the rules observed at the transport of goods, etc.

As it was said before, the trading rules do not relate only to the purchase contracts, but
they also relate to other relations, such as contracts of carriage, contracts on intermediation,
etc. Not all usances have a general, respectively global significance (as for example the
commodities’ usances), some of them have only local significance (for example the usances
observed in certain ports).

The trading rules can also arise as a result of a long-term observance of certain rules in
the mutual commercial relation of the business partners.

1. Usances are considered as a supporting source of the interpretation of rights and

obligations of the parties resulting from the concluded contract. They can be used everywhere,
where the parties agreed upon any certain condition indistinctly or roughly, where the parties
failed to agree upon any condition in the contract, or in the case, where the parties explicitly
referred to a certain trading rule. If the business partners apply at the conclusion of contracts a
generally known document (such as for example INCOTERMS), it is sufficient to refer to its
name to become an integral part of the contract. It is not necessary to enclose then this
document to the contract. However, if it concerns any document not generally known or if it
concerns any individual business conditions, then a mere reference to them is not sufficient.
These documents must be enclosed to the contract.

2. Although the trading rules serve for the simplification of the international trade,
they may include in themselves a certain danger. This danger results from the ambiguity of
the interpretation of the trading rules, namely not only interstate, but also intrastate, inside the
particular countries, for example in the particular ports. Therefore it is necessary to proceed

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very carefully at the application of the usances. If any dispute arises, it is necessary to prove
the existence of a certain rule, which is very often very difficult. Some institutions, such as the
International Chamber of Commerce, the chambers of commerce of the particular countries or
the UNO institutions published the interoperations of the rules, which can be used in the cases
of uncertainties or disputes. In such cases it is also possible to use the interpretation of the
trading rules resulting from the practice of the courts, statements of the experts, etc.

3. Another inconvenience connected with the trading rules is represented by the fact
that the business partners cannot be sometimes absolutely sure as for the interpretation of the
rights and obligations, although these rules are commonly observed. Therefore it is
recommended, especially in the case of doubts, to agree explicitly upon the terms and
conditions of the contract.

Sources of interpretation of the rights and obligations from the international

purchase contracts

The main sources, which are used for the interpretation of the rights and obligations of
the contracting parties, include:

• peremptory legal regulations,

• direct agreements between the parties,

• indirect agreements between the parties in the form of general

conditions, standardized (type) contracts, explanatory regulations or rules, to
which the parties referred in the contract,

• non-mandatory regulations of the law,

• common rules observed in the international relations in the relevant

business sector.

There exist countries, in which the trading rules have a higher obligatory force than
the non-mandatory regulations of the law, on the basis of the provisions of legal regulations.
Convention on the international purchase of goods, in article 9, represents a certain
compromise in this direction:

“The parties are bound by any rule, upon which they agreed, and any practice, which
they introduced mutually.

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 If not agreed otherwise, it is presumed, that the parties agreed indirectly that on the
contract or on the conclusion thereof should be applied such a rule, which both parties knew
or should have known, and which is in the international trade widely known to the parties to a
contract of the same type in the relevant sector and which is usually observed by them.”

Intraterms

The set of standard conditions for the sale of goods, which are divided into five
chapters dealing with the contracts generally, international sale, transport of the goods sold,
abbreviated conditions and resolution of disputes, are called International Trade Terms
(INTRATERMS). They have arisen in order to eliminate the uncertainties and disputes
resulting from the disharmonious provisions of the commercial legislation of various states.
The purpose of these conditions is to prevent the dangers, to which the buyers and the sellers
are exposed, if the contract is subject to the English commercial law or to the UNO
Convention on the international purchase of goods (so-called Vienna’s Convention).

The conclusion of a business contract, as well as the contents thereof, is always

dependent on the will of the contracting parties. In the international trade there are used
various business conditions for the purpose of facilitation and acceleration of conclusion of
the contracts and for elimination of danger that the provisions would be formulated
ambiguously. When drawing up a contract, the special conditions and terms agreed between
the parties take precedence over the standard conditions, and if the contract refers to
Intraterms, the specific conditions are just amended and defined, but are not cancelled.

The terms included in Intraterms are based on the principles of contractual freedom,
on the principles of customary law applied in the commercial relation, and on the principles of
fair commerce and well-balanced relationship between the contractual parties. These terms
were drawn up with regard to more than one legal system in order to be comprehensible for
the businessmen in various countries.

Trading rules – negotiations

The conclusion of purchase contracts and the use of usances are also included in the
negotiations at international level, where some different cultures meet, which can mean a
concurrence of certain specialities that must be taken into consideration and which must be

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anticipated in order to avoid any negative impact on the course of negotiation and on the
whole result of the negotiation. So the culture of the particular countries and the cultural
factors may influence the manner of negotiation with the foreign partners.

Although Europe endeavours to unify its manners (partly due to an easier competing
with the U.S.A. or Japan) and its surface is not too large in comparison with other continents,
there are still certain differences, on the one hand between the countries of Northern and
Southern Europe, on the other hand between the countries of Western and Eastern Europe.

The main cultural factors, which influence the negotiations in European Union,
include:

• Utilization of time – the proceeding in European negotiating is usually

quick; the meetings begin and end in time, as scheduled. Yet there are differences,
a more relaxed approach is usual in southern states (Italy, Spain, Greece, Portugal,
and France), in contrast to the strict punctuality in Germany, Netherlands, Belgium
and Scandinavian countries.

• Individualism – in contrast to the Asian and Arabian countries, in

Europe (especially in Western Europe) there predominates the consciousness of
one’s own position and the membership of a certain social class, where the
individuals feel to be independent on the organization of the working process.

• Hierarchy and conformity – the education and connexions have

considerable significance in the working environment, any excessive separation of
powers and delegation of authorities do not occur, although in Scandinavian
countries there is more usual the delegation of authorities and a better
communication. Any frequent change of work position is not common, the work
efforts are appreciated. In personal life there is appreciated the order, the
consciousness of responsibility and the leisure time spent with the family also
plays an important role.

• Verbal communication – a personal form without emotive

communications of the partner is expected especially at the beginning of the
meeting, people are addressed with the surnames, and clear forms of
communication without any uncertainties and ambiguities are used.

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 • Nonverbal communication – especially in the Western Europe the use
of the “body language” is a rarely used form of communication (in contrast for
example to Latin America or Arabian countries), especially an excessive
gesticulation is inappropriate during the business meeting. The distance between
discussing persons is kept in the length of approximately 50 cm; in Belgium and
the states of Northern Europe this distance is rather longer. Any physical contact,
except for handshake and handgrip, is not used at the business negotiations at all.
The eyes’ contact is almost a must, especially in the western countries. The
difference in the nonverbal communication is mainly in the southern states, where
a more expressive gesticulation and a more expressive manifestation of
temperament are being used.

• Business negotiation and decorum – the proceeding at the business

negotiation runs step by step (item by item), the introducing phase is neither too
long, nor unnecessarily quick. In comparison with the Northern America’s
representatives, in Europe there is a higher level of patience, which however does
not reach the Asian or Arabian patience. During the negotiations the firms’
representatives are usually formal, polite, flexible and open. They endeavour to
reach consensus, although they are not afraid to disagree and to resolve the
problems in a polite form.

The rules of decorum relate to handing over of visit cards, dressing, business
dinners, etc.

The basic aspects, for which you should be prepared before the business
negotiation at the international level, are as follows:

• Language of negotiation – the main negotiating languages

include: English, French, German, Spanish, Russian and others.

• Visit cards – the visit cards belong to the most common parts of
the business negotiations in most of the countries. The visit cards are usually
printed both in native language and in English. However, in various countries
there are differences as for the details mentioned on the visit cards (academic
titles, occupation functions, ……….).

• Addressing – the differences in addressing people may be

considerable, as in some countries it is common to use the Christian names, on

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the contrary in other countries it is considered as very impolite and is obvious
to use the titles when addressing people.

• Dressing – formal and elegant clothing without any fads is

normal at business negotiations in almost all countries.

• Preparation and forms of negotiation – the advance, in which it

is necessary to start with the preparation of negotiations, may vary in various
countries. In various countries there are commonly applied various rules for
the negotiations, such as for example: the delegation should be led by the
highest ranked person at the entry to the room (for example in China), or the
connection of successful contacts should be intermediated by a known and
reputable third person (for example in Japan), or the business negotiations
usually continue far into the night (for example in Spain), etc.

• Common dining – in many countries the business dinners or

lunches connected with the tasting of national specialities form an integral part
of the business life. It is usual to continue the business negotiation during the
lunch; however it is taboo in many countries to continue the negotiation during
the dinner.

• Humour – although the humour forms an integral part of the

negotiation in some countries (both satiric and personal), there are countries, in
which the negotiations are running in absolute seriousness and any humour is
inappropriate.

• Topics of discussions – various topics are sensitive for various

cultures, these may include for example: the family, the critique of the culture
of the relevant country, the politics, the company’s problems, taxes, habitation,
religion, etc.

• Gifts – although the company’s gifts and presents form an

integral part of the business negotiation in some countries, yet there are
cultures, in which it is absolutely inappropriate to bring any gift to the business
negotiation.

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 Summary:

The trading rules (usances) are certain rules known and observed in the business
circles, which developed separately in the particular sectors of the international trade. The
usances important for the international purchase contracts are as follows: the usances
connected with the interpretation of the terms and conditions of the purchase contracts, the
usances typical for the trade with certain commodities and the rules observed at the transport
of goods.

The peremptory legal regulations, the direct or indirect agreements between the parties
or the laws are the main sources, which are used for the interpretation of the rights and
obligations from the international purchase contracts.

The Intraterms have arisen in order to eliminate the uncertainties and disputes
resulting from the disharmonious provisions of the commercial legislation of various states. It
concerns a set of standard conditions for the sale of goods. The contracting parties may refer
to these conditions in the purchase contract.

The culture of the particular countries and the cultural factors may influence the
manner of negotiation with the foreign partners; therefore it is useful to get acquainted with
the differences of culture of the country, with which the international purchase contract is
being concluded.

The terms to be remembered:

• trading rules (usances)

• Intraterms

The trading rules (usances), which have a special significance at the conclusion of
purchase contracts, are certain rules known and observed in the business circles.

The set of standard conditions for the sale of goods, which are divided into five
chapters dealing with the contracts generally, international sale, transport of the goods sold,
abbreviated conditions and resolution of disputes, are called International Trade Terms
(INTRATERMS).

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Check questions and tasks:

• What is ranked among the main sources of the interpretation of

rights and obligations of the contracting parties?

• Why did the Intraterms arise?

• What forms of the physical contact are acceptable at the

negotiation?

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9. BALANCING AND FINANCING OF THE
FOREIGN TRADE

Objective of the chapter: The objective of the chapter is to make the students
acquainted with the possibilities of financing the international trade, with the particular types
of possible credits and with the instruments and methods, which can be used at the short-term
and long-term financing. Furthermore the students shall get acquainted with the term of
balance of payments, its structure, with the basic rules for its analysis and with the processes
of its balancing.

The receivables and payables arising out of the foreign trade activity may be balanced
in various ways. This chapter describes the possibilities of financing the foreign trade and the
balance of payments of state, which is closely connected with the balancing of foreign
receivables and payables.

9.1 Financing of foreign trade

The financing of domestic trade inland and financing of the international trade are
different in many aspects. The areas, which show the basic differences, include: the
demandingness on the financial means, the character of financial resources used for the
financing, the methods used and the risk rate, with which the financing of international trade
is connected. The differences are caused above all by the geographic distance between the
place of production and place of consumption. The overcoming of this distance may be very
time-consuming. Another issue that causes the abovementioned differences is the time
disharmony between the movement of goods and its payment, which is being influenced both
by large competition and by the credit requirements of the buyers. We can mention other
causes as well7:

• different dimension of the risk rate of international economic relations

in comparison to the domestic economy relations,

7
MACHKOVÁ, H. and composite authors International business transactions. Prague: Grada Publishing, 2003.
232 page ISBN 80-247-0686-5.

111
 • differences in the means, in which the business partners sharing the
transaction, act,

• and other factors.

Although it concerns the financing of international business transactions, this activity

is closely connected with the process of intra-company financing of both exporters and of
importers. It is impossible to separate the “foreign” activities of a company within the intra-
company finance management from the total finance flows, which are running within this
company, therefore even the financing of the international business transactions form an
integral part of the financing of company.

Financing of the international trade, due to the specifics connected with it, may bring
to the company new problems, which are different from the problems of domestic financing,
however it may also bring new possibilities of solutions. Therefore the decision-making
process, which takes place still before the conclusion of the business, is very important. This
process is targeted on the decision-making on the choice of resources required for acquisition
of necessary financing means, but also on the selection of appropriate methods, which would
ensure the return of means with regard to the run risks. The major part of the decision-making
process concerning the international market with goods or capital relates mostly to the
exporter, however even the importer must search for the most suitable methods for financing
of his activity.

The problems of financing, which are being resolved in addition to the financing of the
export and import transactions, relate to the activities, which are connected with the
commerce. They are as follows8:

• costs of research of the market,

• provision of the distribution channels,

• warehousing of products,

• promotion and publicity,

• guarantee repairs,

• service network and others.

8
MACHKOVÁ, H. and composite authors International business transactions. Prague: Grada Publishing, 2003.
232 page ISBN 80-247-0686-5.

112
 With regard to the fact that a number of subjects (producers, exporters, importers and
various types of commercial interlinks) participate in the safeguarding of the international
trade, the process of financing becomes more and more difficult. The financing is traditionally
provided especially by the banks and insurance companies, but it is also possible to use the
services of various specialized financing institutions, which may be state institutions, half-
state or private institutions. Also various international organizations may be partly involved in
this process.

On the market of the buyer the granting of credits became in the recent time a service,
which may significantly influence the saleability of goods on the foreign markets. This
however results in the increase of the finance-demandingness of export, thereby the times of
crediting are prolonged and this can lead to the larger competition in the area of credit terms.
The offered credit terms represent for some customers a priority aspect when selecting the
supplier, therefore the exporters often endeavour to offer at least such finance services
comparable to the common practice of the competitive firms.

Types of credits in the international trade

The international trade is often very finance-consuming, therefore the companies must
use the possibilities of credits. The credits, which are granted in connection with the
international trade, form very various groups that can be divided from the point of view of
various aspects. One of the aspects is the aspect of the credit grantor, we can then distinguish:

• supplier credit,

• credit granted by the customer,

• mediatory credit,

• bank credit,

• governmental credit,

• credit of the international organization.

Supplier credit

This credit is granted to the foreign customer by the exporter and in most cases it is
connected with the delivery of goods or services. In the purchase contract, contract for work
or in another contractual arrangement, which is relevant to it, there are agreed upon the credit

113
terms within the term of payment. The possibility to conclude a framework payment
agreement for a certain period of time, in which there are determined the terms of credit
granted together with the deliveries of goods within the appropriate period, is used only
rarely; this possibility is used especially between the firms with long-term stable business
relations.

Credit granted by the customer

This type of credit is used very rarely with regard to the current conditions of the
market of the buyer, mostly at the sale of specific sorts of goods or at the sale to risky
markets. In the purchase contracts this credit is agreed upon as a payment in advance. A
partial payment in advance (the so-called advance payment) represents a most frequent form
of this credit. It is being agreed upon at large deliveries of goods, which are being
manufactured custom-made, or at the realization of large projects, etc.

Mediatory credit

Some types of intermediaries (such as the dealers, brokers, etc.) grant this type of
credit on a short-term basis. These intermediaries are mostly represented by well-established
companies, which know very well the market as well as the financial needs of suppliers and
customers. However it may also concern such intermediaries, who directly specialize on
provision of the financial services to the business partners.

Bank credit

The most frequent method of direct crediting of the international trade is represented
just by the bank credit. The forms of credits granted by the banks may vary. It may concern
the short-term credits and long-term credits. The conditions of a bank credit and the
conditions of an export contract are resolved by different, absolutely separate contractual
provisions. The credit relation with the bank and the transaction, for which the credit serves,
are so separated, which is an advantage of the bank credits (especially because the customer
cannot avoid its payment obligations or delay them by means of claims on the quality, term of
delivery or similar objections towards the fulfilment of the contract from the side of the
supplier).

In the recent time the frequently used form of credit is represented by the credit
granted to the buyer (or the export customer’s credit), which is granted by the “bank of the
country of the exporter to the foreign customer either directly, or by means of its bank, on the
purchase of machines, equipment, complete industrial plants, on realization of large projects,

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etc.”9 The credit is quite advantageous for the exporter, as the bank usually provides the
settlement to the supplier at the time of delivery or at the time of placing into operation, and
so the credit does not enter in the balance of this company and thereby its liquidity is
influenced favourably.

Another form of bank credits is represented by the inter-bank credit arrangements,

which are being concluded without any direct connection with the certain business
transaction. These arrangements are usually agreed upon for the total value’s frame of the
credit, furthermore there are determined in them the purpose of credit, method of utilization,
maturity of credit, interest rates, etc.

Syndicated credits granted by the syndicate, or a group of banks, represent another

form of bank credits. They are being used for the crediting of projects requiring large amounts
of money. In the head of the syndicate there is a leading designer, who himself participates in
the granting of a certain part of the credit and who provides the means at other banks for the
remainder of the credit. Thanks to this connection it is possible to grant such financial
amounts, which otherwise could not have been granted because of their high amount as they
exceed the credit capacities of the banks.

Governmental credits

The governments of industrially advanced countries grant these credits to the

governments or public institutions of the underdeveloped countries as an instrument of
economic help. These credits are being granted on the basis of a separate intergovernmental
convention or as a part of agreements on the economic or other help, in which there are
agreed upon the amount of credit, the maturity of credit, interest rates, currency, character of
goods and services, for which the credit is determined, etc. It is also possible to grant within
the frame of these credits a part of the means in the form of non-returnable help (donations).

The conditions, under which the receiving party may obtain the governmental credit,
are usually more favourable than the conditions and terms of the supplier or bank credits. The
country, which grants the credits, thus supports its own export and usually meets even its
political objectives.

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 The disadvantage of such credits for the granting party is represented by the fact that
the governmental credits are reclaimable with difficulties in the event that the financial
solvency of the receiving country becomes worse.

Credits of the international organizations

The last of the above-mentioned types of credits is represented by the credits of

international organizations. They are important above all for the financing of economic help
either to the underdeveloped countries or to the transitive economies. The international
organizations granting the credits are as follows: World Bank, to which belong the IBRD
(International Bank for Recovery and Development), its subsidiaries companies IDA and IFC,
and regionally specialized development bank.

These credits can be granted to the governments, banks or public institutions and are
mostly used for the financing of selected development projects in the sphere of energetic,
agriculture, traffic, etc. These credits are often long-term credits 20 years and more) and have
a low interest rate.

Methods and instruments of financing

The companies operating within the international trade take into consideration – when
selecting the methods of financing – their own financial situation, the possibilities, which they
have, as well as the instruments and possibilities, which their business partner has. The
competition also plays an important role; therefore the companies also utilize the information
about the development on the national and international financial markets, which the
competition uses. Various legislative and other provisions concerning the currency sphere, tax
regulations, etc. may limit the companies’ possibilities, as well as the character of the
international payment relations or the level of development of the domestic financial market.

A big role - at selecting from the alternatives of acquisition of foreign sources - is

played by the costs, with which the particular methods are being connected, the speed of
acquisition of the financial means and the flexibility at their utilization, connected risks, tax
consequences, etc.

The methods used for the short-term financing of the international trade, are in
principle identical with the methods used for the domestic financing. They are as follows:

Bank overdraft

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 - this credit is granted by the bank to the clients having with this bank a bank overdraft
account. To such accounts it is possible to determine in advance the amount of debit, which
the client can agree, and with which a certain interest rate is connected. Up to this determined
limit the client may use the credit without limitation, which brings a considerable advantage
in the form of flexibility and operativeness of the utilization of the credit. It is being used
most frequently for the “bridging” of the short-term terms of payment and for payment of
costs of circulation.

Discount of bills of exchange

– the bills of exchange belong to the traditional methods of export. This method
functions as follows: the bills of exchange accepted by the customer are offered to the bank
for discount, the bank may buy the so far undue bills’ receivable of its client, and afterwards,
after reducing the discount the bank may give to the disposal the appropriate bills’ amount.
The drawee (at the foreign bill) or the drawer (at the foreign bill, which is usually the buyer)
undertakes to pay either within the term of a bill (by a certain fixed date), within a certain
period after the sight or within a certain period after issuing the bill.

Documentary letter of credit

– this instrument serves for the securing of payment, which functions as follows: the
bank undertakes to pay relatively independently on the will or ability of the buyer to pay. On
of the forms of the documentary letters of credit, which belongs to the most perfect methods
of securing the credit risks, is the L/C with deferred maturity, because the banks are often
willing, after deducting the discount, to buy such a secured receivable. Another type is the
transferable L/C, which is important for the commercial companies, because by transferring
the rights from L/C to the supplier the authorized entity may finance the purchases without
demands for its own financial sources.

Back-up of the export receivables

– this method concerns the exporters, to which the bank grants it for the undue
commercial receivables, so it finances usually only a certain part of this receivable. The costs
of this method are not low, as they are formed by the interest, by the commission to the bank

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for provision of the operation, and very often also the expenses connected with securing the
receivable (insurance premium, etc.).

Factoring

– it is a complex financial service concerning the financing and securing of the short-
term credits, which are granted at the supplies of goods and services. The short-term
receivables arising from the sale of goods and services are ceded to a specialized factoring
company ensuring its collection. If the factoring company takes over the guarantee for
payment, then the appropriate receivable is ceded without penalties for the original creditor.
However, this may take place on the basis of a factoring contract, which represents a legal
basis for that. In the above-mentioned contract the seller undertakes to cede his receivables to
the factor, and the factor undertakes to provide certain services. These services and their
scope are determined precisely in the contract. It may concern the financing of businesses,
performing the collection from the debtors, evaluation of creditworthiness of the customers,
etc. The factoring may be regressing (if the factor does not bear the delcredere risk and
provides only the financing), non-regressing (if the factor takes over the delcredere risk) or
maturity factoring (if the factor does not back-up the receivables before maturity, he performs
only the guarantee function. The collection from the customer is performed not before the
maturity). A special case is represented by the exporting factoring, which enables to overcome
the discrepancy between the credit requirements, markets, increased risk rate and financial
possibilities of the exporter. In this case it is possible to use the system of two factors, when
one factor is in the country of the exporter and the other is in the country of import, or to use
the second possibility, namely to insure the risk delcredere with a domestic insurance
company. The factoring represents an advantage for the exporter, as follows: it speeds up the
collection, saves the administrative costs or for example increases the competitiveness thanks
to the term of payment, which is more favourable for the customer. However, the factoring
has also some disadvantages, above all the costs connected with it, or the territorial limitation.

Loans on financial market

– the short-term credits, which are due within 12 months, can be obtained even in this
way. However, a problem consists in that the particular credit operations suppose a large

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value’s size, so they are available rather for the large companies. Small companies may utilize
this instrument through an intermediary, through a bank.

The methods used for the acquisition of financial sources of the long-term financing
of the international trade are usually connected with a concrete business transaction. The
medium-term and long-term financing is connected with high risks, therefore all subjects
participating in its securing endeavour to obtain certain guarantees that the due amount will be
returned to them. This can be provided either in the form of insurance, guarantee of reliable
sureties or in the form of cover of the receivables by valued securities.

National systems of financing the export credits

– these systems functions as a support of export in almost all states. The state, mostly
by means of specialized financial institutions (so-called agencies for export credits),
commercial banks, specialized on the foreign relationships, or credit institutions, which have
no concrete specialization, may share the financing in this form. The national systems finance
mainly the export of machines and equipment, furthermore the export of services and building
industry works. In order to limit the risks of the concrete credit relation, the financing is
linked with the insurance, which is usually supported by the state, but is limited by the
possibilities of financing.

Forfeiting

– this method is often used for the export of machines, equipment and complete
industrial plants, which are of high value. The forfeiting is gradually being used also for the
financing of goods or services. It concerns the “purchase of medium-term or long-term export
receivables, safety secured by the bank or by a specialized institution without any regress
towards the original creditor (exporter). In fact it concerns a certain perfecting of the classical
discount of bills of exchange, consisting in that the purchasing subject – forfeiter – assumes
all risks connected with the credit and does not claim any regress towards the exporter, when
the debtor does not pay.”10 In order for the forfeiter to be willing to accept these conditions,
the receivable must be negotiable on the financial market. An advantage of the forfeiting for
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MACHKOVÁ, H. and composite authors International business transactions. Prague: Grada Publishing,
2003. 232 page ISBN 80-247-0686-5.

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the exporter is his liberation from the credit risks. The exporter often obtains up to 100% of
financing of the export credit, namely without any demands for his own financial sources, so
his balance is not debited, which has a favourable impact on his liquidity. However a
disadvantage is represented by high costs, which include the commission for securing the
sources, the discount determined on the basis of a rate, for which the concrete currency is
negotiated and further fees.

Leasing

– it is similar to a lease relation, in which participate the subjects of at least of two

countries. At the leasing the tenant receives a right to use the goods of investment character
for the fees, which are fixedly determined, for a time of a predetermined period. The
difference between the common rent and the leasing consists in that the interested company
itself may select the leased object directly with the producer. At the end of the determined
period the user is offered a possibility to purchase the equipment for the price, which was
predetermined, to continue in leasing or to return the equipment to the lessor. Leasing is
provided by specialized financial institutions, frequently by subsidiary companies of large
banks, namely for the machines and equipment, traffic means (vehicle) and real estates. A
disadvantage is represented by the amount of fees, however the advantages are represented by
tax connections, by not debiting the balance of company by a debit or by possibility to better
harmonise the revenues and expenses, as the fees are paid not before the placing of equipment
into operation. We can divide the leasing operations as follows:

The leasing can be divided:

• By the number of the participating subjects:

Direct leasing – it concerns a relationship of two subjects,

usually the producer and the user of the equipment.

Indirect leasing – the indirect leasing relationship is formed by

three participants – the exporter, the lessor (leasing company) and the lessee
(the receiver of the leasing).

• By the scope of the services provided and time, for which the leasing is agreed
upon:

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Financial leasing – is concluded for a longer period, during
which the leased object is fully amortized. The user himself selects with the
producer the leased object and he also himself resolves with the producer any
possible claims. The fees, which are paid, include the purchase price, interests,
the risks surcharge and the commission to the leasing company.

Operative leasing – in contrast to the financial leasing the

operative leasing is being agreed upon for a short period, namely for a period,
which is shorter than the amortization period of the object of leasing. The
lessee has a possibility to withdraw from the leasing contract. The lessor, who
usually provides also additional services during the leasing period, bears the
risk that after the termination of the contracted period he will not obtain any
other interested entity. Operative leasing is used for the serially manufactured
products.

Return leasing - it is a special type of leasing, which is

concluded on the equipment already owned by the user, which is usually in the
operation. In this case the leasing company buys the equipment back and
immediately lease it to the original owner. The return leasing is being used in
order that the user would acquire the liquid means for further utilization.

In the international trade the leasing relationship is influenced by several additional

risks, such as the differences in the legal regulation of the participating countries, or by the
currency risk. The customs, tax and currency policies also belong to additional factors
influencing the leasing.

Medium-term and long-term loans on the market

– this instrument belongs to the modern ways and methods of financing and it is
possible to develop it further with the development of financial markets. It is available for
large companies, with good position on the market and with a good name. It is being used for
the financing of export of the complete industrial plants, building industry works, services and
direct foreign investments. The medium-term and long-term loans are usually provided by the
governments, governmental institutions, banks or even by large companies. The interest rate,
which is regularly modified, is usually completed by a margin influenced by the financial
standing of the debtor.

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 Project financing

– also this instrument belongs to the modern instruments and is used especially for the
financing of capital-intensive investments in the sphere of energetic, mining of raw materials,
construction of highways and railroad corridors, etc.

This method uses especially the private sources. The particular participants share even
the risks involved in the project. The sponsors, named as founders, participate in the
foundation of a special economic unit, which “roofs” the building and operations of the
project. The sponsors are usually represented by financially powerful subjects, which design
the project and are interested themselves in its implementation.

They often participate somewhat in the realization of the project (for example they
supply the technologies, they provide their own special unit, etc.). As a minimum these
founders participate with 25% in the means necessary for the realization of the project. The
foreign resources are also used for the project financing; the creditors are represented by the
banks or financial institutions crediting the established special economic entity. The project is
often accompanied by a study of feasibility.

9.2 Balance of payment and its significance

The balance of payment may be characterized as “a systematic statistic statement

(summary) of all economic transactions, which were effected within a certain period (usually
one year) between the national economy and the foreign states”11. The data may be of course
published even for a shorter period of time, for example one month or a quarter, and then
summarized into an annual statement.

The balance of payment includes then:

• clean currency flows (currency collections and currency

payments),

• also some material flows, which are not followed by the

monetary flows (for example real investments, tangible gifts or barter trades).

Balance of payment is a very important source of information for various analyses,

because it enables to evaluate the status and external performance of the relevant economy, its

11
PIPEK, J. and composite authors International trade. Prague: School of Economics in Prague, 1994. ISBN 80-
7079-472-0. page 147.

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aiming or character of the development, bur also the successfulness of the economic politics.
However, the balances of payment may have in different countries a different evidencing
ability, which depends on the level of the market orientation of the economy or on the role of
money in the relevant economy.

Depending on the purpose, for which they serve, the balances of payment are drawn
up in differently detailed classification. If the balance of payment has just an informative
character, a less detailed arrangement is sufficient, which summarizes the particular items into
groups or categories according to certain common characters. However the economic analysts
usually need a more detailed classification, such arrangements may then include more than
one hundred items.

9.3 Structure of balance of payment

9.3.1 Horizontal structure of balance of payment

The horizontal structure of balance of payment is indicated as material structure. The

basic groups of the items of balance of payment, in which all the international transactions
may be included, are as follows:

• goods

• services

• revenues (incomes)

• transfers (unilateral transfers)

• capital (long-term and short-term)

• foreign exchange reserves

1. In the group goods there are monitored the values of export and import of the
goods, which passed the frontier of the state, but the goods need not to be paid for in the same
period. In the more detailed arrangements the goods are then usually divided according to the
particular commodities groups (for example raw materials, agriculture crops, consumer goods,
etc.), whereas some sort of goods may be stated even separately, if it represents for example a
dominant part of the export.

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 2. In the group services there are monitored the values of exported or imported
services, such as transport, services of travel movement, communications, building and
mounting (assembling) works, warehousing, insurance, financial services, patents, licences,
scientific and technical knowledge, etc. It is necessary to remind that the importance of
services in the international trade always increases.

3. The group of revenues (incomes) includes the revenues from the domestic capital,
which was invested abroad and at the same time the costs connected with the foreign capital
invested in domestic economy. It concerns then various profits, dividends or interests, both
received and paid abroad, but also the revenues from the work abroad and the expenses of the
work of foreigners in domestic economy.

4. The group transfers include the unilateral transfers, which do not result in any
origin of any foreign receivables or obligations. The transfers may be official or private,
financial or material. The International Monetary Fund distinguishes furthermore the common
transfers and capital transfers.

Common transfers include the private transfers of the inhabitants, governmental

technical aid (for example the help at removing the after-floods’ damages), contributions to
international organizations, etc.

Capital transfers are such transfers, which are connected with the migration of
population, excuse of debts, with the property rights to the tangible assets, furthermore the
transfers of non-productive tangible assets or transfers of intangible rights.

5. In the group capital we can find both the long-term capital and short-term capital.
Long-term capital can be divided into direct investments, portfolio investments and other
long-term capital.

The direct investments are represented by the export and import of capital, where the
investor acquires an important portion on the basic capital of a company. The opinions on the
concrete amount of this portion differ somewhat, however it is necessary to follow the
appropriate laws in the particular countries. The direct investments may have a form of
purchase or sale of shares, real investments, reinvested profit, etc.

Portfolio investments are for example the investments in the property securities, which
however do not exceed the limit determined for ranging among direct investments, or
investments in the debt securities.

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 Other long-term capital includes for example the governmental credits or long-term
private commercial credits.

Short-term capital represents the short-term commercial credits, purchase and sale of
short-term securities, trade with foreign exchange, etc. A part of then capital in this group
may have a character of so-called speculation (leverage) capital.

6. The group foreign exchange reserves monitor the liquid foreign exchange assets of
the central bank, possibly of other official institutions (Ministries of Finance, etc.). These
assets may be in free convertible currencies, both in cash and on the accounts of foreign
banks, in gold, in foreign state securities, etc. The central banks use the foreign exchange
reserves for interventions on the foreign exchange markets with the aim to influence the rates
of exchange of their currency. It is also possible to balance the balance of payment by means
of the foreign exchange reserves.

9.3.2 Vertical structure of balance of payment

The vertical structure of balance of payment divides the items into credit items and
debit items. We can namely find in the balance of payment both the receivables and the
obligations, and at the same time a principle of duality applies here, so the summary of all
items must equal to zero. When evaluating whether a relevant item of the balance of payment
is a credit item or a debit item, we must proceed from the fact, if the evaluated transaction
means an inflow or an outflow of the foreign exchange for the relevant country.

Credit items of the balance of payment:

• export of goods

• export of services

• import of revenues

• import of transfers

• import of capital

• decrease in the foreign exchange reserves

Debit items of the balance of payment:

• import of goods

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 • import of services

• export of revenues

• export of transfers

• export of capital

• increase in the foreign exchange reserves

9.3.3 Basic structure of the balance of payment according to the International

Monetary Fund

International Monetary Fund developed a methodology for the drawing up of the

balances of payment, which should unify the evidencing of the data in order that the balances
would be comparable internationally.

The balance of payment drawn up according to these recommendations has the

following structure:

• current account

- balance of trade

- balance of services

- balance of revenues

- common transfers

• capital account

• finance account

- direct investments

- portfolio investments

- financial derivatives

- other investments

• balance of errors and omissions, exchange-rate differences

• change in the foreign exchange reserves

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 For the purpose of explanation it is necessary to add some additional information.

Balance of trade is a comparison between the value of export and the import of goods.
Common transfers include a part of transfers, concretely the common transfers. On the capital
account there is then recorded the remaining part of transfers, i.e. the capital transfers.
Financial derivatives include the forwards, futures, swaps and options. Under the item of
other investments we can find the other long-term capital and the short-term capital. As for
the balance of errors and omissions, it forms a part of the balance of payment with regard to
the fact that some data required for its drawing up can be inaccurate, possibly they are just
estimated. This may cause that the summary of the credit items would not be equal to the
summary of the debit items, which is just corrected by means of the balance of errors and
omissions.

9.4 Analysis of balance of payment

The total balance of the balance of payment is of course important economic

information; however it cannot evidence everything on the development of the external
economic relationships. Therefore it is necessary to carry out more detailed analyses of the
balance of payment, which focuses on its structural development, i.e. the movement of the
particular items or groups, especially of the most important items.

For the purpose of requirement for more detailed analyses there are created various
cumulative balances. It is possible to create a number of these analyses, depending on which
detailed classification of the balance of payment we have to our disposal. However not all the
cumulative balances have an economic meaning, therefore in practice there are used only such
cumulative balances, which have the highest evidencing ability and which are connected with
the balance of the particular parts of the balance of payment.

We create the cumulative balances in such a manner that we divide the items in the
balance of payment by means of a fictive line, into two circles, i.e. the items above the line
and the items below the line. We could make such a fictive line practically in any place of the
balance of payment, however as it was said before, we must take into consideration the
meaning and the evidencing ability of such created balance.

The items divided into two circles can be recorded in the form of a formula, whereby
the left side of the formula is created by the items above the line, and the right side of the
formula is created by the items below the line. That means that the change, which is caused by

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the movement of the first circle items, must be quantitatively equal to the change of the
second circle items, but with a reverse sign. At the same time the first circle delimits the
appropriate kind of the cumulative balance.

The most important cumulative balances of the balance of payment are based on its
basic structure, as it was characterized in the previous part. They include the following:

• balance of trade balance

• balance of performance balance

• balance of common balance

• balance of basic balance

• total balance of the balance of payments

Balance of trade balance represents a balance of the goods that means it compares
the exports of goods with the imports of goods. Active balance of trade means that the export
of goods exceeds its imports; otherwise the balance of trade is passive.

As it was said before, the balance of the trade balance is the difference between the
export and import of the goods. It was also explained that in the items of goods there are
included all material flows, also such flows, which were not followed by appropriate
payment, and in some cases they will never be followed by the appropriate payment, such as
the material gifts or real investments.

At the performed analyses it is necessary to monitor the balance of the balance of trade
in connection with other parts of the balance of payment. The passive balance of the balance
of trade may be balanced already within the frame of the current account, for example by
active balance in the item of services, or by means of finance account, for example by inflow
of the foreign investments, etc. It results from the above that the passive balance of the trade
balance does not need always to represent a threat to the total balance of the balance of
payments. At the same time on the basis of the balance of trade balance we cannot directly
evaluate the payment position of the country towards foreign countries; however it provides
us also important information about the economic activity of the relevant country.

Balance of performance balance includes in addition to the items of goods also the
services. It concerns then a balance of goods and services, which becomes at the present time
very important, with regard to the increasing share of services in the international trade.

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 For the purpose of evaluating the external performance of the relevant economy the
balance of the performance balance becomes much more important, because the share of
services in the international trade always increases. This balance enables to evaluate the
balance of export and import flows of goods and services, however by means of this balance
we cannot determine the foreign exchange balance of the balance of payments, because it
does not include the revenues and the transfers.

Balance of common balance is in fact the balance of the whole current account of the
balance of payment. Namely the items above the line include in this case also the transfers;
such transfers, which form a part of the current account, which means the common transfers.

For the analysis of the foreign exchange balance of the balance of payment the balance
of common balance is the most suitable. This balance is closely connected with the insolvency
of the country towards the foreign countries. It is impossible to determine the total status of
the country’s insolvency from the balance of payments, however we can find out the change
in the foreign exchange position of the country, namely by means of the balance of common
balance. If this balance is active, a growth in clean foreign receivables occurred, if this
balance is passive, a growth of clean foreign obligations occurred. The zero balance says that
the status of external insolvency of the country has remained unchanged.

The balance of the common balance must be balanced by the remaining accounts of
the balance of payments, which means by the capital account and finance account. If it does
not take place, a change in the foreign exchange reserves occurs. This change occurs even as a
result of the interventions of the central bank on the foreign exchange markets, which are
connected with the endeavour of the central bank to keep the exchange rate of the domestic
currency. The need of the foreign exchange interventions of the central bank may be caused
for example by the movement of the speculation capital. If the central bank does not have
enough of the foreign exchange reserves, a change in the exchange rate may occur.

Balance of basic balance removes to the left side of the formula yet the capital
transfers and the long-term capital, which are in fact the financing items. However when
analysing the balance of payment there are always understood as financing items such items,
which are to be found in the circle of items below the line, i.e. on the right side of the formula.

Some economic experts prefer rather the balance of the basic balance than the balance
of common balance when analysing the foreign exchange balance, as they do not consider as
appropriate that the direct and portfolio investments would form a part of the financing items.

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These investments namely usually represent the permanent re-division of the sources between
the domestic economy and foreign countries.

Other economists, to the contrary, mention that the long-term capital is not represented
just by the direct and portfolio investments, but also by the remaining long-term capital,
which has definitely a financing character and should remain on the right side of the formula.

Total balance of the balance of payments is usually indicated also as the balance of
maximal liquidity. In this case to the items above the line there is also removed the item of
short-term capital. This means that on the right side of the formula only the change in the
foreign exchange reserves remains.

The total balance of the balance of payments is historically the oldest balance;
however it has a problematic evidencing ability, especially as for the balance of the external
relationships.

The balance of the total balance, which includes all the economic transactions in
relation to the foreign countries, does not namely represent such a balanced status of the
balance of payments, which would be sustainable from the long-term point of view without
any considerable changes in the development of the particular items.

These balances have a great importance for the analysis of the balance of payment. By
means of these balances we can evaluate the external economic balance of the country, but
also the extent of balance between the material and foreign exchange flows, the impacts of the
resulting balance of the balance of payments on the currency balance, etc.

9.5 Balancing processes of the balance of payments

As it results from the previous explanation, the unbalance of the trade balance,
respectively of the performance balance does not need to cause always the total unbalance of
the balance of payments. For example the passive balance of the trade balance, respectively of
the performance balance may be balanced by means of other parts of the current account, but
also by the items of the capital account and finance account. It is also possible to use the
foreign exchange reserves. But all these possibilities are of course limited.

The country may also use for the purpose of suppression of the passive balance of the
trade balance, respectively of the performance balance, various trade-policy instruments,
which however prevent the liberal (free) trading and furthermore they may bring

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complications connected with the fact, that the use of a number of autonomous trading-policy
instruments is at the present time already regulated by means of the contractual instruments.

Another method, by means of which the balance of payments is being balanced in the
market economies, is represented by the automatic market balancing. The economic theory
distinguishes four basic types of the automatic balancing processes of the performance
balance:

• exchange rate balancing process

• price balancing process

• income balancing process

• monetary balancing process

However it is necessary to remind that in practice only the exchange rate balancing
process functions, the other balancing processes are rather certain theoretical constructions.
Their functioning is namely conditioned by various presumptions, which are not always quite
real. Yet these other balancing processes have a certain influence in practice to a certain
extent, therefore it is useful to mention them at least in a brief summary.

The exchange rate balancing process is based on the fact that the balance of payments
is closely connected with the rate of exchange and that these indicators are influencing each
other mutually. The free movable rates of exchange, but also the fixed rates of exchange with
the zones of oscillation and with the possibility of more flexible regulations of the central
rates of exchange have stabilizing impacts on the balance of payments.

The exchange rate balancing process functions as follows: in the case of a

considerable deficit of the trade balance, respectively of the performance balance there occurs
a pressure on the devaluation of the domestic currency, because on the foreign exchange
market the demand for the foreign exchange increases and at the same time the offer of the
domestic currency increases, so in the end the modification of the rate of the domestic
currency yet occurs. The devaluation of the domestic currency may result in the higher prices
of the imported goods and services and at the same time the export is supported, because the
exported goods and services become cheaper for the foreign customers. Thereby the above-
mentioned deficit starts decreasing, which leads to the renewal of the balance. We could
explain in a similar way even the functioning of the exchange rate balancing process in the

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contrary case, i.e. under presumption that the trade balance or the performance balance would
be considerably active.

On the contrary, the price balancing process is based on the quantitative theory of
money, which is based on the presumption that the increase in the amount of money in
circulation leads to the increase of the price level and vice versa.

The passive trade balance, respectively the passive performance balance in this case
means an outflow of money from the country, which will cause in the domestic economy a
decrease in prices and subsequently the increase of exports thereby the balance would be
improved. On the contrary, the active trade balance, respectively the active performance
balance will cause an increase in the domestic prices and the import of cheaper goods from
abroad, which will worsen the balance.

The income balancing process is based on the fact, that the unbalance of the trade
balance, respectively of the performance balance will cause the change in the gross domestic
product and this change will subsequently cause a change in import.

In the case of passive trade balance, respectively passive performance balance, there
will occur a decrease in the gross domestic product, which will cause the decrease in import,
which will subsequently lower the deficit if the balance. On the contrary, the active trade
balance, respectively the active performance balance will result in the increase of the gross
domestic product, thereby the increase of the import, which will gradually lower the excess of
the balance.

The monetary balancing process is based on the connection of the balance of trade
balance, respectively of balance of the performance balance with the change in status of the
domestic money reserve. The money reserve influences then the balance of the balance
directly, without intermediary effect of the change in prices.

The passive trade balance, respectively the passive performance balance will cause the
decrease in the money reserve, the import will be lowered and the balance will be improved as
a result. On the contrary, the active balance increases the money reserve, thereby the import is
increased at the same time and the active balance is lowered.

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 Summary:

With regard to the geographic distance between the places of production and
consumption, the time disharmony and the risk rate of international relations the financing of
domestic trade inland and financing of the international trade are different in many aspects.
The types of credits granted include: supplier credit, credit granted by the customer,
mediatory credit, bank credit, governmental credit and credit of the international organization.

The short-term financing can be guaranteed by the bank overdraft, discount of bills of
exchange, by means of documentary letter of credit, by the back-up of the export receivables,
by factoring or by means of the loans on financial market. The sources of the long-term
financing can be granted by the national systems of financing the export credits, by the
forfeiting, by leasing, by the loans on the market or by the project financing.

With the balancing of the receivables and payables arising out of the foreign trade
activity is closely connected the balance of payments of a state that records all the economic
transactions, which were effected between the national economy and the foreign states. The
material structure of the balance of payments is indicated as the horizontal structure; the
classification of the balance of payments into the credit and debit items is indicated as the
vertical structure. The balances of payments are being drawn up according to the
methodology of the International Monetary Fund in order to be internationally comparable
between the particular states.

The balance of payments can be analysed by means of various cumulative balances.

The most important cumulative balances include: the balance of trade balance, the balance of
performance balance, the balance of common balance, the balance of basic balance and the
total balance of the balance of payments. The economic theory distinguishes four basic types
of the automatic balancing processes of the performance balance, namely the exchange rate
balancing process, the price balancing process, the income balancing process and the
monetary balancing process.

The terms to be remembered:

• supplier credit

• credit granted by the customer

• mediatory credit

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 • bank credit

• governmental credit

• bank overdraft

• documentary letter of credit

• factoring

• forfeiting

• leasing

• project financing

• balance of payments

• horizontal and vertical structure

• credit and debit items

• current account

• capital account

• finance account

This credit is granted to the foreign customer by the exporter and in most cases it is
connected with the delivery of goods or services. In the purchase contract, contract for work
or in another contractual arrangement, which is relevant to it, there are agreed upon the credit
terms within the term of payment. The possibility to conclude a framework payment
agreement for a certain period of time, in which there are determined the terms of credit
granted together with the deliveries of goods within the appropriate period, is used only
rarely; this possibility is used especially between the firms with long-term stable business
relations.

This type of credit is used very rarely with regard to the current conditions of the
market of the buyer, mostly at the sale of specific sorts of goods or at the sale to risky
markets. In the purchase contracts this credit is agreed upon as a payment in advance. A
partial payment in advance (the so-called advance payment) represents a most frequent form
of this credit. It is being agreed upon at large deliveries of goods, which are being
manufactured custom-made, or at the realization of large projects, etc.

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 Some types of intermediaries (such as the dealers, brokers, etc.) grant this type of
credit on a short-term basis. These intermediaries are mostly represented by well-established
companies, which know very well the market as well as the financial needs of suppliers and
customers. However it may also concern such intermediaries, who directly specialize on
provision of the financial services to the business partners.

The most frequent method of direct crediting of the international trade is represented
just by the bank credit. The forms of credits granted by the banks may vary. It may concern
the short-term credits and long-term credits. The conditions of a bank credit and the
conditions of an export contract are resolved by different, absolutely separate contractual
provisions. The credit relation with the bank and the transaction, for which the credit serves,
are so separated, which is an advantage of the bank credits (especially because the customer
cannot avoid its payment obligations or delay them by means of claims on the quality, term of
delivery or similar objections towards the fulfilment of the contract from the side of the
supplier).

The governments of industrially advanced countries grant these credits to the

governments or public institutions of the underdeveloped countries as an instrument of
economic help. These credits are being granted on the basis of a separate intergovernmental
convention or as a part of agreements on the economic or other help, in which there are
agreed upon the amount of credit, the maturity of credit, interest rates, currency, character of
goods and services, for which the credit is determined, etc. It is also possible to grant within
the frame of these credits a part of the means in the form of non-returnable help (donations).

This credit is granted by the bank to the clients having with this bank a bank overdraft
account. To such accounts it is possible to determine in advance the amount of debit, which
the client can agree, and with which a certain interest rate is connected. Up to this determined
limit the client may use the credit without limitation, which brings a considerable advantage
in the form of flexibility and operativeness of the utilization of the credit. It is being used
most frequently for the “bridging” of the short-term terms of payment and for payment of
costs of circulation.

This instrument serves for the securing of payment, which functions as follows: the
bank undertakes to pay relatively independently on the will or ability of the buyer to pay. On
of the forms of the documentary letters of credit, which belongs to the most perfect methods
of securing the credit risks, is the L/C with deferred maturity, because the banks are often
willing, after deducting the discount, to buy such a secured receivable. Another type is the

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transferable L/C, which is important for the commercial companies, because by transferring
the rights from L/C to the supplier the authorized entity may finance the purchases without
demands for its own financial sources.

It is a complex financial service concerning the financing and securing of the short-
term credits, which are granted at the supplies of goods and services. The short-term
receivables arising from the sale of goods and services are ceded to a specialized factoring
company ensuring its collection. If the factoring company takes over the guarantee for
payment, then the appropriate receivable is ceded without penalties for the original creditor.

This method is often used for the export of machines, equipment and complete
industrial plants, which are of high value. The forfeiting is gradually being used also for the
financing of goods or services.

It is similar to a lease relation, in which participate the subjects of at least of two

countries. At the leasing the tenant receives a right to use the goods of investment character
for the fees, which are fixedly determined, for a time of a predetermined period. The
difference between the common rent and the leasing consists in that the interested company
itself may select the leased object directly with the producer.

Also this instrument belongs to the modern instruments and is used especially for the
financing of capital-intensive investments in the sphere of energetic, mining of raw materials,
construction of highways and railroad corridors, etc.

The balance of payment may be characterized as “a systematic statistic statement

(summary) of all economic transactions, which were effected within a certain period (usually
one year) between the national economy and the foreign states”12. The data may be of course
published even for a shorter period of time, for example one month or a quarter, and then
summarized into an annual statement.

The horizontal structure of balance of payment is indicated as material structure. The

basic groups of the items of balance of payment, in which all the international transactions
may be included.

The vertical structure of balance of payment divides the items into credit items and
debit items. We can namely find in the balance of payment both the receivables and the
obligations, and at the same time a principle of duality applies here, so the summary of all

12
PIPEK, J. and composite authors International trade. Prague: School of Economics in Prague, 1994. ISBN 80-
7079-472-0. page 147.

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items must equal to zero. When evaluating whether a relevant item of the balance of payment
is a credit item or a debit item, we must proceed from the fact, if the evaluated transaction
means an inflow or an outflow of the foreign exchange for the relevant country.

Credit items of the balance of payment:

• export of goods

• export of services

• import of revenues

• import of transfers

• import of capital

• decrease in the foreign exchange reserves

Debit items of the balance of payment:

• import of goods

• import of services

• export of revenues

• export of transfers

• export of capital

• increase in the foreign exchange reserves

The balance of payment drawn up according to these recommendations has the

following structure:

• current account

- balance of trade

- balance of services

- balance of revenues

- common transfers

• capital account

• finance account

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 - direct investments

- portfolio investments

- financial derivatives

- other investments

• balance of errors and omissions, exchange-rate differences

• change in the foreign exchange reserves

Check questions and tasks:

• What are the causes for differences between the financing of

domestic trade inland and financing of the international trade?

• In what agreements the terms and conditions of the supplier

credit are agreed upon and who grants this supplier credit?

• For what purpose are used the syndicated credits?

• What types of factoring do you know?

• How does the return leasing function?

• What does the balance of payment record?

• What are the basic groups of the items of the balance of

payments?

• What are the parts of the basic structure of the balance of

payments according to the methodology of International Monetary Fund?

• What are the most important balances of the balance of

payments?

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