In the summer of 2022, I needed a grab bar installed in my shower. But I couldn’t find someone to do the work, so my brother Brian took the job. In return, I took him out to eat. I traded my income for his services, but not directly.
Brian wouldn’t take cash from me, but he let me buy him a steak dinner. Instead, I gave my money to the restaurant for the dinner and for the services they provided.
This set of transactions is an example of trade. Trade requires two exchanges: the exchange of goods and services and the exchange of currency to ease these transactions.
Why we trade
An economy runs on trade because we can’t make everything we need or want ourselves. Neither my husband nor I can install a grab bar because we don’t have the skills (or the desire to learn the skills). We have income, so we trade that for what we need.
But we couldn’t find a handy person during the pandemic because many other consumers demanded home improvements. And since it was 2022, we had to worry about COVID. It was much easier to trade my COVID-free brother what we had (income, which we then used to pay for a steak dinner) for what he could do (install a grab bar in a tiled shower).
What we faced was scarcity—in this case, the ability we had, and the time other people had. We couldn’t find the people we needed to install a grab bar because the soggy weather of 2020 in the Atlanta area slowed the production of exterior projects. By 2022, the demand for home improvement had surged as well.
In addition, someone else could do the job better, more quickly, or for a lower price than we could.
I rely on the grocery store to provide me with most of my vegetables, because I lack the resources to grow them myself. And I can better spend my time doing something I’m good at, like teaching and writing about economics.
As another example, I use an AI program to read my work aloud before I send a post because, even though I know all the rules and can spellcheck my own work, I don’t always catch silly mistakes. For this book, someone else edited it, another proofread it, and still another designed the cover and the interior pages.
Trade can get complicated, even between individuals. When I want a haircut, which is something else I can’t do myself, I face my hairdresser’s time constraints. She has school-age children, so she must be there when they get home from school. Since I’m a short appointment, she slides me into her workday when she can.
Other resources are scarce, too. We saw this firsthand during the pandemic when we couldn’t find basic supplies. In the market for cars that we looked at in Chapter 3, we saw how a breakdown in the supply chain (how goods gets from one place to another) of a resource—computer chips—devastated a market.
Sometimes, someone else has a resource we don’t have, and sometimes we have a resource they don’t. For example, suppose you want a sweater. If you’re like me, you’ll go to a store or order online. You could learn how to make it for yourself, assuming you don’t have any barriers that make it unreasonable.
In my case, I don’t know how and the nerve damage in my hands prevents me from learning. Other constraints like time, money, and willingness make purchasing a pre-made sweater the best option.
So, we outsource the work. Outsourcing is when you get someone else to provide a product or service for you. Businesses, for example, outsource payroll to other companies, because it’s cheaper to have that done by someone else who knows all the rules and knows which taxes need to be paid when. In the case of a sweater, that outsourcing is also offshored. Offshoring occurs when someone outside the US completes a task.
In some cases, one person knits the sweater in one country out of yarn from another country. If you’re a knitter, then all you may need is time, a pattern, and some yarn. But is that all? Where did the pattern come from? Where did the yarn come from? If you go to a store, but where did the store get the patterns and the yarn from?
You can design your own pattern, but you’ll probably use a pattern designed by someone else. The well-known pattern designers will have studios and access to printing and distribution sources.
Getting the yarn is more complicated. You’re unlikely to own sheep, or feed and shelter them. Most of us wouldn’t want to shear them, either. Then there’s the dye for the yarn, and so on. And those people want payment, so you can pick up what you need at a store and only pay one supplier. The yarn may also come from another country, with all the distribution and currency problems that come with trade with other countries. But sometimes another country has an advantage over us.
When we get someone to give us a good or service, they expect to be paid. And they’ll expect to be paid in the common currency. We use currency to make trade easier. For example, I wouldn’t tell someone to give me so many chickens in exchange for a lesson on economics.
In our case, we use US dollars to pay suppliers for their time, ability, and raw materials. When we trade between individuals and businesses in another country, we have to get exchange currency first. The exchange market for foreign currency is the largest market of all, with over $6 trillion (US dollars) transactions a day.
For instance, my friend Linh travels from Toronto to Atlanta once a year for a mini-vacation with her Atlanta-based work friends. Each time, she converts Canadian dollars into US dollars.
Currency and trade
Problems arise when buying and selling goods in foreign currencies. Some of the aspects of foreign currency exchange are technical and beyond the scope of this book. But, if you can understand the basics of trade and the idea of paying with currency, then you can understand how globalization can promote growth, which is what we want, but can also cause problems.
In the US, consumers, businesses, and the government primarily depend on goods produced in the US. And it’s easy to get and use US dollars to pay for domestic production and sales.
But we also use raw materials and consumer goods from other countries. For example, if we want lithium to produce batteries for electric vehicles (EVs), we import it from Australia, Chile, and China because we don’t currently mine lithium in the US. The supply chain crisis during the pandemic sparked several projects in Arkansas, Nevada, New Mexico, and Texas.[1]
There are some countries, like Japan, which depend heavily on other countries for goods important to production. Japan doesn’t have any natural sources of oil, coal, or natural gas. The country gets most of its fuel from Russia and the Middle East. They need to trade for these resources.
Other countries rely heavily on imports (what they buy from other countries) and exports (what they sell to other countries) to keep the economy going and to provide income for its citizens. Exports account for about forty-three percent of Mexico’s GDP (seventy-eight percent of that to the US), and imports about forty-six percent of its GDP.
In comparison, the US exports about eleven percent of its GDP and imports about fifteen percent. The proximity of Mexico, Canada, and the US led to the creation of North American Free Trade Agreement (NAFTA) in 1994, an attempt to reduce barriers to trade among the countries. In 2018, the three countries re-negotiated those terms (MCAA).
Most economists think that trade should flow freely or move from one country to another without barriers like tariffs, as long as there is a level playing field. We know that when trade flows freely, goods for consumers and producers are more plentiful and cheaper, because there is a gain to trading with others.
We can both get more stuff at a lower price, because we’re each providing the stuff that we have an advantage in producing.
Financing trade
Trade between countries involves additional transactions, unlike trade within a country. There is the exchange of goods and currency, as is true within a country. But unlike trade within a country where everyone holds the same currency, trade with other countries involves additional steps. The entire trade has three steps:
1) The foreign consumer pays in local currency, e.g., Canadian dollars
2) The foreign currency is converted to the local currency of the provider, e.g., US dollars. This is normally done through a financial institution like a bank.
3) The local currency is then given to the provider/producer for their goods/services
For example, my friend Linh had to buy US dollars (using her Canadian dollars) so she could pay for her share of the cabin we rented.
To keep things simple, let’s look at trade between the US and Canada. To buy goods from the US, consumers from Canada need to use US dollars[BG5] . Similarly, customers from the US need Canadian dollars to buy goods from Canada.
A strong US dollar, compared to the Canadian dollar, means that for residents in Canada the price of the US dollar has increased. To buy our goods, residents in Canada will need more dollars than they needed when the dollar was weaker, as it was during our trip to Quebec City.
This wasn’t always the case. I remember traveling to Quebec City a decade ago when the Canadian dollar was stronger. We had to give up more of our dollars for a ride on the funicular, a Cale railway system for steep slopes, [NF6] than the posted price in Canadian dollars.
For some friends in my writing group, their credit card company took care of the currency conversions. Their bill showed that instead of paying the $49 for their subscription, like their American colleagues were doing, they were paying closer to $60, the difference caused by a strong dollar. How does this affect trade? Let’s look at an example.
We buy canola oil from Canada, and they buy cars from us. Canola oil is $3 Canadian dollars (CAD) and cars are $30,000 in US dollars (USD). Suppose the starting price of one USD is one CAD, as it was when we visited Vancouver on our way to Alaska:
1 USD: 1 CAD
Then the price of a bottle of canola oil in the US is the same as it is in Canada, assuming no tariffs, fees, or charges for exchanging currency. Let’s say it is 3 CAD, then it is also 3 USD. The same for an American car priced at $30,000. It is also $30,000 in Canadian dollars.
But suppose the price of the dollar doubles in terms of the Canadian dollar. So now it takes 2 CAD to buy 1 USD.
1 USD: 2 CAD or 0.50 USD: 1 CAD
Now, the price of those goods differs too.
1.50 USD: 3 CAD.
(Multiply by three and divide by two—3/2.)
The price of the bottle of canola oil has fallen from 3 USD to 1.50 USD. The same will be true for all goods that we buy from Canada. Canadian goods are then cheaper, and we’ll import more.
Let’s look at the American car priced at $30,000. Now that price doubles in Canada.
30,000 USD: 60,000 CAD
Canadians would pay more for cars. Our exports would get more expensive, and they’d buy less. The same thing would happen with other goods we export.
When the dollar is stronger, the US exports less to Canada since US goods are more expensive than when the currencies are equal. If exports are falling, then the trade deficit for the US, the dollar difference between exports and imports, gets larger. On the other hand, if exports rise, then the trade deficit gets smaller.
The US has had a trade deficit consistently since the mid-1970s. Some countries prefer to have a positive trade balance, so they manipulate the value of their currency in relation to the dollar or the euro, to increase exports to the targeted market, most often the US. We’ll look at currency manipulation in Chapter 10.
Why does it matter? If the dollar is strong, the goods we export are more expensive for other countries, so they buy less. If the dollar is weak, the goods we export are cheaper for other countries, so they buy more. Since exports and imports are part of the GDP and growth equations, we would prefer that our goods to be cheaper, so that other countries will buy more of them.
Trade between countries, unlike trade between my brother and me, are part of GDP. In the next chapter, we look at GDP, including exports and imports, and the whole economy (or macroeconomy) in more detail. We said in Chapter 2 that GDP was one of the most important indicators of how the economy is doing,
Before we move on to studying GDP, let’s see how well you understand trade.
Thank you for reading,
Nikki
[1] Benoît Morenne, “The Surprising New Source of Lithium for Batteries,” Wall Street Journal, June 2, 2023, https://www.wsj.com/business/energy-oil/the-surprising-new-source-of-lithium-for-batteries-744463c4; Jennifer Solis, “Lithium Americas to Get Massive Federal Loan to Develop Thacker Pass Mine, Nevada Current,” Nevada Current, March 15, 2024, https://nevadacurrent.com/2024/03/15/lithium-americas-to-get-massive-federal-loan-to-develop-thacker-pass-mine/; Elyse Hauser, “Billions in US Funding Boosts Lithium Mining, Stressing Water Supplies,” Floodlight, July 18, 2024, https://floodlightnews.org/billions-in-us-funding-boosts-lithium-mining/.
I always thought of trading for services as being distinct from buying and selling, so this was a very good read for me, Nikki. Thank you for sharing.
I always liked when I could barter with someone for something I had and they needed and vice versa. Your examples are good.