Developing nations are faced with the gradual erosion of their foreign trade tax revenues, which subsequently reduces their overall tax income. In light of this inevitable process of trade liberalisation, these nations have embarked on tax adjustment reform in order to shift their burden of tax on their domestic sector towards their external market. The main mechanism used is through reductions in the rate of taxation on imports as well as exports of certain items. These restrictive measures often lead to a shift in the classification of the nation’s taxable goods and services on the internal market as well as push up the country’s price level, causing discrepancies between the declared price and the real exchange rate.
To understand how the developing nations cope with trade deficit problems, it is important to analyse the nature of trade flows. Basically, imports consist of the raw materials required for the growth of the economy, while exports refer to the manufactured goods that are re-exported from the country. In terms of international trade, imports and exports are usually inter-dependent. Thus, a nation that heavily relies on imported goods and on foreign investment (exporting) may experience a significant fall in its gross domestic product (GDP) due to trade deficit problems. Conversely, a nation that has a high degree of internal demand, as reflected by rising employment rates, may be capable of reducing its imports as well as its exports to raise its domestic product growth rate.
The extent of trade integration depends on the degree of political unity existing among the countries concerned, as well as on the degree of integration achieved within the single currency. For instance, most developing countries maintain very low levels of cross-border trade with the rest of the world. However, most developed countries regularly enter into extensive free trade arrangements with their foreign trade partners.
Developing nations experience a trade deficit primarily because they have to import goods to meet the requirements of their consumers, which are generally larger than the demand in the country. Exporters from advanced nations often divert a portion of their production cost to purchase low-cost raw materials in other countries, allowing them to reduce the price of their products. This, in turn, causes a reduction in the available foreign currency reserves. The result is a rise in the level of trade deficit, with adverse effects on the countries financing condition, both through consumption cuts and increased taxes.
On the one hand, restrictive export policies make it difficult for developing nations to gain access to foreign capital for investments and industrial scale production. On the other hand, increased access to technology, lower costs of raw materials, and liberalization of foreign trade lead to technological progress, allowing developing countries to reduce their trade deficit. This gap could either be used to finance domestic growth or be used to secure higher foreign portfolio investment. The former option is considered preferable by analysts due to the reduction in the risks involved, while the latter results in higher returns for investors. In either case, a successful negotiation between the two parties (the exporter and the importer) is the only possible solution to the problems arising out of the trade deficit.
Many nations in Europe and North America have long been reluctant to open up their markets to new potentials, even to highly beneficial dumping and subsidization programs that benefit exporters. In order to gain access to international markets, developing countries rely on a mixture of subsidies and protectionist policies that limit foreign competition and force foreign companies to sell at a premium. If these trade barriers were to be reduced, allowing the free flow of goods and services, there would be better access to the international markets for the European and North American exporters.