AN ECONOMIC RATIONALE FOR COUNTERTRADE: Liquidity Constraints

Countertrade is a generic term for parallel business transactions linking sales contracts with agreements to purchase goods or services. Countertrade has been viewed as an inefficient way of doing business primarily because of problems associated with such things as quality variations and increases in transaction costs. A review of the international trade literature suggests that market imperfections (shortage of convertible currency, information asymmetry that may create the so-called lemon problem and moral hazard) may provide motivations for countertrade. This article focuses on one motivation: liquidity constraint. The liquidity constraint is introduced in both goods and the factor markets in addition to the production constraint. The article compares and contrasts two strategies facing the management team of a profit-maximizing firm. The model developed shows that countertrade strategy could be superior to standard money-mediated trade strategy when the liquidity constraint is binding. Therefore, countertrade appears to be a rational response to conditions that restrict standard trade. As such, countertrade can supplement standard money-mediated trade and contribute to the growth of international business.