International Trade Theories 141011

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Theories

ofInternational

Trade


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International Business, 5/e 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

Key Issues

Why do nations trade with each-other?

How do different theories explain trade flows?

How does free trade raise the economic welfareof all participating nations? Any disagreements?

Can government actively influence a countrys

competitive advantage?

Why is an understanding of trade theory

important for managers?


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International Trade Theory

What is international trade?

Exchange of raw materials and manufactured goods

(and services) across national borders

Classical trade theories: explain national economy conditions--country

advantages--that enable such exchange to happen

New trade theories:

explain links among natural country advantages,government action, and industry characteristics that

enable such exchange to happen


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Evolution of Trade Theories

Mercantilism

Absolute advantage (Classical)

Comparative advantage

Factor Proportions Trade International Product Cycle

New Trade Theory

National competitive advantage


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Mercantilism/Neomercantilism

Prevailed from 1500 to 1800

Export more to strangers than we import to amass treasure,

expand kingdom

Maximize exports and minimize imports: no advantage in

increased trade Government intervenes to achieve a surplus in exports

King, exporters, domestic producers: happy

Subjects: unhappy because domestic goods stay expensive and

of limited variety

Today neo-mercantilists=protectionists: some segments

of society shielded short term

Zero-sum vs positive-sum game view of trade


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Defining mercantilism

trade theory holding that nations

should accumulate financial wealth,

usually in the form of gold (forget thingslike living standards or human

development) by encouraging exports

and discouraging imports


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Table for reference

PRODUCT U.S.A. Japan

Case 1 Computer 20 10

Automobile 10 20


Automobile 30 20


Automobile 40 20

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Theory of absolute advantage

Adam Smith: Wealth of Nations (1776) argued:

Capability of one country to produce more ofa product with the same amount of input than

another country A country should produce only goods where it

is most efficient, and trade for those goodswhere it is not efficient

Trade between countries is, therefore, beneficial

Assumes there is an absolute balance amongnations


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destroys the mercantilist idea since there

are gains to be had by both countries party to

an exchange

questions the objective of national

governments to acquire wealth through

restrictive trade policies

measures a nations wealth by the living

standards of its people


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PPFProduction Possibility Frontier


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Theory of comparative advantage

David Ricardo: Principles of Political Economy (1817)

Extends free trade argument

Efficiency of resource utilization leads to more

productivity Should import even if country is more efficient in the

products production than country from which it isbuying.

Look to see how much more efficient. If onlycomparatively efficient, than import.

Makes better use of resources

Trade is a positive-sum game

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Theory of comparative advantage

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Comparative advantage and the gains

from trade

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Comparative advantage: Bollywood

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Assumptions and limitations

Driven only by maximization of production

and consumption

Only 2 countries engaged in production and

consumption of just 2 goods.

What about the transportation costs?

Only resourcelabour (that too, non-transferable)

No consideration for learning theory

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Factor proportions theory

Heckscher (1919) - Olin (1933) Theory

Export goods that intensively use factor endowmentswhich are locally abundant

Corollary: import goods made from locallyscarce factors Note: Factor endowments can be impacted by

government policy - minimum wage

Patterns of trade are determined by differences in

factor endowments - not productivity Remember, focus on relative advantage, notabsolute

advantage

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Factor proportions theory

trade theory holding that countries produce

and export those goods that require resources

(factors) that are abundant (and thus cheapest)

and import those goods that require resourcesthat are in short supply

Example:

Australialot of land and a small population

(relative to its size)

So what should it export and import?

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Factor Proportions Trade Theory

Considers Two Factors of Production

Labor

Capital

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Factor Proportions Trade Theory

A country that is relatively labor

abundant (capital abundant)

should specialize in the production

and export of that product which is

relatively labor intensive (capitalintensive)


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Heckscher (1919)-Ohlin (1933) Theory

The pattern of international trade depends on

differences in factor endowments not on

differences in productivity

Absolute amounts of factor endowments matter Leontief paradox:

US has relatively more abundant capital yet imports

goods more capital intensive than those it exports

Explanation(?): US has special advantage on producing new products made

with innovative technologies

These may be less capital intensive till they reach mass-

production state

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International Trade Theories 141011

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