International Trade Theory and the World Trading System.

International Trade Theory

and the World Trading System

EVOLUTION OF THE THEORY OF INTERNATIONAL EVOLUTION OF THE THEORY OF INTERNATIONAL TRADE TRADE

Theorists:Theorists:Adam Smith (1776)David Ricardo (1817)Eli Heckscher (1919) / Bertil Ohlin (1933)Wassily Leontif (1953)Raymond Vernon (1966)Paul Krugman and others (1980s & 1990s)Michael Porter (1990)

ABSOLUTE ADVANTAGE - ADAM SMITH

Two countries - Two products

Each country can produce one product more efficiently than the other.

They should specialize and trade.

COMPARATIVE ADVANTAGE - RICARDO

Two countries - Two products

One country can produce both products more efficiently than the other country.

Each should specialize in the product in which it has a RELATIVE advantage and trade for the other product

FACTOR ENDOWMENT - HECKSCHER-OHLIN

Countries are differently endowed with each of the factors of production (LAND, LABOR, CAPITAL; ENTREPRENEURSHIP & TECH)

Countries should specialize in those products that utilize the factors of production with which they are abundantly endowed

FACTOR SUBSTITUTABILITY - LEONTIEF'S PARADOXFACTOR SUBSTITUTABILITY - LEONTIEF'S PARADOX

Countries which have a scarcity of particular factor inputs may be able to compensate by using more abundant inputs.

Technology (and capital) is usually the most effective medium through which this compensation takes place.

For example, India and USA both produce textiles, but India uses its abundant cheap labour while USA uses high technology.

INTERNATIONAL PRODUCT-LIFE CYCLE (IPLC)- RAYMOND VERNON

PRINCIPLE PRINCIPLE

Original innovation of a particular product generally occurs in a country with favorable demand conditions.

Trade and location of production will shift depending on the stage of the PLC.

Countries lead or lag each other in terms of their position on the PLC for a particular product.

INTERNATIONAL PRODUCT-LIFE CYCLE (IPLC) - RAYMOND VERNON

LIMITATIONS OF THE THEORYLIMITATIONS OF THE THEORY

There are too many exceptions to the theory, eg, luxury products, products with very short life cycles, non-traded products.

Product differentiation may keep the production from shifting to the next tier of countries.

Companies with global strategies develop products and services for global markets and set up production in least-cost countries.

The theory did not differentiate between FDI and licensing for a new foreign production site. (This conceptual limitation meant the IPLC did not provide a satisfactory theory for FDI.)

Most theories have attempted to answer the question,

“Why do countries trade?” However,

the real question is: “Why do companies trade?”

THEORIES ORIENTED ON FIRMS/INDUSTRIES:

New Trade Theory

National Competitive Advantage

NEW TRADE THEORY - PAUL KRUGMAN and others

PRINCIPLEPRINCIPLE

First Mover Advantages will create Barriers to Entry

(Economies of scale & Experience curve)

Rationale for governments to pursue Strategic Trade Policy

(i.e., Some firms in specific industries are favored, nurtured, promoted and protected from international competition.)

(See Strategic Trade.doc.)

NATIONAL COMPETITIVE ADVANTAGE NATIONAL COMPETITIVE ADVANTAGE - - PORTERPORTER

FACTOR ENDOWMENTSBasic (natural resources; climate; location)

Advanced (specialized infrastructure; skilled labor; tech.)

DEMAND CONDITIONSNature of home demand (concentrated, sophisticated, demanding home customers push firms to be globally competitive)

RELATED & SUPPORTING INDUSTRIESStrong spill-over effects from related industries create internationally competitive clusters of industries

FIRMS' STRATEGY, STRUCTURE & RIVALRY Organization, management and domestic rivalry of firms in a country. (Vitality of domestic environment prepares firms for international competition)

GOVERNMENT POLICIESGovernment policies on each of the above factors promotes or suppresses ability of domestic firms to compete internationally.

THE POLITICAL ECONOMY OF WORLD TRADEHistory of the free trade movement

origins: end of “mercantilism” in Europe in 17th centurypost WWII: under the auspices of GATT

GATT (GENERAL AGREEMENT ON TARIFFS AND TRADE)created in 19481 of 3 major institutions created to guide the “free world”purpose: multilateral negotiating forum to achieve free trade

GATT championed TRADE LIBERALIZATION and a 16-fold increase in world trade in 50 years.

Mercantilism: exports good, imports bad; to accumulate gold

Mercantilism: exports good, imports bad; to accumulate gold

GATT PRINCIPLES

1. Non-discrimination – MFNMFN - If country A gives country B "most-favored nation”

concessions, must give the same to all member countries.

2. Reciprocity

3. Exceptions to GATT rules:Regional Blocs - EU, NAFTA, etc. - exempt from giving MFN to

non-member countries.Less-developed countries (LDCs) generally did not participate and

were not expected to reciprocate for concessions offered by developed countries.

GATT NEGOTIATIONS

Date name outcome

1947 Geneva tariffs (45000 tariff concessions)

1949 Annecy tariffs

1950-1 Torquay tariffs

1955-6 Geneva tariffs

1960-1 Dillon tariffs

1964-7 Kennedy 35% tariff reduction; anti-dumping

1973-9 Tokyo 34% tariff reduction; NTB codes

1986-94 Uruguay complex international business package

URUGUAY round

Initially 15 negotiating groups for new areas, including:

tariffs and NTBs*foreign investmentservicesagriculturetextilestropical productsintellectual propertyanti-dumpingcountervailing dutiesetc

* NTB: non-tariff barrier, ie, everything else.

eg, subsidies, quotas, administrative policies

* NTB: non-tariff barrier, ie, everything else.

eg, subsidies, quotas, administrative policies

WORLD TRADE ORGANIZATION – WTO

WTO inaugurated on 1/1/1995

Will there be a new “round”?

unresolved issues for the WTO:unfinished business from Uruguay Roundthe environmentlabor standards and human rightsharmonization of domestic policiesregional and bilateral negotiations

GOVERNMENT INTERVENTION IN INTERNATIONAL TRADE

Justification: (generally rejected by classical economists)

protecting jobs and industries

national security

infant industry

various political reasons, eg, bargaining tool

strategic trade policy (see Strategic Trade.doc)

What is it? It refers to domestic policies to

create new industry to compete internationally.

(industrial policy)