6,7,8 international trade theories

8/6/2019 6,7,8 International Trade Theories

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International Trade TheoriesInternational Trade Theories


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F ree tradeF ree trade

A Government does not attemptA Government does not attemptto influence trade throughto influence trade through

quotas or duties, what itsquotas or duties, what itscitizens can buy from anothercitizens can buy from anothercountry, or what they cancountry, or what they can

produce and sell to anotherproduce and sell to anothercountrycountry


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TheoriesTheories

M ercantilismM ercantilismAbsolute advantage TheoryAbsolute advantage Theory

Comparative cost advantage theoryComparative cost advantage theoryFactor proportion/ HecksherFactor proportion/ Hecksher- -Ohlin theoryOhlin theoryThe new Product life cycle theoryThe new Product life cycle theoryThe New trade theoryThe New trade theoryCompetitive advantage theory/PortersCompetitive advantage theory/PortersDiamond modelDiamond model


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M ercantilismM ercantilism

M ercantilismM ercantilism is a 16is a 16 thth CenturyCenturydoctrinedoctrine

GovernmentsGovernments j ob is to create job is to create policy policy that promotes heavythat promotes heavyexportation, collection of exportation, collection of

revenue, and industrialrevenue, and industrialdevelopment internally.development internally.


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A country should maintain a tradeA country should maintain a tradesurplus, to export more than import.surplus, to export more than import.

It is a zero sum gameIt is a zero sum game- - A gain by oneA gain by onecountry results in a loss for another.country results in a loss for another.Gold and silver were the currenciesGold and silver were the currenciesof trade.of trade.


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In PracticeIn Practice , it serves to make, it serves to makethe State the stockholder,the State the stockholder,

financier, customer, marketer,financier, customer, marketer,collector, and enforcer of collector, and enforcer of contracts with other nations.contracts with other nations.Colonial relationship resultedColonial relationship resultedfrom mercantilism.from mercantilism.


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Ab solute A dvantage Theory Ab solute A dvantage Theory

Given by Adam Smith, in the bookGiven by Adam Smith, in the book Wealth of Nations Wealth of Nations

Countries should specialize in theCountries should specialize in theproduction of goods for which theyproduction of goods for which theyhave absolute advantage, and tradehave absolute advantage, and tradethese for goods produced by otherthese for goods produced by othercountries.countries.


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Ab solute A dvantage Ab solute A dvantage

Countries should specialize inCountries should specialize inproducing what they are best atproducing what they are best at- -things they have an absolutethings they have an absoluteadvantage.advantage.Incentive to trade is based on eachIncentive to trade is based on eachcountry having an absolutecountry having an absolute

advantage in a product.advantage in a product.In realityIn reality- -this is unrealistic and quitethis is unrealistic and quiteuncommon to happen this way.uncommon to happen this way.


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COCO

A

20

15

10

5

0

RICE

0 5 10 15 20

A

B

G

K

K

G


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Resources required to produce 1 ton of Cocoa and Rice

Cocoa Rice

Ghana 10 20South Korea 40 10

Production and consumption without trade

Cocoa RiceGhana 10 5South Korea 2.5 10

Total production 12.5 15.0

Production with specialization

Cocoa RiceGhana 20 0South Korea 0 20

Total Production 20 20


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C omparative advantageC omparative advantage

RicardoRicardo indicated that nationsindicated that nationsthat arethat are comparativelycomparatively more moreefficient at production will makeefficient at production will make

those goods even though theythose goods even though theymay not have an absolutemay not have an absoluteadvantage.advantage.I t is thisI t is this Comparative AdvantageComparative Advantage

that explains and predicts tradethat explains and predicts tradeof goods where absoluteof goods where absoluteadvantages may not exist.advantages may not exist.


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RicardoRicardo indicated that nationsindicated that nationswill produce and trade goodswill produce and trade goodswhere they have awhere they have aC omparative AdvantageC omparative Advantage eveneventhough more than one nationthough more than one nationholdsholds Absolute Advantage Absolute Advantage inin

production. I t is the nation thatproduction. I t is the nation thatis comparatively better inis comparatively better inproduction that will trade.production that will trade.


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TheThe implicationimplication for Ricardo is thatfor Ricardo is thathuman skill, productivity, capital, orhuman skill, productivity, capital, orgovernment policy can intervene andgovernment policy can intervene andmake a nation an exporter of goods.make a nation an exporter of goods.ExamplesExamples can be where governmentscan be where governmentspromote comparative advantagepromote comparative advantage

through subsidies, resources andthrough subsidies, resources anddevelopment, or direct fundingdevelopment, or direct funding


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SmithSmith said trade was explainedsaid trade was explainedthroughthrough Absolute Advantage Absolute Advantage ; Ricardo; Ricardosaid it wassaid it was C omparative AdvantageC omparative Advantage ; ;

HeckscherHeckscher- -Ohlin indicates it isOhlin indicates it is supply supply of factorsof factors that predicts, explains, andthat predicts, explains, andcontrols trade.controls trade.Every producer has to have a supplyEvery producer has to have a supply

base. Sources of supply coming frombase. Sources of supply coming fromlocally abundantlocally abundant Factor EndowmentsFactor Endowmentslower supply costs and make forlower supply costs and make forcheaper production and more likelycheaper production and more likelyexport.export.


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C omparative A dvantage TheoryC omparative A dvantage Theory

It makes sense for a country toIt makes sense for a country tospecialize in the production of thosespecialize in the production of thosegoods that it produces mostgoods that it produces mostefficiently and to buy the goods thatefficiently and to buy the goods thatit produces less efficiently from otherit produces less efficiently from othercountries, even if this means buyingcountries, even if this means buyinggoods from other countries that itgoods from other countries that itcould produce more efficiently itself.could produce more efficiently itself.


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20

15

10

5

0

0 5 10 15 20

COCOA

RICE

G

G

K

K

C

A

B


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Resources required to produce 1 ton of Cocoa and Rice

Cocoa Rice

Ghana 10 13.33South Korea 40 20

Production and consumption without trade

Cocoa RiceGhana 10 7.5South Korea 2.5 5

Total production 12.5 12.5

Production with specialization

Cocoa RiceGhana 15 3.75South Korea 0 10

Total Production 15 13.75


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A ssumptions of comparative A ssumptions of comparative

advantage theoryadvantage theoryOnly two countries in the worldOnly two countries in the worldNo transportation costsNo transportation costs

No tariffs between countriesNo tariffs between countriesConstant returns to scaleConstant returns to scaleFixed stock of resourcesFixed stock of resources

Effects of trade on incomeEffects of trade on incomedistribution of a country are ignored.distribution of a country are ignored.


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H eckscher H eckscher- -ohlin Theoryohlin Theory

Comparative advantage arises due toComparative advantage arises due todifferences in national factor endowments,differences in national factor endowments,like land, labor and capitol.like land, labor and capitol.

Countries will export those goods that makeCountries will export those goods that makeintensive use of locally abundant factors,intensive use of locally abundant factors,different factor endowments explain thedifferent factor endowments explain thedifferences in factor costs. The moredifferences in factor costs. The moreabundant a factor, the lower its costabundant a factor, the lower its cost


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The Leontief ParadoxThe Leontief Paradox

Wassily Leontief empirically testedWassily Leontief empirically testedthe Heckscherthe Heckscher- -ohlin Theory, theseohlin Theory, thesetests question the validity of tests question the validity of HeckscherHeckscher- -ohlin Theoryohlin TheoryLeontief postulated USA hasLeontief postulated USA hasabundant capital, compared to otherabundant capital, compared to other

nations, so US would be an exporternations, so US would be an exporterof capitalof capital- -intensive goods and anintensive goods and animporter of laborimporter of labor- -intensive goodsintensive goods


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Issues with H eckscher Issues with H eckscher- -ohlin Theoryohlin Theory

OhlinOhlin assumed also that technologyassumed also that technologyfor production was universallyfor production was universallyavailable, which it isnt.available, which it isnt.HeckscherHeckscher- -OhlinOhlin also assumes thatalso assumes thatproducts can be either capital orproducts can be either capital orlabor intensive, not both.labor intensive, not both.

HeckscherHeckscher- -OhlinOhlin also ignorealso ignoretransportation and logistical costs totransportation and logistical costs toand from a factoryand from a factory


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Leontief ParadoxLeontief Paradox

Surprise findingSurprise finding- - US exports wereUS exports wereless capital intensive than USless capital intensive than USimports.imports.Possible explanation could be US hasPossible explanation could be US hasadvantage in producing innovativeadvantage in producing innovativetechnology( software) basedtechnology( software) basedproducts which may be less capitalproducts which may be less capitalintensive than mature productsintensive than mature products(Heavy machinery)(Heavy machinery)


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Leontief Propositions toLeontief Propositions to

overcome Issues in Hovercome Issues in H- -O TheoryO Theory1.1. There areThere are differences indifferences in tastes andtastes andpreferences that contradict marketpreferences that contradict marketand factor influences. These areand factor influences. These arecalledcalled demand biasesdemand biases ..

2.2. There areThere are trade barrierstrade barriers thatthatgovernment imposes that influencegovernment imposes that influenceproduction.production.

3.3. There areThere are natural resourcesnatural resources ininabundance or not.abundance or not.

4.4. There areThere are factor intensity reversely factor intensity reversely that occur over time.that occur over time.


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Product Life C ycle theoryProduct Life C ycle theory


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The PL C TheoryThe PL C Theory

The product life cycle model wasThe product life cycle model wasgiven by Raymond Vernongiven by Raymond Vernon

Vernons PLC model asserts thatVernons PLC model asserts thatproduct innovation and initial useproduct innovation and initial useoccurs first in higher incomeoccurs first in higher incomecountries and then diffuses tocountries and then diffuses tomiddle and lower income countriesmiddle and lower income countriesas technology and skills gapsas technology and skills gapsovercome and consumer preferencesovercome and consumer preferencesswitch to the newer products.switch to the newer products.


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Trends in PLCTrends in PLC

1.1. The export performance of the matureThe export performance of the matureinnovating country is better than others.innovating country is better than others.

2.2. Technology is better in the matureTechnology is better in the maturecountriescountries as products diffuseas products diffuseproduction tends to move fromproduction tends to move fromtechnologytechnology- -intensive to laborintensive to labor- -intensive.intensive.

3.3. Countries that were innovators can fallCountries that were innovators can fall

from that place.from that place.4.4. Trade may increase in later stages of Trade may increase in later stages of

product maturity as costs and pricesproduct maturity as costs and pricesdecline and production economies rise.decline and production economies rise.


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C ompetitive A dvantageC ompetitive A dvantage

of Nationsof NationsM icheal E PorterM icheal E Porter


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chance

F irm strategy, structure & rivalry

Demand conditions

governmentRelated & supporting industries

Factor conditions


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Introduction to the New TradeIntroduction to the New TradeTheoryTheory

Up to now, trade theory has been dependentUp to now, trade theory has been dependenton national advantage, productionon national advantage, productionefficiency, factor endowments,efficiency, factor endowments,government agendas, country or industrygovernment agendas, country or industrymaturity, or overlapping demandmaturity, or overlapping demandsimilarity. These theories have a fewsimilarity. These theories have a fewcommonalities:commonalities:

1.1. They depend onThey depend on national differencesnational differences totoexplain, predict, and control trade.explain, predict, and control trade.

2.2. They assume government is eitherThey assume government is eitherinvolved, or not involved at all.involved, or not involved at all.

3.3. They dont consider firm level strategy,They dont consider firm level strategy,structure or economy.structure or economy.

4.4. The newer trade theories do that.The newer trade theories do that.


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New Trade TheoryNew Trade Theory- -contdcontd

According toAccording to New Trade TheoryNew Trade Theory , which is, which isactually a set of papers by variousactually a set of papers by variousscholars, trade is predicted by thescholars, trade is predicted by the

increasing returnsincreasing returns that firms can earnthat firms can earnby trading intentionally. I n Newby trading intentionally. I n NewTrade Theory:Trade Theory:

1.1. There is increasing return inThere is increasing return inEconomy of Scale.( learning effect)Economy of Scale.( learning effect)

2.2. First mover advantageFirst mover advantage


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New Trade theoryNew Trade theory- -contdcontd

3. Intra3. Intra- -Industry tradeIndustry trade is bestis bestexplained by increasing returns.explained by increasing returns.

4. Externalities4. Externalities like governmentlike governmentpolicy, political relations,policy, political relations,national history, consumptionnational history, consumptiondifferences, accident, and luckdifferences, accident, and luckall predict variance in tradeall predict variance in trade


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C onclusionC onclusion

RememberRemember , no theory thoroughly, no theory thoroughlyexplains all trade, predicts it allexplains all trade, predicts it allaccurately, and establishesaccurately, and establisheslimits on where trade does orlimits on where trade does ordoes not occur. Every theorydoes not occur. Every theoryhas advantages though, and ithas advantages though, and it

may be better to considermay be better to considertheoriestheories in comb in at i o nin comb in at i o n ratherratherthanthan independently independently ..


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Implications for BusinessImplications for Business

The implications of trade theories forThe implications of trade theories forBusiness areBusiness are

1.1. Location implicationsLocation implications2.2. First mover ImplicationsFirst mover Implications3.3. Policy ImplicationsPolicy Implications

6,7,8 international trade theories

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