Theories of International Trade

1. Theories of International Trade

2. Introduction • In the 1600 and 1700 centuries, mercantilism stressed that countries should simultaneously encourage exports and discourage imports. • Although mercantilism is an old theory it echoes (repeat) in modern politics and trade policies of many countries • The neoclassical economist Adam Smith, who developed the theory of absolute advantage, was the first to explain why unrestricted free trade is beneficial to a country. • Two theories have been developed from Adam Smith's absolute advantage theory. • First is the English neoclassical economist David Ricardo's comparative advantage. • Two Swedish economists, Eli Hecksher and Bertil Ohlin, develop the second theory.

3. Mercantilism According to Wild, 2000, the trade theory that states that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports is called mercantilism

5. Absolute Advantage • The Scottish economist Adam Smith developed the trade theory of absolute advantage in 1776 • A country that has an absolute advantage produces greater output of a good or service than other countries using the same amount of resources. • Smith stated that tariffs and quotas should not restrict international trade • Contrary to mercantilism Smith argued that a country should concentrate on production of goods in which it holds an absolute advantage. No country would then need to produce all the goods it consumed

6. Adam smith

7. Assumptions of the theory • Trade is between two countries • Only two commodities are traded • Free trade exists between the countries • They only element of cost of production is labour.

8. Example Country A can produce 1,000 parts per hour with 200 workers. Country B can produce 2,500 parts per hour with 200 workers. Country C can produce 10,000 parts per hour with 200 workers. _______has the absolute advantage.

9. Contd…….. According to the absolute advantage theory, international trade is a positive-sum game, because there are gains for both countries to an exchange. Unlike mercantilism this theory measures the nation's wealth by the living standards of its people and not by gold and silver.

10. problem with absolute advantage. If there is one country that does not have an absolute advantage in the production of any product, will there still be benefit to trade, and will trade even occur? The answer may be found in the extension of absolute advantage, the theory of comparative advantage.

11. Comparative Advantage The most basic concept in the whole of international trade theory is the principle of comparative advantage, first introduced by David Ricardo in 1817. The principle of comparative advantage states that a country should specialize in producing and exporting those products in which is has a comparative, or relative cost, advantage compared with other countries and should import those goods in which it has a comparative disadvantage.

12. law of comparative advantage refers to the ability of a country to produce a particular good or service at a lower opportunity cost than another party.

13. opportunity cost • The cost of passing up the next best choice when making a decision • Eg: you have Rs.100. u can use this to buy either

14. limitations The assumption that countries are driven only by the maximization of production and consumption, and not by issues out of concern for workers or consumers is a mistake.

15. Heckscher-Ohlin theory History of Bertil ohlin:Between 1944 and 1967, Bertil Ohlin was the leader of the Swedish Liberal Party, and between 1944 and 1945 he was also the Secretary of Trade of the Swedish Government. Bertil Ohlin died in 1979.

16. The countries differ with respect to the availability of the factors of production. They differ if one country, for example, has many machines (capital) but few workers, while another country has a lot of workers but few machines. According to the Heckscher-Ohlin theory, a country specializes in the production of goods that it is particularly suited to produce Countries in which capital is abundant and workers are few production of goods in particular, require capital.

17. Machines and Workers • The production of goods and services requires capital and workers. Some goods require more capital - technical equipment and machinery - and are called capital intensive. Examples of these goods are cars, computers, and cell phones. • Other goods require less equipment to produce and rely mostly on the efforts of the workers. These goods are called labor intensive. Examples of these goods are shoes and textile products such as jeans.

20. product life-cycle • The product life-cycle theory is an economic theory that was developed by Raymond Vernon • The intent of his International Product Life Cycle model (IPLC) was to advance trade theory beyond David Ricardo’s static framework of comparative advantages. • the product life cycle - explain how trade patterns change overtime.

21. The International Product Life Cycle Introduction and Growth Stages: Early Maturity: Late Maturity Decline Developing Country Competitor Exports Product To MNC Home Country; Competes with MNC Imports MNC Manufactures Product in Developed Countries; Exports to Developing Countries MNC Moves Production to Developing Country; Begins Importing to Home Country Developing Country Markets Remain Viable Target Markets for MNC; MNC Home Country Market Is Diminishing Sales Time

22. The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. In some situations, the product becomes an item that is imported by its original country of invention

23. 1 Product life-cycle • Stage 1: Introduction • Stage 2: Growth • Stage 3: Maturity • Stage 4: Decline

24. Stage 1: Introduction New products are introduced to meet local (i.e., national) needs, and new products are first exported to similar countries, countries with similar needs, preferences, and incomes. (E.g., the IBM PCs were produced in the US and spread quickly throughout the industrialized countries.)

25. Stage 2: Growth Increase in sale of new pdt attracts competitors. Increase of demand in advanced countries; exports – increase further innovation in pdt, cost reduction, mkt process takes place (tech equipped) Shift manufacturing to foreign countries

26. Stage 3: Maturity • World wide pdtn;Export decline. • Large scale of pdtn • Low cost pdtn – shift manufacturing to developing countries • Tech become standard

27. Stage 4: Decline Mks for the pdt concentrate in less developed countries as the customers in advanced countries shift their demand to further new pdts –thus pdtn in developing countries Original innovator becomes importer

28. PORTER'S DIAMOND OF NATIONAL ADVANTAGE

29. What is the Diamond Model? • The Diamond Model of Michael Porter for the competitive advantage of Nations offers a model that can help understand the comparative position of a nation in global competition.

30. Traditional country advantages Traditionally, economic theory mentions the following factors for comparative advantage for regions or countries:1. Land2. Location3. Natural resources (minerals, energy)4. Labor, and5. Local population size. Because these 5 factors can hardly influence…..

31. Porter says that sustained industrial growth has hardly ever been built on above mentioned basic inherited factors • According to Porter, as a rule competitive advantage of nations is the outcome of 4 interlinked advanced factors and activities in and between companies

33. PORTER used a diamond shaped diagram as a basis of a frameworkto illustrate the determinants of national advantage. • The points of the diamond are described as follows ……..

34. 1.FACTOR CONDITIONS • Classical factors – land, labour, capital and org • Porter emphasize education level of labour, quality of country infrastructure

35. 2.DEMAND CONDITIONS

36. 3.Related and supported industries • Suppliers of raw mtls, market intermediaries, financial companies, consulting agencies, ancillary industries etc…. • It competes and come with high input quality pdts

37. 4. Firm stg, structure and rivalry • Continuouslyv improve pdt design, invest in R & D, HRD, Tech … • High quality; low cost = export internationally • Japan – electronic goods