International Trade Theory
Overview of Trade Theory
• Free Trade occurs when a government does not
attempt to influence, through quotas or duties, what its
citizens can buy from another country or what they
can produce and sell to another country
• The Benefits of Trade allow a country to specialize in
the manufacture and export of products that can be
produced most efficiently in that country
Trade Theory-Overview
• The Pattern of International Trade displays patterns
that are easy to understand (Saudi Arabia/oil or
China/crawfish).
- Others are not so easy to understand (Japan and
cars)
• The history of Trade Theory and government
involvement presents a mixed case for the role of
government in promoting exports and limiting imports
• Later theories appear to make a case for limited
involvement
Mercantilism: Mid-16th Century
• A nation’s wealth depends on accumulated treasure
- Gold and silver are the currency of trade
• Theory says you should have a trade surplus
- Maximize export through subsidies
- Minimize imports through tariffs and quotas
• Flaw: “zero-sum game”
Mercantilism-Zero-Sum Game
• In 1752, David Hume pointed out that:
- Increased exports lead to inflation and higher prices
- Increased imports lead to lower prices
• Result: Country A sells less because of high prices
and Country B sells more because of lower prices
• In the long run, no one can keep a trade surplus
Theory of Absolute Advantage
• Adam Smith argued (Wealth of Nations, 1776):
Capability of one country to produce more of a product
with the same amount of input than another country
can vary
- A country should produce only goods where it is most
efficient, and trade for those goods where it is not efficient
• Trade between countries is, therefore, beneficial
• Assumes there is an absolute balance among
nations
- Example: Ghana/cocoa
Theory of Absolute Advantage
Absolute Advantage and the
Gains From Trade
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
product’s production than country from which it is buying
- Look to see how much more efficient
• If only comparatively efficient, than import
• Makes better use of resources
• Trade is a positive-sum game
Theory of
Comparative Advantage
Comparative Advantage and the
Gains From Trade
Simple Extensions of the
Ricardian Model
• Immobile resources:
- Resources do not always move easily from one
economic activity to another
• Diminishing returns:
- Diminishing returns to specialization suggests that
after some point, the more units of a good the country
produces, the greater the additional resources
required to produce an additional item
- Different goods use resources in different proportions
Simple Extensions of the
Ricardian Model
• Free trade (open economies):
- Free trade might increase a country’s stock of
resources (as labor and capital arrives from abroad)
- Increase the efficiency of resource utilization
PPF Under Diminishing Returns
Influence of Free Trade on PPF
Heckscher (1919)-Olin (1933) Theory
• Export goods that intensively use factor endowments
which are locally abundant
- Corollary: import goods made from locally scarce 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, not absolute
advantage
Product Life-Cycle
Theory - R. Vernon (1966)
• As products mature, both location of sales and optimal
production changes
• Affects the direction and flow of imports and exports
• Globalization and integration of the economy makes
this theory less valid
Product life cycle theory
Fig 4.5
New Trade Theory
In industries with high fixed costs:
- Specialization increases output, and the ability to enhance
economies of scale increases
- Learning effects are high.
• These are cost savings that come from “learning by doing”
New Trade Theory-Applications
• Typically, requires industries with high, fixed costs
- World demand will support few competitors
• Competitors may emerge because of “ First-mover
advantage”
- Economies of scale may preclude new entrants
- Role of the government becomes significant
• Some argue that it generates government intervention
and strategic trade policy
Theory of National
Competitive Advantage
• The theory attempts to analyze the reasons for a
nation’s success in a particular industry
• Porter studied 100 industries in 10 nations
- Postulated determinants of competitive advantage of a
nation were based on four major attributes
•
•
•
•
Factor endowments
Demand conditions
Related and supporting industries
Firm strategy, structure and rivalry
Porter’s Diamond
• Success occurs where these attributes exist
• More/greater the attribute, the higher chance of
success
• The diamond is mutually reinforcing
Porter’s Diamond
Factor Endowments
• Factor endowments: A nation’s position in factors
of production such as skilled labor or infrastructure
necessary to compete in a given industry
- Basic factor endowments
- Advanced factor endowments
Basic Factor Endowments
• Basic factors: Factors present in a country
- Natural resources
- Climate
- Geographic location
- Demographics
• While basic factors can provide an initial advantage
they must be supported by advanced factors to
maintain success
Advanced Factor Endowments
• Advanced factors: The result of investment by
people, companies, and government are more likely to
lead to competitive advantage
- If a country has no basic factors, it must invest in advanced
factors
Advanced Factor Endowments
• Communications
• Skilled labor
• Research
• Technology
• Education
Related and Supporting
Industries
• Creates clusters of supporting industries that are
internationally competitive
• Must also meet requirements of other parts of the
Diamond
Porter’s Theory-Predictions
• Porter’s theory should predict the pattern of
international trade that we observe in the real world
• Countries should be exporting products from those
industries where all four components of the diamond
are favorable, while importing in those areas where the
components are not favorable
Implications for Business
• Location implications:
- Disperse production activities to countries where they can
be performed most efficiently
• First-mover implications:
- Invest substantial financial resources in building a firstmover, or early-mover advantage
• Policy implications:
- Promoting free trade is in the best interests of the home
country, not always in the best interests of the firm, even
though many firms promote open markets
Looking Ahead to Chapter 6
• The Political Economy of International Trade
-
Instruments of Trade Policy
The Case for Government Intervention
The Revised Case for Free Trade
Development of the World Trading System