InternationalTrade
References Griffin and Pustay, Chapter 6; Rugman and Collinson, Chapter 6
FundamentalIssues
» Whytrade?
» Tradetheories:AbsoluteAdvantage,ComparativeAdvantage
andNewTradetheory
» Barrierstotrade:protectionismandtheimpactoftariffs
» FreetradeandtheWTO
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page 1
Why Trade Internationally?
» Non‐availabilityofgoodsorservices
» Permanentand/ortemporarynon‐availability
» Productdifferentiation
» Consumerspreferdiversity
» Differencesininfrastructure,resourceendowmentand
technology
» Theoriesofabsoluteadvantage,comparativeadvantage andNew
TradeTheory
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Theoretical Underpinnings
AbsoluteAdvantage
» AdamSmitharguedthatagivencountryhasanabsoluteadvantageover
anothercountryintheproductionofagoodifitusesfewerresourcesto
producethatgoodthantheothercountrydoes
ComparativeAdvantage
» DavidRicardoarguedthatagivencountryhasacomparativeadvantage
intheproductionofagoodifthatgoodcanbeproducedatalower
opportunitycost,relativetotheproductionofanothercountry
» Acountryshouldproduceandexportthosegoodsandservicesforwhichit
isrelativelymoreproductivethanothercountries
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Absolute Advantage: An Example
Amutualabsoluteadvantage:
Product
:
UAE
Brazil
6tons
peracreofland
2tons
peracreofland
2tons
peracreofland
6tons
peracreofland
Now,supposetheUAEandBrazildivideup100acresoflandeachtoobtain
equalunitsofbananaanddateproduction:
:
Before specialisationandtrade
Product
TotalOutput
UAE
Brazil
25acresx6tons/acre
150tonsofdates
+
75acresx2tons/acre
150tonsofdates
+
75acresx2tons/acre
150tonsofbananas
25acresx6tons/acre
150tonsofbananas
300tons
300tons
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Absolute Advantage – Gains from Trade
Becausebothcountrieshaveanabsoluteadvantageintheproductionofa
differentproduct– allotherthingsbeingequal– bothwillbenefitfrom
productspecialization and tradewithoneanother.
Anagreementtotrade300tonsofEmiratidatesoffor300tonsofBrazilian
bananaswoulddoubletheconsumptionoftheseproductsinbothcountries.
Putdifferently,post‐tradewithBraziltheUAEcouldconsume600,not300
tonsofproduce:
PRODUCTION
Product
Total
AFTERSPECIALISATIONANDTRADE
CONSUMPTION
UAE
Brazil
UAE
Brazil
100acresx6tons
600tons
0acres
0 tons
300tons
ofdates
+
300tons
ofdates
+
0acres
0 tons
100acresx6tons
600tons
300tons
ofbananas
300tons
ofbananas
600tons
600tons
600tons
600tons
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Comparative Advantage: An Example
Product
India
Oman
6tonsofpapayaperacreofland
1ton ofpapaya peracreofland
50acres x6=300tons
75acres x1=75tons
6tons ofmangoperacreofland
3tonsofmango peracreofland
50acres x6=300tons
25acres x3=75tons
600tons
150tons
TotalOutput
Evenifacountryhadaabsoluteadvantageintheproductionofallgoods,
Ricardowouldarguethatspecializationandtradearestillmutuallybeneficial.
Thisisbecausewhencountriesspecializeinproducingthegoodsinwhich
theyhaveacomparativeadvantage,theymaximizetheircombinedoutput
andallocatetheirresourcesmoreefficiently.
Ifeachcountry specializes inthosegoodswheretheyhavea
comparative advantage,thentotaloutputand economicwelfare canbe
increased. Thisistrueevenifonenationhasan absoluteadvantage over
anothercountry.
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Comparative Advantage – Opportunity Cost
Priortospecialisationandexploitingagivencomparativeadvantagethe
internalOpportunityCostforeachcountrymustfirstbeconsidered:
Opportunity “cost”ofpapaya
Tonsofmango
givenup
Opportunity “cost”ofmango
Tonsofpapaya
gained
India
Tonsofpapaya
givenup
Tonsofmango
gained
India
1
1
Oman
1
1
⅓
1
Oman
3
1
Indiahasacomparativeadvantagein
papayaproduction
Omanhasacomparativeadvantagein
mangoproduction
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Comparative Advantage – Specialisation
Step1:Omanspecialisesinmangoproduction.Indiacannotcompletely
specializeinpapayabecauseitneeds300tonsofmangoandwillnotbeableto
getenoughmangofromOman,ittransfers25acresoutofmangoandinto
papaya
AFTERSPECIALISATION
Product
India
Oman
75acres x6=450tons
0acres =0tons
25acres x6=150tons
100acres x3=300tons
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Comparative Advantage – Gains from Trade
Step2:IndiaandOmantrade.Aftertrading,India’stotalofbothgoods
increasesfrom600to700tons,Oman’stotalofbothgoodsincreasesfrom150
to200tons.
POSTTRADECONSUMPTION
Product
India
Oman
IndiasendstoOman100tonsofits450toncropofpapaya
(450‐100=)
(0+100=)
350tons
100tons
OmansendstoIndia200tonsofits300toncropofmangoes
TotalOutput
(150+200=)
(300‐200=)
350tons
100tons
700tons
200 tons
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Comparative Advantage – in the real world
CanComparativeAdvantageexplaintradetoday?
» Ricardo'stheory ofcomparativeadvantagewasfurtherdevelopedby
Heckscher,OhlinandSamuelsonwhoarguedthatcountrieshave
different factorendowments oflabour,landandcapitalinputs.
» Countrieswill specialise inand export thoseproductswhichuse
intensivelythefactorsofproductionwhichtheyaremostendowed.
» Thistheorycanexplainthetradewhichoccursbetweencountrieswith
differentfactorendowmentssuchastheUAEandChina.
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UAE: Revealed Comparative Advantage
» TheBalassa RevealedComparativeAdvantage(RCA)Indexbasedonthe
Ricardian comparativeadvantageconceptallowsustocalculateempirically
theindustrieswhereacountryhasacomparativeadvantageintrade.
Exports as a share of total exports (%)
27.11
49.87
Exports as a share of world exports (%)
5.38
1.93
Net trade
‐7,788,217
23,403,632
Specialisation
(BalassaRCA
Index ) 10.7
3.8
(76) Aluminium and articles thereof
(25) Salt, sulphur, earth, stone, plaster, lime and cement
2.19
1.21
434,706
2.4
0.46
0.88
‐8,495
1.8
(69) Ceramic products
0.41
0.79
‐304,968
1.6
(78) Lead and articles thereof
0.06
0.67
17,468
1.5
(17) Sugars and sugar confectionery
0.38
0.7
‐518,933
1.4
(01) Live animals
0.14
0.56
‐178,190
1.1
Industry
(71) Pearls, precious stones, metals, coins,
(27) Mineral fuels, oils, distillation products
Source: INTERNATIONAL TRADE CENTRE 2010
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New Trade Theory
inthe20thcentury,alargeshareoftradeoccurredbetweencountrieswithvery
similarcharacteristicsandfactorendowments,NewTradeTheorysuggested
somereasonsforthis:
TradeCosts
» PaulKrugman arguesthatthe'costoftradeeffect'caneliminatesomeof
theabsoluteand/orcomparativeadvantagesofinternationaltrade,costs
includetransportation,exchangerateriskandimport/exporttariffs
Consumerpreferences
» Consumerspreferadiversechoiceofbrandse.g BMWandToyota.
TheEUisboththelargestexporterandimporterofcarsworldwide
EconomiesofScale
» Productionfavourseconomiesofscale,itisnotprofitabletospreadthe
productionofe.g.carsallovertheworld,onlyafewcountrieswillbe
specialisedinproducingcars.
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Barriers to Trade
PROTECTIONISM IS:
agivencountry'spolicyofrestraininginternationaltrade
TARIFFS ARE:
dutiesortaxesimposedonimportedgoods
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Protectionism
Reasonsfortariffs:
» Toretaliateagainstdumping:thesellingofgoodsatapricebelow
thatinthehomecountry,orbelowcost,toprotectlocalindustry
» Toraiserevenuesforthegovernment
» Toreduceforeignexpendituresbycitizensinordertoimprovethe
country’sbalanceofpayments
» Tariffs(orcustomsduties)includeimportandexporttariffs
Quantitylimits:
» Quotasareaquantitylimitonimportedgoods.Embargoisaquota
settozero.
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The ‘Free Market’ Alternative
TheWorldTradeOrganisationseekstopromote‘freetrade’and
reduceprotectionistpolicies
» Promotetradeflowsbyencouragingnationstoadopt
nondiscriminatory,tradepolicies
» Reduceremainingtradebarriersthroughmultilateralnegotiation
» Establishimpartialproceduresforresolvingtradedisputesamong
members
» CriticismsofWTO:
» 2001Doharoundnotcompleted
» SinceDohalargeincreaseinbilateralFTAs
» Placestradeabovehealth,socialandenvironmental
concerns
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