International Trade Theory

							International Trade Theory


       Dr Carol Reade
          Bus 187
Learning Objectives
• Introduce theories that explain why it is
  beneficial for a country to engage in
  international trade

• Examine the pattern of international trade
  that we observe in the world economy
Where do these roses come from?
Equadorian Roses




               “The Rolls-Royce
                  of Roses”
Theories

• Mercantilism
• Theory of absolute advantage
• Theory of comparative advantage
• Heckscher-Ohlin theory
• Product life-cycle theory
• New trade theory
• Theory of national competitive advantage
 Mercantilism

• First theory of international trade – 16th C England
• A nation’s wealth depends on accumulated
  treasure
   • Gold and silver are the currency of trade
• A country should maintain a trade surplus
   • Maximize export through subsidies
   • Minimize imports through tariffs and quotas
• Viewed trade as a zero-sum game –
  a gain by one country results in a loss
  by another .
Mercantilism
• In 1752, David Hume pointed out that:
  • Balance of trade surplus leads to:
     • inflow of gold and silver; inflation and higher
       prices
  • Balance of trade deficit leads to:
     • outflow of gold and silver; lower prices


• In the long run, no country can keep
  a trade surplus
Theory of Absolute Advantage
• Adam Smith (Wealth of Nations, 1776) argued
  that countries differ in their ability to produce
  goods efficiently
  • A country should produce only goods where it is most
    efficient, and trade for those goods where it is less
    efficient

• Trade is a positive sum game
  • Example: Ghana/cocoa and South Korea/rice
Theory of Absolute Advantage
Theory of Comparative Advantage
• David Ricardo (Principles of Political Economy, 1817):
   • Extends Adam’s Smith’s argument
   • A country should import even if it is more efficient in the
     good’s production than the country from which it is buying
   • The key is how much more (comparatively more) efficient


• Basic message is that potential world production
  is greater with unrestricted free trade than with
  restricted trade
Theory of Comparative Advantage
Comparative Advantage & Gains From Trade
  Heckscher-Ohlin Theory

• Swedish economists, Eli Heckscher (1919) and
  Bertil Ohlin (1933) proposed that comparative
  advantage arises from differences in national
  factor endowments (land, labor, and capital), not
  differences in productivity

• Theory predicts that countries will export goods
  that intensively use factor endowments which are
  locally abundant and import goods made from
  locally scarce factors
Product Life-Cycle Theory

 • Raymond Vernon’s (1966) theory is based on
   observation that many of the world’s products
   were developed in US and first sold in US.

 • Proposed that as products mature, both location
   of sales and location of optimal production
   changes, affecting the direction and flow of
   imports and exports

 • Integration of the global economy makes this
   theory less valid
New Trade Theory
Paul Krugman, 1970s
• In some cases countries specialize in production
  and export of particular goods because in certain
  industries the world market can support only a
  limited number of firms

• The pattern of trade we observe in the world
  economy may be the result of first mover
  advantages and economies of scale
New Trade Theory

•New trade theory suggests that for those
products where economies of scale are
significant and represent a substantial
proportion of world demand, first movers can
gain a scale based cost advantage that later
entrants find difficult to match

•Some argue that it generates government
intervention and strategic trade policy
Theory of National Competitive Advantage


 • Michael Porter’s (1990) theory sets forth the reasons
   for a nation’s success in a particular industry

 • Four major attributes of a nation determine competitive
   advantage
    • Factor endowments
    • Demand conditions
    • Related and supporting industries
    • Firm strategy, structure and rivalry
Porter’s Diamond
 Summary

• Each theory explains something about the
  pattern of trade

• The theories agree that international trade is
  beneficial to a country though lack agreement in
  their recommendations for government policy