International Trade Theory

1
International Trade Theory

• Dr Carol Reade
• Bus 187

2
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

3
Where do these roses come from?
4
Equadorian Roses

• The Rolls-Royce
• of Roses

5
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

6
Mercantilism

• First theory of international trade 16th C
  England
• A nations 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 .

7
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

8
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

9
Theory of Absolute Advantage
10
Theory of Comparative Advantage

• David Ricardo (Principles of Political Economy,
  1817)
• Extends Adams Smiths argument
• A country should import even if it is more
  efficient in the goods 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

11
Theory of Comparative Advantage
12
Comparative Advantage Gains From Trade
13
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

14
Product Life-Cycle Theory

• Raymond Vernons (1966) theory is based on
  observation that many of the worlds 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

15
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

16
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

17
Theory of National Competitive Advantage

• Michael Porters (1990) theory sets forth the
  reasons for a nations 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

18
Porters Diamond
19
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