Growing Importance of Trade in World Economy & Foreign Trade Theories
Growing Importance of Trade in World Economy & Foreign Trade Theories
Growing Importance of Trade in World Economy & Foreign Trade Theories
Benefit of International trade is enjoyed by both, the exporting nations as well as importing nations. Some feel that the commodities imported is the actual benefit of international trade, whereas, export activities involve a lot of expenses. The "Balance of Payments", including payment for services as well as goods; yearly capital fluxes entering in and moving out of a country, is more or less stable and remains in equilibrium and requires few adjustments. Studies have revealed that United States of America, has a highly competitive market, and by investing in America, the returns are good. International trade has reduced inequalities and facilitated growth in economy of different countries. Studies revealed that majority of the countries of the European Economic Community, manifested very little tendency towards convergence in income during the period 1870 through World War II.
Due to international trade, a new trend has been observed. Countries, all over the world are making all efforts to adhere to monetary policies, which have zero inflation, thereby reducing restrictions in trade worldwide. After conducting research on international trade, it was found out that if a particular nation reduces its tariffs, it is enough to boost long term growth of the other economies as well. However, if there is unanimous reductions in tariffs, the growth is even faster. It was also observed that , majority of the countries, adopted methods of ensuring growth on a long term basis. These countries, manifested a trend, where the levels of income were also high.
Introduction
International trade theory explains why it is beneficial for countries to engage in international trade helps countries formulate their economic policy explains the pattern of international trade in the world economy
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
Mercantilism
A nations wealth depends on build up wealth of
Gold and silver as they were the currency of trade in that age.
Mercantilism (mid-16th century England) asserted that
it is in a countrys best interest to maintain a trade surplus, to export more than it imports Maximize export through subsidies Minimize imports through tariffs and quotas it advocated government intervention to achieve a surplus in the balance of trade it viewed trade as a zero-sum game (one in which a gain by one country results in a loss by another) Stayed from 1500-1800, and trade strategy of many nations were boost exports and limit import.
prices and Country B sells more because of lower prices In the long run, no one can keep a trade surplus Mercantilism is problematic and not economically valid, yet many political views today have the goal of boosting exports while limiting imports
In 1776, Adam Smith in his book The Wealth Of Nations argued: Countries differ in their ability to produce goods efficiently. A country has an absolute advantage when it is the most efficient in producing a particular product. (Countries should specialize in producing products for which they have an absolute advantage, and trade these goods for those produced more efficiently by other countries.) Such trade will be beneficial to both countries. Thus it is a positive-sum game
G 15 Cocoa 10
A K
B
2.5
5 Rice
G 10
K 15 20
Resources Required to Produce 1 Ton of Cocoa and Rice. Production and Consumption without Trade.
10 40 10.0 2.5 12.5 20.0 0.0 20.0 14.0 6.0 4.0 3.5
Consumption After Ghana Trades 6 Tons of Cocoa for 6 Tons of S. Korean Rice Increase in Consumption as a result of Specialization and Trade
more efficiently in comparison to other goods even if the country doesnt hold an absolute advantage for that good. The country should import the goods it produces less efficiently, even if it can produce that good all by itself. Due to increased efficiency (better use of limited resources), potential world production is greater with unrestricted free trade. Comparative Advantage maximize countries combined output Therefore, free trade is universally beneficial (a positive-sum game) even when nations do not have an absolute advantage.
5
2.5
Cocoa 10
15
20
K 10 Rice
G 15 20
Resources Required to Produce 1 Ton of Cocoa and Rice. Production and Consumption without Trade (points A and B).
Production with Specialization (points C and K) Consumption After Ghana Trades 4 Tons of Cocoa for 4 Tons of S. Korean Rice Increase in Consumption as a result of Specialization and Trade
S. Korea
1.5
1.0
Comparative advantage
But Comparative
Advantage can gain by production of one good A country enjoys an absolute advantage over another country in the production of a product if it uses fewer resources to produce that product than the other country does.
comparative advantage in the production of a good if that good can be produced at a lower cost in terms of
another within a country. There are constant returns to scale. That free trade does not change the efficiency with which a country uses its resources, or the stock of resources.
Heckscher-Ohlin Theory
Comparative advantage arise from differences in
Productivity. Swedish economists Eli Heckscher (in 1919), and Bertil Ohlin (in 1933) had another explanation for comparative advantage. Comparative advantage did not stem from differences in productivity (as theorized by Ricardo), but from differences in national factor endowments. (the extent to which a country is gifted with resources such as land, labor, capital, human resources, capital) A country should export goods that intensively use factor endowments which are abundantly available in the country. A country should Import goods that make intensive use of factors which are scarce.
the Hechscher-Ohlin theory in some instances. The US is abundant in capital relative to most other nations. So, according to Hecksher-Ohlin, the US should be an exporter of capital-intensive goods, and an importer of labor-intensive goods. Actually, in 1953, US exports were less capital-intensive than US imports. Heckscher-Ohlin is a relatively poor predictor of realworld trade patterns. Ricardos theory is more accurate. In the end, differences in productivity may be the key to determining trade patterns.
an issue
Limited initial demand in other advanced countries Exports more attractive than production in other countries
When demand increases in advanced countries Produce in foreign countries when demand necessitate
economies of scale.
The world economy will profitably support only a few
as they are first to gain economies of scale; this discourages new entries the first mover advantage. 1. Because of economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods 2. In those industries Where demand become more crucial, the global market may only be able to support a small number of firms Important factors to first-mover advantage are:
luck
entrepreneurship innovation government intervention.
proactive trade policy if it helps domestic firms become first movers in an industry; this is in conflict with earlier free-trade theories
Michael Porter (1990), of HBS, tried to explain why a nation achieves international success in a particular industry Porter identified four attributes he calls the diamond that promote or impede the creation of competitive advantage 1. Factor endowments 2. Demand conditions 3. Related and supporting industries 4. Firm strategy, structure, and rivalry In addition, Porter identified two additional variables (chance and government) that can influence the diamond in important ways
Porters Diamond
The conditions in the nation governing how companies are created, organized, and managed and the nature of domestic rivalry.
A nations position in factors of production, such as skilled labor or infrastructure necessary to compete in a given industry.
The presence or absence in a nation of supplier industries or related industries that are nationally competitive.
Factor Endowments
factors of production such as skilled labor or infrastructure necessary to compete in a given industry
Basic factor endowments (Natural resources, Climate, Geographic location, Demographics) Advanced factor endowments
Technology
Education
Demand Conditions
Demand: creates capabilities creates sophisticated and demanding consumers
Demand impacts quality
and innovation
success Management ideology and structure of the firm can either help or hurt you Presence of domestic rivalry improves a companys competitiveness
Porters Theory-Predictions
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
most efficiently Ex: If design can performed most efficiently in France, it is where design facility should be kept.
First-mover implications:
Invest substantial financial resources in building a first-mover, 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
Thank you!