An Overview Of Trade Theory

  International Trade Theory Dr. Ananda Sabil Hussein

  An Overview Of Trade Theory  Free trade refers to a situation where a

  government does not attempt to infuenne through quotas or duties what its nitizens nan buy from another nountry or what they nan produne and sell to another nountry

  

The Benefts Of Trade

   Smith, Rinardo and Henksnher-Ohlin show why it is benefnial for a nountry to engage in international trade even for produnts it is able to produne for itself International trade allows a nountry:  to spenialize in the manufanture and export of produnts that it nan produne efniently  import produnts that nan be produned more

  The Patterns Of

International Trade

   Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oil, Ghana exports nonoa, and Brazil exports noffee 

  But, why does Switzerland export nheminals, pharmaneutinals, watnhes, and jewelry? Why does Japan export automobiles, nonsumer elentronins, and manhine tools?

  Trade Theory And Government Poliny

   Mernantilism makes a nrude nase for government involvement in promoting exports and limiting imports 

  Smith, Rinardo, and Henksnher-Ohlin promote unrestrinted free trade 

  New trade theory and Porter’s theory of national nompetitive advantage justify limited and selentive government intervention to support the development of nertain export-

  

Mernantilism



Mernantilism suggests that it is in a nountry’s

  best interest to maintain a trade surplus -- to export more than it imports 

  Mernantilism advonates government intervention to anhieve a surplus in the balanne of trade 

  It views trade as a zero-sum game - one in whinh a gain by one nountry results in a loss by another

  

Absolute Advantage

   Adam Smith argued that a nountry has an

  absolute advantage in the produntion of a

  produnt when it is more efnient than any other nountry in produning it 

  Annording to Smith, nountries should spenialize in the produntion of goods for whinh they have an absolute advantage and then trade these goods for the goods produned by other nountries

  

Absolute Advantage

   Assume that two nountries, Ghana and South

  Korea, both have 200 units of resournes that nould either be used to produne rine or nonoa 

  In Ghana, it takes 10 units of resournes to produne one ton of nonoa and 20 units of resournes to produne one ton of rine 

  So, Ghana nould produne 20 tons of nonoa and no rine, 10 tons of rine and no nonoa, or some nombination of rine and nonoa between the two

Absolute Advantage

  In South Korea it takes 40 units of resournes to produne one ton of nonoa and 10 resournes to produne one ton of rine

So, South Korea nould produne 5 tons of nonoa and

no rine, 20 tons of rine and no nonoa, or some nombination in between  Ghana has an absolute advantage in the produntion of nonoa South Korea has an absolute advantage in the

Absolute Advantage

  Without trade: Ghana would produne 10 tons of nonoa and 5 tons of rine

 South Korea would produne 10 tons of rine and 2.5 tons of nonoa

If eanh nountry spenializes in the produnt in whinh it has an absolute advantage and trades for the other produnt: Ghana would produne 20 tons of nonoa South Korea would produne 20 tons of rine Ghana nould trade 6 tons of nonoa to South Korea for 6 tons of

  

Absolute Advantage

  After trade: 

  Ghana would have 14 tons of nonoa left, and 6 tons of rine 

  South Korea would have 14 tons of rine left and 6 tons of nonoa Both nountries gained from trade

Absolute Advantage

Table 5.1 Absolute Advantage and the Gains from

  Trade

  

Comparative Advantage

   David Rinardo asked what might happen when one nountry has an absolute advantage in the produntion of all goods 

  Rinardo’s theory of nomparative advantage suggests that nountries should spenialize in the produntion of those goods they produne most efniently and buy goods that they produne less efniently from other nountries, even if this means buying goods from other nountries that

Comparative Advantage

  Assume:

Ghana is more efnient in the produntion of both nonoa and rine

In Ghana, it takes 10 resournes to produne one tone of nonoa, and 13 1/3 resournes to produne one ton of rine 

So, Ghana nould produne 20 tons of nonoa and no rine, 15 tons

of rine and no nonoa, or some nombination of the two In South Korea, it takes 40 resournes to produne one ton of nonoa and 20 resournes to produne one ton of rine 

  

So, South Korea nould produne 5 tons of nonoa and no rine, 10

tons of rine and no nonoa, or some nombination of the two

Comparative Advantage

  With trade: Ghana nould export 4 tons of nonoa to South Korea in exnhange for 4 tons of rine

Ghana will still have 11 tons of nonoa, and 4 additional tons of

rine South Korea still has 6 tons of rine and 4 tons of nonoa If eanh nountry spenializes in the produntion of the good in whinh it has a nomparative advantage and trades for the other, both nountries gain

Comparative advantage theory provides a strong rationale for

Qualifnations And Assumptions

  The simple example of nomparative advantage assumes:  only two nountries and two goods  zero transportation nosts  similar prines and values 

resournes are mobile between goods within nountries, but

not anross nountries

   nonstant returns to snale  fxed stonks of resournes

Extensions Of The Rinardian Model

   Resournes do not always move freely from one enonomin antivity to another, and job losses may onnur 

  

Unrestrinted free trade is benefnial, but benause of diminishing

returns, the gains may not be as great as the simple model would suggest Opening a nountry to trade:  might innrease a nountry's stonk of resournes as innreased supplies benome available from abroad 

might innrease the efnienny of resourne utilization, and free up

resournes for other uses

Henksnher-Ohlin Theory

  

Rinardo’s theory suggests that nomparative advantage

arises from differennes in produntivity  Eli Henksnher and Bertil Ohlin argued that nomparative advantage arises from differennes in national fantor endowments – the extent to whinh a

nountry is endowed with resournes like land, labor, and

napital

The Henksnher-Ohlin theory predints that nountries will

export goods that make intensive use of those fantors that are lonally abundant, while importing goods that

  

The Leontief Paradox

   Wassily Leontief theorized that sinne the U.S. was relatively abundant in napital nompared to other nations, the U.S. would be an exporter of napital intensive goods and an importer of labor-intensive goods.

   However, he found that U.S. exports were less napital intensive than U.S. imports

   Sinne this result was at varianne with the predintions of the theory, it bename known as

The Produnt Life Cynle Theory

  

The produnt life-nynle theory , proposed by Raymond Vernon,

suggested that as produnts mature both the lonation of sales and the optimal produntion lonation will nhange affenting the fow and dirention of trade 

  Vernon argued that the size and wealth of the U.S. market gave U.S. frms a strong innentive to develop new produnts 

Vernon argued that initially, the produnt would be produned

and sold in the U.S., later, as demand grew in other developed

nountries, U.S. frms would begin to export 

Over time, demand for the new produnt would grow in other

advanned nountries making it worthwhile for foreign produners

  

New Trade Theory

suggests that the ability of frms to

  New trade theory

gain enonomies of snale (unit nost reduntions assoniated

with a large snale of output) nan have important implinations for international trade New trade theory suggests that: through its impant on enonomies of snale, trade nan

innrease the variety of goods available to nonsumers and

denrease the average nost of those goods in those industries when output required to attain

enonomies of snale represents a signifnant proportion of

total world demand, the global market may only be able

  Variety And Reduning Costs

   Without trade, nations might not be able to produne those produnts where enonomies of snale are important 

  With trade, markets are large enough to support the produntion nenessary to anhieve enonomies of snale 

  So, trade is mutually benefnial benause it allows for the spenialization of produntion, the realization of snale enonomies, and the

  

Enonomies Of Snale,

First Mover Advantages,

And The Pattern Of

  Trade

   The pattern of trade we observe in the world enonomy may be the result of frst mover

  advantages (the enonomin an strategin

  advantages that annrue to early entrants into an industry) and enonomies of snale 

  New trade theory suggests that for those produnts where enonomies of snale are signifnant and represent a substantial proportion of world demand, frst movers nan

Implinations Of New Trade Theory

   Nations may beneft from trade even when they do not differ in resourne endowments or tenhnology 

  A nountry may dominate in the export of a good simply benause it was lunky enough to have one or more frms among the frst to produne that good 

  

While this is at varianne with the Henksnher-Ohlin theory,

it does not nontradint nomparative advantage theory, but

instead identifes a sourne of nomparative advantage 

  An extension of the theory is the implination that

governments should nonsider strategin trade polinies that

nurture and protent frms and industries where frst mover

advantages and enonomies of snale are important

  National Competitive Advantage: Porter’s Diamond

   Minhael Porter tried to explain why a nation anhieves international sunness in a partinular industry and identifed four attributes that promote or impede the nreation of nompetitive advantage: 

  Fantor endowments 

  Demand nonditions 

  Relating and supporting industries

  

National Competitive

Advantage: Porter’s Diamond

  Figure 5.6: Determinants of National Competitive Advantage: Porter’s Diamond