INTERNATIONAL TRADE THEORIES

Trade theories help managers and govt policy makers to focus

on the questions like what, how much and with whom their
country should import and export.

Some trade theories prescribe that govt should influence trade

partners and others propose a laissez faire treatment of trade.

They help companies to determine where to locate their

production facilities.

These theories also improve understanding about govt trade

policies and predict how these policies might affect companies
competitiveness.
INTERVENTIONIST THEORIES
Mercantilism - Foundation for economic thought
from 1500-1800.Countrys wealth is measured by
its holdings of treasure which usually meant its
gold. weakened after 1800 but terminology like
Favourable balance of trade is still under usage.

Neo-mercantilism - countries maintain favourable

balance of trade in an attempt to achieve some
social or political objective.
FREE TRADE THEORIES

Theory of Absolute Advantage - 1776 by Adam smith -Different countries

produce some goods more efficiently than other countries; Global efficiency
increase through free trade
Labour become more skilled
Labour would not loose time in switching production
Long production runs - more effective working methods
-Natural Advantage - Srilanka - Graphite, Russia - iron Ore, India -
Chromium
-Acquired Advantage - Process technology/ Product technology
Japan export steel by importing iron and coal ( Labour-saving and Material
saving processes)
Denmark - silver table ware ( not because they are not rich in silver mines
but because they can develop distinctive products)
Eg : Costa Rica and USA

ASSUMPTIONS

Costa Rica

100 units of resources available

10 units to produce a ton of wheat

4 units to produce a ton of coffee

Uses half of total resources per product when there is no foreign trade

USA

100units of resources available

5 units to produce a ton of wheat

20 units to produce a ton of coffee

Uses half of total resources per product when there is no foreign trade
without trade Coffee (ton) wheat (Ton)

Costa Rica 12.5 5

USA 2.5 10

15 15

with trade

Costa Rica 25 0

USA 0 20

25 20
Theory of Comparative Advantage - 1817 David Recordo
Global effeciency gain may still result from trade if
a country specialises in those products that it can
produce more efficiently than other products-
regardless of whether other countries can produce
those products even more efficiently.

Physician and secretary

Costa Rica and USA

ASSUMPTIONS

Costa Rica

100 units of resources available

10 units to produce a ton of wheat

10units to produce a ton of coffee

Uses half of total resources per product when there is no foreign trade

USA

100units of resources available

4 units to produce a ton of wheat

5 units to produce a ton of coffee

Uses half of total resources per product when there is no foreign trade
without trade Coffee (ton) wheat (Ton)

Costa Rica 5 5

USA 10 12.5

15 17.5

with trade ( increasing coffee production)

Costa Rica 10 0

USA 6 (30%) 17.5 (70%)

16 17.5
LIMITATIONS
Full employment

Economic efficiency Objective

Division of Gains

Two countries, Two commodities

Transport costs

Statics and dynamics

Services

Mobility
What type of products does a country trade?

FACTOR PROPORTION THEORY - Eli Heckscher and Bertlin

Ohlin - Factors in relative abundance are cheaper then factors
in relative scarcity. ( land , labour , capital)

Land - Labour relationship: In countries in which there are many

people relative to the amount of land (eg: Hong Kong and
Netherlands) land prices are very high because it is in
demand. Regardless of climate and soil conditions neither
HongKong or Netherlands excel in production of goods requiring
large amounts of land such as wheat.Eg HongKong -clothing
production occur in multi-storey factories where workers share
minimal space.

Australia and Canada- Abundant land compared to people.

Labour - capital relationship : In countries where little capital
is available for investment and where the amount of
investment per worker is low, managers might expect to find
cheaper labour rates and export competitiveness in products
that require large amounts of labour relative to capital.

Eg Iran -Labour abundant compared to capital - hand made

carpets

USA - cheap capital - machine made carpets

This theory assumes that production factors are

homogeneous but in reality labour skills vary.

Technological complexities: Theory becomes complicated

when the same product can be manufactured by different
methods.

Canada : Wheat - Capital Intensive India - Wheat- Labour

LEONTIEF PARADOX

Factor Proportion theory became most influential

theoritical ideas in International Economics. So it was
subjected to many emperical tests.In 1953 Wassily
Leontiff (Winner of Nobel prize in economisin 1973)
published a study which became very popular. Based
on Factor Proportion theory he assumes that as US was
relatively abundant in capital relative to other
countries, it should be exporter of Capital intensive
goods . But reverse were the results. It became
popular as Leontiff Paradox.
DYNAMICS OF TRADE

PLC THEORY OF TRADE :Raymond Vernon developed

the theory of international product life cycle to explain
trade based on technological gaps. He asserts that the
initial production of a new product usually requires
skilled labour, which can be replaced by a unskilled
labour once the product acquires mass acceptance
and is standardised. Thus, the comparative advantage
held by the industrialised nations that introduce new
products shifts to lower-wage nations. Vernons
contribution to the theory of internationalisation of
business is that he put together explanations of
international trade and investment flows that were
following trade.
Introduction, Growth , Maturity and Decline
Stages

Production Location

Market Location

Competitive factors

Production Technology
 Introduction Growth Maturity Decline

Production Innovating Country Innovating & other Multiple countries Mainly in

Location industrial countries developing
countries

Market Innovating country Mainly industrial Growth in developing Mainly in

Location & some exports countries countries developing
Shift in export Some decrease in countries an some
markets as some Industrial Countries exports to
production replaces developed
exports in some countries
countries
Competitive Near Monopoly, Fast Growing Overall stabilized Overall decline in
Factors sales based on demand , demand , No. of demand Price is
uniqueness rather No. of competitors competitors key weapon
then price, increases, decreases, Price is Number of
Evolving product Some companies very important producer
characteristics begin price cutting, especially in countries continue
Product becomes developing countries to decrease
more standardized
 Introduction Growth Maturity Decline
Production Short Production Product input Long Production Unskilled labour
Technology runs increases runs Long production
Evolving methods Methods are more Highly runs
to coincide with standardized standardized
product evolution product
High Labour Less labour skills
input and labour needed
skills relative to
capital.
Limitations

If transportation cots are very high, there is little possibility for export sales,
regardless of stage of life cycle.

There are many types of products for which shift in production location do
not usually occur (Products of very rapid innovation and short life cycles,
luxury products, product that require specialised technical labour) -
production continue in innovative country Eg US dominance of medical
equipment products.

Changes in technology and demand might lead to all kinds of changes. Eg

Microchip production

Some MNCs introduce at home and abroad simultaneously

Company produce abroad simply to take advantage of production economies

rather than in response to growing foreign markets Eg : Ericsson produces in
Srilanka to sell in export markets .
NATIONAL COMPETITIVE ADVANTAGE THEORY

Michel Porter of Harward business published the

results of intensive research (He studied 100
companies in 10 developed countries) to determine
why some firms succeed and others fail in
international competition.

Japan - Electronic Industry

Germany & US - Chemical industry, Textile Industry

Italy - Ceramic Tiles industry

Other two are Chance and Government

A) Factor Conditions - Basic factors, Advanced Factors

Japan - lack land and mineral deposits.But large pool of engineers have been vital
to Japans success

B) Demand conditions - Home demand (Italian Ceramic Tile Industry)

C)Related and supporting Industries : Swedish strength in fabricated steel

products (Ball bearings and cutting tools) was due to strength of sweden
speciality steel industry.

d) Firm Strategy Structure and Rivalry : Predominance of engineers on top

management teams of Germany and Japanese firms - resulted in improvement of
manufacturing processes & product design

USA - predominance of people with strong financial background - overemphasis

on maximising short term financial returns.

Other two factors Government & chance

Role of Government by taking important decisions
and by implementing effective policies.

Chance refers to random events such as major

technological breakthroughs, political decisions by
foreign governments, war & destruction, fluctuations
in exchange rates, sudden drop in demand, sudden
discovery of pesticides in food etc.
Limitations

Focus more on developed nations

Natural resources are also important

Government has role in determining competitiveness