CHAPTER 5 INTERNATIONAL TRADE THEORY Benefits of trade:

Proponents of international trade theories are Smith, Richardo, and Heckcher-Ohlin. According to them, No country is self sufficient. So a country must depend on another country for the goods which they cannot produce. t is !eneficial for a country to engage in international trade e"en for products it is a!le to produce itself. #he gains arise !ecause it allows a country to speciali$e in the manufacture and e%port of products that can !e produced more efficiently.

nternational trade theories help us to understand and e%plain the pattern of international trade that we o!ser"e in the economy.

1. Theory of

er!anti"is#

#he main tenet of mercantilism is& It is in a countrys best interest to maintain trade surplus, to export more than import. 'ountries used to conduct trade in e%change of gold and sil"er. So if a country imported more than e%port, then gold and sil"er reser"e will reduce. 'ontrarily, if they e%ported more, then they will accumulate gold and sil"er and conse(uently, will gain national wealth and prestige. So to maintain trade surplus go"ernment inter"enes. #his theory is critici$ed !ecause, #rade surplus increase money supply in a country. So people ha"e more money in their hands. So they spend more which raises the demand and conse(uently, price of goods. #he result of this is inflation. #his theory leads to a zero sum game )when one country losses and another country gains* rather than a positive sum game )+hen !oth,all the countries are !enefited*.

$. Theory of A%so"&te Ad'anta(e:

Proponent& #he proponent of this theory is Adam Smith. He is against mercantilism. A country has a!solute ad"antage in the production of a product when it is more efficient than other country in producing it. A country should ne"er produce goods at home that it can !uy at a lower cost from other countries. -.g. .hana and South /orea. )Page 012-034*

$. Theory of Co#)arati'e Ad'anta(e:

5a"id Ricardo e%tended Adam Smith6s #heory !y e%ploring what might happen when one country has a!solute ad"antage in production of all goods. He e%tended the free trade argument and pro"ed that trade is a positi"e-sum game. According to Richardo6s theory of comparati"e ad"antage, it makes sense for a country to speciali$e in the production of those goods that it produces most efficiently and to !uy the goods that it produces less efficiently from other countries, e"en if this means !uying goods from other countries that it could produce more efficiently itself. -.g. -%ample in page 030 7 038.

*. He!+!her,Oh"in Theory
#he Proponents of the theory are -li Heckscher and 9ertil Ohlin. #hey argued comparati"e ad"antage arises from differences in national factor endowment such as land, la!or and capital. Nations ha"e "arying factor endowment and different factor endowment e%plain differences in factor cost. #he theory argues that countries will e%port those goods that make intensi"e use of factors that are locally a!undant and import those goods which make use of factors that are locally scarce. :actor prices dictate manufacturing costs. ; A la!or a!undant country will manufacture and e%port la!or intensi"e products. ; A capital a!undant country will manufacture and e%port capital intensi"e products. Ricardo6s theory& National differenced in producti"ity determines comparati"e ad"antage.

Heckcher-Ohlin #heory& National factor endowment determines comparati"e ad"antage. -.g. 'hina and <SA e%ample )pg. 03=*

-. The Prod&!t Life,Cy!"e Theory

#he production location for many products mo"es from one country to another depending on the stage in the product6s life cycle. .ta(e 1: Introd&!tion nno"ation, production, and sales in same country )usually <SA* nno"ation in response to o!ser"ed need -%porting !y the inno"ati"e country to other ad"anced nations )like, .reat 9ritain, :rance, .ermany and >apan*. Howe"er, the demand is limited to the high income people. So it is not yet worthwhile to produce the products in these countries. -"ol"ing product ? non-standardi$ed products .ta(e $: /ro0th @ore competition in the home market 5emand in other ad"anced countries is increased which also raises the e%ports !y the inno"ating country ncreased capital intensity Some foreign production starts in other ad"anced countries who were pre"iously importers. #he inno"ating country starts e%porting to A5's. .ta(e *: Ear"y at&rity 5ecline in e%ports from the inno"ating country. Other ad"anced nations e%ports to A5' and <SA,inno"ating country6s e%port to A5's decline. At later stage <SA,inno"ati"e country starts importing from other ad"anced nations. .ta(e -: Late at&rity ncreased competiti"eness in the home market of the inno"ati"e country. t is not efficient to produce only for inno"ati"e country6s home market. So the inno"ati"e country !ecomes the net importer rather that net e%porter. t starts importing the product from other ad"anced nations .ta(e 5: De!"ine Product !ecomes standardi$ed ncreased competiti"eness of price Production startups in A5's and gradually production concentrates in A5's. #he inno"ati"e country and other ad"anced nations !ecome the net importer of the standardi$ed product.

Net e%porter #ime

Net importer

New product )9rands Aike 9@, Apple*

Phase I All production in <S <S e%ports to ad"anced countries like -urope, >apan

Phase II Production started in other ad"anced nations <S e%ports mostly to A5's

Phase III Other ad"anced nations e%port to A5's <S e%ports to A5's displaced

Phase IV -urope e%ports to <S

Phase V Production shifted to de"eloping countries like ndia, 'hina, @alaysia through in"estment and alliances and then e%ported.

2i(&re -.1: The )rod&!t "ife !y!"e Source& +ells )02B8*, as cited !y 5icken )844C*, p.84C.

5. Nationa" Co#)etiti'e Ad'anta(e: Porter1s Dia#ond

n 0224, @ichael Porter of Har"ard 9usiness School pu!lished his study on 044 industries from 04 nations. #he study was attempted to determine why some nations succeed and other nations fail in international competition. Porter !elie"es that four !road attri!utes of a nation shape the en"ironment in which local firms compete.

2a!tor Endo0#ent: 9asic factors& Natural resources, climate, location and demographics Ad"anced factors& 'ommunication infrastructure, sophisticated and skilled la!or, research facilities, technological know-how. 9asic factors are naturally gi"en !ut ad"ance factors are product of in"estment !y indi"iduals, companies and go"ernment. Ad"ance factors are keys to de"elop sustaina!le competiti"e ad"antage. -.g. .o"ernment in"estment in higher education has created large pool of educated workers in ndia which is an e%ample of ad"anced factor. #his ad"anced factor is the key to de"elopment of the # industry of ndia.

De#and Condition: :irms are typically most sensiti"e to the needs of their closest customers. #hus the characteristics of home demand are particularly important in shaping the attri!utes of domestically made products and in creating pressures for inno"ation and (uality. -.g. #echnologically sophisticated consumers of >apan pressure camera companies to impro"e product (uality and introduce inno"ati"e models. Re"ated and s&))ortin( ind&stries: Presence of suppliers and related industries are one of the reasons of competiti"e ad"antage. n"estment !y supplier or related industry for creating ad"anced factors can !e the source of competiti"e ad"antage. -.g. #echnological leadership of <S semiconductor industry is the source of competiti"e ad"antage of <S personal computer industry. 2ir# strate(y3 str&!t&re and ri'a"ry: :irst, different nations are characteri$ed !y different management ideologies. -.g. .erman and >apanese firm put more emphasis on manufacturing process and product design as they ha"e predominance of engineers in the top management. 'on"ersely, predominance of financial e%perts in the top management in the <S companies make <S firms to put emphasis on short-term financial gains. #his pre"ented <S firms to achie"e success in engineering-!ased industries. Second, domestic ri"alry also induces firms to look ways to impro"e efficiency, to inno"ate, to impro"e (uality, to reduce cost and to in"est in upgrading ad"anced factors. -.g. after @:A phase-out, garment manufacturers of 9angladesh face immense competition from other local manufacturers for international !uyers. #his domestic competition has increased the efficiency of the manufacturers.

/o'ern#ent )o"i!y and Chan!e Porter also contends that go"ernment can influence each of the four components of the diamond. Aike, :actor endowments can !e affected !y su!sidies, policies toward capital market, policies toward education etc. 5omestic demand can !e affected !y local product standards or with regulations that mandate or influence !uyers needs. .o"ernment policy can influence supporting and related industries through regulation :irm ri"alry can !e influenced through capital market regulation, ta% policy and antitrust laws.

#he competiti"eness of the four components can !e affected !y another factor and that is chance. #his chance may arise from any new agreement, opening of a new market. Aike, @ulti-:i!er Agreement of +#O created huge chance for the ready-made garments industry of the de"eloping nations.