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 Section I

Paper 1: Factor Proportions and the Structure of Commodity Trade (Romalis)

This paper by Romalis ventures to examine the fashion in which factor proportions impact the
structure of a commodity trade. It utilizes the Heckscher-Ohlin model in addition to the
Krugman’s model of monopolistic competition. The Heckscher-Ohlin model is also called the
“one of the pillars of international trade”. The paper also lays a special emphasis on the concept
of “abundance”. It argues that countries that are able to better capitalize on their factors of
“abundance” are able to garner a higher level of market share in the international markets. It
must be pointed out that this prediction is back-up by actual detailed trade data.

Paper 2: Endowments, Output, and the Bias of Directed Innovation (Blav)

This paper by Blav ventures to answer the question, “Does the output-mix of countries change in
response to changes in factor endowments?” to answer this question, it renders the use of data
from 27 developing and developed countries from a time period of 1973-1990. The data is
targeted at skilled labor, unskilled labor and capital. The changes in factor endowments can lead
to various drastic changes for the various related factors. To make sure that it does not lead to
gargantuan losses or miscalculations, it becomes essential to factor in these changes in
endowments and develop a prudent framework that is able to deal with it. For this, understanding
the effects of endowment changes becomes essential and this paper ventures to elucidate this
factor.

Paper 3: Do endowments predict the location of production? Evidence from national and
international data (Bernstein and Weinstein)

This paper by Bernstein and Weinstein ventures to delve deeper into the relationship that exists
between factor endowments and production patters. For this purpose, it renders the use of data
from OECD nations and Japan. It argues that the presence of more goods than factors in the trade
lead to more chances for error in goods traded freely. This chance of miscalculations can lead to
various detrimental results that can ultimately turn into major losses for the various companies
employing the use of that data. Hence, it becomes essential to cater to this aspect. The paper

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renders the use of statistical analysis as well to better justify its arguments in the presence of
empirical evidence.

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 Section II

Introduction

International trade is the exchange of goods and services across national boundaries or between
two countries. It is a trade that is transacted in the global arena and the principles of demand and
supply are affected by international factors.

Political changes or conflict in a particular region will have a strong impact on international trade
by altering factors such as the cost of labor, the costs of production or the cost of oil which may
trigger an increase in prices of commodities. International trade is beneficial in the sense that it
exposes consumers in different countries to a wide range of products (Bernstein & Weinstein,
2002).

At the international trade, the goods that are sold are exports and those that are bought are called
imports. Global market gives the developed countries the opportunity to exercise leverage due
their wealthy nature and their advantage over the countries at the periphery. International trade
gives these countries chances to use their labor, technology and capital. The principle of
comparative advantage as advocated by Ricardo and Adam Smith is more put into the practice in
international trade.

It is true that international trade is beneficial to countries in the globe. This is because it has been
flourishing in the exchange of goods, services and also facilitates free flow of capital among
nations. To substantiate the significance of international trade is evidence that international trade
accounts for a large percentage of countries’ gross domestic products and an important generator
of revenue in developing countries.

David Ricardo who was one of the classical economists in market principle of comparative
advantage clearly illustrated how trade between countries can benefit several parties. He defined
this benefit as that of gains from trade. It is noted that the principle of comparative advantage
shows that benefits of trade are dependent on the opportunity cost of production (Blum, 2010).

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Adam smith, also a classical economist introduced the principle of absolute advantage. This
theory argued that a country can only benefit from the principle of absolute advantage when it
incurs the minimum cost of production.

Literature Review

In his book the wealth of nations, Adam smith analyzed the operations in a modern international
market. He identified two principles in his book: the division of labor and absolute advantage.
According to Adam Smith, a country enjoys absolute advantage over its trading partners if it can
produce more outputs with a certain amount of input. Therefore, if a country can participate in
the production of what it has an absolute advantage on, then it will be in a position to enjoy the
benefits of international trade.

According to the theory of comparative advantage each country “will have a comparative
advantage over its trading partners in the production of that good for which its opportunity cost is
lower than that of its trading partner”.

Opportunity cost is defined as what it takes to produce the last or the next unit of a good of the
next best alternative product. The following are the actual terms that facilitate the smooth flow of
goods in international trade; first is the degree of relative bargaining by different nations which is
determined by the level of prosperity and the market size that a country can control.

Another theory that explains international trade is the endogenous trade theory. This theory
explains that some goods are traded at the international market because they not available in the
local production, this applies for rare resources. Majority of the goods that this theory seeks to
expound on include natural resources like mineral and oil (Romalis, 2004).

Gold, oil and gas are only found in small locations or countries. When a country enjoys this
endogenous advantage then it will be attractive. Goods such as oil and diamond, for example,
have higher demand at the international market.

The promotion of international trade is considered the province of the World Trade Organization
(WTO). According to the Euro barometer report on the international trade, Europeans countries
are positive in their evaluation of international trade and the reasons they give for this positive

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response is that through international trade they are in a position to access cheaper goods of
wider variety.

Other countries like the Great Britain considered international trade as an avenue of creating
employment. From the above economic explanations it is imperative to explain that international
trade has a lot of benefits to the trading partners which include the following:

From the principle of comparative advantage and absolute advantage, a country can be able to
trade in goods that it can produce at the cheapest costs. This has the net effect of the country
reaping more from the trade relationships which is positive in the gross domestic product (Ready
et al, 2017).

Also the theory of endogenous principle is an indication that there are several commodities that
are in demand at the international trade due to the fact that they are strategic and every country
needs them; such goods include oil which is important in the production process of any
commodity.

The exposure to the international trade increases the variety of goods available at the market. Not
all countries produce similar goods and if, their quality is not similar. Also the issue of taste and
preference by the customer who is the ultimate target of the production process is important in
bringing goods to the market.

Countries also enjoy lower costs of commodities due to the economies of scale. An economy of
scale is a fundamental principle in trading process. An industry that is small can only be
profitable if it can sell to a small market. International market gives firms opportunity to enjoy a
wider market.

Other benefits that are accrued from the international trade are new technologies which are
spread out to other countries which are yet to develop. The underdeveloped countries thus get a
chance to develop alongside the develop countries especially as they exchange ideas though
international trade.

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The main weakness of international trade is that weaker counties face stiffer competition from
developed countries and some industries in the weaker countries will likely close down due to
stiff competition (Kharrazi et al, 2017).

Also another risk is the unreliability by trading partners for example a trading partner may
consider it unfit to sell a specific commodity at particular times when it comes to matters of
national security; a country might consider it fundamental not to sell food products to
international market in times of extreme drought to safeguard its food security.

The risks of international trade are also in the sense where a country enjoys narrow degree of
specialization and can be adversely affected when there is an unfavorable terms of trade in the
demand market.

International trade is considered instrumental since it creates an opportunity for countries to

practice specialization and hence efficiently manage resources. It also enables a country to
maximize its potential and its capacity to get what it does not produce.

The development and intensification of international trade has been made possible by the
availability of advanced techniques of production, modern transport system, growth of
transnational corporations or multinational corporations and the overwhelming growth in
industrialization. International trade has emerged as a major driver of development among
countries.

Most of the western countries can be said to have benefited most from international trade. The
countries that are strong and prosperous in international trade have become wealthy and
prosperous. It has in this sense led to the elimination of poverty (Bahmani-Oskooee et al, 2017).

The recent development in the international trade system that has involved the formation of
trading blocs has impacted on the scope of international trade. Also it is worth to mention that
there has been a decline in the international trade due to the changes in the rules and norms that
characterized the foundations and the development of global trade which had been negotiated
under the banner of General Agreement on Trade and Tariffs (GATT).

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Factors of production differ from country to country. The difference is significant in the labor
skills, availability of raw materials, climate and population density. These factors are generally
immobile; hence, their differences tend to persist from country to country.

Even though climate and land are immobile, other factors like capital and labor have tight
restrictions in terms of their physical, legal, cultural, and social form especially when their
movement is between two countries as opposed to the movement within one particular country.
This hence differentiates the ability in terms of supplying goods between countries.

The difference is attributed to the difference in cost of production of goods. These differences
ultimately establish the solid foundation of trade. Comparative advantage on the other hand is the
beneficial trade between countries, despite one country having the upper hand of producing all of
its goods by use of minimum resources. This therefore brings about relative efficiency that
differentiates production of goods between the two countries (Musselli, 2019).

The economic theory of international trade unlike other economic theories emphasizes on
international movement of capital and labor (otherwise known as factor endowment). The
general pattern in the international trade is that countries with relatively more capital exports
capital-intensive commodities and import labor-intensive commodities as demonstrated by
Leontief paradox.

A two-country-two commodity-two factor model posits that equilibrium in commodity price can
guarantee equilibrium in factor price and factor price can guarantee equilibrium in commodity
price only if the marginal productivity depend on the proportion of the in which the factors are
combined. For instance, if two countries producing cotton and steel by means of labor and
capital, a country which is endowed with labor but has less capital will concentrate in producing
cotton which is labor intensive relative to steel and vice versa.

Country endowed with more capital can pump more capital in the poor country to enhance the
production of cotton. The capital intensive nation can also import some labor from the labor
intensive nation to help in the steel industry.

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Trade between two or more country is generally influenced by tariff and non-tariff barriers. Non-
tariff barriers include quota system, setting of standards for imports, government active
participation in local and international trade, bureaucratic custom procedures, and extra charges
on imported commodities among others. Tariff is a tax imposed on imports which increases the
prices of imported goods (Fasanya et al, 2019).

The reasons of enacting these policies are to protect the local infant industries, safeguarding
employment opportunities for the locals, consumer protection, national security and retaliatory
measures. There are two main types of tariffs namely Specific tariffs and Ad-Valorem tariffs.
Specific tariffs are fee levied on a unit of imported commodity. Ad-Valorem tariff on the other
hand is levied in accordance with the value of the commodity.

Government benefits from the revenues collected from these trade barriers. Domestic companies
benefits from the reduced competition because the process of the imported commodities are
inflated. However, the main victims of the tariff and non-tariff barriers are the consumer and
local businesses who depend on the restricted commodities.

Trade barriers tend to benefit the producers and negatively affect the consumers. Normally
consumers enjoy plenty of a commodity under low prices without the influence of tariff and non-
tariff barriers. When these barriers are imposed, the prices of commodities rise and the supply
dwindle.

The law of comparative advantage states that two nations or any other parties will benefit from
trade, on if there relative cost of productions is different. Comparative advantage results mainly
from the difference in technology, factor endowment, and other minor factors.

In addition to this, capital costs also play a significant role in determination of prices. The effect
of increase in wages average prices is attributed as a result of the quantity of labor and capital
costs, which are factors of production in the different commodities.

In a simpler format, a country’s comparative advantage in certain commodities and comparative

disadvantage in other commodities is attributed to the fact that the country’s endowment of

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climate, technology, natural resources and the productivity of labor force (Cao et al, 2017) (Luo
& Ji, 2018).

The prediction that is normally kept across of an international trade is that a nation is likely to
export the commodities whose endowment in terms of land, capital and labor has room for
output expansion with minimal sacrifice of any other domestic goods. Technology was also used
to create trade opportunities.

The Heckscher-Ohlin Trade Theory, attempts to answer the pending questions that were not
answered by David Ricardo and his theory. Questions that reflects on the reason behind
comparative advantage or why there is a difference in comparative costs in regard to production
of commodities in various countries and the impact of international trade in terms of earnings
received by the two countries in trade.

These are some of the questioned that have been tackled by the Heckscher-Ohlin Trade Theory.
This theory as the name suggest, was named after Eli F. Heckscher and Bertil Ohlin who were
economists. The two economists also shared the same nationality, which was Swedish.

Hecksher was the first economist that published an article in 1919 that had the heart of the
Hecksher-Ohlin theory. Bertil on the other hand was a student of Hecksher who later worked on
the unnoticed publication of Hecksher to give it life through publishing of his own book in the
year 1933. In 1977, Ohlin received the Nobel Prize in the field of economics as his work was
internationally accepted and was crucial in international trade (Stepanova et al, 2017).

The Heckscher-Ohlin Trade Theory is founded on the foundation of general equilibrium theory.
The validation of the general theory was considered particularly for one market. It was later
concluded that due to the differences that existed between international trade and domestic trade,
it was ideal to have a separate theory that incorporated international trade.

This however was not in agreement with Ohlin who perceived international trade as a case of
interregional trade. In addition to this, he considered the application of general equilibrium
theory to both domestic and international trade. The assumptions considered in this theory

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include the use of the similar technology in the two countries of trade, Presence of perfect
competition and the trade is free without barriers among others.

Heckscher-Ohlin Trade theory does not contradict nor reject the theory of comparative
advantage, but instead it acts as a supplement to the theory as it removes the main limitation
from the theory and provides a comprehensive explanation of comparative advantage. The
differences in prices of commodities to be traded, act as the main reason behind the trade of the
two countries (Bernstein & Weinstein, 2002).

The commodity’s price in return is affected by the factor prices that differ from country to
country. In addition to this, the rise in the factor prices is initiated by the difference in supply
factor between the countries of trade. In consideration of Heckscher-Ohlin Trade theory, the
distribution of income, tastes, and preferences of the consumer and distribution factors of
production determines the level of demand for the commodities.

This means that the demand that is based on the factors of production depends on the demand
that is based on final commodities. In this case the taste and preference of consumers in the two
countries is similar as well as the income distribution. Therefore, the demand of factors and the
demand for commodities play an insignificant role in the final prices of the commodity.

Differences in prices in various countries represent the difference in cost of production thus
signifying the basic cause of trade. In the world trade in one way or the other tries to reduce, the
resource costs attributed to production.

This tend to happen more often as in the world of trade producers from different countries can
specialize on economic trade activities that tend to utilize the country’s resources to the
maximum. The differences in international trade of the relative cost of production indicate the
comparative advantage notion, which is the basis of international trade theory.

The introduction of comparative advantage was brought about by David Ricardo and later on
upon extension; it was refined by the two economists Eli Heckscher and Bertil Ohlin.
International trade in consideration of the two theories will result to expansion of export

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production sector and at the same time contraction will be taking place on the import sector. This
is attributed to shift of focus by a nation to commodities of comparative advantage (Blum, 2010).

Monopolistic competition is a kind of market structure that occupies an intermediate position

between perfect competition and a monopoly. It possesses the characteristic features of both
systems. In a monopolistic competition market structure, competition exists among organizations
proposing similar goods or services (that still cannot be called identical substitutes). It keeps
prices close to average costs and at the same time fosters preferences for differentiation of goods
and services. This approach makes it possible for manufacturers to have a marginal quantity of
market power. Thus, it can be stated that such differentiation results in intra-industry trade due to
its ability to ensure both perfect competition and market power.

The Gravity Model of Trade is a highly significant model for understanding the function of
international economics. The model of new trade theory is considered to be an alternative
approach to provide the required theoretical basis for the gravity model. It incorporates various
factors including the colonial history of the counties involved, the variables needed to perform
accounting at the income level (GDP), tariffs, pricing, and language communication.

Monopolistic competition is represented under this model by particular assumptions:

Manufacturers view marginal utility of income as an unchanging cost. Another assumption is
that price terms are created externally. The differentiation of goods and services happens not by
the country of origin. Instead, products become differentiated among manufacturing firms. The
actual success of the model supports the explanation of intra-industry trade provided within the
framework of monopolistic competition. In summary, the foundation for intra-industry trade in a
market dominated by monopolistic competition is differentiations of products manufactured and
services provided (Romalis, 2004).

Strategic trade policies are alliances that allow creating global oligopolies. Trades can be
investigated with the help of the model of reciprocal markets. This model assists in
understanding the functioning of the intra-industry trade system within the given framework. The
reciprocal-markets model is quite a simple structure that allows analyzing trade in the conditions
of oligopoly. The most convenient of its properties is the possibility to explore the market of

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each separate country in isolation from others due to the assumption that all national markets are
divided into segments. This implies that the presence of the side party is impossible, which
allows the output to command equilibrium prices.

However, it also means that organizations can make price decisions for each market. Oligopolies
foster intra-industry trade, which happens because of the variation of equilibrium prices in
different countries. Oligopolies receive a greater profit in the global market rather than in the
isolated one. Since the global market, with its enormous level of competitiveness, is capable of
restricting the earning potential of oligopolies, they have to use strategic trade policies to
guarantee the stability of high outputs.

Thus, the varying levels of equilibrium prices in different countries, as well as segmented
markets influencing price considerations, form the foundation of intra-industry international
trade.

Agglomeration economies result from external economies of scale. It can be exemplified by

Walmart’s distribution center being situated close to most of its suppliers. This helps reduce
transportation and transactional expenses. Agglomeration economies can exist as long as the
external economies of scale are able to reduce the cost of production. The most important thing
for the economy is to understand how agglomeration economies can contribute to intra-industry
international trade. In fact, they usually cause a variation in employment levels and wages (Ready
et al, 2017). This often results in the outsourcing of services and can also cause the import of
products, which has the purpose of reducing total cost. Therefore, external economies of scale
are more integrated into the world’s economy and trade markets rather than connected with the
country in which they are situated.

The decision to use such combination of words is based on the nature of Nike and Yue Yuen’s
work and the results they achieved. They are unexpected, unusual, and global. This is why the
chosen phrase is a proof that the success of transnational corporations such as Nike or Yue Yuen
depends on how a number of factors like differentiation, reputation, or upgrading are elaborated
by the agents on a global level and turn out to be influential for the individuals, who are going to
use a particular production.

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The opinions of these authors help to realize that the level of work influence not only the quality
of the production but also the order of its manufacturing. The experts have to identify ‘low order’
and ‘high order’ factors and imply them accordingly.

The global commodity chain approach focuses on the evaluation of the relations that take place
between production of a good and its trade and the identification of the activities that have to be
performed by a number of actors. This is why the role of managers or other representatives of the
companies remains to be crucial regardless the current technological progress and the
possibilities to replace people by technologies (Kharrazi et al, 2017).

Critical Analysis

The principle of comparative advantage has been named the deepest and the most beautiful result
in all of economics”. This concept plays a crucial role in international trade despite lacking a
satisfactory and common definition to define it.

In the dictionary of economics, this concept has been defined as a systematic definition of gains
attained from trade in reference to division of labor and specialization. It is the perception of
others to define specialization effects in terms of comparative advantage as well as use theories
in consideration of its sources.

Overall, comparative advantage is side supplying of differences between various countries in

regard to technologies as well as factor endowments. This explanation has been subjected to
criticism from different quarters, with some arguing that the explanation failed to account
beyond reasonable doubt, the trade pattern after World War II, in particular concerning the
expansive fraction of world trade, which was tribute to growth, and the nature of intra-industry.

This has partly led to the constant challenging of Hecksher-Ohlin theory over the last two
decades by the new trade theory. Despite of these shortcomings, the trade models founded on
comparative advantage continue to be popular in regard to international economics. The concept
continues to receive praises from high-learned professionals.

Comparative advantage is achieved by a country if it is more productive in a given commodity as

compared to both other countries other products. In defining the law of comparative advantage,

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one can consider the scenario of a country exporting products whose production is cheaper as
compared to other countries.

It is easier to understand this scenario, as no complicated commodities exist. However,

complications may arise especially when the scenario becomes general in terms of technology as
well as a number of factors and products (Bahmani-Oskooee et al, 2017).

The theory states that, despite a nation having absolute disadvantage in producing commodities
as compared to other countries, trade could still be undertaken, which is mutually advantageous.
The nation with less efficiency is supposed to focus on both the production and exportation of
commodities with advantage that is more absolute.

It is this kind of commodity that the nation in question has comparative advantage. In addition to
this the vice versa should happen which means the nation should undertake importation of
commodities which it has less advantage. In 1821, Ricardo indicated that despite a country
having absolute advantage in production of every commodity that does not mean it has
comparative advantage in the production of every commodity.

This therefore signifies the fact that it is impossible for a nation to be importing everything. It
was the theory of comparative advantage that incorporated together a large portion of trade
within the world by eliminating the necessity that pertains to absolute differences in cost, which
in the past was used in trade.

In this theory as Suggested by David Ricardo, even lack of absolute differences in cost, the two
countries could still engage in beneficial and mutual trade. The mutual benefits in trade are still
possible despite the fact that one country could be less efficient in producing both commodities
as compared to counterpart nation.

One nation may undertake to specialize in producing and exporting commodities of a lesser
disadvantage and at the same time import a commodity that has a higher absolute advantage. The
restriction in this case is that absolute advantage should not be similar in the two commodities.
The assumptions in this theory include; Presence of two countries, the trade is free and no
transportation cost.

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The Ricardian model usually illustrates the universe where commodities are produced
competitively from just one production factor called labour. During the production, the level of
technology applied by different nations differs significantly to generate the competitive
advantage amid countries (Musselli, 2019).

From the supply side economics, the Ricardian model tries to clarify the comparative advantage
disparities arising from the nations technological differences. According to this model, different
nations have identical production factors except the level of technological adoption and
capability.

The labour value theory is perceived to be the basis of the model though differences in
technological endowment are key grounds under which trade activities are conducted.

 The manufactured commodities are perceived to be homogeneous athwart nations

 At home borders, labour is supposedly homogenous although the productivities of
laborers fluctuate athwart states
 The Ricardian model was created based on the structure of the universal equilibrium.
 During the production process, labour is assumed to be the only critical production factor
 There are two nations that take part in the commerce activities

Assuming that there are two nations namely foreign (F) and home (H) countries. However, only
a single production factor named labor is available, but in every nation, labor (Lc) supply is
constant. Besides, both countries can produce two commodities such as C and W.

The returns to scale in the adopted technology are constant and the level of output will hardly
vary since labour supply is fixed (Ld). The available labour in every nation is used to produce
both the commodities C and W irrespective of the total quantity produced.

When the countries draw on the Ricardian trade model, they are likely to gain from free trade.
Given that, the budget is constrained while the nations want to produce both goods, it is
important to determine the opportunity costs of producing these commodities.

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When country F can produce product W at a relatively lower cost than product C while country
H can produce C at extremely lower cost than it can produce product W, then each country can
benefit from free trade by specializing in the production of a commodity that the country has a
comparative advantage. Producing both commodities will leave the countries at the same
equilibrium point.

Through specialization, the available labour will be geared towards the production of a single
commodity which the country has a comparative advantage. Each country specializing in the
production of one commodity will experience an increase in commodity demand and the
indifference curve will be higher implying that the countries are better off.

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The relative extent of the derived gains depends on the global demands for the commodities and
the nation’s labor or resource endowment put to meet the export demands.

This theory expounds on the reasons why different nations trade services and goods amongst
themselves. The dissimilarity in the capacity to obtain factors of production gives one condition
for trade between two republics. The difference emerges when a nation possesses vast capital
inform of machineries but with insufficient employees while the other country shows the inverse
(Fasanya et al, 2019).

Therefore, a commodity that might be generated by a realm permits the kingdom to direct the
production processes towards the H-O presumption. A nation specializes in specific goods that
necessitate enough capital if it has abundant capital with limited workforces. The theory thus
supposes that higher living standards in these countries are generated via the trade and product
specialization.

 There is no cost related to the shipping of goods amid two states

 The general public coming from different (two) states share or have equal market
demands
 There is no movement of capital and labour amid nations
 Relatively more labour and extra capital is required for the two commodities produced

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  Capital and labour, which are the major factors of production, are not proportionally
available in both countries

The household or national manufacturers are forced out of the trade dealings whenever
businesses incorporate the economical worldwide market rivals. Often, this argumentative case
materializes to be restricted given that the case is precisely faulty.

Two important considerations arise when discussing free trade. One consideration asserts that
reducing the costs of goods bought by shoppers’ couple the forfeiture of domestic jobs. When
considering the tradeoffs engaged in protecting free trade versus domestic production, there is
essence to disregard the ensuing benefits.

The second consideration provides that free trade generate jobs in some industries besides
reducing job in certain industries. Hence, both these happen as improved income held by foreign
personnel benefiting from free trade increase while utilizing domestic goods. However, some
national manufacturers in other industries end up becoming exporters.

Studies show that it is uncertain to hinge on antagonistic homelands for the central commodities
as suggested in this case. In fact, some industries ought to get defense from the national security
interest. In order to salt away the distinctive and the firms’ significance without regard for
clientele, this case is functional than initially thought given that the argument seems precisely
acceptable.

Substantial learning curves in certain industries permit the companies to develop and stay longer
in the business thus quickly augmenting their production. Hence, to be competitive, the
corporations catch up by lobbying for the global provision of competition security.

If long-term achievements are considerable then the companies require no assistance from the
government. Such companies will yearn to experience short-term losses (Cao et al, 2017).

However, some companies cannot survive the short time losses due to the liquidity constraints.
As an alternative to providing global business cover, the state administration ought to
recommend liquidity via issuing out mortgages.

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The all-inclusive negotiations can employ threats of quotas and tariffs in haggling chip as
claimed by the trade restriction advocates. Threatening to be decisive must not be the attention of
the state since the strategy is regarded as a non-credible hazard thus, unproductive and risky
strategy.

With regard to the complicated and diverse nature of the global trade imbalance, the solutions
should also approach the problem in a multi-dimensional way. More importantly, both domestic
and international perspectives should be taken into consideration to define how those are
interchanged.

At a domestic level, the country experiencing trade deficit should widen their perspective and
consider issues other than inflation targeting regimes. Policy frameworks should strengthen the
monetary policy and provide an opposition to the financial imbalances.

At the international level, complicated issues are involved. In particular, excess focus on the
domestic trade can deprive the country of the possibility to global spillovers.

In this situation, the country can leave the problem unsolved because of the unfulfilled
possibility of international cooperation. In addition, the excess elasticity of the financial system
provides much wider policies to introduce. In particular, the focus n the fiscal policy is a
beneficial point because this sphere should carefully be tackled so as to avoid the trade
imbalances.

Judging from the above-presented problems and solutions, there is a potential need for a more
systematic financial and monetary policies addressing to the macroeconomic issues. Increasing
elasticity of the credit economy can allow the financial system to generate more approaches to
gain revenue and stay afloat at the international market (Luo & Ji, 2018).

In other words, the role of money in the international economy is critical and, therefore,
reference to the traditional economic paradigms can provide a fresh insight to solving the
problem of global trade imbalance.

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Referring back to the problem of borrowing and lending, specific attention should be paid to the
analysis of the international capital market to understand the main underpinnings of the global
trade imbalance. In this respect, acting as lenders and borrowers, the emerging countries are
under the greatest threat because of the possibility of default.

Because lenders often denominate their currency, they are unlikely to risk due to the constant
discount rates they receive. As a result, the emerging economies can be detached from the
international capital market, contributing to the rapidly growing global trade imbalances.

At this point, the risk-neutral lenders do not lend because they acknowledge that higher rates of
lending can lead to the risk of default. Among the risk factors that the borrowing countries can
face, it is possible to single out such issues as fluctuations in foreign interest rates, returns to
output growth, and output variance.

In addition, in case of the countries’ default, the high probability of being out of the threat
provides the borrowing countries with an incentive to take advantage of high-variance projects.
Consequently, such countries are likely to have output variance as compared two the developed
countries with a lower risk of default (Stepanova et al, 2017).

Assuming the fact that there is a rigid disparity between the developed and the developing
economies, the international capital market share of the latter is the smallest one. Nevertheless,
the third-world countries are greatly motivated by the ability to receive an option value of not
being defaulted and, therefore, their projects are much more competitive than those proposed by
the developed economies.

While evaluating the exports and imports within the countries and outside them, the perspectives
of current account balance provide a complicated picture. In particular, they are expressed in
connection to the world GDP to provide an analysis of their global appropriateness.

In this respect, countries such as Asia, Japan, and oil-exporting countries confront the current
account deficit in the United States. In contrast, the current account balance is observed in the
European region. In order to understand the future trends of reversal and change, it is reasonable
to link them to the development of current account balances for a longer period of time.

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While focusing on the United States and Europe and their GDP levels, a negative movement of
the current account can be observed. This is of particular concern to the 1980s when both Europe
and the United States undergo significant current account fluctuations (Stepanova et al, 2017).

At this point, the European countries underwent a positive trade balance, whereas the United
Stated experienced a strongly negative trade balance. In 1990s, the international trade faced
serious shifts due to the deterioration of current account balances in both regions.

Drawing the parallels between the periods, the 80s witnessed a negative balance of -0.68 whereas
1996-2006 witnessed a positive increase of balances up to 0.40. Within the perspectives and
future trends, collective deficit will not exceed the current value, which about 3 % of GDP in
2006.

It is twice larger than in 1980s that reflected the extreme deficit in the USA. While combining
the trade balances of Japan, Europe and the United States, future tendencies will not differ
significantly from the figures established in the 80s of the past century.

With regard to the different roles and degrees to which current account balances fluctuations
among the developed and developing countries, it should be stressed that the future trends in
international trade will be preserved in terms of the entire external balance (Bernstein &
Weinstein, 2002).

With regard to the investment and saving behavior and dynamic optimization, the external
balances, along with the exchange rate, are consistent. Due to the U.S. trade deficit caused by the
dollar expansion, the prices significantly increased and the employment rates did not correspond
to the existing economic standards.

This negative shift was closely connected with the external deficit at the end of the 1990s. The
problem is that US policy trade suffered a difficult situation because of the failure to mediate the
supporters and opponents of the liberalization in the country. Judging from the above-presented
assumptions, the high evaluation of dollar caused a growing external imbalance.

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According to Institute of International Economics, dollar overvaluation…is demonstrably the
most accurate leading indicator of protectionist trade policies in the United States. With regard to
the assumption based on the historical facts, future trends can resemble the previous ones.

The consequences of the U.S. trade deficit had a significant impact on the European trade surplus
and currency undervaluation. In particular, the external surplus of the European Union ranged
between 1 % and 1.5 % at the end of 1990.

The unusual situation triggered an abrupt deterioration of the EU trade balance that was also
followed by the deplorable unemployment rates. As soon as the European currency sets its
credibility, the portfolio diversification will start (Blum, 2010).

In other words, a shift from dollars to euro appreciation will occur, which will result in a
significant reversal of the EU’s external position. It will later move into a substantial deficit
leading to a financial crisis and, as a result, the monetary dynamic in Europe and the United
needs to be reevaluated to avoid overvaluation of the currency and eliminate the huge deficit.

Relevance to Pakistan

It is also essential to draw a link between the findings above and the context of Pakistan. The law
of comparative advantage states that two nations or any other parties will benefit from trade, only
if there relative cost of productions is different. The two countries can benefit from producing the
same products provided there are differences in efficiency of their trading. The law of
comparative advantage also refers to the ability of one entity to produce specific goods and
services at a minimal marginal cost and opportunity cost than its counterpart. This is an aspect
Pakistan needs to consider in its trade relations and volumes.

For instance, if using advanced technology, one country can produce a bag of sugar and coffee in
six hours, while another country with less technology can produce 2 bags of sugar or four bags of
coffee in an hour, each country will benefit from trade between them since their internal trade-
offs between sugar and coffee are different.

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The less proficient country has a comparative advantage in producing coffee, therefore it will
find it more efficient to produce coffee and trade them off with the country which is more
efficient in producing sugar.

Without trade, the opportunity cost of producing sugar per coffee is 2; by trading, the cost per
sugar can decrease up to 1 coffee depending on the level of trade. Most efficient countries
usually experience 1:1 trade offs. The more efficient country has a comparative advantage in
sugar and can afford to move some of their labor from coffee production to sugar production and
trade more sugar for coffee (Romalis, 2004).

Without trade, the cost of producing a bag of coffee was one bags of coffee. By trading these
cost can minimized by half depending on the level of trade between Pakistan and these countries.
The net gain received by each country is referred to as benefits of trade.

The main sources of comparative advantage are technology and factor endowment. However,
there are also other factors including tastes, market structure, institutions, location, and
conditions of trade. Technology dictates the efficiency in production of goods and services.

Countries with advanced technology usually produce goods and services at a lower cost in
comparison with those with less advanced technology. Pakistan is unable to do so at the present.
Advancement in technology means high volume of production per hour, less labor, and overall
efficiency in production. Factor endowment denotes difference in factors of production (labor,
land, capital, and management).

The difference in factor endowment determines the level of specialization and trade. If countries
differ in relative factor endowment, and then each has a comparative advantage in goods and
services that makes reasonably intensive use of the available copious factors (Ready et al, 2017).

Other things equal (Ceteris paribus), countries have comparative advantage in goods and services
that are less inclined to the local consumers but are on high demand to the foreign consumers.
This kind of trade is normally common among the European nations who are at per in technology
and factor endowment but have diverse tastes and preferences among their consumers.

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The most recent studies on comparative advantage identified the significance of institution in
international trade. Institutional sources of comparative advantage include financial
development, security of contract enforcement, and flexibility in the labor market.

The importance of sustaining a global trade imbalance designates future successful development
of fixed and emerging economies like Pakistan. The importance of establishing trade relations
attains increasing importance because it identifying the constantly changing patterns of
international trade.

In particular, input and output operations are closely associated with such trade factors as
geographic location, natural resources, and technological development — all these determinants
in complex shape the overall current account balance and international capital market (Kharrazi
et al, 2017).

More importantly, the financial aspects of international trade are largely dependent on the
surpluses and deficits rates, as well as the stability of the currency exchange rates. Looking from
these perspectives, the U.S. trade deficit, its complicated relationships with the Asian countries,
as well as undervaluation of the European currency have greatly contributed to the trade
imbalance.

Other nuances, such as impossibility of emerging economies to engage with the international
capital market operation, are also considered as the underpinnings of the identified problems.

In order to address the issue, a more systematic and broader view should be introduced to define
the positions and potential of the international market. Widening elasticity and focusing on
money as the primary source of relations are obligatory for sustaining the trade imbalance.

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References

Bernstein, J. R., & Weinstein, D. E. (2002). Do endowments predict the location of production?:
Evidence from national and international data. Journal of International Economics, 56(1), 55-76.

Blum, B. S. (2010). Endowments, output, and the bias of directed innovation. The Review of
Economic Studies, 77(2), 534-559.

Romalis, J. (2004). Factor proportions and the structure of commodity trade. American

Economic Review, 94(1), 67-97.

Ready, R., Roussanov, N., & Ward, C. (2017). Commodity trade and the carry trade: A tale of
two countries. The Journal of Finance, 72(6), 2629-2684.

Kharrazi, A., Rovenskaya, E., & Fath, B. D. (2017). Network structure impacts global
commodity trade growth and resilience. PloS one, 12(2), e0171184.

Bahmani-Oskooee, M., Iqbal, J., & Khan, S. U. (2017). Impact of exchange rate volatility on the
commodity trade between Pakistan and the US. Economic Change and Restructuring, 50(2),
161-187.

Musselli, I. (2019). Curbing Commodity Trade Mispricing: Simplified Methods in Host

Countries.

Fasanya, I. O., Odudu, T. F., & Adekoya, O. (2019). Oil and agricultural commodity prices in
Nigeria: New evidence from asymmetry and structural breaks. International Journal of Energy
Sector Management.

Cao, G., Li, K., Wang, R., & Liu, T. (2017). Consumption structure of migrant worker families
in China. China & World Economy, 25(4), 1-21.

Luo, J., & Ji, Q. (2018). High-frequency volatility connectedness between the US crude oil
market and China's agricultural commodity markets. Energy Economics, 76, 424-438.

Stepanova, Y. N., Zinovieva, I. S., & Busarina, Y. V. (2017). Complementary approach to

functioning of entrepreneurial structures under the conditions of economic instability of region.
In Integration and Clustering for Sustainable Economic Growth (pp. 519-528). Springer, Cham.

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