Theories of

inTernaTional
Trade
By dr. vandana singh
(researcher &educaTor)
Mercantilism
Mercantilism was an economic system of trade
that spanned from the 16th century to the18th
century. Mercantilism is based on the principle
that the world's wealth was static, and
consequently, many European nations attempted
to accumulate the largest possible share of that
wealth by maximizing their exports and by
limiting their imports via tariffs.
Characteristics
 Accumulation of bullions (Gold, silver and
other precious metals).
 New colonies and markets.
 International trade.
 Belief in the profitable trading or
favorable balance of trade
( Export > Import )
 Seeking to secure political and economic
supremacy in its rivalry with other state.
Limitations
 Wealth at the cost of their trading partner.
 It is like Zero-sum game. (Gain by one party
required a loss by another)
 No contribution to the global wealth.
 Colonial power used it as a means of
exploitation.
 Self –sufficiency (focus on domestic
manufacturing).
 Economic regulation.(entry and price control)
Absolute Cost Advantage Theory

Adam Smith (1723 –1790) was a Scottish economist, philosopher and

author also known as ''The Father of Economics”.
Anti –mercantilist thought
Book – The Wealth of Nations
Assumptions
 Trade is between two countries.
 Only two commodities are traded.
 Free trade exist between the countries.
 The only element of cost of production is
labour.
 Taste and preferences of both countries
are same.
 According to Adam Smith, every country should
specialise in producing those products which it
can produce at less cost than that of other
countries and exchange these products with
other products produced cheaply by the other
countries.
 Countries have absolute advantage due to:
 Natural advantages (climate, soil, minerals
wealth etc. )
 Acquired advantages (technology and skill
development).
Comparative Cost Advantage Theory

David Ricardo (1772 – 1823) was a British political economist,

one of the most influential of the classical economists.
Theory of comparative advantage given in his book entitled
principles of political economy and taxation.
Assumptions
 Trade is between two countries.
 Only two commodities are traded.
 Free trade exist between the countries.
 The only element of cost of production is
labour.
 No transportation cost.
 Their exist full employment.
 Comparative cost advantage theory states that
a country should produce and export those
products for which it is relatively more
productive than that of others countries and
import those goods for which other countries
are relatively more productive than it is.
 It is an improvement over absolute advantage
theory.
 This theory is based on relative productivity
differences and incorporates the concept of
opportunity cost.
 Factor Endowment Theory

Bertil Gotthard Ohlin(1899-1979)

Eli Filip Heckscher(1879– 1952)
was a Swedish economist and
was a Swedish political
politician.
economist.
• Also known as Heckscher-Ohlin theory or H-O
theory.
• Based on 2x2x2 model (i.e.2 country
2commodity 2 factors of production, (labour and
capital)
• Factors endowments are :
Land ,Capital , Natural resources , Labour,
Climate etc.
• Factor endowments may very among countries.
e.g. USA is rich in capital resources , India is rich
in labour, Saudi Arabia is rich in oil resources.
 According to these economist a country
will export that commodity whose
production requires intensive use of
country's relatively abundant and cheap
factor and import that commodity whose
production requires intensive use of
country's scarce and expensive factor.
 Competitive Advantage Theory

Michael Porter (born on May 23, 1947) is an American economist,

researcher, author, advisor, speaker and teacher , known for his theories
on economics, business strategy, and social causes.
 Porter’s Diamond Model

Porter name these four attributes as constituting the diamond.

He dealt with 100 industries in 10 major nations to determine why
some nations succeed and other fail in international competition.
He argues that a favorable diamond may lead to
the success of a firm.
 Factor Conditions/Endowments: it involves the
availability of factors of productions and the
necessary infrastructure needed by a business
firm compete in an industry.
 Demand Conditions: it deals with nature of
domestic demand for the industry product or
service. A more demanding home markets thus
a driver of growth innovation and quality
improvements.
 Related and Supporting Industries: it may
involve the presence and absence of supplier
industries that are internationally competitive.
the benefits of investment in the advance
factors of production by related and supporting
industries can help an industry to achieve a
strong competitive position internationally.
 Firm Strategy, Structure and Rivalry: firms
continuously improve the quality, product
design, invest in R&D in order to compete
domestically. Firms also invest in human resource
development technology etc. in the domestic
market. Rivalry in the domestic market leads to
efficiency thereby turning them into better
international competitors.
Porter further hold that two additional variable
can influence national diamond in important way:
 Chance: chance events such as major
innovation create, unexpected oil price changes,
revolutions, wars etc. allow new players to
exploit opportunities arising from a reshaped
industry structure.
 Government: choice of policies can influence
each of the attributes.
According to poter, firms can have competitive
advantage with in increase investment in
educational infrastructure and basic research.