ALIGARH MUSLIM UNIVERSITY

MURSHIDABAD CENTRE
SESSION: 2021-22
1st GCT

SUBJECT - INTERNATIONAL TRADE LAW

TOPIC = AN ANALYSIS OF THEORIES OF
INTERNATIONAL TRADE

SUBMITTED TO SUBMITTED BY

Dr. Aijaj A Raj Mohammad Daniyal Siraj

(Asst. Professor) 18BALLB55
GL0749
4 YEAR
th

8th SEMESTER

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AN ANALYSIS OF THEORIES OF INTERNATIONAL
TRADE

INTRODUCTION:

International trade is the exchange of goods and services between countries and beyond their
national borders. The social, economic and political importance of international trade has risen
significantly in recent years. In most countries, such trade represents a significant share of gross
domestic product (GDP). While international trade has been present throughout much of history
(see Uttarapatha, Silk Road, Amber Road, salt road), its economic, social, and political
importance has been on the rise in recent centuries. It is the presupposition of international trade
that a sufficient level of geopolitical peace and stability are prevailing in order to allow for the
peaceful exchange of trade and commerce to take place between nations. Trading globally gives
consumers and countries the opportunity to be exposed to new markets and products. Almost
every kind of product can be found on the international market: food, clothes, spare parts, oil,
jewelry, wine, stocks, currencies and water. Services are also traded: tourism, banking,
consulting and transportation. A product that is sold to the global market is an export, and a
product that is bought from the global market is an import. Imports and exports are accounted for
in a country's current account in the balance of payments. Industrialization, advanced
technology, including transportation, globalization, multinational corporations, and outsourcing
are all having a major impact on the international trade system. Increasing international trade is
crucial to the continuance of globalization. Without international trade, nations would be limited
to the goods and services produced within their own borders1

THEORİES OF INTERNATIONAL TRADE

A- The Absolute Advantage Theory (Adam Smith)

Adam Smith (1723-1790) is recognized as the founder of modern economics and as one of the
first and most famous thinkers who argued in favor of free trade. First of all Adam Smith reject

1 http://www.jstor.org/topic/international-trade/

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the idea of mercantilism and he said that the international competition are more beneficial to a
nation than the mercantilist economic policy that existed in many parts of Europe during the 18th
century. In his book called “The cause of the nation wealth” he described what he call “the
absolute advantage theory”.

What is the Absolute Advantage?

The theory that Adam Smith put forward to explain the reasons for the foreign trade is the
Absolute Advantage (Superiority) Theory. It becomes Smith's work to make foreign
economics a science. According to the Mercantilist way of thinking before it, the world's
fortunes are fixed, the gain of one of the countries that cannot be increased through foreign trade
and the trade is the loss of the other. However, the theory of Absolute Advantage (and the free
trade and international division of labor that it supports) shows that both countries will benefit
from international trade and that the world resources will be used in the most optimal way.
According to the theory of absolute advantage, each country should produce goods that have
absolute production advantages at a lower cost than others, specialize in their production, and
import them from abroad, which they can produce at a lower cost.
First example, according to this model, if Turkey can produce the fabric and England can
produce the engine at a lower price, Turkey should import the engine from England and export
the fabric to this country.
It is in the interest of all the participating countries to go to such an international division of
labor based on the specialization of goods produced by each country cheaply. Because countries
will have the opportunity to produce more goods and services, according to a closed economy
model in foreign trade. The Theory of Absolute Advantage is an important concept leading to
the formation of modern foreign trade theory.
According to Adam Smith, the countries are measured by goods and services that can provide
real wealth to their citizens. According to Smith's Theory of Absolute Advantage, some countries
produce certain goods more efficiently than others, and global trade can be enhanced through
free trade.
According to Smith, if there are no restrictions on trade, each country is specialized in the
production of products that are advantageous to itself. The resources of each country are used in

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active industries because they cannot compete in inactive production areas. Through
specialization, countries can improve their activities for three reasons:
 Repeating the same job increases the skills of the workers and master the field
 Workers do not waste time switching from one product to another
 Long production steps encourage more efficient working methods to shorten the
production phase.
For these reasons, more raw material can be taken before production is available as a result of
specialization. But it may come to you as a question of which products an industry should
specialize in its production. Although Smith has said that this decision market will give, he
thinks that the advantage of a country may be natural or gained.2
Second example:
Production A B

USA 50 30

Germany 20 80

USA produces 50 units of A per day and 30 units of B per day, which means that it produces
5 A products and 3 B products in one day and A product is cheaper than B, so A product will
specialize in America when it opens to international trade.
Germany produces 20 units of A per day and 80 units of B per day, so one worker can produce 2
A products and 8 B products per day, so that means the production of B specialized in Germany.
In this example, USA has absolute advantage in production of A, Germany has absolute
advantage in Production of B.3

B- The Comparative Advantage Theory:

DAVID RICARDO (1772 – 1823) was a British political economist. He was one of the most
influential of the classical economists. The theory of comparative advantage is popularly

2 http://notoku.com/mutlak-ustunluk-teorisi/
3 https://iktisatbilgisi.blogspot.com/2015/02/mutlak-ustunluk-teorisi-adam-smith.html

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attributed to English political economist David Ricardo and his book “Principles of Political
Economy and Taxation” in 18174.
The comparative advantage is an economic theory referring the ability of an individual,
company or country to produce a good or service at a lower opportunity cost than the others
(individual, company or country).
The Comparative advantage is contrasted with the absolute advantage theory: here we have
to know difference between the two theory as we say before the Absolute advantage refers to
the ability to produce more or better goods and services than somebody else (than other
countries). Comparative advantage deals the ability to produce goods and services at a lower
opportunity cost, not necessarily at a greater volume.

For example:
In this part we retake the famous example of Ricardo while he was explaining the
comparative advantage:
In order to understand how the concept of comparative advantage might be applied to the real
world, we can consider the simple example of two countries producing only two goods - cloth
and wine.

Using all its resources, country England can produce one unit of cloth in 100 hour or one unit of
wine in 120 hours, and Portugal can produce one unit of cloth in 90 hour or one unit of wine 80
hour.
In this case, Portugal has the absolute advantage in producing both products, but it has a
comparative advantage in wine because it is relatively better at producing them and England is
more efficient at producing cloth than wine. Specializes in the good for which it has a
comparative advantage, then the global production of both goods increases, as for England can

4 Wikipedia

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spend 220 labor hours to produce 2.2 units of cloth while Portugal can spend 170 hours to
produce 2.125 units of wine. Moreover, if both countries specialize in the above manner and
England trades a unit of its cloth for  then both countries can consume at least a unit each of cloth
and wine, with 0 to 0.2 units of cloth and 0 to 0.125 units of wine remaining in each respective
country to be consumed or exported. Consequently, both England and Portugal can consume
more wine and cloth under free trade than in autarky (Krugman & Obstfeld, 2006)

C- The Heckscher-Ohlin (factor production).

It is an international trade model developed by Eli Heckscher and Bertil Ohlin from
Stockholm School of Economics. David Ricardo's theory of comparative advantages is based on
the assumption that production and trade patterns are based on the intensity of an individual
country's production factors. The model basically says that countries export the goods they use
the abundant production factors, while the scarce ones import the goods they use. Relative
intensities of production factors (land, labor and capital) determine the comparative advantage of
a country. In other words, countries have comparative advantage in the production of goods for
which they use relatively abundant production factors. The reason for this is that the prices of the
goods are determined by the prices of the resulting inputs. The production of goods which
require the use of locally abundant production factors is cheaper than the production of goods
which require locally scarce production factors.5
According to this theory, one condition for trade is that countries differ with respect to the
availability of the factors of production. The Heckscher-Ohlin theory focuses on the two most
important factors of production: Labor and Capital.
 Country where capital is relatively abundant / cheaper and labor is relatively costly is
called capital rich country.
 Country where labor is relatively abundant /cheaper and capital is relatively costly is
called labor rich country.
Example: the developed countries specially the west have relatively more abundant capital so
these countries have special advantage on producing new products made with innovative
technologies. On the other hand developing countries like Brazil , China , India labor is cheaper
and they produce mostly the production which requires more labor than capital. 6
5 https://tr.wikipedia.org/wiki/Heckscher-Ohlin_model
6 Les theorie de l’economie politique international, author: Gerrard K., 1999/ house of edition : Le point.

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CONCLUSIONS

This study follows the tendency of classical economic theories and international trade theories to
start with classics as a part of it, and looks at the evolutionary process of these theories, the cost
structure of information concepts and information-related elements and the effects of foreign
trade patterns. Although classical economists have emphasized the importance of knowledge and
technological development elsewhere, they have emphasized the labor factor as the only cost
element in their studies on foreign trade. The conceptualization of neoclassical contributions and
opportunity costs made it possible to include analytical capital as well as labor. The Heckscher-
Ohlin model and derivative theorems explain the cost / efficiency differences between countries,
depending on the differences in production costs between countries, the increase in labor and
capital supply, and the welfare consequences of trade policies, depending on the factor and labor
equipment. However, we see that "knowledge" has begun to enter international trade theories as
a factor affecting the cost structure and the international trade pattern, as well as efforts to
interpret the results of anticipatory inferences of the theory of factoring that have been
encountered. Contemporary international trade does not resemble the exchange seen by the
classics. While traditional theories perceive inter-country trade as a way of benefiting countries
from differences, international trade reflects the shift in leadership in scale economies and close
technology competition, which is also important for R & D.