SUBJECT: INTERNATIONAL TRADE

SUBJECT CODE:F010602T
UNIT-1
Basics of international trade
A country specializes in a specific commodity due to mobility, productivity and
other endowments of economic resources. This stimulates a country to go for
international trade. The basis of international trade lies in the diversity of
economic resources in different countries. All countries are endowed by nature
with the same productive facilities.

Economists cite Ricardo’s theory of Comparative Advantage as the first

principle of international trade. This theory demonstrates that it benefits all
countries to be involved in international trade, even if they do not have an
absolute advantage. Ricardo demonstrated that countries benefit from
specializing in those areas where they offer the greatest relative (or
comparative) advantage. Thus, all countries can benefit from international trade,
especially with the subsequent “knock-on” effects of this activity.

There are differences in climatic conditions and geological deposits as also in

the supply of labour and capital. These differences provide to a country an
opportunity to specialize in the production of some specific commodities. Such
specialization is facilitated by the exchange of surplus production through
international trade. International trade takes place when buyers find foreign
markets cheaper to buy in and sellers find them more profitable to dispose of
their products than the domestic market. Thus, a more effective use of the
world’s resources is made possible through international trade.

A second principle is that nations may develop a competitive advantage

relative to other nations, based on skills, access to resources, and the
competitive situation arising from domestic competition.

There are many obvious examples of this principle. Switzerland is the home of
banking, based on the number of high quality competitors; Germany is the
centre of engineering industries, which developed originally due to their access
to mineral and energy resources, but now relies on technical skills and
knowledge; US companies are leaders in high tech and software sectors because
of a strongly supportive competitive environment.

Michael Porter identifies four factors which either individually or in

combination will help a country develop competitive advantage in a given
industry. These factors are presented in a diagram known as Porter’s diamond.
The four factors are:

· International trade between nations

International trade between nations is a very important part of an economy. For

the most part, international trade is beneficial between two nations that have
strong markets in two different sectors.

A country with a strong market in one sector has a comparative advantage over
another nation because of lower opportunity costs. This opportunity cost
translates into gains from trade because of the resulting net savings by a nation
on manufacturing goods. By importing goods, a nation does not have to spend
time, money or resources developing sectors of an economy, which it does not
necessarily need.

International trade becomes an attractive option when gains from trade are taken
into account. When a nation produces a certain good, such as automobiles, the
product can be exported to another nation for goods and services in return.

One example of this is in the electronics and software industries. The US

produces a large amount of the world’s software. Companies such as Microsoft,
Oracle and Netscape, develop this software for use at home and for export

With this demand comes the need for supply, which is satisfied by large
corporations. Software cannot necessarily be considered a commodity but it has
become an essential component of most businesses in the US and abroad.
However, since it is of value, it is commonly traded in the international market.

In the US, if the opportunity cost to produce one portable radio were equivalent
to producing two pieces of software, then the country would find it beneficial to
trade with Japan, where software is not produced to any great extent, and they
could establish a one-to-one trade ratio between electronics and software.

Both nations would realize a gain and this would be a successful bout of
international trading. This short example of cost savings attained by
participating in international trade illustrates how important it is in regulating
the economy.

Another aspect to consider is that no single nation can produce everything it

requires for survival. This may not be because of lack of effort but because of
geographical location and the climate of that region. It is in this respect that we
consider international trade to be extremely important.

International trade asserts that a country will export the products that it can
produce at the lowest relative cost. So China can export cameras and textiles
because it can produce those goods with the least sacrifice of alternative
production.

Demand conditions

Porter’s model states that strong local demand creates benefits based on better
understanding of market needs. Proximity to the market facilitates this dialogue.

· Factor conditions

The factors of production- land, labour, enterprise and capital- all potentially
contribute to the development of competitive advantage. Many Gulf nations are
rich in oil and gas resources; South Africa is rich in diamond mines. Developed
nations such as Switzerland and Germany have well-educated labour markets,
whereas other nations, such as Sudan, Haiti and Benin have low levels of
literacy.

 Related and supporting industries

Successful national industries normally attract good local suppliers, which in

turn increases the competitiveness of this industry in international markets.
Competitive advantage, once established, can be sustained and developed by
improvements in each of these areas. For example, national governments may
support training initiatives or allow tax incentives or grants to encourage or aid
supporting industries to further develop the national advantage.

· FIRMS, STRATEGY, STRUCTURE AND RIVALRY

High levels of local competition encourage competitive companies to improve,

and the resulting strong competition in home markets provides a base for
exploiting strengths internationally.

International Business Theories

For the success of business, it is important to understand all the key types of
international trade theories. The concept of international trading is not limited
to, just sending and receiving products and services and putting all of the profits
in the pockets. Instead, it’s a lot more complicated thing. In fact, its current
shape is the result of many different types of international trade theories that
helped it in its evolution through various eras. Honestly saying, apart from
making your syllabus boring, these theories can be of great assist in the long run
since most parts of these ideas still, hold right. So in this article, we will go
through each and every theory and will provide you with a somewhat in-depth
detail of these.

7 TYPES OF INTERNATIONAL TRADE THEORIES

1. Mercantilism
2. Absolute Advantage
3. Comparative Advantage
4. Heckscher-Ohlin Theory
5. Product Life Cycle Theory
6. Global Strategic Rivalry Theory
7. National Competitive Advantage Theory

Above are the 7 different types of international trade theories, which are
presented by the various authors in between 1630 and 1990.

MERCANTILISM

The oldest of all international trade theories, Mercantilism, dates back to 1630.
At that time, Thomas Mun stated that the economic strength of any country
depends on the amounts of silver and gold holdings. Greater are the holdings,
more economically independent a country is.

Furthermore, the idea of favoring greater exports and promoting efforts to

minimize imports also belongs to the same theory. Well! The thinking behind
this concept is evident since you pay for the imports from the pay that you get
from exports. So, if you a country has a lot to pay for the imported products
then it will get from exported products, its economy will get inclined towards
declination. Even though the view is old but the roots of modern thinking
towards the financials is deeply embedded in it.

ABSOLUTE ADVANTAGE

The Theory of Absolute Advantage is based on the notion of increasing the

efficiencies in the production processes. In 1776, Adam Smith, a renowned
financial expert of the time being, proposed the theory that the manufacturing a
product with high efficiency as compared to any other country on the globe is
highly advantageous.
The concept can just be understood by the idea that if two countries specialize
in exactly same kind of product. But the product of one country being better in
quality or lower in price will bring tremendous absolute advantage to the
country as compared to the other one. From another point of view, if two
countries specialize in entirely different products, then they can quickly increase
their influence in their localities by having trade with each other (by creating
absolute advantages at both ends).

COMPARATIVE ADVANTAGE

As compared to absolute advantage, Comparative Advantage favors relative

productivity. According to this concept, as put forward by David
Ricardo in 1817, a country with maximum absolute advantage in the creation
of more than one product as compared to other, can still trade with another
country with less efficient ways to create that product, that’s readily available in
first, to boost its productivity.

To illustrate this idea with an example, let’s say that I have expertise in two
fields like graphics designing and writing, where designing lets me earn a lot
more than writing. Keeping in mind that I can work on only one side at a time, I
will most likely hire a writer, and we both will work in a comparative
atmosphere.

HECKSCHER-OHLIN THEORY

Both the Absolute as well as Comparative international trade theories assume

that the choice of the product that can prove itself to be of great advantage is led
by free and open markets instead of using the resources available inland. That’s
what caused Bertil Ohlin and Eli Heckscher to put forward the idea of
determination of the prices that relies on the differences in supply and demands.

This can just be understood as, if the supply of a product grows greater than it is
in demand in the market, its price falls and vice versa. So, export of a country
should mainly consist of the product that is abundantly available in it, and
imports should count the products that are in high demand. Since, this concept
ensures utilization the country’s factors like labor, land and funding sources for
the purpose of product manufacturing that’s why it is also known by the name
of “factor proportion theory.”

PRODUCT LIFE CYCLE THEORY

In the 1970s, Raymond Vernon introduced the notion of using a product’s life
cycle to explain global trade patterns, in the field of marketing. According to
theory, as the demand for a newly created product grows, the home country
starts exporting it to other nations. Where when the demand grows, local
manufacturing plants are opened to meet the request. And the scenario covers
the whole globe time to time, thus making that product a standardization.

You can take the example of computers in consideration to understand how this
works. The earlier personal computers appeared in 1970’s available only in a
few countries and from 1980’s to 1990’s, the product was moving through the
stage of maturity where the production spread to many other nations. And now
in 21st century, every third house has a PC in it.

GLOBAL STRATEGIC RIVALRY THEORY

The continuous evolutionary behavior of international trade theories brings us

back in the 1980’s where Kalvin Lancaster and Paul Krugman introduced the
concept of strategies, based on global level rivalries, targeting multinational
corporations and the struggle needed in achieving higher advantages as
compared to other international companies.

According to the concept, a new firm needs to optimize a few factors that will
lead the brand in overcoming all the barriers to success and gaining an
influential recognition in that global market. In all these factors, a thorough
research and timed developmental steps are crucial. Whereas, having the
complete ownership rights of intellectual properties is also necessary.
Furthermore, the introduction of unique and useful methods for manufacturing
as well as controlling the access to raw material will also come handy in the
way.

NATIONAL COMPETITIVE ADVANTAGE THEORY

Michael Porter in 1990’s suggested that the success of any business in

international trade depends on upgradable and innovational capacities of the
industry as well as four other factors, which determine how that firm is going to
perform in this global level race. The main concept behind this theory gives the
feel of holding factor proportion as well as many other international trade
theories in it.

One of those factors is the availability of resources in the local market and their
prices which are necessary for providing a sustainable and stable environment
for the trade to grow. Moreover, the ability of the firm to face competitors and
its capacity to upgrade itself also determines the success rate of that brand.
Furthermore, keeping the track of the change in demand and the behavior of
local suppliers is also important.

Drivers of international trade

As the international environment is constantly changing due to today’s
economic crisis, where are we going to be able to grow our businesses? You
may need to grow your business internationally. At HSI, we have noticed that
different companies have different reasons for growing their business and these
are summarized below:

1. Cost

A. Export

 Some companies require large capital investments in plants and

machinery.
 Strong incentive to spread the costs of these fixed costs over a large
number of units

B. Import / Outsourcing

Some companies, in response to consumer demands, attempt to offer goods at

the lowest possible price, moving manufacturing overseas (such as in China or
Mexico)

Strong incentive to lower production costs

2. Competitition

 Companies follow their domestic competitors abroad to maintain their

world-wide market share.
 Companies retaliate against foreign competitors entering their home
market by going to these competitors’ home markets.
 Companies counter a competitor’s new product entry by offering a
similar product, often produced abroad.

3. Market factors

 Consumers’ tastes and preferences have become increasingly uniform

worldwide.
  Consumers have become increasingly knowledgeable about products and
willing to try new foreign alternatives.

4. Technology

 Diffusion of information is universal

 Competition for products is worldwide: the Internet allows people to
trade with one another.

Driving and Restraining forces of International Business

DRIVING FACTORS

The important forces driving globalisation are as follows:

1. Liberalisation: One of the most important factors which have given a

great forward thrust to globalisation since the 1980’s is the formation of
universal economic policy resulting in liberalisation of economy in many
countries. The immediate result of liberalisation in globalisation of
business. Now many business firms can involve themselves is
international trade as the restrictions imposed by various countries is
highly restricted under GATT/WTO.
2. MNC’s: The companies which have taken a complete advantage of trade
liberalisation caused under GATT (General Agreement on Tariffs &
Trade )/WTO are MNC’s (Multi – National Companies). Sony, Philips,
Coco Cola, Pepsi, Procter & Gamble, etc are some famous examples for
MNC’s. These companies combine their resources and objectives to
achieve profit in global market.
3. Technology: Technology in a powerful driving force of
Globalisation. Once a Technology is developed, it soon becomes
available every where in the world.
4. Transportation and Communication revolutions: Technological
revolution in several spheres, like transport and Communication, has
given a great impetus to globalisation. The Microprocessor in computers
has created the flow of information from one part of the globe to another
not only fast but also cost effective. It has played a pivotal role in
reducing space and time. It has made world in to a global
village. Microprocessors coupled with satellite, optical fibre, wireless
technologies, world wide web have made this ‘World in to a global
village. The consumers/ customers has become more global. By sitting
in front of the computer and logging on to world wide web the consumer
can download any type of information from any part of the world. Flow
 of information is business. It determines profit. Hence technology is a
strong driving force for Globalisation.
5. Product development and efforts: The immediate impact of increase of
Technology is the growth of new products due to innovation. The fast
technology hastens product obsolescence. This has made many firms to
invest heavily on R&D activities with cross – border alliances . These
companies have to stay in business and survive competition. In order to
achieve this, many companies have crossed their borders and have tie –
ups to update their products through research and development with
foreign companies. This causes globalisation.
6. Rising aspirations and wants: Because of the increasing levels of
education and exposure to the media, aspirations of people around the
world are rising. They aspire for everything that can make life more
comfortable and satisfying. If domestic firms are not able to meet the
wants, they would naturally turn to the foreign firms to satisfy their
aspirations. This promotes Globalisation.
7. World economic trends: The world economic conditions are changing
fast. There, is a great difference in the growth rates of economies/
markets between developing nations and developed nations. In
developed nations the economies have become stagnant, due to saturation
on the otherhand, the developing nations are experiencing tremendous
growth rate in various business sector. Cheap labour, high investment in
research and development, improvements in technology are some of the
factors which have driven the developing nations towards achieving high
growth rate in business. Hence it is very common for the developing
nations to have a strong international trade links with developed
nations. Thus difference in world economies between nation causes
gobalisation.
8. Regional Integration: Nowadays many countries are joining hands
together to promote free and fair international trade across the
borders. They are forming separate trade blocks. European Union and
North American Free Trade Agreements are two such classical
examples. This promotes globalisation.
9. Leverages: Leverage is simply some type of advantage that a company
enjoys by conducting business in more than one country. A global
company can experience three important types of leverages.
10.Experience transfers: The experience that a company gains by doing
business in one country can be effectively transferred to some other
country if the particular company does business on global scale. This is
called experience transfer (For example) Coca- cola first developed a
strong marketing strategy to tap tea and coffee market in India.
11. Scale economies: The art of cutting down the cost of production is called as
scale economies. One major cause for scale economies is technology
breakthroughs. Many companies are now heavily infesting in R&D in an
attempt to reduce the cost of production. They are attempting to produce
cheaper and more reliable products.

12. Resource Utilisation: Another strength of global company is its resource

utilisation. It can now successfully outsource its resources globally thereby
making better utilisation of resources.

RESTRAINING FORCES ON GLOBALISATION

There are also several factors which restrain Globalisation trend. They are

1. External Factors
2. Internal Factors

External Factors: These are government policies and controls which prevents
cross-border business.

Internal Factors: These are collection of factors that exists within the
organisation that prevents Globalisation. One such factor is called as
management myopia or near sightedness. The company with an aim to make
immediate profit engage itself in short-term plan and target local markets for
business. This is called as management myopia. This acts against Globalisation
of business.

GLOBALIZATION MEANING, NATURE AND STAGES OF

GLOBALIZATION, FEATURES OF GLOBALIZATION
The aim of globalization is to secure socio- economic integration and
development of all the people of the world through a free flow of goods,
services, information, knowledge and people across all boundaries.

Globalization is seen as a conscious and active process of expanding business

and trade across the borders of all the states. It stands for expanding cross-
border facilities and economic linkages. This is to be done with a view to secure
an integration of economic interests and activities of the people living in all
parts of the world. The objective of making the world a truly inter-related, inter-
dependent, developed global village governs the on-going process of
globalization.
Globalization Meaning, Nature and stages of Globalization, features of
Globalization.
The aim of globalization is to secure socio- economic integration and
development of all the people of the world through a free flow of goods,
services, information, knowledge and people across all boundaries.

Globalization is seen as a conscious and active process of expanding business

and trade across the borders of all the states. It stands for expanding cross-
border facilities and economic linkages. This is to be done with a view to secure
an integration of economic interests and activities of the people living in all
parts of the world. The objective of making the world a truly inter-related, inter-
dependent, developed global village governs the on-going process of
globalization.

“Globalization represents the desire to move from national to a global sphere of

economic and political activity”. It seeks to transform the existing international
economic system into a unified system of global economics. In the existing
system, national economies are the major players. In the new system, the
globalized economic and political activity will ensure sustainable development
for the whole world.

“Globalization is both an active process of corporate expansion across borders

and a structure of cross border facilities and economic linkages that has been
steadily growing and changing.” —Edward S.Herman

“Globalization is the process whereby social relations acquire relatively

distance-less and borderless qualities.” —Baylis and Smith

NATURE OF GLOBALIZATION

1. Liberalization

It stands for the freedom of the entrepreneurs to establish any industry or trade
or business venture, within their own countries or abroad.

2. Free trade

It stands for free flow of trade relations among all the nations. Each state grants
MFN (most favored nation) status to other states and keeps its business and
trade away from excessive and hard regulatory and protective regimes.

3. Globalization of Economic Activity

Economic activities are be governed both by the domestic market and also the
world market. It stands for the process of integrating the domestic economy
with world economies.

4. Liberalization of Import-Export System

It stands for liberating the import- export activity and securing a free flow of
goods and services across borders.

5. Privatization

Keeping the state away from ownership of means of production and distribution
and letting the free flow of industrial, trade and economic activity across
borders.

6. Increased Collaborations

Encouraging the process of collaborations among the entrepreneurs with a view

to secure rapid modernization, development and technological advancement.

7. Economic Reforms

Encouraging fiscal and financial reforms with a view to give strength to free
world trade, free enterprise, and market forces.

Globalization accepts and advocates the value of free world trade, freedom of
access to world markets and a free flow of investments across borders. It stands
for integration and democratization of the world’s culture, economy and
infrastructure through global investments.

TYPICAL STAGES OF THE GLOBALIZATION OF BUSINESS

COMPANIES

1. “In the first stage of globalization, companies normally tend to focus

on their domestic markets. They develop and strengthen their
capabilities in some core areas.
2. In the second stage of globalization, companies begin to look at
overseas markets more seriously but the orientation remains
predominantly domestic. The various options a company has in this stage
are exports, setting up warehouses abroad and establishing assembly lines
in major markets. The company gets a better understanding of overseas
markets at low risk, but without committing large amounts of resources.
 3. In the third stage of globalization, the commitment to overseas
markets increases. The company begins to take into account the
differences across various markets to customize its products suitably.
Different strategies are formed for different markets to maximize
customer responsiveness. The company may set up overseas R&D centers
and full-fledged country or region specific manufacturing facilities. This
phase can be referred to as the multinational or multi-domestic phase. The
different subsidiaries largely remain independent of each other and there
is little coordination among the different units in the system.”
4. In the final stage of globalization, the transnational corporation
emerges. Here, the company takes into account both similarities and
differences across different markets. Some activities are standardized
across the globe while others are customized to suit the needs of
individual markets. The firm attempts to combine global efficiencies,
local responsiveness and sharing of knowledge across different
subsidiaries.

IMPORTANT FEATURES OF GLOBALIZATION

1. Liberalization

It stands for the freedom of the entrepreneurs to establish any industry or trade
or business venture, within their own countries or abroad.

2. Free Trade

It stands for free flow of trade relations among all the nations. Each state grants
MFN (most favoured nation) status to other states and keeps its business and
trade away from excessive and hard regulatory and protective regimes.

3. Globalization of Economic Activity

Economic activities are be governed both by the domestic market and also the
world market. It stands for the process of integrating the domestic economies
with world economy.

4. Liberalization of Import-Export System

It stands for liberating the import-export activity and securing a free flow of
goods and services across borders.
 5. Privatization

Keeping the state away from ownership of means of production and distribution
and letting the free flow of industrial, trade and economic activity across
borders.

6. Increased Collaborations

Encouraging the process of collaborations among the entrepreneurs with a view

to secure rapid modernization, development and technological advancement.

7. Economic Reforms

Encouraging fiscal and financial reforms with a view to give strength to free
world trade, free enterprise, and market forces.

8. Several dimensions of Globalization

Increased and Active Social, Economic and Cultural Linkages among the
people. Globalization has social, economic, political cultural and technological
dimensions. It involves all round inter-linkages among all the people of the
world.

Free flow of knowledge, technology goods services and people across all
societies is it key feature. It attempts at making geographical borders soft
permitting all the people to develop their relations and links.

Globalization accepts and advocates the value of free world, free trade, freedom
of access to world markets and a free flow of investments across borders. It
stands for integration and democratization of the world’s culture, economy and
infrastructure through global investments.

IMPORTANT QUESTIONS

Short Answer type questions:

1.Define: International Trade. New Trade Theory. Export Trade, Opportunity

cost, Entrepot trade

2.Differentiate between domestic and international trade.

3.Elaborate the need for international trade.

4.Discuss comparative cost advantage theory.

5.State the relevance of International Trade theories.

6.Discuss the features of International trade along with the limitations of

international trade.

7. What are the restraining forces of International Trade? State the recent trends
in world trade.

8. What do you understand by Mercantilism theory and the absolute advantage

theory?

9. Describe International trade theories in detail.

10. Explain Hecksher Ohlin Theory & discuss the assumptions of the theory.

11.Describe Porters Diamond theory. Highlight the components of Porter’s

Diamond model.