* THEORIES OF

INTERNATIONAL
TRADE
Dr.Saira Gori
Assistant Professor of Law
Former Dean, Training Division
Gujarat National Law University
Mob.:-+91-8128650867
* International trade theories are the principles, which offers an
insight into the product portfolio and trade pattern and the evolution
of a country as a supply base or market for specific goods. trade.
* Trade is the concept of exchanging goods and services between two
people or entities.
* International trade is then the concept of this exchange between
people or entities in two different countries.
* People or entities trade because they believe that they benefit from
the exchange.
* They may need or want the goods or services. While at the surface,
this may sound very simple, there is a great deal of theory, policy,
and business strategy that constitutes international trade.

*Introduction
* Trade is also called the exchange of goods
economy, is to transfer of the commodities from
one person to another.
* Sometimes trade is also called in simple terms as
commerce or financial transaction of barter.
Where the transfer of the commodities between
the persons took place is called a market.
* If we throw light on the history of trade, the
original form of trade was barter, where direct
exchange of goods and services took place.
* With the passage of time the barter system was
replaced by the money exchange system in
which the commodities are transferred
therough a medium of exchange such as
money.
* Bilateral trade
* multilateral trade
* The evolution of Trade can traced with the
beginning of human life and shall continue as
long as human life exists on the earth.
* It
enhances the living of standard of living of
consumers.
* Thus we can say that trade is a very important
social activity.

*Historical Background
* Trade is broadly divided between two types:
* 1. Internal or Home or Domestic Trade.
* 2. External or Foreign or International Trade.

*Different Types of
Trade
* Theexchange of goods across national borders is
termed as international trade.
* Countries differ widely in terms of the products and
services traded.
* Countriesrarely follow the trade structure of other
nations; rather they evolve their own product
portfolios and trade patterns for exports and
imports.
* Besides,nations have marked differences in their
vulnerabilities to the upheavals in exogenous factors.
* The theory of mercantilism attributes and
measures the wealth of a nation by the size of
its accumulated treasures.
* Accumulated wealth is traditionally measured
in terms of gold, as earlier gold and silver were
considered the currency of international trade.
* Nationsshould accumulate financial wealth in
the form of gold by encouraging exports and
discouraging imports.

*Theory of
Mercantilism of
International Trade
* The theory of mercantilism aims at creating
trade surplus, which in turn contributes to the
accumulation of a nation’s wealth.
* Between the sixteenth and nineteenth
centuries, European colonial powers actively
pursued international trade to increase their
treasury of gold, which were in turn invested
to build a powerful army and infrastructure.

* 16th
& 19th
Century
* The colonial powers primarily engaged in
international trade for the benefit of their
respective mother countries, which treated
their colonies as exploitable resources.
* The first ship of the East India Company arrived
at the port of Surat in 1608 to carry out trade
with India and take advantage of its rich
resources of spices, cotton, finest muslin cloth,
etc.
* Other European nations—such as Germany, France,
Portugal, Spain, Italy—and the East Asian nation of
Japan also actively set up colonies to exploit the
natural and human resources.
* The colonies served as cheap sources for primary
commodities, such as raw cotton, grains, spices, herbs
and medicinal plants, tea, coffee, and fruits, both for
consumption and also as raw material for industries.
* Thus, the policy of mercantilism greatly assisted and
benefited the colonial powers in accumulating wealth.

*Colonial Era
* Economist Adam Smith critically evaluated mercantilist trade
policies in his seminal book “An Inquiry into the Nature and
Causes of the Wealth of Nations”, first published in 1776.
* Smith posited that the wealth of a nation does not lie in
building huge stockpiles of gold and silver in its treasury, but
the real wealth of a nation is measured by the level of
improvement in the quality of living of its citizens, as reflected
by the per capita income.

*1776,Theory of
Absolute Advantage of
International Trade
* Smith emphasized productivity and advocated free trade as a
means of increasing global efficiency.
* Asper his formulation, a country’s standards of living can be
enhanced by international trade with other countries either by
importing goods not produced by it or by producing large
quantities of goods through specialization and exporting the
surplus.

*Specialization
* Anabsolute advantage refers to the ability of a country to
produce a good more efficiently and cost-effectively than
any other country.
* It is the maxim of every prudent master of a family, never to
make at home what it will cost him more to make than to
buy.
* Thus, instead of producing all products, each
country should specialize in producing those
goods that it can produce more efficiently.
* i. Repetitive production of a product, which
increases the skills of the labour force.
* ii.Switching production from one produce to
another to save labour time.
* iii.Long product runs to provide incentives to
develop more effective work methods over a
period of time

*Such efficiency is
gained through:
* The theory of absolute advantage is based on
Adam Smith’s doctrine of laissez faire that means
‘let make freely’. When specifically applied to
international trade, it refers to ‘freedom of
enterprise’ and ‘freedom of commerce’.
* Therefore, the government should not intervene
in the economic life of a nation or in its trade
relations among nations, in the form of tariffs or
other trade restrictions, which would be
counterproductive.

*Free Trade
* InPrinciples of Political Economy and Taxation,
David Ricardo (1817) promulgated the theory of
comparative advantage, wherein a country benefits
from international trade even if it is less efficient
than other nations in the production of two
commodities.
* Comparative advantage may be defined as the
inability of a nation to produce a good more
efficiently than other nations, but its ability to
produce that good more efficiently compared to
the other good

* Theory of Comparative
Advantage of International
Trade
* Therefore, a country should specialize in the production and
export of a commodity in which the absolute disadvantage is less
than that of another commodity or in other words, the country has
got a comparative advantage in terms of more production
efficiency.
* Toillustrate the concept, let us assume a situation where the UK
requires 10 units of resources for producing one tonne of tea and 5
units for one tonne of rice whereas India requires 5 units of
resources for producing one tonne of tea and 4 units for one tonne
of rice . In this case, India is more efficient in producing both tea
and rice. Thus, India has absolute advantage in the production of
both the products.
* UK--- 10 Units for 1 tonne of Tea
* 05 Units for 1tonne of Rice
* India--- 05 Units for 1 tonne of Tea
* 04 Units for 1 tonne of Rice
*The Balassa Index is often used
as a useful tool to measure
revealed comparative advantage
(RCA) that measures the
relative trade performance of
individual countries in particular
commodities.

*Measuring
Comparative
Advantage:
* Theidea to determine a country’s 'strong' sectors by analyzing the
actual export flows was pioneered by Liesner (1958).
* Since the procedure was refined and popularized by Bela Balassa
(1965, 1989) it is popularly known as the Balassa Index. Alternatively,
as the actual export flows ‘reveal’ the country’s strong sectors it is
also known as Revealed Comparative Advantage.
* Many countries are, for example, producing and exporting cars. To
establish whether a country, say Japan, holds a particularly strong
position in the car industry, Balassa argued that one should compare
the share of car exports in Japan’s total exports with the share of car
exports in a group of reference country’s total exports.

*Balassa Index
*Revealed Comparative
Advantage
*Revealed comparative
advantage
*The earlier theories of absolute and comparative
advantage provided little insight into the of
products in which a country can have an
advantage.
*Eli Heckscher (1919) and Bertil Ohlin (1933)
developed a theory to explain the reasons for
differences in relative commodity prices and
competitive advantage between two nations.

*Factor Endowment
Theory of
International Trade
* According to this theory, a nation will export the commodity
whose production requires intensive use of the nation’s
relatively abundant and cheap factors and import the
commodity whose production requires intensive use of the
nation’s scarce and expensive factors.
* Thus,a country with an abundance of cheap labour would
export labour-intensive products and import capital-intensive
goods and vice versa. It suggests that the patterns of trade
are determined by factor endowment rather than
productivity.
* The theory suggests three types of
relationships, which are discussed here:
* (i) Land-Labour Relationship:
* (ii) Labour-Capital Relationship:
* (iii) Technological Complexities:
*According to the factor endowment theory,
a country with a relatively cheaper cost of
labour would export labour-intensive
products, while a country where the labour
is scarce and capital is relatively abundant
would export capital-intensive goods.

*The Leontief
Paradox:
* Wassily Leontief carried out an empirical test
of the Heckscher-Ohlin Model in 1951 to find
out whether or not the US, which has abundant
capital resources, exports capital-intensive
goods and imports labour-intensive goods. He
found that the US exported more labour-
intensive commodities and imported more
capital-intensive products, which was contrary
to the results of Heckscher-Ohlin Model of
factor endowment.

*Wassily Leontief
* As per the Heckscher-Ohlin theory of factor
endowment, trade should take place among
countries that have greater differences in their
factor endowments.
* Therefore, developed countries having
manufactured goods and developing countries
producing primary products should be natural
trade partners.
* i. If two countries have similar demand patterns, then
their consumers would demand the same goods with
similar degrees of quality and sophistication. This
phenomenon is also known as preference similarity. Such
a similarity leads to enhanced trade between the two
developed countries.
* ii. The demand patterns in countries with a higher level
of per capita income are similar to those of other
countries with similar income levels, as their residents
would demand more sophisticated, high quality, ‘luxury’
consumer goods, whereas those in countries with lower
per capita income would demand low quality, cheaper
consumer goods as a part of their ‘necessity’.

* The country similarity theory

Staffan B (Swedish economist)
* iii.Since most products are developed on the
demand patterns in the home market, other
countries with similar demand patterns due to
cultural or economic similarity would be their
natural trade partners.
* iv. Countries with the proximity of geographical
locations would also have greater trade compared
to the distant ones. This can also be explained by
various types of similarities, such as cultural and
economic, besides the cost of transportation. The
country similarity theory goes beyond cost
comparisons. Therefore, it is also used in
international marketing.

*country similarity
theory
*Countries do not necessarily trade only to
benefit from their differences but they also
trade so as to increase their returns, which in
turn enable them to benefit from specialization.
*International trade enables a firm to increase its
output due to its specialization by providing a
much larger market those results in enhancing
its efficiency.

*New Trade Theory of

International Trade:
Paul Krugman
* International markets tend to follow a cyclical
pattern due to a variety of factors over a
period of time, which explains the shifting of
markets as well as the location of production.
The level of innovation and technology,
resources, size of market, and competitive
structure influence trade patterns.

* International Product Life-

Cycle Theory of International
Trade
* The Product Life Cycle Theory is an economic theory that was developed by
Raymond Vernon in response to the failure of the Heckscher-Ohlin model to explain the
observed pattern of international trade. The theory suggests that early in a product's life-cycle
all the parts and labor associated with that product come from the area where it was invented.
After the product becomes adopted and used in the world markets, production gradually
moves away from the point of origin. In some situations, the product becomes an item that is
imported by its original country of invention
* Incase the innovating country has a large
market size, as in case of the US, India, China,
etc., it can support mass production for
domestic sales.
* This mass market also facilitates the producers
based in these countries to achieve cost-
efficiency, which enables them to become
internationally competitive.

*Mass Market
* As propounded by Michael Porter in The
Competitive Advantage of Nations, the theory
of competitive advantage concentrates on a
firm’s home country environment as the main
source of competencies and innovations. The
model is often referred to as the diamond
model.

* Theory of Competitive
Advantage of International
Trade
*diamond model.
* In order to facilitate the quantifiable assessment of competitiveness, the World Economic
Forum has developed the Global Competitiveness Index. It presents a quantified
framework aimed to measure the set of institutions, policies, and factors that set the
sustainable current and medium-term levels of economic prosperity.

* India has moved down 10 places to rank 68th on an annual global competitiveness index,
largely due to improvements witnessed by several other economies, while Singapore has
replaced the US as the world's most competitive economy.

India, which was ranked 58th in the annual Global Competitiveness Index compiled by
Geneva-based World Economic Forum (WEF), is among the worst-performing BRIC

India has climbed eight places to 72nd rank in the 2020 Global Talent Competitiveness
Index (GTCI), which was topped by Switzerland, the US and Singapore.
* Sweden (4th), Denmark (5th), the Netherlands (6th), Finland (7th), Luxembourg (8th),
Norway (9th) and Australia (10th) complete the top 10 league table.

*Assessing country
competitiveness:
* India has made remarkable progress in improving its
global competitiveness during the recent years. The
rapid rise in the share of the working age population
for the last 20 years would add to favourable
demographics to India’s competitiveness.
* However, to benefit from this India will have to find
ways to bring its masses of young people into the
workforce, by spending on education, capacity
building & Training and improving the quality of its
educational institutions so as to enhance the
productivity of its young.
*Moreover, the country still has to
take effective measures to deal with
its bureaucratic red-tape, illiteracy,
and infrastructure bottlenecks,
especially road, rail, seaports and
airports, and electricity, among
others, so as to boost its global
competitiveness.

*Concluding Remark