International Trade Theories

• International trade includes transactions among inhabitants of different countries
• International trade catalysts growth
• International trade Provides a number of employment opportunities
• International trade is a reason for rising living standards
• International trade theories explain the mechanism of international trade, how countries exchange goods and services
• International trade theories help countries decide import and export quantities and with whom to trade
• Classical trade theories were developed based on the country
• Modern theories shifted from country-based to firm/company-based in the mid-20th century

Classical Country-Based Theories

• Mercantilism
• Absolute advantage
• Comparative advantage
• Heckscher-Ohlin

Modern Firm-Based Theories

• Country similarity
• Product life cycle
• Global strategic rivalry
• Porter's national competitive advantage

Classical Theories

• Also known as "Country Based Approach," emphasizes increasing the wealth of one's nation

Mercantilism

• A country must prioritize its own welfare by expanding exports and discouraging imports
• In mercantilism, wealth accumulation occurs at the expense of another trading partner, resulting in a win-lose zero-sum game
• A favorable trade balance is only possible in the short run and would automatically be eliminated in the long by David Hume's Price-Specie-Flow doctrine
• An influx of gold from more exports than imports raises domestic prices then increases export prices
• The mercantilist theory overlooks factors like natural resources, manpower, and skill levels
• If all countries restrict imports and promote exports, this will result in a highly restrictive environment for international trade
• Mercantilist policies were used by colonial powers by charging higher prices from their colonial markets for their finished industrial goods and lower costs for raw materials
• Exports, rather than imports are actively promoted with the ‘import substitution strategy’ prior to economic liberalization

Absolute Advantage

• States that a country, company, or individual can produce more of a good/service at a than another at a lower cost
• Developed by Scottish economist Adam Smith in 1776

Assumptions of Absolute Advantage Theory

• No barriers to trade like tariffs or transport costs
• No change in advantage, resources, or factors over time
• Fixed factors of production
• Fixed technology
• Mobility of Factors of Production
• Trade Barriers
• Trade Balance
• Constant Returns to Scale

Pros of Absolute Advantage

• Shows how countries benefit by trading on their advantage

Cons of Absolute Advantage

• Lacks explanatory power of comparative advantage theory
• Does not account for trade costs or barriers
• Used to justify exploitative policies
• Saudi Arabia with its oil supplies are a nation with an absolute advantage

Comparative advantage

• Countries benefit from specializing in what they produce best and trading with other countries
• Better for a country to export goods with greater relative cost advantage than absolute cost advantage
• This was developed by David Ricardo in 1817
• Opportunity cost is a potential benefit someone loses when selecting one option over another
• Opportunity cost is factor for analysis when choosing between 2 production options

Example of Comparative Advantage

• Michael Jordan can paint a house in 8 hours, but he has other things to do that would earn him $50,000

• Joe, his neighbor, can paint a house in 10 hours and could be working in a restaurant earning $100

• The absolute cost of producing goods impacts whether a country has an absolute advantage

• The opportunity cost of producing goods impacts the country's comparative advantage

Heckscher-Ohlin Theory

• Based on Factor Proportions Theory
• Developed by Swedish economist Eli Heckscher (1919) and his student Berlin Ohlin (1933)
• The Heckscher-Ohlin model, or 2x2x2 model, suggests that nations export goods that are plentiful and produced skillfully
• Evaluates trade equilibrium between two countries with varying specialties and natural resources
• Countries should produce and export goods for which the resources required in their production are available in a greater quantity
• Certain countries have extensive oil reserves but very little iron ore
• Other countries can easily access precious metals but have little in the way of agriculture
• Land, labor, and capital provide the funds for investment in plants and equipment
• The Heckscher-Ohlin model has components of Factor Price Equalization Theorem, the Stolper-Samuelson Theorem, the Rybczynski Theorem, and the Heckscher-Ohlin Trade Theorem

Modern Theories

• Also known as “Firm Based Approach," explains how countries and firms gain competitive advantage in trade
• Countries should trade with each other, even if one is more efficient at producing all goods

Country Similarity Theory

• Developed by Swedish economist, Steffan Linder
• Countries with similar economic development levels have similar consumer preferences
• Companies should first produce for their domestic market, then expand production to similar countries

Product Life Cycle

• Key factors of it are new, maturing, and standardized products
• Explains how a product 's life cycle affects trade
• Explains how a country's trade patterns change as a product moves through its life cycle
• Change from being a net exporter to a net importer of the same product.
• Functions include market expansion, cost management, innovation diffusion, competition dynamics, adaptation and standardization, economic development, strategic planning, and regulatory compliance and adaptation
• Components include innovation phase, local market saturation, exportation, shift in production, global standardization, market expansion, local competition, and decline adaptation

Global Strategic Rivalry Theory

• Developed by economists Paul Krugman & Kelvin Lancaster in the 1980s
• Describes how multinational corporations (MNCs) compete to gain competitive advantage
• MNCs use strategic actions to differentiate themselves and outmaneuver firms in their industry
• Focuses on multinational companies and their strategies and efforts to gain a comparative advantage
• Firms face global competition to prove their superiority
• Barriers for this theory are research and development, ownership of intellectual property rights, economies of scale, unique business processes or methods, or the control of resources or favorable access to raw materials

Porter's National Competitive Advantage Theory

• Developed by economist Michael Porter in the 1990s
• A nation's industry competitiveness depends on its capacity to innovate and upgrade
• Explains why some nations are more competitive in certain industries
• Components of it are local firm characteristics, local market resources and capabilities, local market demand, and local suppliers and complementary industries