BSA 4201. Chapter 1-2. International Trade PDF

CHAPTER I: EVOLUTION OF INTERNATIONAL TRADE INTRODUCTION World Trade Organization (WTO) ​ It is the only global international organization dealing with the rules of trade between nations. ​ It oversees agreements negotiated and signed by the bulk of the world's trading nations and ratified in...

CHAPTER I: EVOLUTION OF INTERNATIONAL TRADE INTRODUCTION World Trade Organization (WTO) ​ It is the only global international organization dealing with the rules of trade between nations. ​ It oversees agreements negotiated and signed by the bulk of the world's trading nations and ratified in their parliaments. The following are some examples of WTO agreements: ○​ Agreement on Agriculture ○​ Agreement on Trade Facilitation ○​ Agreement on the Expansion of Trade in Information Technology Products ○​ Plurilateral Agreement on Government Procurement ​ Primary Goal: To ensure that trade flows as smoothly, predictably, and freely as possible and to help producers of goods and services, exporters, and importers conduct their business. ​ The roles of WTO: 1. It operates a global system of trade rules. 2. It acts as a forum for negotiating trade agreements. 3. It settles trade disputes between its members. 4. It supports the needs of developing countries. ​ Primary Function: To open trade for the benefit of all. ​ Its headquarters is located in Geneva, Switzerland. ​ WTO has 164 members and 22 countries are in the process of acceding to it, making it a veritably universal multilateral institution. ​ Appointments of positions and responsibilities: Officially, each council, committee, or working party elects its own chairperson. However, to ensure a good distribution of appointments over all these bodies, informal consultations are held to produce consensus on slates of chairpersons in three groups: 1.​ those directly involving the General Council (including the bodies reporting to the Trade Negotiations Committee); 2.​ those reporting to the Goods Council; and 3.​ those reporting to the Services Council. ​ Decision-making: All major decisions are made by the WTO's member governments: either by ministers (who usually meet at least every two years) or by their ambassadors or delegates (who meet regularly in Geneva). ​ Organizational Structure:  ​ Pioneered by WTO: General Agreement on Tariffs and Trade (GATT) ​ established by a multilateral treaty of 23 countries in 1947 after World War II in the wake of other new multilateral institutions dedicated to international economic cooperation-such as the World Bank (founded in 1944) and the International Monetary Fund (founded in 1944). LESSON 1.1. THEORY: A GLIMPSE The evolution of the international trade theories reflects the ways nations were addressing basic economic problems due to unequal distribution of natural resources or difference in geographical locations. Over time, economists have developed theories to address these economic problems and explain the mechanisms of international business and trade. This reflects the dynamic ways nations have sought to address fundamental economic challenges arising from the unequal distribution of natural resources, differences in geographical locations, and disparities in productive capacities. These challenges necessitated the development of frameworks to understand and manage the exchange of goods and services between nations, ensuring mutual benefits and economic progress. The main historical theories are called classical and are from the perspective of a country, or country-based. The classical country-based theories include mercantilism, absolute advantage, comparative advantage, and Heckscher-Ohlin theories. Classical or country-based theories of international trade refer to economic theories that focus on the characteristics and advantages of individual countries in the context of global trade. These theories emphasize the role of a nation's resources, labor, and productivity in determining what goods a country should produce and trade with other nations. 1.​ Mercantilism - This theory stated that a country’s wealth was determined by the amount of its gold and silver holdings. In its simplest sense, mercantilists believed that a country should increase its holdings of gold and silver by promoting exports and discouraging imports. In other words, if people in other countries buy more from you (exports) than they sell to you (imports), then they have to pay you the difference in gold and silver. 2.​ Absolute Advantage - focused on the ability of a country to produce a good more efficiently than another nation. Smith reasoned that trade between countries shouldn’t be regulated or restricted by government policy or intervention. He stated that trade should flow naturally according to market forces. Example. If Country A could produce a good cheaper or faster (or both) than Country B, then Country A had the advantage and could focus on specializing on producing that good. 3.​ Comparative Advantage - Comparative advantage occurs when a country cannot produce a product more efficiently than the other country; however, it can produce that product better and more efficiently than it does other goods. The difference between these two theories is subtle. Comparative advantage focuses on the relative productivity differences, whereas absolute advantage looks at the absolute productivity. Example. Miranda is a Wall Street lawyer who charges $500 per hour for her legal services. It turns out that Miranda can also type faster than the administrative assistants in her office, who are paid $40 per hour. Even though Miranda clearly has the absolute advantage in both skill sets, should she do both jobs? No. For every hour Miranda decides to type instead of do legal work, she would be giving up $460 in income. Her productivity and income will be highest if she specializes in the higher-paid legal services and hires the most qualified administrative assistant, who can type fast, although a little slower than Miranda. By having both Miranda and her assistant concentrate on their respective tasks, their overall productivity as a team is higher. This is comparative advantage. 4.​ Heckscher-Ohlin Theory - In the early 1900s, two Swedish economists, Eli Heckscher and Bertil Ohlin, focused their attention on how a country could gain comparative advantage by producing products that utilized factors that were in abundance in the country. Their theory is based on a country’s production factors—land, labor, and capital, which provide the funds for investment in plants and equipment. ​ ​ In contrast to classical, country-based trade theories, the category of modern, firm-based theories emerged after World War II and was developed in large part by business school professors, not economists. The firm-based theories evolved with the growth of the multinational company (MNC). The country-based theories couldn’t adequately address the expansion of either MNCs or intraindustry trade, which refers to trade between two countries of goods produced in the same industry. 1.​ Country Similarity Theory - proposed that consumers in countries that are in the same or similar stage of development would have similar preferences. In this firm-based theory, Linder suggested that companies first produce for domestic consumption. When they explore exporting, the companies often  find that markets that look similar to their domestic one, in terms of customer preferences, offer the most potential for success. 2.​ Product Life Cycle Theory - The theory, originating in the field of marketing, stated that a product life cycle has three distinct stages: (1) new product, (2) maturing product, and (3) standardized product. The theory assumed that production of the new product will occur completely in the home country of its innovation. 3.​ Global Strategic Rivalry Theory - Global strategic rivalry theory emerged in the 1980s and was based on the work of economists Paul Krugman and Kelvin Lancaster. Their theory focused on MNCs and their efforts to gain a competitive advantage against other global firms in their industry. Firms will encounter global competition in their industries and in order to prosper, they must develop competitive advantages 4.​ Porter’s National Competitive Advantage Theory - In the continuing evolution of international trade theories, Michael Porter of Harvard Business School developed a new model to explain national competitive advantage in 1990. Porter’s theory stated that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. His theory focused on explaining why some nations are more competitive in certain industries. The evolution of what is recognized as the Standard Theory of International Trade goes back to the years when Adam Smith's Wealth of Nations (1776) and David Ricardo's Principles of Economics (1951) were published. ​ Adam Smith -​ Considered division of labor, as observed in the nascent large-scale industries of his homeland England, as the base for lowering labor costs, which ensured effective competition across countries. -​ The possible dilemmas in terms of the need for monetary adjustments for countries having a continuous trade surplus with absolute advantage in all traded goods could be shelved aside by relying on the automatic adjustment as posited by Smith's contemporary, David Hume (1776) when he offered the theory of the price-specie flow mechanism. Trade surplus is the amount by which the value of a country's exports exceeds the cost of its imports. It was left to Ricardo to sort out the basic premises of a theory of free trade, which Smith had initiated. -​ Free trade, as opposed to the mercantilist policies of protection, was championed by both Smith and Ricardo as a route to achieve production efficiency at a global level. In a free trade system, individuals benefit from a greater choice of affordable goods, while mercantilism restricts imports and reduces the choices available to consumers. ​ David Ricardo -​ Cost calculations, despite his concerns for the introduction of machinery on a large scale, were based on labor hours, which were treated as a single homogeneous input with production in a two-commodity world, subject to constant costs. -​ It was comparative advantage and not absolute advantage, which was considered both necessary, as well as sufficient, to ensure mutually gainful trade across nations, warranting complete specialization in the specific commodity with a comparative advantage in terms of labor hours used per unit of output. Economic Concepts Related to Trade 1.​ Marginal cost is the cost incurred in producing an additional unit of a product. 2.​ Opportunity cost means the value you will get from an alternative that you did not choose. For example, you can earn interest on money if you deposit it in the bank, but you opted to spend it or lend it to somebody. The interest you would have earned in the bank is the opportunity cost of the money you spent or lent to somebody. The theory of international trade and commercial policy, still considered to be one of the oldest branches of economic thought, has evolved from the standard theory of international trade. ​ From the ancient Greeks to the present, government officials, intellectuals, and economists have deliberated about the determinants of international trade, have discussed whether trade is beneficial or harmful to nations, and, more importantly, have tried to determine what trade policy is best for any particular country. ​ Since the time of the ancient Greek philosophers, there has been a dual view of trade: a recognition of the benefits of international exchange combined with a concern that certain domestic industries, laborers, or culture would be harmed by foreign competition. Depending  upon the weights put on the overall gains from trade or on the losses of those harmed by imports, different analysts have arrived at different conclusions about the desirability of having free trade. ​ But economists have likened free trade to technological progress; although some narrow interests may be harmed, the overall benefits to society are substantial. Still, as evidenced by the intense debates over trade today, the tensions inherent in this dual view of trade have never been overcame (econlib.org 2021). LESSON 1.2 BARTER Barter -​ Age-old system (6000 BC) -​ Introduced by the tribes of Mesopotamia, adopted by Phoenicians and improved by the Babylonians. -​ Practice for centuries facilitating the exchange of goods & services before the advent of the monetary system -​ Involves a direct trade/ exchange of goods and services -​ Exchange goods/ services for other goods/ services other people have in return -​ Ancient Time: local phenomenon, which involved people in the same locality -​ Process of trading services/ goods between 2 parties w/o using money in the transaction Situation: 1.​ Service can be exchanged for an item, an item exchanged for a service, an item can be exchanged for some other item. ​ ​ Middle Ages: -​ Europeans started traveling across the globe & used barter services to trade their goods like fur & crafts to the East, in exchange for perfume & silk. -​ Colonial America used wheat, the skin of male deer (bucks), and musket balls to do business. > Experts in exchanging services ​ Example: -​ If members of one family agreed to help their neighbors in planting crops, the latter would help the former in painting their houses. -​ Initial years of Oxford & Harvard Universities, students used to pay their fees in Octterms of food items, firewood, or livestock. ​ ​ Advantage of Bartering 1.​ It does not involve money 2.​ It is very simple – Ex: issues confronted in international trade like foreign exchange & unbalanced economic power are virtually nonexistent ​ Disadvantage of Bartering 1.​ Difficult to find people who need what other people have 2.​ Difficult to find the value of what one has VS the value of what the other one has 3.​ No standard measure of value 4.​ Time-consuming – parties in the bartering transaction will need to spend time agreeing on the terms of the deal. 5.​ Goods are perishable – hard to preserve; go to waste ​ Note: ​ Invention of money did not put an end to bartering services ​ Monetary Crises - fueled the revival of bartering & the current recession has once again set a stage for its come back. ​ Internet (sophisticated techniques) - barter is once more present in our current times. Example: swap markets & online auctions Historyplex - has the following account for the development of barter through the centuries (1)​Early Humans -​ Had very little needs -​ Used leaves & animal skin – CLOTHES & ate vegetables, fruits, fish & animal meat  -​ No need for exchange of goods, as their needs were limited. (2)​Formation of Groups -​ Number of people increased, and the early humans had to travel long distances to find food – they started forming groups. -​ The members stayed together while traveling & hunting – they refrained from any interaction w/ other groups -​ Intergroup interaction started & this paved the way for a system of trading > started exchanging their goods for what they needed, which the other groups had > this type of exchange was mainly done to fulfill basic needs (food, clothes & the like) LESSON 1.3. ORIGIN OF MONEY The disadvantages of the Barter System gave birth to multiple ideas that will eventually come up with the origin of money. In the course of history, the following were the valuable things that were acceptable for a majority and were noted to have been used as primitive means of payment in ancient societies: ​ Salt ​ Metal ​ Farm animals In addition to this, people of centuries ago had agreed upon specific values for certain materials to be used as money for trade such as: ​ Shells ​ Feathers ​ Animal teeth However, it became difficult to carry and use these materials. So traders wanted something that was not perishable and easy to carry as a medium of exchange. This led to the use of metal pieces as money. Timeline of Events That Led to the Origin of Money in China ❖​ 1000 BC: It is believed that the first recognizable metal coins appeared in China. The earliest currency of China of the eighth century BC consisted of miniature hoes and billhooks (pruning implements), with inscriptions indicating the authority. ❖​ 770 BC: Miniature replicas of tools and weapons cast in bronze were used by the Chinese as a medium of exchange. The small bronze celts (prehistoric tools resembling chisels) and bronze rings frequently found in hoards in Western Europe probably played a monetary role. Even in modern times, such mediums of exchange as fishhook currency have been known. Due to impracticality, these tiny daggers, spades, and hoes were eventually abandoned for objects in the shape of a circle. These objects became some of the first coins. ❖​ 700 BC: the Chinese moved from coins to paper money. ❖​ AD 1271: Marco Polo (the Venetian merchant, explorer, and writer who travelled through Asia along the Silk Road between AD 1271 and 1295) visited China and witnessed the emperor of China having a good handle on both the money supply and various denominations. Other Notable Events That Led to the Origin of Money in World History ❖​ The first region of the world to use an industrial facility to manufacture coins (a mint) that could be used as currency was in Europe, in the region called Lydia (now western Turkey). In 600 BC, around the time China started using paper money, Lydia's King Alyattes minted the first official currency, non-standardized coins from electrum (a naturally occurring alloy of gold and silver) that did not have a standardized value. ​ Minting - the process of making a coin by stamping metal. ❖​ King Croesus (son of King Alyattes) (reigned 560-546 BC) produced a bimetallic system of pure gold and pure silver coins. The Croeseid, anciently Kroiseioi stateres, was a type of coin, either in gold or silver, which was minted in Sardis by the king of Lydia, Croesus, from around 550 BC. Croesus is credited with issuing the first true gold coins with a standardized purity for general circulation, and the world's first bimetallic monetary system. While these coins were in circulation, it was the issuing of the Croeseid that changed the way that people did trade. Lydia's currency helped the country increase both its internal and external trading systems, making it one of the richest empires in Asia Minor. ❖​ The foundation deposit of the Artemisium (temple to Artemis) at Ephesus shows that electrum (which the Greeks called "white gold") coins were in production even before Croesus, possibly under King Gyges. The coins were stamped with pictures that acted as denominations. They were stamped on one  side with the facing heads of a lion and a bull; this type was later transferred to the bimetallic series of pure gold and pure silver. The early electrum coinage consisted of small, thick, bean-shaped pieces, with a device stamped in relief on one side, the other being roughly impressed. Their intrinsic value fluctuated according to their gold and silver content, but the weight of the unit was fairly steady at about seven to eight grams, and the types stamped on them were the guarantee of authority. The Bank of Canada had the following account of the history of the Canadian dollar: ❖​ The European colonial governments in North America issued the first paper currency. Because shipments between Europe and the North American colonies took so long, the colonists often ran out of cash as operations expanded. Instead of going back to a barter system, the colonial governments issued IOUS (promissory notes) that traded as a currency. The first instance was in Canada (then a French colony). ❖​ According to Adam Shortt, the great Canadian economic historian, the first regular system of exchange in Canada involving Europeans occurred in Tadaoussac in the early seventeenth century, where French traders bartered each year with the Mantagnais people (also known as the Innu) trading weapons, cloth, food, silver items, and tobacco for animal pelts, especially those of the beaver. ❖​ The first colonial settlement at Quebec on the St. Lawrence River was established by Samuel de Champlain in 1608. The beaver pelt was the one universally accepted medium of exchange in the infant colony, although wheat and moose skins were also employed as legal tender. ❖​ As the colony expanded and its economic and financial needs became more complex, coins from France came to be widely used. Silver and copper coins designed especially for the colonies were minted in the 1670s due to the inability to keep coins in circulation in French Colonies in the Americas. These coins could not be circulated in France. While apparently intended only for the West Indies, a small number of these coins are believed to have circulated in Canada. The West Indies are a chain of islands in the Caribbean Sea and Atlantic Ocean divided into three groups: ​ Bahamas ​ Greater Antilles ​ Lesser Antilles. ❖​ During the mid-1600s, Spanish dollars (piastres) began to circulate in the French colonies owing to illegal trading with English and Dutch settlers to the south, who used them extensively. Full-weighted Spanish dollars were stamped with a fluer-de-lys and were valued at four livres, while light coins, depending on their weight, were stamped with a fleur-de-lys and a Roman numeral with the lightest coin assigned a value of only 3 livres. These over-stamped Spanish dollars represent the first distinctive Canadian coins. ❖​ In 1685, the colonial authorities in New France found themselves short of funds. Jacques de Meulles, Intendant of Justice, Police, and Finance came up with the temporary issuance of paper money printed on playing cards. Card money was purely a financial expedient initially, but was later acknowledged as a medium of exchange. ❖​ The first issue of card money occurred on June 8, 1685 and was redeemed three months later. These cards were readily accepted by merchants and the general public and circulated freely at face value. ❖​ Card money was next issued in February 1686. ❖​ Because of another revenue shortfall, the colonial authorities reissued card money in 1690. The following year, with yet another issue of card money, the Governor, Louis de Buade, Comte de Frontenac, acknowledged the useful role that card money played as a circulating medium of exchange in addition to being a financing tool. The cards served as money in Canada, just as coin did in France.  ❖​ Transporting gold and silver across the Atlantic was risky and to attract and retain fresh supplies of coin, coins were given a higher value in the French colonies in Canada than in France. In 1717, all debts and contracts in Canada became payable in monnoye de France. ❖​ The livre (French for "pound" and the name of both units of account and coins) was the currency of the Kingdom of France and its predecessor state of West Francia from 1781 to 1794. ❖​ Copper coins were introduced in 1722, but they were not well received by merchants. Notes issued by private individuals based on their own credit standing also circulated as money, which continue periodically well into the nineteenth century. The government, once again short of funds, also issued promissory notes called ordonnances and treasury notes called acquits, which began to circulate as money. ❖​ In March 1729, card money, which were strictly limited, were legal tender for all payments and replaced the ordonnances in circulation. ​ Legal tender means currency, such as coin and paper money, that are declared by law to be valid and sufficient for the payment of debts, and meet a financial obligation, including tax payments, contracts, and legal fines or damages. ❖​ By the early 1750s, the distinction between card money and treasury notes had largely disappeared. ❖​ By 1757, the government had discontinued payment in specie; all payments were made in paper. A rapid increase in the amount of paper in circulation during the late 1750s led to rapid inflation. ​ Inflation means increase in prices, reducing the purchasing power of money. ❖​ On October 15, 1759, the French government suspended payment of bills of exchange drawn on the Treasury for payments of expenses in Canada until three months after peace was restored. ❖​ Paper money traded at a sharp discount and ultimately became worthless following the British conquest in 1760. Gold and silver, which had been hoarded, came back into circulation. Settlement of the paper obligations issued by the colonial authorities in Canada was included in the Treaty of Paris, signed in February 1763, which ended the war between Great Britain and France. LESSON 1.4 HISTORY OF THE PHILIPPINE CURRENCY Pre-Hispanic Era ​ Barter -​ Trade long before the Spaniards came to the Philippines -​ Trade among the early Filipinos & within traders from the neighboring countries like China, Java, Borneo & Thailand was conducted through barter > Cowries -​ Medium exchange adopted due to the inconvenience of the barter system -​ Produced in gold, jade, quartz & wood – became the most common & acceptable form of money through many centuries ​ ​ > Ovulidae Triviidae (allied cowries)  -​ Is the most popular marine gastropods, having glossy, often colorfully patterned shells ​ ​ Barter Rings -​ Made in gold (since the PH is naturally rich in gold) were used in ancient times for personal adornment, jewelry, and the first local form of coinage called piloncitos. -​ Had a flat base that bore an embossed inscription of the letters “MA” or “M” similar to Javanese script of the 11th century >> “MA” or “M” – was believed as the name by which the PH was known to Chinese traders during the pre-Spanish time Spanish Era (1521-1897) -​ Ancestors were already trading w/ China, Japan, Siam, India, Cambodia, Borneo & Moluccas -​ Spanish Government – continued trade relations w/ these countries, & manila became the center of commerce in the East -​ Spaniards – closed the ports of Manila to all countries except Mexico -​ Ruled the PH for 300 years > Cobs/ Macuquinas (silver coins) -​ Earliest coins brought by the galleons from Mexico & other Spanish colonies -​ Usually bore a cross on one side & the Spanish royal coat-of-arms on the other ​ > Barillas -​ Due to shortage it was struck in the PH as ordered by the Royalty of Spain -​ Crude bronze/ copper coin worth about one centavo -​ First coin struck in the country -​ It is the origin of the Filipino term “barya”, referring to small change Note: ​ Coins from other Spanish colonies also reached the PH & were counter-stamped to legalize their circulation in the country: 1.​ Gold Coins w/ the portrait of Queen Isabela were minted in Manila 2.​ Silver Pesos w/ the profile of young Alfonso XIII were the last coins minted in Spain 3.​ Peso Fuertes issued by the country’s first bank, the El Banco Espanol Filipino de Isabel II, were the first paper money circulated in the country Revolutionary Period (1898-1899) -​ Philippine Republic of 1898 under General Emilio Aguinaldo issued its own coins & paper currency backed by the country’s natural resources -​ Philippines was asserting its independence -​ At Malolos Arsenal, two types of two-centavo copper coins were struck  -​ One Peso & Five Peso printed as Republika Filipina Papel Moneda de Un Peso and Cinco Pesos were freely circulated – hand-signed by Pedro Paterno, Mariano Limjap, & Telesforo Chuidian. American Period (1900-1941) -​ Coming of Americans (1898) - modern banking, currency & credit systems were instituted making the PH one of the most prosperous countries in East Asia. -​ Americans - instituted a monetary system for the PH based on gold (gold standard) & pegged the PH peso to the American dollar at the ratio of 2:1; 2 pesos = 1 US dollar. -​ US Congress - approved the Coinage Act of the PH in 1903 -​ Gold Standard - monetary system where a country’s currency or paper money has a value directly linked to gold. > countries agreed to convert paper money into a fixed amount of gold per unit of currency -​ Coins issued under the system bore the designs of Filipino engraver & artist, Melecio Figueroa -​ Renaming of El Banco Espanol Filipino to Bank of the Philippine Islands in 1912 paved the way for use of English from Spanish in all noted & coins issued up to 1933 -​ Beginning May 1918, treasury certificates replaced the silver certificates series, and a one-peso noted was added. The Japanese Occupation (1942-1945) -​ Outbreak of WWII – caused serious distrubance in the PH monetary system -​ Two kinds of Notes circulated in the country during this period: (1)​Japanese Occupation Forces issued war noted in high denominations – these war notes had no back up reserves, thus, Filipinos dubbed it as “Mickey Mouse” money -​ During the worst inflation in PH history, Filipinos would go to the market laden w/ “bayongs” of Mickey Mouse bills, since one duck egg = 75 pesos, and a box of matches more than 100 pesos. (2)​Guerilla Notes/ Resistance Currencies, low denominations, were issued by different province and, in some instances, municipalities through their local currency boards to show resistance against the Japanese occupation ​ The Philippine Republic -​ After the end of WWII, gained independence from the United States -​ Philippines used old treasury certificates as currency overprinted w/ word “Victory” -​ Establishment of the Central Bank of the Philippines (1949) – first currencies issued were the: (1)​English series notes by Thomas de la Rue & Co., Ltd. – England (2)​Coins minted at the US Bureau of Mint ​ Filipinization (republic coins & notes) – began in the late 60s to present ​ 70s – Ang Bagong LIpunan (ABL) series notes circulated - printed at the Security Printing Plant (1978 - start) ​ Flora and Fauna coin series (1983) - new wave of change swept through the Philippine coinage system ​ New Design Series (1985) replace ABL ​ 10 yeast later - new set of coins & notes w/ logo of the New Bangko Sentral ng Pilipinas ​ ​ CHAPTER II: CLASSICAL COUNTRY-BASED THEORIES OF INTERNATIONAL TRADE LESSON 2.1. MERCANTILISM History of Mercantilism -​ The Commercial Revolution which took place between 1450 and 1750( (300 years) brought a revolutionary change in the economy of Europe. It saw the transition from local economies to national economies, from feudalism to capitalism from a rudimentary trade to a globally larger international trade. -​ The commercial revolution gave birth to mercantilism, which played a vital role for the economic prosperity of a nation and created a milestone in the field of European Economy (historydiscussion.net 2021). Definition of Mercantilism -​ This theory stated that a country's wealth was determined by the amount of its gold and silver holdings. Mercantilists believed that a country should increase its holdings of gold and silver by promoting exports and discouraging imports. -​ Mercantilist policies focus on the accumulation of wealth and resources while maintaining a positive trade balance with other countries. By maximizing exports and minimizing imports, mercantilism is also viewed as a form of economic protectionism. -​ The objective of each country was to have a trade surplus, or a situation where the value of exports are greater than the value of imports, and to avoid a trade deficit, or a situation where the value of imports is greater than the value of exports. -​ The 1500s marked the rise of new nation-states, whose rulers wanted to strengthen their nations by building larger armies and national institutions. These rulers placed lots of importance on the development of merchants and naval fleets, which would facilitate exports. By increasing exports and trade, these rulers were able to amass more gold and wealth for their countries. In addition, mercantilism believes that the state should actively intervene in the economy. Key Figures to Mercantilist Theory 1.​ Adam Smith -​ Adam Smith described mercantilism as an economic system aimed at enhancing the power and wealth of states by prioritizing the accumulation of precious metals, particularly silver and gold,  as a key measure of national prosperity. This system involved policies that favored exports over imports, restricted free trade, and encouraged the establishment of colonies to ensure a steady flow of valuable resources and raw materials to the home country, thereby increasing its wealth and economic influence. -​ Mercantilism led to the massive and rapid unification of economic and political control within countries by implementing strict protectionist policies designed to shield domestic industries from foreign competition. These policies included high tariffs on imports, subsidies for exports, and strict regulations on trade, ensuring that wealth and resources remained concentrated within the country. This centralization of control aimed to strengthen the state's power and maintain a favorable balance of trade, which was seen as essential for national prosperity and security. -​ Mercantilism aggressively pursued a favorable balance of trade, aiming to achieve a trade surplus by maximizing exports and minimizing imports. This was accomplished through strict government intervention, including imposing high tariffs and import restrictions, subsidizing domestic industries to boost exports, and negotiating trade agreements that favored the home country. The ultimate goal was to ensure that more wealth flowed into the nation than out, with the accumulation of gold and silver seen as a critical measure of national strength and economic dominance. -​ In mercantilism, the government strengthens the private owners of the factors of production, which are: -​ Labor - refers to the work performed by a person for monetary consideration. It is the monetary consideration that forms part of the cost of production. -​ Natural resources (land) - Natural resources are those found in nature, including land. Land, trees, and mines are natural resources and a major factor of production. -​ Capital goods (capital) - Capital goods consist of those goods which are produced by the economic system and are used as inputs in the production of further goods and services. Capital is often the one considered as a factor of production, which refers to the money or funds used to purchase the goods used in the production process. -​ Entrepreneurship - The entrepreneur is the one that combines the factors in the correct proportion and mobilizes them; that is why entrepreneurship is considered as one of the factors of production 2.​ Jean-Baptiste Colbert (1619-1683) -​ a French statesman who served as Comptroller General of Finance (1665-1683) and Secretary of State for the Navy (1668-1683) under King Louis XIV of France, was considered as a more profound influence on the development of mercantilism in France, where it was known as "Colbertism." -​ Jean- Baptiste did not use the term "mercantilism," but he described and supported a similar system that played a crucial role in boosting the economy after the French industry had been ravaged by religious wars. He proposed ways of reviving it and saving the country's economy from bankruptcy. He molded the French economic policy emphasizing the need for full state control over the economic activities with a view to make France a powerful and self-sufficient nation. -​ He adopted economic policies that would increase the country's exports and reduce imports, so that it could accumulate precious metals to be distributed to all provinces to boost industry and provide more taxes to the government. -​ He directed governmental support for the establishment of glass manufacturing industries to replace glass imported from Venice and export the surplus and he also worked for the manufacture of cloth and tapestry. -​ Moreover, he raised tariffs and encouraged public work projects to create an enabling environment for French producers. Colbert fostered national mercantilism, in which the state concentrates on developing its industry and manufacturing to minimize imports and maximize exports to maintain a favorable balance of trade (difference between exports and imports). -​ Merchant fleets played an important role in the international market so the French government established marine merchant fleets that would aid in exportation making the whole process more efficient. -​ The long-term effects of Colbertism resulted in impoverished trading partners, while France became wealthier. Such policies were also applied to all its colonies so that there would be an inflow of precious metals from colonies to France. 3.​ William Petty (1623-1687) -​ Sir William Petty (1623-1687) was an English economist, physician, scientist, and philosopher. He was a supporter of Oliver Cromwell's government of England. After numerically comparing economic data of England, France, and the Netherlands, Petty concluded that England was three times richer than the Netherlands and two times richer than France. -​ According to Petty, surplus gain or surplus value leads to expanded reproduction and that expanded reproduction is conditional on capital accumulation (productive capital expansion). This means that if a country has accumulated capital, it will have surplus value and, consequently, expanded reproduction. -​ While the labor market in England included an abundance of productive labor, the French absolutist system was supported by masses of men engaged in unproductive labor such as the nobility or the clergy. Therefore, even though both countries held similar productive conditions (e.g., climate, population, technology), England was richer than France due to a more extensive productive labor force that could reproduce economic surplus and not just simply consume it unproductively. 4.​ Philipp Wilhelm von Hornick -​ The Austrian lawyer and scholar Philipp Wilhelm von Hornick, in his Austria Over All, If She Only Will of 1684, detailed a nine-point program of what he deemed effective national economy, which sums up the tenets of mercantilism comprehensively (iquisearch.com 2021): i.​ That every inch of a country's soil be utilized for agriculture, mining, or manufacturing; ii.​ That all raw materials found in a country be used in domestic manufacture, since finished goods have a higher value than raw materials; iii.​ That a large, working population be encouraged; iv.​ That all export of gold and silver be prohibited and all domestic money be kept in circulation; v.​ That all imports of foreign goods be discouraged as much as possible; vi.​ That where certain imports are indispensable they be obtained at first hand, in exchange for other domestic goods instead of gold and silver; vii.​ That as much as possible, imports be confined to raw materials that can be finished; viii.​ That opportunities be constantly sought for selling a country's surplus manufactures to foreigners, so far as necessary, for gold and silver; and ix.​ That no importation be allowed, if such goods are sufficiently and suitably supplied at home. 5.​ Sir Thomas Mun (1571-1641) -​ a famous economic thinker, was most closely associated with the idea of mercantilism in England, where mercantilism was called commercial system or mercantile system, because it emphasized the importance of commerce and free trade. This school of thought mainly focused on international trade and the balance of trade through acquisition of silver and gold. -​ When Thomas Mun first introduced his idea of foreign trade, it was during a time of an economic downfall in England. Many people believed that the East India Company was to blame because they had financed their trade by exporting a large amount of "bullion in order to purchase spices." When accusations arose of his company being at fault for the trade imbalance in England, Mun's defense strategy involved informing the citizens of the country about the benefits of international trade to increase England's wealth. -​ Thomas Mun declared that "foreign trade ought to be encouraged, for upon it hinges the great revenue of the King, the honor of the kingdom, the noble profession of the merchant, the supply of our poor, the improvement of our lands and means of our treasure. 6.​ Antoine de Montchrétien -​ published a book titled A Tract on Political Economy in which he laid great emphasis on development of agriculture and described it as the basis of all wealth. He stood for the principle of self-sufficiency and asserted that it is not the abundance of gold and silver, the quantities of pearls and diamonds, which make a state rich and opulent, but the convenience of the things necessary to life (preservearticles.com 2021).  7.​ Richard Cantillon -​ Cantillon's only known book, Essai sur la Nature du Commerce en General (the Essai), may represent one of the single largest steps forward in the social sciences. -​ He laid emphasis on the import of precious metals to make the country prosperous. Cantillon lived and wrote before the physiocrats. Physiocrats is an eighteenth-century group of French economists who believed that agriculture was the source of all wealth and that agricultural products should be highly priced. Advocating adherence to a supposed natural order of social institutions, they also stressed the necessity of free trade. -​ Many attempts have been made to classify Richard Cantillon into a well-defined school of thought and he has been claimed as a forerunner by many schools of economic thought, but for purposes of categorization, he is most often placed with the mercantilists. 8.​ Giovanni Botero and Antonio Serra -​ Giovanni Botero and Antonio Serra of Italy did not directly touch on mercantilism, but developed theories using the city as a unit of analysis and finding development to be the result of human industrial potpourri. -​ In 1613, Antonio Serra adds the argument that the core of the virtuous circle of growth is found in increasing returns to scale. What Botero and Serra were emphasizing was that a nation can be rich through industrialization that will bring results of cumulative causations originating in increasing returns (elgaronline.com 2021). LESSON 2.2. THEORY OF ABSOLUTE ADVANTAGE ​ The abilities of companies and nations to produce goods efficiently are the basis for absolute advantage. Absolute advantage is accomplished by creating the good or service at a lower absolute cost per unit using fewer inputs, or a more efficient process. Countries tend to avoid producing goods and services with little to no demand. ​ Absolute advantage is recognized with lower labor costs, access to a supply of resources, and a large pool of available capital. Example: Japan and Italy both produce automobiles. If Italy can manufacture higher quality sports cars with greater profit, then Italy is said to have an absolute advantage in that industry. Adam Smith -​ Adam Smith is recognized as the founder of modern economics; hence, considered as the father of economics. He is credited with using the word mercantilism first and that his book, The Wealth of Nations, marked the birth of modern capitalism. -​ Smith made a number of important criticisms of mercantilist doctrine. -​ He demonstrated that trade, when freely initiated, benefits both parties. -​ He argued that specialization in production allows for economies of scale, which improves efficiency and growth. -​ Finally, Smith argued that the collusive relationship between government and industry was harmful to the general population. While the mercantilist policies were designed to benefit the government and the commercial class, the doctrines of laissez-faire, or free markets, which originated with Smith, interpreted economic welfare in a far wider sense of encompassing the entire population. -​ In 1776, Adam Smith offered a new trade theory called absolute advantage, which focused on the ability of a country to produce a product more efficiently than another country. Smith believed that if a certain country could produce a product cheaper or more efficiently than another country, the former should specialize in producing that product. This means that each country will produce the product it is able to produce cheaper and more efficiently, thereby giving specialization to each country. In this case, therefore, these countries can export those products where it is more efficient. Their labor force would become more skilled by doing the same tasks and production would, also, become more efficient. -​ The theory of absolute advantage in international trade evolved as a strong reaction to the restrictive and protectionist mercantilist views on international trade. This theory was put forward by Adam Smith to explain the reasons for foreign trade. -​ According to the theory, countries should manufacture products that they can produce efficiently at a lower cost as compared to other countries, products the countries have specialization on. Countries should produce and export such products which they can produce efficiently and import those goods that  they produce relatively less efficiently and at a higher cost. This kind of trade will be beneficial for both countries. For example, if Country A can produce cars at a lower cost than others and Country B can produce trucks at a lower cost than others, then Country B should import cars from Country A and Country A can import trucks from Country B. 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. Physiocrats -​ The cornerstone of the Physiocratic doctrine was François Quesnay's (1759, 1766) axiom that only agriculture yielded a surplus -- what he called a produit net (net product). Manufacturing and commerce, the Physiocrats argued, took up as much value as inputs into production as it created in output, and consequently created no net product. Like many Enlightenment thinkers, and contrary to the Mercantilists, the Physiocrats believed that the wealth of a nation lay not in its stocks of gold and silver, but rather in the size of its net product. -​ Modern capitalism emerged as a result of the appearance of the physiocrats in France after 1750 and the devastating impact of the ideas of Adam Smith relative to the principles and practice of mercantilism. -​ The physiocrats were a group of economists who believed that the wealth of nations was derived solely from agriculture. The term "physiocracy" itself, introduced by Dupont de Nemours (1767) literally translates to "the rule of nature." Physiocracy is perhaps the first well-developed theory of economics. Impact of Absolute Advantage on International Trade & Development -​ Extension of markets enhances division of labor and productivity. By division of labor, employees become skilled and specialized in their respective tasks and by specialization, productivity is enhanced thereby attaining efficiency. -​ Satisfies more population needs by fully utilizing productive capacity. Producers with an absolute advantage can produce more output with the same or fewer resources, maximizing the utilization of productive capacity. This means more goods and services are available to meet the population's needs. -​ Promotes knowledge and technology transfer between nations. Smith also mentioned an additional beneficial aspect of international trade— it transfers knowledge and technology between different nations. The adoption and use of new production techniques lead to productivity growth and thus, to an increase in wealth and economic development. -​ Domestic producers improve performance. The gains from international trade are reinforced by the increased competition that domestic producers are confronted with. Increased competition drives companies to perform and produce better, to have absolute advantage. -​ Leads to innovations and economic growth. Efficient production reduces costs, allowing firms to invest in new technologies and processes. These investments can lead to innovations that further enhance productivity and economic growth. -​ Trade integrates with theories of division of labor and specialization. In essence, trade complements the theories of division of labor and specialization by facilitating the exchange of specialized goods and services, leading to a more efficient and interconnected global economy. LESSON 2.3. THEORY OF COMPARATIVE ADVANTAGE Comparative advantage ➔​ It refers to the country's capability to produce specific goods or manufacture multiple types of goods with limited resources at lower marginal cost and opportunity cost compared to other countries. ➔​ Illustration: If a country can produce goods or services at a lower (total) cost than other countries, it has comparative advantage. The trick to understanding comparative advantage is in the phrase "lower cost." ◆​ To contextualize: Oil-producing nations have a comparative advantage in chemicals. Their locally produced oil provides a cheap source of material for the chemicals when compared to countries without it. A lot of the raw ingredients are produced in the oil distillery process. As a  result, Saudi Arabia, Kuwait, and Mexico are competitive with the US chemical production firms. Their chemicals are inexpensive, making their opportunity cost low. ➔​ In older economic terms, comparative advantage has been opposed by mercantilism and economic nationalism. They argue that while a country may initially be comparatively disadvantaged in a given industry, countries should shelter and invest in industries until they become globally competitive. Tabulated Comparison Between the Theory of Absolute Advantage and the Theory of Comparative Advantage Theory of Absolute Advantage Theory of Comparative Advantage Absolute advantage is accomplished by creating the Comparative advantage occurs when a country can good or service at a lower absolute cost per unit using produce a product better and more efficiently than it fewer inputs, or a more efficient process. does other goods. Absolute advantage looks at absolute productivity. Comparative advantage focuses on the relative ​ Absolute productivity looks at an productivity differences. entity's/country's productivity without regard ​ Relative productivity compares the to other entity's/country's productivity. productivity of different entities/ countries. Productivity is an average measure of the efficiency of production. It can be expressed as the ratio of output to inputs used in the production process, i.e., output per unit of input. Absolute advantage solely tackles marginal cost. Comparative advantage talks about marginal cost and ➔​ Marginal cost opportunity cost. Therefore, in comparative ◆​ is the cost incurred in producing an advantage, we are looking at total cost. additional unit of a product ➔​ Opportunity cost ◆​ is described as the sacrifice of the highest value of a good that one has to forego to obtain another. ◆​ what is lost or missed out on when choosing one possibility over another. ◆​ Example: Assume a company can put their money in the bank and earn a 10% interest. For the same amount of money, the company can buy a new equipment it can use for production. If the company buys the equipment, the opportunity cost is the 10% it will earn if it puts the money in the bank. Background: Theory of Comparative Advantage David Ricardo ➔​ became an economist after reading Adam Smith's The Wealth of Nations, he ➔​ formulated the theory of comparative advantage when he investigated in detail the advantages and alternative or relative opportunity in his 1817 book, “On the Principles of Political Economy and Taxation” in an example involving England and Portugal. ➔​ He pointed out that significant increases in the money supply created inflation in England in 1809. ➔​ He argued that a country boosts its economic growth the most by focusing on the industry in which it has the most substantial comparative advantage. ◆​ Example: England was able to manufacture cheap cloth. Portugal had the right conditions to make cheap wine. Ricardo predicted that England would stop making wine and Portugal would stop making cloth. He was right. England made more money by trading its cloth for Portugal's wine, and vice versa. ➔​ Primary ideology: Even if a country had the absolute advantage in the production of several products, specialization and trade can still happen between two countries. A person or a country will specialize in doing what they do relatively better.  ◆​ Example: A doctor is better at doing his job as a doctor even if he can also cook. He is better off doing his job as a doctor and just hire a cook to do the cooking. Their overall productivity is higher as a team. That is comparative advantage. We are looking at the doctor and the cook comparatively/relatively. Barriers to trade may exist, and goods must be transported, stored, and distributed. However, this simplistic example demonstrates the basis of the comparative advantage theory. ➔​ According to his comparative advantage principle, developing countries with a comparative advantage in agriculture should continue to specialize in agriculture and import high-technology widgets from developed countries with a comparative advantage in high technology. ◆​ Ricardo explicitly based his argument on an assumed immobility of capital: if capital freely flowed toward those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labor price of commodities, than the additional quantity of labor required to convey them to the various markets where they were to be sold. ➔​ Ricardo developed the theory of monetarism ◆​ the theory or practice of controlling the supply of money as the chief method of stabilizing the economy. ➔​ He also developed the law of diminishing marginal returns ◆​ one of the essential concepts in microeconomics ◆​ states that there is a point in production where the increased output is no longer worth the additional input. Adam Smith ➔​ among the first to put in writing the theory of comparative advantage ➔​ He wrote: “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.” ◆​ Explanation: It would be better to import something that is cheaper than producing it at a higher cost and offset such importation with exporting what can be produced cheaper. Each country should export a good for which it has a comparative advantage over other countries and import goods produced in another country which has a comparative advantage for such goods imported. ➔​ He propounded division of labor to lower labor cost to reduce the cost of the product so that the country can have comparative advantage. ➔​ He initiated the basic premises of a theory of free trade. For him, the specialization and division of labor, in the emerging large-scale industries of his homeland England, provided the base for lowering labor costs, which ensured effective competition across countries. ◆​ The extent of specialization and division of labor was dependent upon the size of the market. A larger market would encourage a greater degree of specialization and division of labor; hence, the development of international trade. ◆​ International trade enlarged the market and allowed further gains from specialization and division of labor. Common beliefs among classical theorists ​ Each country will specialize in the production of those goods for the production of which it is especially suited on account of its climate, of the qualities of its soil, of its other natural resources, of the innate and acquired capacities of its people, and of the real capital which it possesses as a heritage from its past generation, such as buildings, plants and equipment, and means of transport. ​ Each country will concentrate upon the production of such goods, producing more of them than it requires for its own needs and exchanging the surplus with other countries against goods which it is less suited to produce or which it cannot produce at all. Industrial Capitalism ​ is an economic system in which trade, industry, and capital are privately controlled and operated for profit. It saw the rapid development of the factory system of production characterized by much more rigid, complex, and intricate division of labor that Smith was propounding. Free trade ​ a route to achieve production efficiency at a global level. ​ a trade policy that binds countries into an agreement wherein the system of trade is governed with reduced barriers on importation and exportation among the involved parties.