MANA 1301 2 - International Trade Theories PDF

Trade surplus - A trade surplus occurs when a country's exports exceed its imports during a specific period. In simpler terms, it means the country sells more goods and services to other countries than it buys from them. This results in a positive balance of trade. Example: If Country A exports go...

Trade surplus - A trade surplus occurs when a country's exports exceed its imports during a specific period. In simpler terms, it means the country sells more goods and services to other countries than it buys from them. This results in a positive balance of trade. Example: If Country A exports goods worth $100 billion but imports goods worth only $80 billion, it has a trade surplus of $20 billion. Why it matters: ​ Positive Indicator: It often reflects a strong economy, as the country is producing and selling more than it consumes. ​ Foreign Currency Reserves: It increases the country's foreign currency reserves, strengthening its financial position. ​ Economic Growth: A surplus can boost domestic industries and create jobs, especially in export-focused sectors. However, excessive trade surpluses can also lead to trade tensions with other nations, as seen in cases like the U.S.-China trade relationship. The Heckscher–Ohlin (H–O) theory, also known as the factor endowment theory, is an economic theory in international trade that explains how and why countries trade goods and services. It focuses on the relative abundance of a country’s factors of production (such as labor, capital, or land) and how these influence its comparative advantage in trade. Core Idea: The theory states that: 1.​ Countries will export goods that use their abundant and cheap factors of production intensively. 2.​ Countries will import goods that require factors that are relatively scarce and expensive domestically. Key Assumptions: 1.​ Two countries, two goods, and two factors of production (e.g., labor and capital). 2.​ Countries differ in their factor endowments (e.g., one has more labor, the other more capital). 3.​ Production of goods uses these factors in varying proportions (e.g., one good is labor-intensive, the other is capital-intensive). Example:  ​ Country A: Labor-abundant and capital-scarce (e.g., developing nations). ​ Country B: Capital-abundant and labor-scarce (e.g., developed nations). According to the H–O theory: ​ Country A will specialize in and export labor-intensive goods (e.g., textiles). ​ Country B will specialize in and export capital-intensive goods (e.g., machinery). Implications: 1.​ It helps explain patterns of international trade based on factor endowments rather than just productivity (as in Ricardo’s theory of comparative advantage). 2.​ Over time, trade can equalize the prices of factors of production (known as factor price equalization). Limitations: ​ In reality, assumptions like perfect competition and identical technologies rarely hold true. ​ The theory doesn’t always align with real-world trade patterns (as shown in the Leontief Paradox, where the U.S., a capital-rich country, exported more labor-intensive goods than expected). Despite its limitations, the H–O theory remains a foundational concept in international trade economics. The Factor Price Equalization (FPE) theory is an extension of the Heckscher–Ohlin (H–O) theory in international trade. It suggests that free trade between countries will lead to the equalization of the prices of factors of production (e.g., labor and capital) across countries, even if the factors themselves cannot move between borders. Core Idea: When countries trade goods, they are effectively "trading" the factors of production (like labor and capital) embedded in those goods. Over time, this trade causes the prices of those factors to converge across countries. Key Assumptions: 1.​ Free trade exists, with no tariffs or barriers. 2.​ Countries use the same technology for production. 3.​ Factors of production (e.g., labor, capital) are immobile internationally but mobile domestically. 4.​ Both countries produce both goods, and goods are homogeneous. Mechanism: ​ A country with abundant labor will produce and export labor-intensive goods. ​ A country with abundant capital will produce and export capital-intensive goods. ​ As trade occurs: ○​ Labor-abundant country: Demand for labor-intensive goods increases, driving up wages (the price of labor). ○​ Capital-abundant country: Demand for capital-intensive goods increases, driving up the return to capital (the price of capital). ​ Over time, this leads to wage equalization and capital price equalization between the countries. Example: ​ Country A (Labor-abundant): Low wages for labor, high returns on capital. ​ Country B (Capital-abundant): High wages for labor, low returns on capital. When they trade: ​ Country A's wages rise because of increased demand for labor-intensive exports. ​ Country B's wages fall because labor-intensive imports reduce demand for domestic labor. ​ The prices of labor and capital converge. Limitations: 1.​ Real-world frictions: In reality, barriers like transportation costs, tariffs, and quotas prevent full equalization. 2.​ Technology differences: If countries have different production technologies, factor prices won’t fully equalize. 3.​ Incomplete specialization: If countries don’t fully specialize in production, the theory may not hold. 4.​ Labor immobility: Domestic and cultural differences often restrict factor mobility even within borders. Significance: The FPE theory highlights the interconnectedness of global trade and its impact on wages and returns to capital. However, its strict assumptions mean it often serves as an idealized model rather than a perfect predictor of real-world outcomes. tariff concession refers to a reduction or elimination of import duties (tariffs) on certain goods, typically as part of trade agreements or policies designed to promote international trade. It allows businesses or countries to import specified goods at lower tax rates, making imports cheaper An ad valorem tariff is a type of tax or duty imposed on imported goods based on their value rather than their quantity or weight. The term "ad valorem" comes from Latin, meaning "according to value." How it works: ​ The tariff is calculated as a percentage of the imported good's value. ​ For example, if a country imposes a 10% ad valorem tariff on imported smartphones and the value of an imported smartphone is $500, the tariff would be 10% of $500 = $50. So, the importer would pay $50 as the tariff on top of the cost of the phone. Why is it used? 1.​ Revenue generation: It provides income for the government. 2.​ Protecting domestic industries: By making imported goods more expensive, ad valorem tariffs encourage people to buy locally made products. 3.​ Fairness: Since the tariff is proportional to the value of the goods, it adjusts automatically for high-value and low-value products. Example in real life: Imagine you're a business owner in the U.S. importing luxury handbags from Italy: ​ Each handbag costs $1,000. ​ The U.S. imposes a 20% ad valorem tariff on luxury handbag imports. ​ For each handbag, you'd pay $200 in tariffs (20% of $1,000), making the total cost $1,200 per handbag. Pros of ad valorem tariffs: 1.​ Simple to calculate: It’s straightforward if the product's value is clear. 2.​ Proportional: Higher-value goods pay higher tariffs, which can balance economic fairness. Cons: 1.​ Valuation disputes: Determining the "true value" of a good can lead to disagreements between importers and customs officials. 2.​ Inflation sensitivity: If the price of goods increases, the tariff amount also increases, which could make imports more expensive during inflationary periods. Why does it matter for business management students? If you're studying business management, understanding ad valorem tariffs is essential because tariffs can directly affect the cost of goods, pricing strategies, and profit margins for companies involved in international trade. As a manager, you'll need to consider tariffs when sourcing materials, pricing products, or deciding on markets to enter. The infant industry argument is an economic concept used to justify temporary protectionism for new or developing industries within a country. It suggests that young industries need protection from foreign competition until they become strong enough to compete globally. This protection is often provided through tariffs, subsidies, or quotas. Key Idea: The argument is based on the idea that: 1.​ New industries in a country may lack the experience, economies of scale, or advanced technology to compete with well-established foreign competitors. 2.​ Without protection, these industries may fail to grow, preventing the country from diversifying its economy or developing a competitive advantage in those sectors. 3.​ Temporary support (e.g., tariffs or subsidies) gives the industry time to mature and eventually thrive without government assistance. Example: Imagine a developing country wants to establish a car manufacturing industry: ​ Imported cars from developed countries are cheaper and of better quality because foreign car companies are well-established with advanced technology and economies of scale. ​ Without protection, local car manufacturers in the developing country might struggle to compete and eventually collapse. ​ The government imposes tariffs on imported cars, making them more expensive. This gives the local car industry a chance to grow, improve its technology, and eventually become competitive globally. Common Policy Tools for Infant Industries: 1.​ Tariffs: Taxes on imports to make foreign goods more expensive.  2.​ Quotas: Limits on the quantity of goods that can be imported. 3.​ Subsidies: Financial assistance to local industries to reduce production costs. 4.​ Tax incentives: Reduced taxes for domestic companies in certain sectors. Benefits of the Infant Industry Argument: 1.​ Economic growth: Helps countries develop new industries, leading to diversification and job creation. 2.​ Long-term competitiveness: Once the industry matures, it can compete globally and contribute to economic stability. 3.​ Self-reliance: Reduces dependence on imports for critical goods. Criticisms: 1.​ Risk of inefficiency: Protected industries might become reliant on government support and fail to improve efficiency or innovate. 2.​ Consumer costs: Protectionism can make goods more expensive for consumers by limiting access to cheaper imports. 3.​ Corruption and misuse: Government support can be misallocated to industries with poor prospects or due to political favoritism. 4.​ Difficulty in removing protection: Once an industry is protected, it may lobby to keep that protection indefinitely, even after it matures. Why it matters for business management students: The infant industry argument is important because it highlights the trade-offs between protectionism and free trade. As a future manager, understanding this concept can help you: ​ Recognize how government policies impact industry dynamics. Thank you for the clarification! Here's the corrected explanation: Question 1: The result of several recent pieces of legislation is that infrastructure projects are required to use commodities such as iron and steel that are only domestically sourced, even though these products cost more than comparable imports. Which international trade theory would firmly oppose these actions? Correct answer: a. Absolute advantage Explanation:​ The absolute advantage theory, developed by Adam Smith, states that if a country can produce a good more efficiently than another country, it should specialize in producing that good and trade it with others. Protectionist measures that require the use of domestically sourced products would oppose this theory because they disregard the efficiency gains that could be made by importing cheaper goods from countries that have an absolute advantage in producing those products. Therefore, absolute advantage would firmly oppose such legislation. Question 4: Managed trade—agreements, sometimes temporary, between countries (or a group of countries) that aim to achieve certain trade outcomes for the countries involved—aims to replace global market or economic forces with government actions to determine trade outcomes. Which of the following is a socioeconomic rationale used by economic policymakers to protect specific companies or industries and achieve particular strategic objectives? Correct answer: b. Export cartels Explanation:​ Export cartels are groups of countries or companies that agree to restrict supply or control the price of a specific product in international markets. Economic policymakers might use export cartels to manage trade and protect industries by regulating prices or controlling market access. This strategy could help achieve strategic economic objectives such as stabilizing markets, ensuring supply, or influencing global competition. Let me know if you need further clarification! Buy American" restrictions are an example of extreme economic nationalism. A more moderate approach might allow imports, but with certain restrictions regarding the sourcing of materials for those products. Which type of nontariff trade barrier would facilitate this middle-of-the-road approach? ​ a. Domestic content provisions​ ​ b. Preferential duties​ ​ c. Voluntary export restraint (VER)​ ​ d. Import quotas​ ChatGPT said: ChatGPT The correct answer is: a. Domestic content provisions Explanation: Domestic content provisions are a type of nontariff trade barrier that require a certain percentage of a product's value to be sourced from domestic materials or labor in order to qualify for sale or preferential treatment in the domestic market. This approach represents a middle ground between strict "Buy American" restrictions and completely open trade. It allows imports but imposes rules to ensure some level of domestic involvement in the production process. Why not the other options? ​ b. Preferential duties: These are reduced tariffs applied to imports from specific countries, often as part of trade agreements. While they encourage trade with preferred partners, they don't impose restrictions on the sourcing of materials. ​ c. Voluntary export restraint (VER): This is an agreement where an exporting country voluntarily limits the quantity of goods it exports to another country. It doesn't involve requirements for sourcing materials domestically. ​ d. Import quotas: These set a maximum limit on the quantity of goods that can be imported, restricting overall imports but not specifically addressing the sourcing of materials. Domestic content provisions are specifically designed to ensure that some part of the production process benefits the domestic economy, making them the most suitable answer for this scenario. 4o You said: As described in this mini case, the ideology of economic nationalism seeks to implement trade policies that help to keep jobs and investment at home. The belief that a country must export as much as possible and, in turn, import as little as possible is described by which theory of international trade? ​ a. Mercantilism​ ​ b. Heckscher-Ohlin (H–O) theory​ ​ c. Comparative advantage​ ​ d. Factors of production ChatGPT said: ChatGPT The correct answer is: a. Mercantilism Explanation: Mercantilism is an economic theory that emphasizes the importance of maximizing exports and minimizing imports to accumulate wealth and maintain a favorable trade balance. It promotes economic nationalism by advocating for policies that protect domestic industries, create jobs, and keep investments within the country. The ideology of economic nationalism described in the mini-case aligns closely with mercantilist principles. Why not the other options? ​ b. Heckscher-Ohlin (H–O) theory: This theory explains international trade based on a country's factor endowments (e.g., labor, land, and capital). It doesn’t emphasize restricting imports or maximizing exports. ​ c. Comparative advantage: This theory, introduced by David Ricardo, suggests that countries should specialize in producing goods where they have the greatest efficiency relative to others and engage in free trade. It supports mutual benefit through trade, not restricting imports. ​ d. Factors of production: This refers to the inputs used in production (e.g., land, labor, and capital). It’s not a trade theory and doesn’t describe economic nationalism or trade policies. Summary: Mercantilism is the best fit for the belief that a country should maximize exports and minimize imports to preserve jobs, investments, and wealth within its borders. What are the three ways international trade benefits consumers International trade benefits all consumers in three major ways by providing:  ​ A greater amount of choice in the availability of goods and services. ​ Lower prices for goods and services consumed. ​ Higher living standards. Why should we have the right to freely export and import? The right to export and import freely enhances the quality of life and living standards of people in the countries involved in trade. In addition, trade brings with it cultural and technological riches; it can also make the world a more inclusive and peaceful place because of national interdependence.Trade generates jobs in both the export and import sectors of an economy. What does FDI do? FDI in a country brings funds (foreign savings) and business culture from abroad, creates new well-paying jobs, introduces innovative technologies, and enhances the skills of domestic workers. Why does Singapore get investments? Singapore, a regional center for global companies, continues to attract sizable amounts of foreign investment given its strategic location, world-class infrastructure, and productive workforce International trade is the exchange of goods and services between countries. It benefits consumers by providing a greater amount of choice, lower prices, and higher living standards. Trade also brings cultural and technological riches, and can make the world a more peaceful place. Foreign direct investment (FDI) is the inflow of capital, technology, and skills to enhance domestic investment and economic growth. FDI creates jobs, introduces new technologies, and enhances the skills of domestic workers. Governments all over the world try to create a business-friendly environment to attract FDI. Both trade and FDI have winners and losers. Some workers may lose jobs or be forced to accept lower wages due to competition from imports. However, the overall gains from trade and FDI are greater than the losses. Countries in the developed world should try to soften the disruptive nature of trade competition by retraining and reeducating their workforce What were the downsides of mercantilism? Mercantilist policies aimed at maximizing exports and minimizing imports to accumulate gold and silver, the perceived source of national wealth. However, this approach had several flaws: ​ Price Depression: A global focus on exports would lead to a surplus of goods in the world market, driving down prices and reducing earnings for exporting countries. ​ Increased Competition: To remain competitive, countries would engage in price wars, further depressing prices and lowering wages for workers in the export sector. ​ Exploitation of Labor: To maintain low labor costs, mercantilist policies often encouraged large families, leading to a surplus of cheap labor and ultimately harming the well-being of workers. This focus on accumulating gold and silver at the expense of the well-being of citizens highlights the short-sighted and ultimately flawed nature of mercantilist economic thought. Adam Smith challenged mercantilism and argued that free trade, without restrictions, would benefit all participating countries. His theory is based on specialization, where countries focus on producing goods and services they can produce most efficiently. There are two main theories explaining why specialization benefits countries engaged in free trade: absolute advantage and comparative advantage. Absolute advantage exists when a country can produce a good more efficiently than another country. For instance, Brazil is more efficient at producing coffee than the US due to better soil and climate. Comparative advantage is a refinement of absolute advantage. It considers which good a country has a greater advantage in producing relative to other goods it can produce. Even if a country has an absolute advantage in producing two goods, it should specialize in the good for which it has a greater advantage. Continuing the Brazil-US example, let's say Brazil can produce both coffee and corn more efficiently than the US, but it has a much larger advantage in coffee (5 times more than the US) compared to corn (only 2 times more). In this case, Brazil should specialize in coffee production because it has a comparative advantage in coffee over corn. Even though Brazil is absolutely better at producing both goods, specializing based on comparative advantage ensures a higher standard of living for both countries. This is because scarce resources (land, labor, capital) are used more efficiently, leading to a greater total output for the world. The Heckscher-Ohlin (H-O) theory of international trade argues that a country will export goods that intensively use its abundant factors of production. For example, a country with abundant low-cost labor, like China, will likely export labor-intensive goods like manufactured products. Key assumptions of the H-O theory include perfect competition in markets and the immobility of factors of production between countries. Factor price equalization theory states that free movement of factors of production between countries will lead to more efficient resource allocation and eventually equalize factor prices (like wages) across countries. For example, the free movement of labor within the European Union has led to wage equalization for certain professions. Similarly, the influx of skilled workers from India to the US on H-1B visas has helped stabilize wages for software engineers in the US while increasing them in India. These theories highlight the importance of factor endowments and their movement in shaping international trade patterns and influencing the distribution of income across countries. Michael Porter's "Diamond" Model of National Competitive Advantage explains why some countries excel in certain industries and markets. It goes beyond traditional trade theories by considering firm-specific and country-specific characteristics. Porter's diamond consists of four groups of characteristics that influence a country's competitive advantage: 1.​ Factor Conditions: The quality of a country's factors of production (land, labor, capital, and technology) plays a crucial role. For example, a skilled workforce or strong research institutions can give a country an edge.​ 2.​ Demand Conditions: A strong domestic demand for a product or service can drive innovation and create a pool of sophisticated customers, making the country a global leader in that industry.​ 3.​ Related and Supporting Industries: The presence of supporting industries in a country creates a competitive ecosystem. Silicon Valley's success is due in part to the presence of numerous world-class semiconductor suppliers.​ 4.​ Firm Strategy, Structure, and Rivalry: A country's competitiveness is also influenced by how firms within an industry are managed and structured. Competitive industries with innovative firms are more likely to succeed globally.​ Two additional factors outside the diamond also play a role:  ​ Chance: Unexpected events like technological advancements or pandemics can drastically change the course of economic development.​ ​ Government: Government policies can affect all four characteristics within the diamond. For example, investment in education improves the quality of the labor force, while high taxes can stifle innovation.​ By analyzing these characteristics, Porter's model provides a framework for understanding why certain countries excel in specific industries and how they achieve a competitive advantage in international trade. When domestic demand remains high, the number of suppliers will also be high. With sizable demand, domestic competition among suppliers will intensify and result in lower prices as well as sophisticated, innovative new products. This could lead to product specialization Trade policy all government actions that seek to alter the size of merchandise and/or service flows from and to a country Despite the clear economic benefits of open trade, such as increased choice, lower prices, and job creation, governments often intervene through trade policies. These policies aim to alter the free flow of goods and services, often to protect domestic industries from foreign competition. While tariffs and quotas have historically been the primary tools, modern trade policy also includes nontariff barriers and export subsidies. These interventions are often driven by special interest groups seeking to protect jobs and limit competition, even if it may harm the overall economy in the long run. Key Takeaways: ​ Open trade benefits: Increased choice, lower prices, job creation in export and import sectors. ​ Trade policy aims: To alter the free flow of goods and services, often to protect domestic industries. ​ Common trade policy tools: Tariffs, quotas, nontariff barriers, and export subsidies. ​ Motivations for trade policy: Protection of domestic jobs and industries, even at the expense of long-term economic growth. ​ Impact on trade: Trade policies significantly influence the value and volume of a country's exports and imports. Tariffs:  ​ Types: ○​ Specific: Fixed dollar amount per unit (e.g., $0.54 per gallon on ethanol imports). ○​ Ad Valorem: Percentage of the import's value (e.g., 2.5% on imported cars). ​ Preferential Duties: Lower tariffs for certain countries (e.g., Generalized System of Preferences). ​ Revenue Source: Major source of government revenue for many developing countries. Export Subsidies and Taxes: ​ Export Subsidies: Government payments to reduce export prices and boost exports (e.g., government subsidies for agricultural exports). ​ Export Taxes: Discourage exports and keep production within the country (e.g., export taxes on rice to control domestic prices). World Trade Organization (WTO): ​ Successor to GATT: Established in 1995 to set rules for international trade. ​ Objectives: Lower tariffs, reduce trade barriers, and settle trade disputes. ​ Membership: 164 members as of July 29, 2016. ​ Most Favored Nation (MFN) Principle: Requires equal tariff treatment for all WTO members. Key Takeaways: ​ Tariffs are taxes on imports, while export subsidies aim to increase exports.  ​ These trade policies have significant impacts on international trade flows and economic activity. ​ The WTO plays a crucial role in setting rules for international trade and promoting open markets. Managed trade aims to replace global market or economic forces with government actions to determine trade outcomes. Under a managed trade regime, economic policy makers may use various socioeconomic or geopolitical rationales to protect specific companies or industries and achieve particular strategic objectives.