International Trade Theories PDF

TRADE THEORIES  CONTENTS 1.Mercantilism theory 2.Absolute Advantage theory 3.Comparative Advantage theory 4.Factor Endowment theory 5.Product Life Cycle theory 6.Leontief Paradox 7.Heckscher Ohlin theory 8. Porter`s Diamond theory 9.New Trade Theory...

TRADE THEORIES  CONTENTS 1.Mercantilism theory 2.Absolute Advantage theory 3.Comparative Advantage theory 4.Factor Endowment theory 5.Product Life Cycle theory 6.Leontief Paradox 7.Heckscher Ohlin theory 8. Porter`s Diamond theory 9.New Trade Theory Trade Theory-Global Business Management 2  CONTENTS 1. Availability of products (natural resources, new products, etc.) 2. International price differential as a consequence of: Productivity differential Differences in technology Differences in factor endowments Economies of scale 3. Product differentiation and market structure Trade Theory-Global Business Management 3 WHAT IS TRADE THEORY Exchange of raw materials and manufactured goods (and services) across national borders Trade Theory-Global Business Management 4 MERCANTILISM THEORY The theory that a country’s power depended mainly on its wealth to build strong navies and purchase vital trade goods Trade Theory-Global Business Management 5 MERCANTILISM THEORY 6 Trade Theory-Global Business Management CONTD.. 7 CONTD.. GOLD AND SILVER ARE CURRENCY FOR TRADE THEORY SAYS YOU SHOULD HAVE A SURPLUS MAXIMIZE EXPORT THROUGH SUBSIDIES MINIMIZE IMPORTS THROUGH TARIFFS AND QUOTAS Trade Theory-Global Business Management 8  ASSUMPTIONS THERE IS A FINITE AMOUNT OF WEALTH IN THE WORLD A NATION CAN ONLY GROW RICH AT THE EXPENSE OF OTHER NATIONS A NATION SHOULD TRY TO ACHIEVE & MAINTAIN A FAVOURABLE TRADE BALANCE ( EXPORTING MORE THAN ITS IMPORT) 9 Trade Theory-Global Business Management  LIMITATIONS In modern economy a nation holding gold will lose the competitive price advantage Mercantilism is expensive to implement because it requires complex navigation laws that are difficult to enforce Overlooked other sources of country’s wealth like capital & skilled work force Economic regulation tends to result in illegal activity or smuggling Trade Theory-Global Business Management 10 ABSOLUTE ADVANTAGE THEORY CONTD.. Destroys the Questions mercantilist the objective Efficient Both idea since of national production exporting & there are governments of goods the gains to be to acquire leads to importing had by both wealth potential country gain countries through well being of by engaging party to an restrictive people in trade exchange trade policies Trade Theory-Global Business Management 12  LIMITATIONS Fails to explain how free trade can be advantageous to two countries when one country can produce all goods Country not having absolute advantage can’t gain from free trade Differences in climatic conditions & natural resources won’t lead to absolute advantage What if the country is bad at making everything? Trade Theory-Global Business Management 13 COMPARATIVE ADVANTAGE THEORY David Ricardo: Even if a country is (1817) argued: efficient in A country should producing all the produce only goods where it is most efficient goods, still trade & import those goods in between two which it’s less efficient countries will prove beneficial Country gains in Assumes that a those activities country does not which it can have to be best at produce at world anything to gain prices even though from trade it may not have absolute advantage Trade Theory-Global Business Management 14 LIMITATIONS Ricardo's Theory was based on only two countries & only two commodities, but international trade is among many countries with many commodities Assumption of full employment helps theory to explain trade on the basis of comparative advantage. Cost of production, even in terms of labour, may change as countries, at different levels of employment move towards full employment Another serious defect is that transportation costs are not considered in determining comparative cost differences Ricardian theory is not applicable to developing countries as these countries are nowhere near to full employment Trade Theory-Global Business Management 15 FACTOR ENDOWMENT THEORY Trade theory holding that countries produce & export those goods that require resources (factors) that are abundant (and thus cheapest) & import those goods that require resources that are in short supply Example: Australia – lot of land and a small population (relative to its size) So what should it export and import? Trade Theory-Global Business Management 16  1.Assumes that production function are identical for all countries CONTD.. 2.Assumes that there is no unemployment Trade Theory-Global Business Management 17  4-18 TWO FACTORS OF PRODUCTION Labour Capital LIMITATIONS Assumes that the production Assumes that Considered Had poor functional are there is no capital as predictive power identical for all unemployment homogeneous the countries Trade Theory-Global Business Management 19  PRODUCT LIFE CYCLE THEORY ( R.VERON ( 1966)) Trade theory holding that a country will begin by exporting its product & later undertake foreign direct investment as product moves through its lifecycle As products mature, both location of sales optimal production changes Affects direction & flow of imports & exports Globalization & integration of economy makes this theory less valid Trade Theory-Global Business Management 4-20  PRODUCT CYCLE AND TRADE IMPLICATION Increased emphasis on technology’s impact on product cost Explained international investment Limitations Most appropriate for technology-based products Some products not easily characterized by stages of maturity Most relevant to products produced through mass production 4-21 Trade Theory-Global Business Management  HECKSCHER OHLIN THEORY Eli Heckscher ◼ Given by Filip Heckscher ◼ Explained link between factor endowments & comparative advantage of nations Eli Filip Heckscher ◼ Country has comparative advantage in (1879-1952) those factors which make use of abundant factor ◼ Free trade equalizes factor prices ◼ Trade gains are greatest between countries with greatest difference in economic structure Trade Theory-Global Business Management 22  LIMITATIONS 1.Based on over simplified assumptions & is unrealistic 2.Gives undue importance to supply & less importance to demand Trade Theory-Global Business Management 23 LEONTIEF PARADOX ◼ Given by Wassily Leontief in 1973 ◼ Found out that U.S. exports were apparently labour intensive & imports capital intensive ◼ Findings were contradictory to predictions of Heckscher-Ohlin theorem ◼ Stimulated enormous amount of empirical & theoretical research on subject Trade Theory-Global Business Management 24  LIMITATIONS 1.Leontief considered 2.But in reality capital only capital & labour & natural resources inputs, leaving out are used together in natural resource inputs production Trade Theory-Global Business Management 25  PORTER’S DIAMOND MODEL ◼ Developed by Michael Porter in his book ‘The Competitive Advantage of Nations’ ◼ Explains why particular industries become competitive in particular locations ◼ Competitiveness of one company is related to the performance of other companies ◼ Demand, factor conditions, government policies help companies Trade Theory-Global Business Management create competitive advantage 26  LIMITATIONS 1.In his book, Porter was 2.It was basically a home optimistic about future of based concept & ignored Korea & less optimistic the nature of about future of Singapore multinational activities Trade Theory-Global Business Management 27  NEW TRADE THEORY ◼ Collection of economic models in International trade which focuses on role of increasing returns to scale ◼ This theory relaxed the assumption of constant returns to scale ◼ Emphasized firm level differences in same industry of the same country ◼ Also emphasized the growing trend of intermediate goods ◼ Assumed that all firms are symmetrical, meaning they have the same production co-efficient Trade Theory-Global Business Management 28 Trade Theory-Global Business Management 29  LIMITATIONS 1.Can only treat a situation 2.Assumes that all firms when there are many firms are symmetrical, which with different production may not be true in every processes case Trade Theory-Global Business Management 30