Theories of international trade

Theories of international tradeIntroduction International trade becomes possible for mutual benefits to the two countries due to the differences in opportunity costIt has gain a comparative advantage There are nine types of theories developed by the international economistTypes of theoriesMercantilismTheory of absolute cost advantageComparative cost advantageComparative cost advantage with moneyRelative factor endowments/Hukscher-Owen theoryCountry similarity theoryProduct life cycle theoryGlobal strategic rivalry theoryPorters national competitive advantageMercantilism Holdings of the country treasure primarily in form of gold constituted its wealthIt specifies that countries should export more than they import and receive the value of trade surplus in form of gold from those countries which experience trade deficitsThis theories suggest for maintaining favorable balance of trade in the form of import of gold for export of goods and servicesNeo-MercantilismIt proposes that countries attempt to produce more than the demand in the domestic country in order to achieve a social objectiveIt attack on the ground that the wealth of a nation is based on its available goods and services rather than the goldTheory of Absolute Cost AdvantageAdam Smith advocates free trade among countries to increase a countries' wealthFree trade enables a country to provide a variety of goods and services to its people by specializing in the production of some goods and services and importing othersWhich is to produce and which is to import?It is based on the principle of division of labor

Skilled labor and specialization advantageSuitability of the skill of the labor of the country in producing certain productsSpecialization of laborEconomies of scale would reduce the labor cost per unit of outputNatural advantage it is due to climatic conditions and natural resourcesAcquired advantage it is due technology and skill developmentAssumption of this theoryTrade between two countriesOnly two commodities are tradedFree trade exist between the countriesThe only element of cost of production is laborImplications Two countries have more quantities of both the productsIncreased standard of livingInefficiency in producing certain products can be avoidedGlobal efficiency and effectiveness can be increasedGlobal labor and resource productivity can be increasedCriticism No Absolute AdvantageCountry sizeVariety of resourcesTransport costScale economiesAbsolute advantage for many productsComparative Cost Advantage TheoryA country should produce and export those products for which it is relatively more productive than that of others countries and import those goods for which other countries are relatively more productive than it isAssumptions It exist full employmentOnly element of cost of productionThere are no trade barriersTrade is free from cost of productionTrade takes place between two countriesOnly two products of tradedThere are no cost of transport etc.

Implications Efficient allocation of global resourceMaximization of global production at least costProduct price become more or less equal among world marketsDemand for resources and products among world nation will be optimized

Comparative advantage with money Absolute differences in money prices determine international tradeAccording to F.W.Taussigcomparative differences in labor cost of commodities can be translated into absolute difference in prices without affecting the real exchange relations between productsCriticisms Two countriesTransportation costTwo productsFull employmentEconomic efficiencyDivision of gainsMobilityservicesRelative factor endowmentFactors endowments are:LandCapitalNatural resourcesLaborClimate etcIt may vary among countries

According to this economistIf labor is available in abundance in relation to land and capital in a country, the price of labor would be low and the price of land and capital would be high in that countryThese relative cost would lead countries to produce at low costsCountries participate in trade by exporting those products which they can produce at low cost upon abundance of factors and import other products which they can produce comparatively at high costLand-labor relationshipLabor-capital relationshipLeontief paradoxTechnological complexityFirm based theoryCountry similarity theoryProduct life cycle theoryGlobal strategic rivalry theoryPorters national competitive advantage theoryCountry similarity theoryInternational trade takes place within each industry between two countriesEconomic similarity of developed countriesInternational trade takes place among the countries that are at the same stage of economic developmentSimilarity of locationAdvantage of less transportation costCultural similaritySimilarity of political and economic interestMade agreement with politically friendly countriesProduct life cycle theoryPLC theory provides inputs for manufacturing, trade and investment decisions.It consists of four stages:IntroductionGrowthMaturitydeclineFour stages of PLCNew productFirm innovate new product based on needs and problem in domestic countryLocation of innovation (financial ability, customers demand, availability of R&D, severe competition)Labor as a major input ( customer feedback)Feedback and development

Four stages of PLCGrowth Attracting competitorsIncreased exportsFurther innovationShift manufacturing to foreign countriesMaturityStandardized productsLarge scale production and economiesLow unit cost of production Shift manufacturing to developing countriesFour stages of PLCDecline Location of manufacturing facilities in developing countriesOriginal innovating country becomes net importerLimitations of PLC theoryit cannot achieve cost reduction with rapid innovationNon cost strategies reduce opportunity for cost minimizationRapid technological development may not shift production to various foreign unitsMNC take advantage on raw material, HR, transportation cost etc. but not based on PLC modelGlobal strategic rivalry theoryIt focus on firms strategic decision to acquire and develop competitive advantage in order to compete internationallyCompany acquire competitive advantage through:Owning intellectual property rightsInvesting in research and developmentAchieving large scale economiesExploiting the experience curvePorters national competitive advantage theoryIt depends upon four factors:Factors conditions ( research, innovation and training)Demand conditionsRelated and supported industriesFirm strategy, structure and rivalry ( quality, design and R&D)