International Trade Theory
and the World Trading System
EVOLUTION OF THE THEORY OF INTERNATIONAL EVOLUTION OF THE THEORY OF INTERNATIONAL TRADE TRADE
Theorists:Theorists:Adam Smith (1776)David Ricardo (1817)Eli Heckscher (1919) / Bertil Ohlin (1933)Wassily Leontif (1953)Raymond Vernon (1966)Paul Krugman and others (1980s & 1990s)Michael Porter (1990)
ABSOLUTE ADVANTAGE - ADAM SMITH
Two countries - Two products
Each country can produce one product more efficiently than the other.
They should specialize and trade.
COMPARATIVE ADVANTAGE - RICARDO
Two countries - Two products
One country can produce both products more efficiently than the other country.
Each should specialize in the product in which it has a RELATIVE advantage and trade for the other product
FACTOR ENDOWMENT - HECKSCHER-OHLIN
Countries are differently endowed with each of the factors of production (LAND, LABOR, CAPITAL; ENTREPRENEURSHIP & TECH)
Countries should specialize in those products that utilize the factors of production with which they are abundantly endowed
FACTOR SUBSTITUTABILITY - LEONTIEF'S PARADOXFACTOR SUBSTITUTABILITY - LEONTIEF'S PARADOX
Countries which have a scarcity of particular factor inputs may be able to compensate by using more abundant inputs.
Technology (and capital) is usually the most effective medium through which this compensation takes place.
For example, India and USA both produce textiles, but India uses its abundant cheap labour while USA uses high technology.
INTERNATIONAL PRODUCT-LIFE CYCLE (IPLC)- RAYMOND VERNON
PRINCIPLE PRINCIPLE
Original innovation of a particular product generally occurs in a country with favorable demand conditions.
Trade and location of production will shift depending on the stage of the PLC.
Countries lead or lag each other in terms of their position on the PLC for a particular product.
INTERNATIONAL PRODUCT-LIFE CYCLE (IPLC) - RAYMOND VERNON
LIMITATIONS OF THE THEORYLIMITATIONS OF THE THEORY
There are too many exceptions to the theory, eg, luxury products, products with very short life cycles, non-traded products.
Product differentiation may keep the production from shifting to the next tier of countries.
Companies with global strategies develop products and services for global markets and set up production in least-cost countries.
The theory did not differentiate between FDI and licensing for a new foreign production site. (This conceptual limitation meant the IPLC did not provide a satisfactory theory for FDI.)
Most theories have attempted to answer the question,
“Why do countries trade?” However, the real question is: “Why do companies trade?”
THEORIES ORIENTED ON FIRMS/INDUSTRIES:
New Trade TheoryNational Competitive Advantage
NEW TRADE THEORY - PAUL KRUGMAN and others
PRINCIPLEPRINCIPLE
First Mover Advantages will create Barriers to Entry (Economies of scale & Experience curve)
Rationale for governments to pursue Strategic Trade Policy (i.e., Some firms in specific industries are favored, nurtured, promoted and protected from international competition.)
(See Strategic Trade.doc.)
NATIONAL COMPETITIVE ADVANTAGE NATIONAL COMPETITIVE ADVANTAGE - - PORTERPORTER
FACTOR ENDOWMENTSBasic (natural resources; climate; location)Advanced (specialized infrastructure; skilled labor; tech.)
DEMAND CONDITIONSNature of home demand (concentrated, sophisticated, demanding home customers push firms to be globally competitive)
RELATED & SUPPORTING INDUSTRIESStrong spill-over effects from related industries create internationally competitive clusters of industries
FIRMS' STRATEGY, STRUCTURE & RIVALRY Organization, management and domestic rivalry of firms in a country. (Vitality of domestic environment prepares firms for international competition)
GOVERNMENT POLICIESGovernment policies on each of the above factors promotes or suppresses ability of domestic firms to compete internationally.
THE POLITICAL ECONOMY OF WORLD TRADEHistory of the free trade movement
origins: end of “mercantilism” in Europe in 17th centurypost WWII: under the auspices of GATT
GATT (GENERAL AGREEMENT ON TARIFFS AND TRADE)created in 19481 of 3 major institutions created to guide the “free world”purpose: multilateral negotiating forum to achieve free trade
GATT championed TRADE LIBERALIZATION and a 16-fold increase in world trade in 50 years.
Mercantilism: exports good, imports bad; to accumulate gold
GATT PRINCIPLES
1. Non-discrimination – MFNMFN - If country A gives country B "most-favored nation”
concessions, must give the same to all member countries.
2. Reciprocity
3. Exceptions to GATT rules:Regional Blocs - EU, NAFTA, etc. - exempt from giving MFN to non-
member countries.Less-developed countries (LDCs) generally did not participate and
were not expected to reciprocate for concessions offered by developed countries.
GATT NEGOTIATIONS
Date name outcome
1947 Geneva tariffs (45000 tariff concessions)1949 Annecy tariffs1950-1 Torquay tariffs1955-6 Geneva tariffs1960-1 Dillon tariffs1964-7 Kennedy 35% tariff reduction; anti-dumping1973-9 Tokyo 34% tariff reduction; NTB codes1986-94 Uruguay complex international business package
URUGUAY round
Initially 15 negotiating groups for new areas, including:tariffs and NTBs*foreign investmentservicesagriculturetextilestropical productsintellectual propertyanti-dumpingcountervailing dutiesetc
* NTB: non-tariff barrier, ie, everything else.
eg, subsidies, quotas, administrative policies
WORLD TRADE ORGANIZATION – WTO
WTO inaugurated on 1/1/1995
Will there be a new “round”?
unresolved issues for the WTO:unfinished business from Uruguay Roundthe environmentlabor standards and human rightsharmonization of domestic policiesregional and bilateral negotiations
GOVERNMENT INTERVENTION IN INTERNATIONAL TRADE
Justification: (generally rejected by classical economists)protecting jobs and industriesnational securityinfant industryvarious political reasons, eg, bargaining toolstrategic trade policy (see Strategic Trade.doc)
What is it? It refers to domestic policies to create new industry to compete internationally.(industrial policy)