MODULE 3

MODULE 3:

MODULE 3

International Trade Theories:

International Trade Theories Mercantilism Theory of Absolute Cost Advantage Comparative Cost Advantage Theory Relative Factor Endowments/ Heckscher – Ohlin Theory Product Life Cycle Theory Porter’s National Comparative Advantage New Trade Theory

Mercantilism:

Mercantilism This is an old 16th century economic philosophy that attempted to explain how countries may become prosperous and strong . Country’s wealth is measured by its holdings of gold & silver (reserves of modern era) Country’s goal should be to enlarge those holdings To do this a country should maximize difference between its exports & imports A country should then promote exports & discourage imports - if exports are more than imports foreigners have to pay the difference in gold & silver

Slide 4:

• Today’s “unfavorable balance of trade” when exports of any country are less than its exports, is the extension of the same idea • With larger holdings of gold and silver kings could have more wealth – and hence could afford larger armies to expand kingdoms • This approach would make exporters happy and domestic manufacturers of export products would also be happy as their businesses grow.

Theory of Absolute Cost Advantage:

Theory of Absolute Cost Advantage This theory was forwarded in 1776 by Adam Smith . It advocates free trade among world countries to maximize citizens’ wealth • Free trade enables a country to expand the amount of goods and services available to it by specializing in production of some goods and services and trading of others

A country can have certain advantages over other countries :

A country can have certain advantages over other countries – Natural advantage: climatic conditions, natural resources, abundant cheap labor-force etc – Acquired advantage: development of product or process, skills development etc • A country should export those goods & services for which it is more productive than others • Import those goods & services for which other countries are more productive

What if a country has absolute advantage in all products?:

What if a country has absolute advantage in all products? Large countries like USA and China can have absolute advantages in manufacturing many types of products. Extent of value addition and profits on various products vary . Some types of products allow better return on resources deployed than others products.

Theory of Absolute Cost Advantage:

Theory of Absolute Cost Advantage Pen 6 Audio Tape Recorder 20 2 60 Output per one day of Labour India Japan

Theory of Comparative Advantage:

Theory of Comparative Advantage Forwarded in early 19th century, the theory of Comparative Advantage resolves the above issue. A country should produce and export such products where it has comparatively more advantage and hence can earn better margins.

Salient features of this theory are in the following;:

Salient features of this theory are in the following; A country should produce & export those goods & services for which it is relatively more productive than other countries • Implement concept of opportunity cost (what a country gives up to get / produce a certain good) in determining which goods a country should produce

Slide 11:

Assume that Ghana is more efficient in the production of both Cocoa and Rice i.e absolute advantage from it’s 200 units it can produce 20 tons Cocoa and no Rice or 15 tons of Rice and no Cocoa or any combinations between these two that is PPP(Purchasing Power Parity)

The Heckscher-Ohlin Theory :

The Heckscher -Ohlin Theory Definition: A nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant and cheap factor and import the commodity whose production requires the intensive use of the nation’s relatively scare and expensive factor.

Slide 13:

The Heckscher -Ohlin theory predicts that countries will export those goods that make intensive use of factors of production that are locally abundant, while importing goods that make intensive use of factors that are locally scarce ..

Slide 14:

Thus, it focuses on differences in relative factor endowments rather than differences in relative productivity. When we look at US agricultural exports (abundant fertile land), Icelandic and Norwegian fish exports (coastal waters climates conducive to good fish), Canadian lumber exports (plentiful forests with few people), Saudi oil exports,and South African gold exports, the Heckscher -Ohlin theory seems to make sense .

The Leontief Paradox:

The Leontief Paradox In 1953 Wassilly Leontief (Winner of noble prize in economics in 1975) conducted various empirical tests which raised the question about the validity of H-O theory. Using this theory Leontief postulated that since USA would be exporter of capital intensive goods & importer of labour intensive goods to his surprise he found that, USA exports less capital intensive goods than labour intensive goods than it imports. This result has been known as Leontief Paradox.

The New Trade Theory:

The New Trade Theory It emerged in 1970’s Economies of scale is the basic component as per this theory. This theory argues that if output required to release significant scale of economies represents as substantial preposition of total world’s demand for that product. Eg . The aerospace industry currently dominated by two firms Boeing and Air Bus .

Slide 17:

NO one knows that why Leontief Paradox occurs. One possible explanation is that the USA has special advantage of producing new products made with innovative technology.

International Product Life - Cycle Theory:

International Product Life - Cycle Theory This theory attempts to explain the impact of a product’s life-cycle stage on flow of its trade (where a product would be manufactured and where it would be in demand ) According to this theory shifts in manufacturing and trade flow of a product goes through four phases whichare in the following;

1. New product stage: :

1. New product stage: A product will be initially produced & sold mostly in the country in which it is developed (nearby observed need & market ). For most advanced and technology products these will initially be conceptualized in developed countries and sold in these markets

2. Growth stage::

2. Growth stage: At the next stage, the market for the successful product would start to rapidly grow. In this stage the product would be produced in the innovating and other industrial countries – and sold in many industrial countries

3. Mature stage::

3. Mature stage: Reaching the maturity stage market for a product would become competitive and buyer would become experienced . As the result margins on the product would decline and competitive pressured would require the manufacturers to seek lower production costs. At this stage production of the products shifts from industrialized countries to countries where costs are lower – the innovating country may stop producing &start importing

4. Decline stage::

4. Decline stage: At this stage demand for the product declines, especially in advanced countries, as other more effective technologies and products are introduced. At this stage production and market of the product is mainly in less developed countries

5. Exceptions::

5. Exceptions: There are however, exceptions to the impact of the life-cycle on a product’s manufacturing locations and trade . Products with very short product-lifecycles, luxury products where cost are less important , products requiring specialized skills, strategic products of a country, differentiated products (i.e., differentiated on country of origin, such as hand made Italian leather fashion products ) will experience less, if any, impact of a life-cycle stage.