International Theories

International Economic Theory

International Trade Theory
Overview
Mercantilism
Absolute Advantage
Comparative Advantage
Competitive -Porter’s Diamond
Product Life Cycle Theory
New Trade Theory

An Overview of Trade Theory
Free Trade occurs when a government does not attempt to influence, through quotas or duties, what its citizens can buy
from another country or what they can produce and sell to another country.
The Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country.

An Overview of Trade Theory
The Pattern of International Trade displays patterns that are easy to understand (Saudi Arabia/oil or Mexico/labor intensive goods). Others are not so easy to understand (Japan and cars).

mercantilism
Mercantilism is a trade theory holding that nations should accumulate financial wealth, usually in the form of gold ( forget things like living standards or human development ) by encouraging exports and discouraging imports

Mercantilism: mid-16th century
A nation’s wealth depends on accumulated treasure
Gold and silver are the currency of trade
Theory says you should have a trade surplus.
Maximize export through subsidies.
Minimize imports through tariffs and quotas
Flaw: restrictions, impaired growth

Theory of absolute advantage
Adam Smith: Wealth of Nations ( 1776) argued:
Capability of one country to produce more of a product with the same amount of input than another country
A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient
Trade between countries is, therefore, beneficial
Assumes there is an absolute balance among nations

Theory of absolute advantage
… destroys the mercantilist idea since there are gains to be had by both countries party to an exchange
… questions the objective of national governments to acquire wealth through restrictive trade policies
… measures a nation’s wealth by the living standards of its people

Theory of comparative advantage
David Ricardo: Principles of Political Economy
Extends free trade argument
Efficiency of resource utilization leads to more productivity
Should import even if country is more efficient in the product’s production than country from which it is buying.
Look to see how much more efficient. If only comparatively efficient, than import.

Theory of comparative advantage
Makes better use of resources
Trade is a positive-sum game

Simple Extensions of the Ricardian Model
Diminishing returns:
More a country produces, at some point, will require more resources.
However:
Free trade can increase a country’s production resources, and
Increase the efficiency of resource utilization.

Examples of National Comparative Advantage
China is a low labor cost production base
India’s Bangalore region offers a critical mass of IT workers
Ireland’s repositioning enabled a sophisticated service economy
Dubai, a previously obscure Emirate, has been transformed into a knowledge-based economy

Limitations of comparative advantage
Driven only by maximization of production and consumption
Only 2 countries engaged in production and consumption of just 2 goods?
What about the transportation costs?
Only resource – labour (that too, non-transferable)
No consideration for ‘learning theory’

Assumptions of Absolute Advantage and Comparative Advantage
Resources fully employed
Countries primarily interested in profit maximization
Two countries, two commodities — not very realistic.
Costs of transportation not considered
Assume that resources can move from one good to another domestically but not free to move internationally

Competitive advantage
Competitive advantage is a position a firm occupies against its competitors.
three methods for creating a sustainable competitive advantage are through
cost leadership,
differentiation
focus
The primary factors of competitive advantage are innovation, reputation and relationships .

Theory of national competitive advantage
The theory attempts to analyze the reasons for a nations success in a particular industry
Porter studied 100 industries in 10 nations
Postulated determinants of competitive advantage of a nation based on four major attributes
Factor endowments
Demand conditions
Related and supporting industries
Firm strategy, structure and rivalry

Success occurs where these attributes exist.
More/greater the attribute, the higher chance of success

Examples of Firm Competitive Advantage
Nokia’s design and technology leadership in telecommunications
Samsung’s leadership in flat-panel TV
Herman Miller’s design leadership
in office furniture
(e.g., Aeron chairs)

Limitations of Early Trade Theories
Do not take into account the cost of international transportation
Tariffs and import restrictions can distort trade flows
Scale economies can bring about additional efficiencies

Limitations of Early Trade Theories
When governments selectively target certain industries for strategic investment, this may cause trade patterns contrary to theoretical explanations
Today, countries can access needed low-cost capital on global markets
Some services do not lend themselves to cross-border trade
full employment

Product life-cycle Theory R. Vernon (1966)
Trade theory holding that a company will begin by exporting its product and later undertake foreign direct investment as the product moves through its lifecycle
As products mature, both location of sales and optimal production changes
Affects the direction and flow of imports and exports

Product life-cycle

Limitations of PLC
There is no set amount of time
No real proof that all products must die
The theory can lead to an over-emphasis on new product releases at the expense of mature products
Individual products

Limitations of PLC
No stress product redesign
Most appropriate for technology-based products
Some products not easily characterized by stages of maturity
Most relevant to products produced through mass production
Globalization and integration of the economy makes this theory less valid

New trade theory
In industries with high fixed costs:
Specialization increases output, and the ability to enhance economies of scale increases
Learning effects are high. These are cost savings that come from ‘learning by doing’

New trade theory - applications
Typically, requires industries with high, fixed costs
World demand will support few competitors
Competitors may emerge because of “ First-mover advantage”
Economies of scale may preclude new entrants
Role of the government becomes significant
Some argue that it generates government intervention and strategic trade policy

Bibliography
www.wikipedia.com
www.google.com
http://ideas.repec.org/p/wop/afpswp/_001.html
http://en.wikipedia.org/wiki/New_Palgrave:_A_Dictionary_of_Economics
http://internationalecon.com/v1.0/ch40/ch40.html
A. O'Sullivan & S.M. Sheffrin (2003). Economics. Principles & Tools .

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YOU

International Theories

by fathima habeeb on Mar 03, 2009

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