International trade policy of india

1. MODERN THEORIES
OF INTERNATIONAL
TRADE
Toolika Singh (63)

2. Theories
 Gravity Model
 New Trade Theory(Paul Krugman)
 The Competitive Advantage (Michael
Porter’s Model)

3. Gravity Model
 The gravity model estimates the pattern of international trade. While the
model’s basic form consists of factors that have more to do with geography
and spatiality, the gravity model has been used to test hypotheses rooted in
purer economic theories of trade as well. One such theory predicts that trade
will be based on relative factor abundances. One of the common relative
factor abundance models is the Heckscher-Ohlin model.
 This theory would predict that trade patterns would be based on
relative factor abundance. Those countries with a relative abundance of
one factor would be expected to produce goods that require a relatively large
amount of that factor in their production. While a generally accepted theory
of trade, comparative advantage has suffered empirical problems.
Investigations into real world trading patterns have produced a number of
results that do not match the expectations of comparative advantage
theories.
 Notably, a study by Wassily Leontief found that the United States, the most
capital endowed country in the world, actually exports more in labor intensive
industries. Comparative advantage in factor endowments would suggest the
opposite would occur. Other theories of trade and explanations for this
relationship were proposed in order to explain the discrepancy between
Leontief’s empirical findings and economic theory. The problem has
become known as the Leontief paradox.

4. Germany As Example Of The
Gravity Model Of Trade
 5 out of 10 in both categories are euro area
countries, namely 4 of the 5 euro area
countries that borders Germany, namely
France, the Netherlands, Austria and Belgium.
The fifth euro area country that borders
Germany, Luxembourg, isn't included because
of its small size, while Italy is with even though
it doesn't border Germany because of its large
size.
 4 non-euro area countries, China, the U.K., the
U.S. and Switzerland is also in both categories.
In the first three cases that reflects the large
sixe of these economies (though Britain is also
relatively close geographically as well), while in
the case of Switzerland it reflects that it borders
Germany.
 In short, Germany's trade is mainly with
countries that are geographically close or
whose economies are relatively large, or
both in the case of France and to a lesser
extent also Britain and Italy.
This is consistent with what one could call

5. Paul Krugman`s New Trade
Theory
 New trade theory (NTT) is a collection of economic
models in international trade which focuses on the
role of increasing returns to scale and network
effects, which were developed in the late 1970s and
early 1980s.
 New trade theorists relaxed the assumption of
constant returns to scale, and some argue that using
protectionist measures to build up a huge industrial
base in certain industries will then allow those
sectors to dominate the world market.
 Less quantitative forms of a similar "infant industry"
argument against totally free trade have been

6. Application of the Theory
 New trade theory has been used by
governments as the logic for supporting infant
industries. For example Demark, with a high
dependency on imported energy, targeted
wind power as an industry to support. By 2000
the country`s wind turbine firms had captured
60% of the world market estimated at 3 billion
a year.

7. The Theory`s Impact
 The models developed were highly technical, and predicted the
possibilities of national specialization-by-industry observed in
the industrial world (movies in Hollywood, watches
in Switzerland, etc.). The story of path-dependent industrial
concentrations can sometime lead to monopolistic
competition or even situations of oligopoly.
 Some economists, such as Ha-Joon Chang, had argued that
free trade would have prevented the development of the
Japanese auto industries in the 1950s, when quotas and
regulations prevented import competition. Japanese companies
were encouraged to import foreign production technology but
were required to produce 90% of parts domestically within five
years. It is said that the short-term hardship of Japanese
consumers (who were unable to buy the superior vehicles
produced by the world market) was more than compensated for
by the long-term benefits to producers, who gained time to out-
compete their international rivals.

8. Porter's Diamond of National
Advantage
 Michael E. Porter argued that a nation can create new
advanced factor endowments such as skilled labor, a strong
technology and knowledge base, government support, and
culture. Porter used a diamond shaped diagram as the basis of
a framework to illustrate the determinants of national
advantage. This diamond represents the national playing field
that countries establish for their industries.
 The individual points on the diamond and the diamond as a
whole affect four ingredients that lead to a national comparative
advantage. These ingredients are:
 the availability of resources and skills,
 information that firms use to decide which opportunities to
pursue with those resources and skills,
 the goals of individuals in companies,
 the pressure on companies to innovate and invest.

9. The role of government in the model is to:
Encourage companies to raise their performance, for example by enforcing strict
product standards.
Stimulate early demand for advanced products.
Focus on specialized factor creation.
Stimulate local rivalry by limiting direct cooperation and enforcing antitrust
Government's Role

10. Application to the Japanese Fax
Machine Industry
 The Japanese facsimile industry illustrates the diamond
of national advantage. Japanese firms achieved
dominance is this industry for the following reasons:
 Japanese factor conditions: Japan has a relatively high
number of electrical engineers per capita.
 Japanese demand conditions: The Japanese market was
very demanding because of the written language.
 Large number of related and supporting industries with good
technology, for example, good miniaturized components
since there is less space in Japan.
 Domestic rivalry in the Japanese fax machine industry
pushed innovation and resulted in rapid cost reductions.
 Government support - NTT (the state-owned telecom
company) changed its cumbersome approval requirements
for each installation to a more general type approval.

11. Thank You