trade theories, absolute, comparative, mercantilism,

1. International Trade and
Investment:
International trade theory
Muhammad Shafiq
forshaf@gmail.com
http://www.slideshare.net/forshaf

2. Indian economy

3. International Trade Theories
• Mercantilism
• Absolute Advantage
• Comparative Advantage

4. Mercantilism
• Countries should export more than they
import
• Theory was famous during 1500 to 1800
• Emphasis on benefit rather than
disadvantageous foreing trade
• Concept of Balance of payment

5. Balance of payment

6. Absolute advantage
• Developed by Adam Smith “ different
countries produce some goods more
efficiently than other countries: hence,
global efficiency can increase through free
trade
• Citizen should purchase those goods
which are cheaper rather than local
• Concept of free trade

7. Absolute advantage…
• Smith says that if trade were unrestricted
– Labor become more skilled by repetition
– Labor would not waste time in switching job
– Long production would provide incentive and
development of more effective working
methods

8. Absolute advantage…
Advantage could either natural or equired
Natural considers climate and natural
resources:
Sri Lanka, Bangladesh, Pakistan
Acquired advantages considers technology
and skill development;
Denmark silver tableware
Japan Steel, Jamaica Ice

9. Comparative advantage
theory(CAT)
• Advancement of Adam Smith Theory
absolute advantage by David Ricardo in
1817.
• Gain from trade will occur even in a
country that has absolute advantages in
all products because the county must
give-up less efficient output to produce
more efficient output.
• Based on specialization

10. CAT:An analogical example
• Example of best doctor in town who is
best known for his administrative work
• country must concentrates it recources on
producing the commodities it can produce
most efficiently

11. CAT: production possibility
example
• Tea & wheat

12. The Principle of Comparative
Advantage: Ricardo
Before Specialization (labor hours / unit)
Timber Wheat Total
Western WA 25 40 65
Eastern WA 30 25 55
(units) 2 2 120
After Specialization (labor hours / unit) Total Savings
Western WA 50 0 50 15
Eastern WA 0 50 50 5
(units) 2 2 100 20
Consequences:
1. Trade powerfully shapes local production systems
2. Specialization lowers total production costs
3. And large markets allow exploitation of scale economies: “the division of
labor is governed by the size of the market” – Adam Smith 1776

13. But, Transport Costs are Crucial in
Determining if Trade will Occur
Before Specialization (labor hours / unit)
Timber Wheat Total
Western WA 25 40 65
Eastern WA 30 25 55
(units) 2 2 120
After Specialization (labor hours / unit) +
Transport Costs
Total Savings
Western WA 55 0 55 10
Eastern WA 0 53 53 2
(units) 2 2 108 12
Trade Feasible in this Case

14. But, Transport Costs are Crucial in
Determining if Trade will Occur
Trade Not Feasible in this Case
Before Specialization (labor hours / unit)
Timber Wheat Total
Western WA 25 40 65
Eastern WA 30 25 55
(units) 2 2 120
After Specialization (labor hours / unit) +
Transport Costs
Total Savings
Western WA 65 0 65 0
Eastern WA 0 55 55 0
(units) 2 2 120 0
Long-run reduction in transport costs has promoted more trade

15. CAT: Assumptions & Limitation
• Full employment
• Economic efficiency objective
• Division of gain
• Two countries, two commodities
• Transport costs
• Mobility
• services

16. Theory of country size
• ToAA and TCA do not deal with country
-by-country differences in how much and
what products will be traded through
specialization.
• Difference are there

17. Differences country by country
• Variety of resources
• Transport costs
• Size of economy and production scales

18. Factor proportion theory
Heckscher theory
• Factors in relative abundance are cheaper
than factors in relative scarcity
• Srilanka, Netherland, and Hong Kong
• Three important characteristics:
– Land-labor relationship
– Labor capital relationship
– Technological complexity

19. The product life cycle theory of trade
Remond Vernon
• The production location for many products
moves from one country to another
depending on the stage in the product’s
life cycle
– Stage 1: Introduction
• Innovation, production, and sales in same country
• Location and importance of technology
• Export and labor
– Stage 2 :Growth Stage 3: Maturity
– Stage 4: Decline
• Verification and limitation of PLC theory

20. Country similarity theory
• Most trade theories emphasize differences
among countries in climate, factor
endowment, and innovative capability
• Different type of similarities:
– Economic similarity of industrial countries
– Similarity of location
– Cultural similarity
– Similarity of political and economic interest

21. Strategic Trade policy
• Countries seek to improve their trade
capabilities by:
– Altering condition for industries in gnernal
– Targeting condition for a specific industry

22. Why companies trade internationally
• The porter diamond
Firm strategy
structure and rivalry
Demand condition
Factor condition
Related and
supporting industries

23. Points and limitations of the
porter diamond
• Most trade theories are based on national
perspective, but decision to trade are
usually made by companies

24. Companies role in trade
• Strategic advantages of exports
• Use of excess capacity
• Cost reduction
• Greater profitability
• Risk spreading
• Strategic advantages of import
• Cheaper supplies
• Additions to product line
• Reduction of risk of no supply

25. Porter’s “Diamond”
Factor Conditions – human, physical,
capital, knowledge-based,
infrastructure
Demand Conditions
Supporting Industries
Firm Strategy, Structure
And Competition –
The importance of
Agglomerations/clusters

26. Porter’s Traded Clusters
Video
Recorded Product
Entertainment Equipment
Entertainment related services
Entertainment venues
Distribution & wholesaling
Marketing & promotion
Related attractions
News syndicates
Audio & video equipment
? Nontraded
Entertainment?

27. Typical Cluster Representation
Source: A.J. Scott, Regional Studies, Vol. 36, no. 9, p. 966

28. Typical Cluster Flow Chart
Musicians
Live
Performances
For audiences
Recording
No
Audience
Equipment: Purchase, rental, repair, manufacture
Replaying music
AM/FM/TV
Web
Muzak
Mobile DJ’s
Training
& Education
• Venues
• Performance/Recording Support
• Business Support
• Composers
Distribution of recordings:
CD’s
Tapes/files for broadcast
Film scores
Games, Ring-tones
Music Heritage Organizations
Royalties &
Licensing
Presenters/Producing Orgs.
From Beyers, Bonds & Wenzl study of
Seattle Music Industry

29. International Trade and Investment
• Explaining the theoretical basis for
international trade and factor flows, including
comparative and competitive advantage
• Understanding trade barriers (tariffs)
• Examining the dynamics of FDI
• Understanding the financing of international
trade
• To appreciate trade organizations such as
GATT and WTO

30. International Trade
The huge national differences in factor endowments;
Long-term shift from barter to money trade
Should be in
constant $
Clear shift towards
more production of
higher value goods