In this essay we will discuss about International Trade. After reading this essay you will learn about: 1. Introduction to Theories of International Trade 2.
Theory of Mercantilism of International Trade 3. Theory of Absolute Advantage 4. Theory of Comparative Advantage 5. Factor Endowment Theory 6. Country Similarity Theory 7. New Trade Theory 8. The exchange of goods across national borders is termed as international trade. Countries differ widely in terms of the products and services traded.
Countries rarely follow the trade structure of other nations; rather they evolve their own product portfolios and trade patterns for exports and imports. Besides, nations have marked differences in their vulnerabilities to the upheavals in exogenous factors.
Mercantilism Theory of International Trade
Trade is crucial for the very survival of countries that have limited resources, such as Singapore or Hong Kong presently a province of China , or countries that have skewed resources, such as those located in the Caribbean and West Asian regions. However, for countries with diversified resources, such as India, the US, China, and the UK, engagement in trade necessitates a logical basis. The trade patterns of a country are not a static phenomenon; rather these are dynamic in nature.
Moreover, the product profile and trade partners of a country do change over a period of time. Till recently, the Belgian city of Antwerp, the undisputed leader in diamond polishing and trade, had witnessed a shift of diamond business to India and other Asian countries, as given in Exhibit 2. It is also imperative for international business managers to find answers to some basic issues, such as why do nations trade with each other?
Trade theories also offer an insight, both descriptive and prescriptive, into the potential product portfolio and trade patterns.
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They also facilitate in understanding the basic reasons behind the evolution of a country as a supply base or market for specific products. The principles of the regulatory frameworks of national governments and international organizations are also influenced to a varying extent by these basic economic theories. The theory of mercantilism attributes and measures the wealth of a nation by the size of its accumulated treasures. Accumulated wealth is traditionally measured in terms of gold, as earlier gold and silver were considered the currency of international trade.
Nations should accumulate financial wealth in the form of gold by encouraging exports and discouraging imports. Between the sixteenth and nineteenth centuries, European colonial powers actively pursued international trade to increase their treasury of goods, which were in turn invested to build a powerful army and infrastructure.
Mercantilist theory of international trade pdf file
The colonial powers primarily engaged in international trade for the benefit of their respective mother countries, which treated their colonies as exploitable resources. The first ship of the East India Company arrived at the port of Surat in to carry out trade with India and take advantage of its rich resources of spices, cotton, finest muslin cloth, etc. Other European nations—such as Germany, France, Portugal, Spain, Italy—and the East Asian nation of Japan also actively set up colonies to exploit the natural and human resources.
Mercantilism was implemented by active government interventions, which focused on maintaining trade surplus and expansion of colonization.
National governments imposed restrictions on imports through tariffs and quotas and promoted exports by subsidizing production. The colonies served as cheap sources for primary commodities, such as raw cotton, grains, spices, herbs and medicinal plants, tea, coffee, and fruits, both for consumption and also as raw material for industries.
Thus, the policy of mercantilism greatly assisted and benefited the colonial powers in accumulating wealth. Under this theory, accumulation of wealth takes place at the cost of another trading partner.
Thus, international trade becomes a zero-sum game. An influx of gold by way of more exports than imports by a country raises the domestic prices, leading to increase in export prices. In turn, the county would lose its competitive edge in terms of price. On the other hand, the loss of gold by the importing countries would lead to a decrease in their domestic price levels, which would boost their exports. Presently, gold represents only a minor proportion of national foreign exchange reserves.
Governments use these reserves to intervene in foreign exchange markets and to influence exchange rates.
If all countries follow restrictive policies that promote exports and restrict imports and create several trade barriers in the process, it would ultimately result in a highly restrictive environment for international trade. Mercantilist policies were used by colonial powers as a means of exploitation, whereby they charged higher prices from their colonial markets for their finished industrial goods and bought raw materials at much lower costs from their colonies.
Colonial powers restricted developmental activities in their colonies to a minimum infrastructure base that would support international trade for their own interests. Thus, the colonies remained poor. A number of national governments still seem to cling to the mercantilist theory, and exports rather than imports are actively promoted. This strategy was guided by their keenness to contain imports and promote domestic production even at the cost of efficiency and higher production costs.
It has resulted in the creation of a large number of export promotion organizations that look after the promotion of exports from the country.
However, import promotion agencies are not common in most nations. Presently, the terminology used under this trade theory is neo-mercantilism, which aims at creating favourable trade balance and has been employed by a number of countries to create trade surplus.
Japan is a fine example of a country that tried to equate political power with economic power and economic power with trade surplus. Economist Adam Smith critically evaluated mercantilist trade policies in his seminal book An Inquiry into the Nature and Causes of the Wealth of Nations, first published in Smith posited that the wealth of a nation does not lie in building huge stockpiles of gold and silver in its treasury, but the real wealth of a nation is measured by the level of improvement in the quality of living of its citizens, as reflected by the per capita income.
Essay on Theories of International Trade
Smith emphasized productivity and advocated free trade as a means of increasing global efficiency. An absolute advantage refers to the ability of a country to produce a good more efficiently and cost-effectively than any other country. It is the maxim of every prudent master of a family, never to make at home what it will cost him more to make than to buy.
The taylor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a taylor. The farmer attempts to make neither one nor the other, but employs those different artificers. All of them find it for their interest to employ their whole industry in a way which they have some advantage over their neighbors. What is prudence in the conduct of every private family can scarce be folly in that of great kingdom.
If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry. Thus, instead of producing all products, each country should specialize in producing those goods that it can produce more efficiently.
Long product runs to provide incentives to develop more effective work methods over a period of time.
Examples of mercantilism
Therefore, a country should use increased production to export and acquire more goods by way of imports, which would in turn improve the living standards of its people. For instance, the agro-climatic condition in India is an important factor for sizeable export of agro-produce, such as spices, cotton, tea, and mangoes.
The production of wheat and maize in the US, petroleum in Saudi Arabia, citrus fruits in Israel, lumber in Canada, and aluminium ore in Jamaica are all illustrations of natural advantages.
Today, international trade is shifting from traditional agro-products to industrial products and services, especially in developing countries like India.
The acquired advantage in either a product or its process technology plays an important role in creating such a shift. The ability to differentiate or produce a different product is termed as an advantage in product technology, while the ability to produce a homogeneous product more efficiently is termed as an advantage in process technology.
Production of consumer electronics and automobiles in Japan, software in India, watches in Switzerland, and shipbuilding in South Korea may be attributed to acquired advantage.
To illustrate the concept of absolute advantage, an example of two countries may be taken, such as the UK and India. Let us assume that both the countries have the same amount of resources, say units, such as land, labour, capital, etc.
However, the production efficiency is assumed to vary between the countries because to produce a tonne of tea, UK requires 10 units of resources whereas India requires only 5 units of resources. On the other hand, for producing one tonne of rice, UK requires only 4 units of resources whereas India needs 10 units of resources Table 2.
Since India requires lower resources compared to UK for producing tea, it is relatively more efficient in tea production. On the other hand, since UK requires fewer resources compared to India for producing rice, it is relatively more efficient in producing rice. Although each country is assumed to possess equal resources, the production possibilities for each country would vary, depending upon their production efficiency and utilization of available resources.
The value of a factor of production forgone for its alternate use is termed as opportunity cost.
For instance, if the UK wishes to produce one tonne of tea, it has to forgo the production of 2. Whereas in order to produce one unit of rice, it has to relinquish the production of only 0.
Suppose no foreign trade takes place between the two countries and each employs its resources equally i. The UK would produce 5 tonnes of tea and This would result in a total output of 15 tonnes of tea and If both India and the UK employ their resources on production of only tea and rice, respectively, in which each of them has absolute advantage, the total output, as depicted in Fig.
Thus, both countries can mutually gain from trading, as the total output is enhanced Table 2. Therefore, the government should not intervene in the economic life of a nation or in its trade relations among nations, in the form of tariffs or other trade restrictions, which would be counterproductive. A market would reach to an efficient end by itself without any government intervention.
Unlike as suggested by the mercantilist theory, trading is not a zero-sum game under the theory of absolute advantage, wherein a nation can gain only if a trading partner loses. Instead, the countries involved in free trade would mutually benefit as a result of efficient allocation of their resources. In Principles of Political Economy and Taxation, David Ricardo promulgated the theory of comparative advantage, wherein a country benefits from international trade even if it is less efficient than other nations in the production of two commodities.
Comparative advantage may be defined as the inability of a nation to produce a good more efficiently than other nations, but its ability to produce that good more efficiently compared to the other good.
Thus, the country may be at an absolute disadvantage with respect to both the commodities but the absolute disadvantage is lower in one commodity than another. Therefore, a country should specialize in the production and export of a commodity in which the absolute disadvantage is less than that of another commodity or in other words, the country has got a comparative advantage in terms of more production efficiency.
To illustrate the concept, let us assume a situation where the UK requires 10 units of resources for producing one tonne of tea and 5 units for one tonne of rice whereas India requires 5 units of resources for producing one tonne of tea and 4 units for one tonne of rice Table 2.
In this case, India is more efficient in producing both tea and rice. Thus, India has absolute advantage in the production of both the products. Although the UK does not have an absolute advantage in any of these commodities it has comparative advantage in the production of rice as it can produce rice more efficiently.
Countries also gain from trade by employing their resources for the production of goods in which they are relatively more efficient. Assuming total resource availability of units with each country, Fig.