Theories and Concepts of International Trade

INTERNATIONAL MARKETING

Section 1-B

Theories and Concepts of International Trade

1.       Theory of Absolute Advantage (Adam Smith)- This exists when one country (country A) has a cost advantage over another country (country B) in the production of one product – (it may be produced using fewer resources (inputs)) while the second country (B) has a cost advantage over the first (A) in producing the second product.

It suggests that a country should:

·         Export goods and services for which it is more productive than other countries.

·         Import goods and services from other countries which are more productive than it is.

Numerical Presentation:

Country	Textile	Rice
A	6	3
B	2	6

Here, numbers are cost of production (resources), by absolute advantage theory, trade can occur between country A & B.

Country A will give up Textile (-1) but specialize in Rice (with 6 resources it can produce 2 rice (6/3).

Country B will give up Rice (-1) and specialize in Textile 3 (6/2).

Presentation: Result of Trading & Specialization

net gains to the world

 

Country	Textile	Rice
A	-1	+2
B	+3	-1
Net gains To the world	+2	+1

    

Note: In this theory, trade is possible and profitable if each country has absolute advantage in production of least one commodity. Trade will not occur if one country has absolute advantage in both products.

2.       Theory of Comparative Advantage ( David Ricardo)- This theory  states that trade can be carried out even if one country has absolute advantage in producing two products. Here the country benefits by specializing in exporting the products in which it has the greatest advantage or a superior (comparative) advantage, and import the products in which its advantage is less.

Country	Textile	Rice	Domestic Exchange Ratio
A	5	15	1:3
B	10	20	1:2

Without Trading:

           Country A could have only produce ⅓ rice for every textile produced (5/15) [1:33=20/15]

           Country B could produce ½ rice for every textile produced (10/20) [2=10/5]

Therefore:

           Country A specializes in textile, while country B specializes in rice. Thru trading, country A export textile and import rice, while country B export rice and import textile.

·         Absolute advantage looks at absolute productivity.

·         Comparative advantage looks at relative productivity. 

However, Smith & Ricardo both agree that trade is neither possible nor profitable when there are equal differences in costs.

3.       Neo Classical Trade Theory- (trade theory of factor proportions). Economists Eli Heckscher & Bertil Ohlin (H.O.) developed  the concept that a country will export goods that are intensive in production in its abundant factors, and import goods intensive in its relatively scarce factor.

Factors of Production – capital, workers.

-          This H.O. theory suggests that a country specializes in the production of goods that it is particularly suited to produce.

-          Countries where capital is abundant & few workers should specialize in capital intensive goods.

-          While countries were workers are abundant and capital is scarce should specialize in labor intensive goods.

4.       Balance of Payments (BOP) – there should be equality (surplus) to payments of a country (imports, bank deposits abroad, etc.) with what it receives.

A deficit results when more payments are made than what it receives. To correct the imbalance investments must be encouraged and intensify the export of goods and services. A favorable BOP would have favorable effect on the economy and strengthen the country’s currency value.

5.       Issue of Protectionism – Protectionism are those pressures on individual governments to protect their local markets from incursion of foreign competition in the guise of trade barriers. Trade Barriers are restrictions on the trading of goods among countries.

Reasons Why are there Trade Barriers:

1.       Infant Industry – to protect a new and developing industry (local).

2.       Industrialization – encouragement to industrialize and build companies (local).

3.       Conservation of Natural Resources – to protect the environment. To encourage wise use and management of valuable natural resources.

4.       National Defense – to help the nation accumulate more crucial materials for the economic and military welfare in the form of stockpiles, or emergency capacity to produce.

5.       Dumping – international price discrimination practice in which an exporting firm deliberately sells merchandise at a lower price in a foreign market than it charges in other markets, specifically & usually in its home market.

2 kinds of Dumping:

a.       Predatory dumping – when the firm discriminately, in favor of some foreign buyers temporarily lowers its price for the purpose of eliminating competitors and later raising its price when the competitor is trounced.

b.      Persistent dumping – dumping that goes on indefinitely.

In other words, if a country feels that its variable costs have already been recovered with sales in the domestic market, then it can afford to sell the products outside the country at a lower price.

6.       Retaliation – a country will impose tariff or any trade barrier if it feels that another country unduly puts tariffs on their products.

Types of Trade Barriers

1.       Tariff – restrictions that are applied explicitly in terms of quantitative restrictions. A tax or duty on imported goods, to protect domestic market or to raise government revenues.

Kinds of Taxes

a.       Specific – a flat charge per physical unit.

b.      Ad Valorem – percentage of the value of the merchandise.

c.       Compound – a combination of both specific and ad valorem

2.       Non-Tariff – restrictions that are applied implicitly, as in stringent standard requirements.

Kinds of non-tariff barriers

a.      Quotas – restrictions on the amount, number of pieces, weight of goods or services within a given period.

2 kinds

1.       Import quota – legal limit on the amount to be imported

2.       Export quota – limit of the amount to be exported.

 

b.      Monetary Barriers – exchange control restrictions.

1.       Blocked Currency – used to improve a difficult balance of payment situation. It is done by refusing to allow importers to exchange their national currency for the seller’s currency.

2.       Differential Exchange Rates – control and discourage importation of goods which the government deems unnecessary. The government requires the importer to pay different amounts of national currency for foreign exchange with which to buy products in different classifications. If the product is deemed necessary the government may simply charge one unit of domestic money for one unit of foreign currency. If the product is deemed unnecessary, the exchange may be 50 units of domestic currency for one unit of foreign currency.

3.       Government approval to secure foreign exchange – The importer requests permission to secure foreign exchange from a government office. This may be in form of an exchange permit which stipulates unfavorable exchange rates to the importer. It may also require that the amount to be exchanged must be deposited in a bank account for a certain period prior to the foreign exchange transaction.

c.       Embargoes – a trade embargo is the refusal to sell to a specific country (political purposes).

d.      Boycotts – the refusal to buy from a certain country.

e.       Customs & Administrative Entry Procedures:

1.       Valuation System – officials enforce valuation process on improved goods usually higher than local goods.

2.       Anti-Dumping Practices – to value imported goods higher so that they will be sold higher than local goods.

3.       Tariff Classification – imported goods are classified in such that they may fall into a high-tariff category.

4.       Documentation Requirements – unnecessary papers or documents that may be required to make importation difficult.

5.       Fees – fees are charged for different services that will surely boost the price of imported goods.

6.       Standards – standards to protect the health and safety of consumers, and ensure product quality.

7.       Government Participation in Trade:

^ Procurement Policies – the government patronizes local products instead of imported

   ones.

^ Countervailing Duties – the government taxes imported goods which have been given

   exporting subsidies by their respective countries. To protect locally produced goods.

^ Export Subsidies – the government provides export incentives and credits to 

   exporters.

^ Domestic Assistance Programs – the government assist domestic firms so that their

   products may become more competitive against imported ones.