International Trade Concepts & Theory

International trade is the exchange of capital, goods, and services

across international borders. In most countries, such trade
represents a significant share of gross domestic product (GDP).
While international trade has been present through the earliest of
civilizations, its economic, social, and political significance has
risen onl in recent centuries.
!he phenomenon of economic development has had a ma"or
impact on the international trade sstem. Increasing international
trade is crucial to the continuance of globalization. Without
international trade, nations #ould be limited to the goods and
services produced #ithin their o#n borders onl.
The Basis of International Trade
!he basis of all trade is economic.
$n a#areness of the underling economic theor of international
business is a necessar basis for consideration of national policies
and this guides the international mar%eter in framing strategies for
operation in foreign mar%ets.
!hree main areas of theoretical analsis relate to&
'. Welfare Economics #hich explains the gains achieved
from international trade through the concept of comparative
and absolute cost advantage.
(. Monetary Equilibrium and International Balance of
Payments.
). Pricin Mechanism through #hich prices of factors of
production are established in international mar%ets.
'
Bac!round of Trade
!rading of goods and services has its roots in the ver earliest
commercial living experiences of man, #ho fulfilled his needs
through a *arter +stem.
!oda, the individual #orld citizen has access to goods and
services of the #orld, in return he exchanges monies that he has
received for goods and services, #hich he has provided.
This process is achie"ed throuh the #lobal Mar!et
mechanism.
The Mar!et $ystem
In a mar%et sstem, the price serves as a primar variable in
regulating suppl and demand and aiding in resource allocation.
!heoreticall, the mar%et is an automatic, competitive and a self-
regulating mechanism #hich provides for maximum consumer
#elfare and #hich regulates the use of factors of production.
If artificial barriers do not exist, then size of the mar%et, and cost
and speed of communication are the onl limiting factors to
mar%eting in the #orld.
!he emergent #orld econom in #hich #e live toda not onl
brings us into a ne# #orld situation of global competition, but
brings significant advantages both to the mar%eter and consumer,
for mutual advantage.
(
%llocation of &esources
!here are essentiall onl t#o methods of allocating goods and
services and establishing prices . the free mar%et mechanism, or
that guided b central planning.
/entral planning does not provide an acceptable alternative to the
efficienc of free mar%et mechanism, as political expedienc or the
"udgment of government officials get substituted for the
impersonal, efficient process of the mar%et place.
International Trade and Economic Well Bein
!he basis of International !rade can be traced bac% to
mercantilism' first advocated b $dam +mith (Wealth of 0ations)
in '112, #herein it #as explained that unrestricted free trade is
beneficial to a countr.
(ree Trade #as defined as a situation #here a government does
not attempt to influence, through artificial barriers, #hat its
citizens can bu from another countr, or #hat the can produce
and sell to another countr. /harles 3ill.
*enefits of International trade are obtained through speciali)ation.
/ateora.
$ll nations are in differing stages of process of development on
account of diversit of economic resources caused b climatic and
geological conditions. 4n account of this diversit, individual
nations tend to specialize in the production of some goods.
)
$peciali)ation
When t#o nations can produce a greater amount of goods and
services b specialization than individuall, then there is a specific
increase in productivit, and #ith free trade, goods #ill
beneficiall move from one countr to another, and there is an
increase in real income of both countries.
Business $tratey
!he fundamental aim of business strateg is to create and sustain
competiti"e ad"antae even in International mar%ets. 5ohansson

6or the International /ompan, there ma be a situation of
% country*specific ad"antae or
% firm*specific ad"antae
Which #ere explained b the mercantilists in terms of the !heor
of 7elative $dvantage.
%bsolute Cost ad"antae ($dvocated b $dam +mith)
When a good can be produced more cheapl in one countr than in
another, the first is said to have an absolute cost advantage.
4n account of specialization, output of both countries #ill increase
and there #ill be net gains both for the consumers and the
producers.
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Comparati"e Cost %d"antae
!he principle of comparative advantage applies #hen one countr
can produce both goods, or all goods more cheapl than another.
David 7icardo offered this vie# in '9'1 (Principles of Political
:conom) to sa that a countr should specialize in the production
of those goods that it can produce most efficientl and bu those
goods from other countries that it produces less efficientl.
6or International trade to ta%e place, a fe# conditions must be
fulfilled, in addition to the existence of demand.
'. !he production gains should be greater than the cost of
trading and shipping.
(. !here must be a sufficientl effective mar%et information
net#or% to ma%e traders a#are of this cost differential.
). !he differential must be sufficient to interest an entrepreneur
in trading.
8. !axes or tariffs must not exist or must not exceed the cost
differential.
;. 0o other governmental or financial restrictions should inhibit
trading in those products.
!he 7icardian <odel, although based on efficienc of production
achieved through division of labor onl, has successfull explained
gro#th of international trade.
+imitations
&esource immobility, 7esources do not move easil from
one economic activit to another.
-iminishin returns, !he theor assumes constant returns
to specialization.
;
In fact, diminishing returns occur to specialization #hen more
resources #ill be re=uired to produce each additional unit.
Firstly, because not all resources are of the same =ualit.
Secondly, different goods use different resources in different
proportions.
Diminishing returns to specialization suggest that the gains from
specialization are li%el to be exhausted before specialization is
complete.

-ynamic effects and Economic #ro.th
/omparative advantages en"oed b different countries and their
patterns of specialization undergo a continuous change due to
/hanges in factor suppl.
7apid technological developments.
Progress of scientific research, innovation and its application.
!his gives rise to a situation of -ynamic Comparati"e
%d"antae.
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/ec!scher*0hlin Theory '>'> ? '>))
!he theor suggests that comparative advantage occurs because of
differences in national factor endo#ments. !he more abundant a
factor, the lo#er the costs.
The +eontief Parado1 ('>;)) refutes the endo#ment theor on
the grounds that several countries, although possessing abundant
factors, sho#ed different patterns of trade.
$ccording to this stud, @+$ possessing excessive capital and
technolog, should have exported more capital-intensive goods,
#as, in fact, importing more of such goods.
The Product +ife*Cycle Theory 7amond Aernon-'>2Bs
$s products reach a maturit stage in advanced countries, #here
innovation too% place, the tend to get produced b countries
#here the #ere previousl exported.
/osts of production are lo#er in these countries, and a reverse flo#
of such products ta%es place.
$s cost pressures continue, production becomes concentrated in
lo#-cost developing countries, #here the product is sub"ected to
et another PC/.
Consequence
$dvanced countries, #hich start innovation and export products
initiall, become net importers of the same products, thus
facilitating a continuous flo# of trade.
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E"aluation of P+C Theory
!he theor has a correct explanation of migration of mature
industries into lo#-cost assembl locations. *ut reverse movement
of goods comes into conflict #ith the Aernon hpothesis.
In fact, multinational companies might engage in production in
more than one location, and this phenomenon is still best explained
b the !heor of /omparative /ost $dvantage.
The 2e. Trade Theory :merged in '>1Bs
!he assumption of diminishing returns to specialization #as
=uestioned, and a number of economists explain that industries, in
fact, experience increasin returns of speciali)ation.
Economies of $cale and inno"ation represent one particularl
important source of increasing returns.
0e# !rade !heor also argues that the #orld mar%et ma be able
to support onl a limited number of firms based in a limited
number of countries in order to enable these firms to realize
significant economies of scale.
e.g. the aerospace industr and oil exploration and refining.
Implications of the 2e. Trade Theory
$ countr ma predominate in the export of a good on account of
(irst*mo"er ad"antaes #hich are the economic and strategic
advantages that accrue to first entrants' as a result of the learnin
effects.
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!hese advantages are the result of innovation and
entrepreneurship, but are vulnerable to government intervention
and strategic trade polic, #hich is at variance #ith the polic of
free trade being advocated at global level.
2ational Competiti"e %d"antae Porter3s -iamond
Porter explained in '>>B that firms that succeed in international
competition are most li%el to be successful in international
mar%ets.
+uccess in international competition is a function of the combined
impact of factor endo#ments, domestic demand conditions, related
and supporting industries, and domestic rivalr.
$ll four components should be present to impact competitive
performance positivel.
/ountries #ould export products #here all four components are
positive, and import those products #here these components are
not positive.
%ll Theories explain patterns f International !rade in some #a,
but in man respects the tend to complement each other.
7icardoDs comparative /ost $dvantage model is still a dominant
explanation of International !rade, and has not been replaced full.
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