International Trade

International Trade

 

 

            This paper is about international trade. It discusses the statement “International trade is really, at best, a zero-sum game. For every winner, there is a loser. It is not so much about creating growth in developing economies as it is about finding ever cheaper products for consumers in the developed economies.” Using different theories on international trade, as well as different examples, it criticizes the said statement. Explanations for the said judgments are also given for further evaluation of the statement. As an introductory, the reader is given a background on international trade and the theories related to it. Then the discussion on the statement is presented with examples to apply the theories behind it. As a concluding part, the topic is wrapped up as to the final judgment regarding the said statement.  

International Trade: An Introduction

            The pure theory of international trade encompasses the determinants of trade and its consequences, the ways of controlling it together with its consequences, and the interaction between international trade and other real aspects of the economy. What is the reason why country A exports good X while country B exports good Y?

            According to the Ricardian Theory, trade is attributed to the differences in the countries’ ability to produce different goods. One produced one good relatively cheaply, while the other another good. These differences arise from the differences in labor productivity. This theory is also known as the classical theory of trade, the earliest and the simplest of all trade theories.

            Another neo-classical theory is the Heckscher-Ohlin theory. It explains countries’ differing abilities in different goods with reference to the differences in their endowments of their factors of production. It justifies some of Ricardo’s point. This theory remains to be the dominant mode of thought within the theories of international trade and underlies much normative analysis.

            The last one is the so-called modern trade theory. It reemphasizes technology on one side; while on the other side, it stresses the role of product differentiation in international trade. The latter is a new, and apparently fruitful, area of research that integrates imperfect competition into international trade theory. It explains the ‘intra-industry’ trade, which is the simultaneous act of importing and exporting (at the same time) of countries, of very similar goods. The explanation for this type of phenomenon is impossible for the earlier trade theories, since they depend only on costs differences of production to be able to generate trade.

International Trade Theory of David Ricardo

Absolute and Comparative Costs: The Principle of Absolute Advantage

            The seed of the modern theory of international trade comes from Adam Smith. His concern lies on the division of labor as a way to enhance efficiency. This is where he is well known to and he further generalizes this to the specialization between trades and between countries.   

            Thus countries trade, and should trade, in order to acquire their consumption more cheaply. They buy where prices are lower compared to their place. This is due to the fact that prices are considered as immediate determinant of trade.

            Another argument relating to international trade that Smith claims is the idea that international trade allows greater specialization and division of labor through market extension. Therefore, it presents possibilities for additional gains through the reduction of costs below their autarky levels. Trade can increase the economic welfare of both countries involved. Thus, not only can absolute advantage describe international trade patterns, it also provides the rationale to prescribe their implementation as a means of raising economic welfare.

            Take this example to further explain the principle of absolute advantage. Britain was the least-cost producer of cloth while America is the least-cost producer of food. Britain will export cloth, because he can gain from it due to its low cost of production. On the other hand, he will import food, because producing it will cost him more than importing it. Same is true with America. Nevertheless, if both goods are produced more efficiently in Britain, applying the principle of absolute advantage suggests that both goods be purchased from Britain. However, this is not applicable in the long-term. Therefore, Ricardo proposes the law of comparative advantage to address this type of situation.   

The Principle of Comparative Advantage

            This theory explains why it can beneficial for two countries to trade, even if one of them is capable of producing both goods more efficiently. What matters for this principle is not the absolute cost of production. Instead, it is focused on the ratio between how easily the two countries can produce different kinds of things.

            To illustrate its difference from absolute advantage, take this situation as an example. In Portugal, production of both wine and cloth is possible, compared with England that requires greater work. However, the two countries have different relative costs of production for the two goods. In England, it is very hard to produce wine while it is moderately difficult for the production of cloth. In Portugal, both productions are easy. Therefore, while it is cheaper to produce cloth in Portugal than in England, it is cheaper still to for Portugal to produce excess wine, and trade that for English cloth. Conversely, England will benefit from this trade because it can now get wine at closer to the cost of cloth, with its cost of production for cloth unchanged. In simpler terms, country A exports the good for which its input requirements are relatively lower compared with those of country B.

            In conclusion, international trade takes place because some goods are produced more cheaply abroad compared at home. Ricardo’s model explains this pattern of trade through the relation of prices to certain features essential to the economies concerned. However, this requires several assumptions. First, there is only one factor of production, and that is labor. Second, its productivity differs between countries. Third, labor is perfectly mobile between industries within a country but perfectly immobile between countries. Fourth, there are constant returns to scale in each industry. Lastly, there are no impediments to trade, such as tariffs, etc.

Extension of Ricardo’s Theory

            While Ricardo expressed his theory in terms of the labor theory of value, Haberler re-expressed his theory in terms of opportunity costs. The opportunity cost of good X is the amount of good Y that has to be surrendered in order to obtain a unit of X. In Ricardo’s theory, the transformation occurs by shifting labor from one industry to the other, so opportunity costs are naturally defined in terms of relative labor productivities. The same concept applies to cases involving several factors of production. If the opportunity costs were constant, the whole of the above theory would follow as is. We have just treated the labor requirements as being part of the bundles of factors, with lower requirements indicating greater efficiency.    

            While the Ricardian theory is a supply theory of international trade, its differences in supply conditions that give rise to the possibilities of trade. Trade also occurs even when, demand conditions are identical across countries. In any case, the analysis may be completed without the assumption of identical demand without any fundamental differences.

The Heckscher-Ohlin Theory of Factor Endowments

            Heckscher and Ohlin asked why productivities differed across countries. They also wondered why the possibilities of transformation differed. According to Ricardo, it is due to the differences in technology. Still, they argue that the ability of the countries varies with their endowments of the different factors of production. Provided with demand patterns that do not differ much between countries, the Heckscher-Ohlin theory of trade states that countries will export the goods whose production is relatively intensive in the factors with which they are well endowed.

            In this approach, it stresses the role of factor endowments. There are seven assumptions to be taken in this approach. First is that consumption should be determined by identical and homothetic preferences. Second is that technology is the same across countries. These first two assumptions separate endowments as the cause of trade. On the other hand, the next two restrict the technology in important respects. They are: (3) the exhibition of constant returns to scale but diminishing marginal returns to any single factor, of the production functions for each good; and (4) the difference in the requirements of different factor inputs for the said goods. If one good requires more labor compared to the other at one set of factor prices, the same applies to all sets of factor prices. This situation is better known as the exclusion of ‘factor-intensity reversals’. It allows a clear identification of labor-intensive product.

            The other two assumptions describe economic behaviour. They are: (5) the presence of perfect competition in all factor and product markets; and (6) the lack of impediments to trade, such as tariffs, etc., although there is no possibility for the migration of the production factors. Lastly, the final assumption that there are only just two factors, two goods and two countries, imposes world restrictions. In addition, there should also be homogeneity between the factors within the countries, identical between them, as well as fixed in supply.      

            The first two assumptions are necessary in answering the question regarding the appearance of the ‘factor-endowment-related’ trade. The next three, on the other hand are among the critical ones. The fifth assumption ensures the equality of prices and costs, as well as of consumption prices and marginal utilities. The technical identification of the labor-intensive good is allowed through the fourth assumption. The third assumption, on the other hand, centers on the translation of price signals into quantity changes. The absence of this assumption would not necessarily invert the trade pattern, although it would make it impossible to prove the constant dominance of the H-O result.

The Modern Trade Theory

            This theory primarily hinge around technology. It also considers the effect of the economies of scale and degree of monopoly to the patterns of trade. The explanation of the ‘intra-industry’ trade is also possible because of this theory. Although this theory returns to the basic approach of Ricardo, it pays more attention to the determining factors of technology. The changing technology is the one that determines trade, that is why a move from equilibrium to disequilibrium theories is necessary for this discussion.

            In conclusion, technological differences and changes can provide us further explanation regarding the international trade in manufactured goods. While goods are relatively young, we expect them to be exported by the innovating country. Subsequently trade may end, as knowledge is diffused, or reversed, as factor endowments replaced knowledge being the principal trade determinant. The fact that one innovation frequently leads to another, means that innovations tend to originate in just a few countries. However, changes in relative dynamism can occur, like the case of Western Europe and Japan. There are at least two channels through which research and development is translated into export advantage. Yet, it is not clear which of the two is dominant over the other. Neither does it give a clear explanation why some countries are more dynamic than others do. Therefore, we are not yet in the proper position to develop a more formal model of technology similar to the Heckscher-Ohlin Theory.

Trade as a Positive-Sum Game

            Trade between economies is not like sports competition. A sports contest is described as a zero-sum game. By that definition, if one competitor does better, its opponents are doing worse. However, because specialization is allowed in trade, each nation can concentrate making the products it produces relatively well (absolute advantage). Trade therefore, simultaneously makes all nations better off. To conclude this statement, trade really is a positive-sum game.

            Take the case of Nike and Reebok. These two companies are almost purely rivals that are selling the same products. Only a small fraction of Nike’s sales is to Reebok workers, and vice versa. So one’s success tends to be at the expense of the other. However, for the major industrial countries, despite the fact that they sell products that compete with each other, they are also each other’s main export markets and main suppliers of useful imports. A successful European or Japanese economy helps the US by providing us with larger markets.

            In addition to that, the purpose of international trade is not to export. Instead, it is to import, and this makes trade useful for us. What a country really gains from trade is its ability to import the things it wants. Exports are not an objective in and of themselves. The need to export implies a burden that a country must bear. This is due to the fact that import suppliers are crass enough to demand payment from the other party.

            Trade patterns influence a number of factors. Among them are: (1) employment in high-wage manufacturing jobs; (2) growth trends relative to one’s productivity; (3) employment shares in the service sector; and (4) the overall wage levels.

           Applying that, international trade again, is not a zero-sum game. When productivity rises in Japan, the main result is a rise in the Japanese real wages. American or European wages are in principle at least as likely to rise as to fall, and in practice seem to be virtually unaffected.

            It would be possible to belabor the point. However, it is clear that while competitive problems could arise in principle, as a practical, empirical matter the major nations of the world are not in economic competition with each other, to any significant degree. It is normal to have rivalry for status and power, as countries that grow faster will see their political rank rise. Nevertheless, asserting that the growth in Japan diminishes the status of the US is very different from saying that it reduces the standard of living in the US. It is the latter that rhetoric competitiveness asserts.

 

 

 

                    
 

 

 

Credit:ivythesis.typepad.com