International Trade and
International Economics
LECTURE 1
“Trade is always political” Robert Kuttner
“In the absence of a world government, cross
border trade is always subject to rules that
must be politically negotiated among nations
that are sovereign in their own realm but not
outside their borders” Robert Kuttner
Between 1960 to 1995 world trade increased
from a total of $629 billion to more than $5
trillion (both figures in constant 1995 dollars)
Three directions pulling the issue of TRADEreflecting the three main schools of thought in
International Economics
1) a large consensus that a liberal
international trading system is desirable
2)Within that liberal consensus..individual
nation states try to pursue mercantilist
policies of tariff based protectionism for
certain industries.
3)This can result in direct subsidies and
various other forms of direct state aid to
certain activities (structuralist)
Historic progression of ideas related to
Trade
16th-18th Centuries-mercantilismpursuit by European powers of trade
surpluses..a close connection seen
between trading power, military might,
and international prestige.
Exemplified by the Spanish Empire-its
conquest of South America-the pursuit
of Gold and Silver
Adam Smith proposed a distinctly
liberal theory of trade ,in direct reaction
to the abuses of mercantilism.
Generally saw trade as a mechanism to
assist nations in the process of
specialization and exchange
increased global wealth and prosperity
DAVID RICARDO 1772-1823….
Ricardo developed and refined Smith’s views
on International Trade…his work on the LAW
OF COMPARITIVE ADVANTAGE
demonstrated that free trade increased
efficiency and had the potential to make all
better off.
Furthermore demonstrated that even if a
nation possessed an ABSOLUTE advantage
in the production of certain goods, it would
still be better off if it concentrated its efforts
upon the activity in which it possessed the
GREATEST COMPARITIVE ADVANTAGE.
This is because RICARDO introduced the
important concept of OPPORTUNITY COST into
the debate, namely trade should occur because
nations need to consider not only what it costs
them to produce something,but must also
consider WHAT OPPORTUNITY THEY FOREGO
IN PRODUCING THAT PRODUCT.
E.G. Perhaps it is possible for the USA to
produce all it needs…but is it better for it, and
world trade, for it to concentrate upon the
activities at which it has the GREATEST
COMPARITIVE ADVANTAGE.Permitting less
advantaged nations to produce those things in
which they experience the LEAST COMPARITIVE
DISAVANTAGE
However the dominance of LIBERAL attitudes to
FREE TRADE were being challenged as the 19th
Century progressed by Alexander Hamilton and
Friedrich List
Both saw the dominance of the FREE TRADE concept
as being no more than an academic justification for
England to maintain its dominant advantage over its
trading partners.
Hamilton argued that US infant industries and
national independence and security required the
employment of trade protectionist measures.
List similarly argued that in a climate of rising
economic nationalism, protectionist trade policies such
as import tariffs and export subsidies were necessary if
Europe's infant industries were to compete on an equal
footing with the UK
Mercantilists next challenged the assumption that
comparative advantage unconditionally benefits both
parties. .Pointing out that the assumptions of liberal
free trade theory is that the process of the working out
of the consequences of comparative advantage is
DYNAMIC….BUT IN REALITY the shift from one
form of activity to another is often slow and painful,
and may not occur at all.
In fact if one sector of an economy faces collapse due to
foreign competition, then the process of the
reallocation of the unemployed resources is IN
IITSELF enormously costly…thus generating a
further set of costs derived from adherence to pure
free trade.Resources are not as mobile or as flexible as
FREE TRADERS would assume.
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Mercantilists also stress the POLITICS of
TRADE…STATES naturally desire to protect
themselves and their industries from the negative
effects of trade
Farmers for example often appeal to and receive
protection form the rigours of FREE TRADE
they tend to be over –represented in the national
legislatures of the USA, Western Europe,and Japan
Nation states FEAR becoming too dependent upon
other nations for certain goods.
By the turn of the 20th century protectionist trade
policies were on the rise.
This led to the Great Depression of the 1930s…trade
protectionism spiraled upwards, whilst international
trade crashed …causing unprecedented hardship in
both the USA and western Europe.
FACT0R PROPORTIONS THEORY
[Heckscher-Ohlin]
Maximize output …Factor endowment varies
among countries
China has a large pool of unskilled labour
Saudi Arabia has large crude oil reserves
Goods differ according to the types of factors that
are used to produce them
Wheat requires land, clothing requires unskilled
labour
Countries will have a comparative advantage in
producing products that intensively use resources
it has in its advantage.
The Heckscher-Ohlin theory presents the issue that international
and interregional differences in production costs occur because of
the differences in the supply of production factors (Ball,
McCulloch, 1999). Those goods that require a large amount of the
abundant, thus less costly factor will have lower production costs,
enabling them to be sold for less in international markets
(Salvatore, 1995).
Countries such as Australia with relatively large amounts of land
do export land intensive products (eg, grain and cattle) whereas a
country like China would export labour intensive products.
There are exceptions to the Heckscher-Ohlin theory which are
due to the assumptions that Ohlin drew.
One assumption was that the prices of the factor depended only
on the factor endowment. This is however untrue as factor prices
are not set in a perfect market. There are such factors to consider
such as legislated minimum wages and benefits force the cost of
labour to rise to a point greater than the value of the product than
many workers can produce (Ball, McCulloch, 1999).
Country Similarity Theory
Country similarity theory was developed by a Swedish
economist named Steffan Linder
Rests on the concept of “Intra industry trade” is trade
between two countries of goods produced by the same
industry. Intra industry trade accounts for approximately
40 per cent of world trade.
Linder believed that international trade of manufactured
goods occurred between countries at the same stage of
economic development that shared the same consumer
preferences. Therefore the country similarity theory
consists of the value that most trade in manufactured
goods should be between nations with similar per capita
income, and that intra industry trade in manufactured
goods should be common
More recent developments in theoretical
approaches in Economics to International Trade
move away from a COUNTRY BASED approach
and move towards a FIRM BASED approach.
International Product Life Cycle Theory (IPLC)
analyses the effects of product evolution on the
global scale.
Applies to established companies in
industrialised countries who expand their
product range. The theory is broken up into five
major stages
1) Release: As competition in Industrialised countries
tends to be fierce, ‘Manufactures are therefore forced to
search constantly for better ways to satisfy their customer
needs.’ (Ball et al, 1999). The core elements in new product
design are gained from customer feedback from previous
models. Once the product enters the domestic market and
begins to create a positive reputation, the demand
increases and hence we come to an end of the first stage
of the IPLC.
2)Exports: As the product receives positive customer
response, the international demand for the product begins.
The manufacturer begins exporting to increase its market
share. An example of this was the personal computer (PC)
craze of the early 1980’s. In 1985 55,000 PCs were sold in
the United States, by 1984 the industry had experienced a
136-fold increase to 7 million PCs (Richter-Buttery, 1998
3)Foreign Production begins: As demand increases with the new
global market, it becomes economically feasible to begin local
production in various nations. By sharing technology on the
manufacturing of the product, the company has lost an
advantage. The end of this stage signifies the highest point in the
International Product Life Cycle Theory.
4)Foreign Competition in exports markets: This is a threatening
stage for the company. Local manufactures have gained
experience in producing and selling their product, hence their
costs have fallen. As they have saturated their initial market, they
may begin to look elsewhere (i.e.. other nations) to promote their
product. The reason that this is threatening is that this other
nation may have a competitive advantage and this places stress on
the company’s own domestic market share.
5)Import Competition in Home Market: If the competitors have a
competitive advantage, or they reach the economies of scale
needed, they will enter the original home market. At this stage the
competitors will have a quality product which will be able to
undersell the original manufactures. Eventually they will be
pushed out from the market and imports will supply the home
nation. These nations have a competitive edge with their low
labour costs. ‘With future innovations and new products and
services the eventuality is that it’s value and hence its price are
likely to diminish’ (Lendrum, 1995). The IPLC theory does have
its disadvantages. Perhaps the most recognisable is the
assumption that products are released initially in the domestic
markets. Many globalised companies tend to release their new
product lines internationally, not domestically.
MICHAEL PORTER…Originator of the
THEORY OF NATIONAL COMPETITIVE
ADVANTAGE
Michael Porter’s Theory of National Competitive
Advantage/Porter’s Diamond published in 1990
was based on a study of 100 firms in 10
developed nations. Porter develops a new theory
of how nations, states, and regions compete and
their sources of economic prosperity
Porter questions how Switzerland, a nation with
few natural resources, is a world leader in the
production of chocolates, and Japan, a country
whose economy was in shambles after World War
2, is now a global leader in making low cost,
mass-produced, quality, high-technology
products. Porter outlines a number of factors
beyond mere natural resources…
PORTERS “DIAMOND”
FACTORS which MICHAEL PORTER BELIEVED
EXTENDED BEYOND NATURAL ENDOWMENT
INCLUDE….
a sizeable demand from sophisticated
consumers,
an educated and skilled workforce,
intense competition in the industry
the existence of related and supporting
suppliers.
Porter also discusses external influences such as
government and chance Demand Conditions:
Porter argues that companies should be
‘participating in national markets with the
strongest rivals and most demanding customers,
in order to build international competitiveness’
(Yip, 1995).
A company facing a more competitive
environment will strive to make itself more
efficient in order to maximise profits.
Factors of production are nothing more than the
inputs to compete in any industry, such as
Labour, arable land, natural resources, capital,
and infrastructure….these are clearly important
but PORTER now believes they are less vital to
success than before.
Porter suggests that the factors most
important to competitive advantage in
most industries, especially in the
industries most vital to productivity
growth in advanced economies, are not
inherited but are created within a nation,
through processes that differ widely
across nations and among industries.
Firm Strategy, Structure and Rivalry:
A key determinant is the context in which firms
are created, organised and managed as well as
the nature of domestic rivalry. The pattern of
rivalry at home also has a profound role to play
in the process of innovation and the ultimate
prospects for international success (Porter,
1980). A firm strategy & competition in
domestic market shapes its performance in the
international market.
Global Strategic Rivalry Theory was developed in
the 1980s as a means to ‘examine the impact on
trade flows arising from global strategic rivalry
between Multi National Corporations.’ (Mahoney,
et al 1998). It explores the notion that in order to
stay viable, firms should exploit their competitive
advantage globally and try to keep it sustainable.
Investing in research
Owning intellectual property rights
Exploiting previous experience
Achieving economies of scale or scope
A good example of strategic alliance which gave two
companies a competitive advantage, is Qantas and British
Airways.
Qantas had solid air route throughout the Asia Pacific
region, likewise British airways had strong network within
Europe, North Atlantics, and North America. By forming
an alliance in 1993, both companies strategically positioned
themselves to have a strong worldwide network.
This global strategic alliance gave them a competitive
advantage.(Mahoney, et al 1998).
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*THIS LECTURE TOPIC WILL BE COMPLETED
NEXT WEEK (SOME TOPICS TAKE TWO WEEKSHENCE 8 TOPICS in 12 WEEKS…)