INTERNATIONAL TRADE
Case: Sri Lankan Trade
• Since independence Sri Lanka has looked to
international trade policy as a means of helping to
solve such problems as:
a) shortage of foreign exchange
b) overdependence on one product and one
market
c) insufficient growth of output and employment
• Import Substitution & Strategic Trade Policy
• Development of exports of nontraditional Products
• Identifying the most likely competitive Industries
• Manufacturing has grown as a portion of total
Exports
I - INTRODUCTION
• Trade theory focuses on three basic questions:
a) What products to import and export?
b) How much to trade?, and
c) With whom to trade?
• Some theories explain trade patterns that exist in the
absence of governmental interference, and some
theories explain what governmental actions should
strive for in trade.
II - TRADE THEORY AND
GOVERNMENT POLICY
A - Mercantilism: mid-16th century, principal assertion
was that gold and silver were the mainstays of
national wealth and essential to vigorous commerce.
Main tenant: it was in a country’s best interest to
maintain a trade surplus, a country would increase its
national wealth and prestige
Autarky
Trade was viewed as a zero-sum-game
David-Hume
Neo-Mercantilism
B – Absolute Advantage: a country has an absolute
advantage in the production of a product when it is
more efficient than any other country in producing it.
Countries should specialize in the production of
goods for which they have an absolute advantage and
then trade these goods for goods produced by other
countries.
Basic Argument: you should never produce goods
at home that you can buy at lower cost form other
countries.
trade
Absolute advantage – exists potential for gains in
Adam Smith’s 1776 “An Inquiry Into the Wealth
of Nations.” Introduced the concept of specialization
Trade is not a zero-sum game situation
1. Natural Advantage: a country may have a natural
advantage in producing a product because of climatic
conditions, access to a certain natural resources, or
availability of an abundant labour force
2. Acquired Advantage: industrial policy
C – Comparative Advantage: In his 1817 book
“Principles of Political Economy”, David Ricardo says
that it makes sense for a country to specialize in the
production of those goods that it produces most
efficiently and to buy the goods that it produces less
efficiently from other countries, even if it could produce
them more efficiently itself.
In other words, nations should produce those goods for
which they have the greatest relative advantage
According to David Ricardo potential world production
is greater with unrestricted free trade than it is with
restricted trade.
Consumers in all countries can consume more if there
are no restrictions to trade.
Differences in labour productivity between nations
underlie the notion of comparative advantage
C.1. Simple Extensions of the Ricardian Model:
Diminishing Returns to Specialization: not all resources
are of the same quality, draw upon marginal resources
whose productivity is not as great as those initially
employed
Dynamic Effect and Economic Growth: Free trade might
increase a country’s stock of resources, free trade
might also increase the efficiency with which a country
utilizes its resources
Dynamic gains in both the stock of a country’s
resources and the efficiency with which resources are
utilized will cause a country’s Production Possibility
Frontiers (PPF) to shift outwards
C.2. Theory of Country Size: larger countries are
more self-sufficient
C.3. Transportation Costs: make it more likely that
small countries will trade internationally
C.4. Scale Economies: countries with large
economies and high per capita income are more
likely to produce goods that use technologies
requiring long production runs.
C.4. Scale Economies: countries with large
economies and high per capita income are more
likely to produce goods that use technologies
requiring long production runs.
D – Heckscher-Ohlin Theory
Two swedish economists put forward a different
explanation of comparative advantage: they argued
that comparative advantage arises from differences in
national factor endowments.
Different nations have different factor endowments and
different factor endowments explain differences in
factor costs. The more abundant a factor, the lower its
cost.
This H-Ohlin theory predicts that countries will export
those goods that make intensive use of those factors
that are locally abundant, while importing goods that
make intensive use of factors that are locally scarce
The Leontief Paradox: U.S. produces and exports
technology intensive
educated labor.
products
that
require
highly
D – Product Life Cycle: Raymond Vernon proposed the
PLC in the early 1960s. Raymond argued that the size
and the wealthy market gave American companies a
strong motivation to develop innovative consumer
goods.
As the market in the US and other more developed
countries matures, the products becomes more
standardized, and price becomes the main competitive
factor.
Further along, the U.S. switches from being an exporter
of the product to an importer of the product as
production becomes concentrated in lower cost foreign
locations.
Ex: cellular phones
PLC weakness
E – The New Trade Theory:
First Mover Advantages: the theory suggests that a
country may predominate in the export of a good simply
because it was lucky enough to have one or more firms
among the first to produce that good.
This theory generates an argument for government
intervention, industrial policy, and strategic trade policy
F
–
National Competitive
Diamond Model
Advantage:
Porter’s
Why a nation achieves international success in a
particular industry?
Porter’s thesis is that four broad attributes of a nation
shape the environment in which local firms compete,
and these attributes promote or impede the creation of
competitive advantage.
a)
Factor
Endowments:
skilled
labour,
infrastructure, technology, etc. Advanced factors
are the most significant for competitive
advantage.
b) Demand Conditions: home demand provides
the
impetus
for
upgrading
competitive
advantage. A nation’s firm gain competitive
advantage if their domestic consumers are
sophisticated and demanding.
c) Related and Supporting Industries: Presence
of suppliers or related industries that are
internationally supportive. Successful industries
within a country ten to be grouped into clusters
of related industries.
d) Firm Strategy, Structure, and Rivalry:
Different nations are characterized by different
management ideologies; there is a strong
association between vigorous domestic rivalry
and the creation and persistence of competitive
advantage in an industry.
e)
Government:
Business
should
urge
government to increase its investment in
education, infrastructure, and basic research and
to adopt policies that promote strong
competition within domestic markets.
G - Country Similarity Theory: observations of actual
trade patterns reveal that most of world’s trade
occurs among countries that have similar
characteristics. Thus, overall trade patterns seem
to be at variance with the traditional theories
that emphasize country-by-country differences.
H - Pairs of Trading Relationships: How do you
explain specific pairs of trade relationships?
¤ transport costs (natural traders)
¤ Cultural Similarity
¤ Historic Ties
¤ Political Relationships and Economic
Agreements
I - Independence, Interdependence, and
Dependence
J – Trade Strategies Among Emerging
Countries
- Outward-Led-Growth Strategies
- Import Substitution Industrialization
K – Why Companies Trade Internationally?