Theories of International Trade

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Theories of International Trade

• AG BM 338
• Agribusiness in the Global Economy

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LEARNING OBJECTIVES

• After todays class, you should be able to
• Understand classical theories of international
  trade
• Understand modern theories of international trade
• Draw implications for action

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Trade Balance

• trade deficit - An economic condition in which a
  nation imports more than it exports
• trade surplus - An economic condition
• in which a nation exports more than it imports
• balance of trade - The aggregation of buying
  (importing) and selling (exporting) by both sides
  leads to the country-level trade surplus or
  deficit.

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Trade Theories

• classical trade theories - major theories
  typically studied consist of mercantilism,
  absolute advantage, and comparative advantage
• modern trade theories - major theories typically
  studied consist of product life cycle, strategic
  trade, and national competitive advantage

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The Age of Mercantilism

• Between 1600 and 1800 most of Western Europe
  pursued a policy of mercantilism
• What was mercantilism?
• Belief that exports should exceed imports
• Bullionism the belief that the economic health
  of a nation was measured by the amount of
  precious metals (gold and silver) it possessed
• Colonialism colonies were viewed as sources of
  raw materials
• Heavy government control of trade, with the
  goals of trade being the goals of governments

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Absolute Advantage

• Producing a good with fewer inputs (capital,
  labor, land, raw materials, etc.) per unit of
  output than other countries
• If input prices are the same in two countries,
  the country with an absolute advantage in a good
  will have a lower unit cost of production for
  that good
• Adam Smith, The Wealth of Nations, 1776
• A country should produce and export products in
  which it has an absolute advantage
• A country should import products in which it has
  an absolute disadvantage

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Absolute Advantage Problems

• What about a country (like the U.S.) that has an
  absolute advantage in most products?
• How can it possibly produce enough of everything
  to satisfy the whole world?
• As production increased, competition for scarce
  inputs would drive up production costs, taking
  away many absolute advantages
• What about a country (like Nepal) that has an
  absolute disadvantage in nearly all products?
• Why should its resources sit around unused?
• As production fell, prices of inputs would fall,
  lowering production costs and creating some
  absolute advantages

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Comparative Advantage

• Producing a good at a lower opportunity cost
  than another country
• Inputs used in the production of one good arent
  available for the production of other goods
• When a country produces a good, what does it
  give up in foregone production of other goods?
• David Ricardo, The Principles of Political
  Economy and Taxation, 1817
• A country should produce and export products in
  which it has a comparative advantage
• A country should import products in which it has
  an comparative disadvantage

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Opportunity Cost

• opportunity cost - the cost of pursuing one
  activity in terms of the foregone return on the
  next-best alternative activity
• Examples
• The opportunity cost of going to college is what
  you could have earned working full-time instead
• The opportunity cost of using a plant to
  manufacture one product is what the company could
  have earned manufacturing another product at the
  plant instead

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Numerical Example

• One input (labor)
• Two goods (corn, timber)
• Two countries (A, B)
• Which country has an absolute advantage in
• Corn production?
• Timber production?
• Which country has a comparative advantage in
• Corn production?
• Timber production?

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More on Comparative Advantage

• Even a country at an absolute disadvantage in
  everything will have a comparative advantage in
  something
• Each country specializes in the production and
  export of what it does relatively well
• Prices of goods and inputs in a free-market
  economy will adjust in order to lead to this
  outcome

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More on Comparative Advantage

• Countries rely on imports to meet consumer
  demands for goods in which they dont have a
  comparative advantage
• A country can achieve consumption levels beyond
  what it could achieve on its own
• Government policy can alter free-market outcomes
  (import tariffs, import quotas, export subsidies,
  etc.)

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Some Definitions

• factor endowments - extent to which different
  countries possess various factors, such as labor,
  land, and technology
• resource mobility - assumption that a resource
• removed from one industry can be moved to another

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Factor Proportions (Heckscher-Ohlin) Trade Theory

• A country that is relatively abundant in a
  factor of production should export goods that use
  a lot of that factor in the production process,
  and import other goods
• Example a country like China with a lot of
  labor should export labor-intensive goods
• Why? If a factor is relatively abundant, it will
  be relatively cheap, and a country will be more
  globally competitive in products that use a lot
  of that factor

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Modern Trade Theories

• product life cycle theory - economic theory that
  accounts for changes in the patterns of trade
  over time
• strategic trade theory - theory that suggests
  that
• strategic intervention by governments in certain
  industries can enhance their odds for
  international success
• first-mover advantages - Advantages that first
  entrants enjoy and do not share with late
  entrants
• strategic trade policy - Economic policies that
  provide companies a strategic advantage through
  government
• subsidies

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Modern Trade Theories

• Theory of national competitive advantage of
  industries (or diamond theory)
• The theory that the competitive advantage of
  certain industries in different nations depends
  on four aspects that form a diamond
• Competitive advantage is created by technological
  and institutional change, not just inherited from
  a countrys natural endowments

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IN-CLASS EXERCISE

• In groups of 3-5 people
• Come up with three examples of imported foods
  eaten by people in your group
• Are there alternatives sources for these foods
  either domestically produced or from different
  countries than the ones you purchase from?
• If so, what factors influence your purchase
  decisions?
• Present your findings to the class