International Business - Theories of International Trade

 

Theories of International Trade

International Trade – Introduction:

            International trade refers to the exchange between people or entities in two different countries to boost their economy. An economy which has decided to embark on a program of development is required to extend its productive capacity at a fast rate. For a developing economy, developmental and maintenance imports set limits to the extent of industrialization which can be carried out in a given period. The inflow of foreign goods into the country along with them the flow of technology, the skills, speed and feed of production, the tastes and experiences will have considerable influence on domestic productions, marketing, lifestyles, and standard of living of people. The growth and pattern of international trade accounts for a major part of the international business which depends on the trading environment.

International Trade Strategy:         

            With a proper trade strategy, a business entering into global market can be successful. The selection of right trade strategy has a greater impact on the volume and composition of imports and exports, pattern of investment, direction of development, competitive and cost conditions, and consumption patterns and so on.

            An outward oriented strategy is one in which trade and industrial policies do not discriminate between production for the domestic markets and exports, or between purchase of domestic goods and foreign goods. It is a neutral strategy and is an open policy. An inward oriented strategy is characterized by bias of trade and industrial policies in favor of domestic production as against foreign trade. Protection of domestic countries from foreign competition by trade barriers, restrictions of trade by licensing or quantitative methods are some of the inward oriented strategy.

Barriers to Trade:

            Trade barriers are government induced restrictions on international trade that typically decrease overall economic potency. The countries which follow inward oriented strategy towards foreign trade use several barriers to protect domestic industries from foreign firms which includes tariff and non-tariff barriers.

Tariff barriers: These are traditional barriers that refer to the duties or taxes imposed on internationally traded goods when they cross the national borders. It aims at limiting the inward flow of products from alternative countries to safeguard the country’s own industries by creating products costlier in the country and are transparent.

·       Import tariff: Taxes levied on imports

·       Export tariff: Taxes levied on exports

·       Transit tariff: Taxes levied on goods passing through one country bound for another country

·       Ad valorem: Taxes levied as a percentage of the value of the product or service

·       Specific tariff: Taxes levied on some particular attributes of goods – weigh ad quantity

·       Combined tariff: Combination of specific and Ad valorem tariff

Non-tariff barriers: These are new protectionism measures which are not transparent and are not anchored in laws and government regulations. The developing countries use non-tariff barriers such as import licensing, import quotas, foreign exchange regulations to prevent foreign exchange outflows, whereas the developed countries to protect the domestic industries which have lost international competitiveness such as voluntary export restraint, technical barriers, minimum pricing regulations, price surveillance and so on.

·       Quotas: Numerical limits on the quantity of goods that may be imported into a country during a specified period

·       Administrative barriers: Regulatory control or bureaucratic rules designed to impair the flow of imports into a country

·       Embargoes: Complete ban on trade in one or more products with a particular country

·       Boycott: Blank prohibition on the import of all goods or services imposed by a designated country

·       Licensing: The prospective importers are required obtain a license from the licensing authorities in terms of cost, volume and product

·       Technical standards: Provisions made by governmental agencies in various countries relating to areas such as safety, pollution, technical performance and so on

Theories of International Trade:

• Theory of Mercantilism (1630) – Thomas Mun: This theory suggest that it is in the country’s best interest to maintain a surplus of trade – to export more than what it imports. By doing so, the country can accumulate more wealth and increase its prestige. Mercantilists believed that a country should increase its holdings of gold and silver by promoting exports and discouraging imports.
• Theory of Absolute Advantage (1776) – Adam Smith: According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods traded by other countries. A country has an absolute advantage if it can produce the same quantity of goods more efficiently than any other country.
• Theory of Comparative Advantage (1817) – David Ricardo: This theory holds that a country should specialize in the production and export of a commodity in which it possesses the greatest relative advantage. Ricardo argued that it makes sense for a country to specialize in the production od those goods that it produces efficiently and to buy the goods that it produces less efficiently from other countries.
• Theory of Reciprocal Demand (1844) – John Stuart Mill: This theory suggests that the equilibrium trade terms are decided by the equation of reciprocal demand which encompasses the relative strength and demand for every other’s product in terms of their own product.
• Factor Proportions theory (1919) – Heckscher-Ohlin: According to them, each country should produce and export that commodity which primarily involves the factor of production abundantly available within the particular country. By factors of production they meant land, labor and capital on a basic level and on a more complex level, such factors as management, technological skills and specialized distribution networks.
• Leontiff Paradox (1953): Wasily – Leontiff tested the validity of Heckscher-Ohlin theory based on the US export of labor-intensive goods and outlined that the factor proportions are not homogeneous and they differ along parameters other than relative abundance.
• Product Lifecycle theory (1960s) – Raymond Vernon: The PLC theory seeks to explain how a company will begin by exporting its products and eventually undertake foreign direct investment, as the product moves through its life cycle. This theory looks at the potential export possibility of a product in four discrete stages in its life cycle which includes innovation, growth, maturity and decline.
• Country Similarity theory (1961) – Steffan Linder: This theory proposed that consumers in countries that are in the same or similar stage of development would have similar preferences. Also, this theory states that most trade in manufactured goods will be between countries with similar per capita incomes, and intra industry trade will be common.
• New Trade theory (1970s and 1980s): The new trade theory states that there are gains to be made from specialization and economies of scale, the first movers into any market can create entry barriers to others, and governments may have a role to play in assisting its home-based firms. The theory emphasizes productivity rather than a country’s resources, it is in line with the theory of comparative advantage but at odds with the factor factor endowments model.
• Global Strategic Rivalry Theory(1980s) – Paul Krugman and Kelvin Lancaster: The theory focused on MNCs and their efforts to gain a competitive advantage against other global firms in their industry.
• Diamond theory of national advantage (1990) – Michael Porter: It refers to the factors responsible for maintaining a nation’s competitive advantage. According to Porter, a firm’s competitive advantage stems from factor conditions, demand conditions, strategy and rivalry and related and supporting industries.