Theories of International Trade Mgmt.pptx

Theories of International Trade

1. Theories of International Trade

2. Theories of International Trade Mercantalism Theory of Absolute Cost Advantage – by Adam Smith Comparative Cost Advantage Theory – by David Ricardo Factor Endowment Theory – by Heckscher – Ohlin Country Similarity Theory – by Steffan Linder Product Life Cycle Theory – by Ramond Vernon Nation’s Competitive Advantage Theory – by Michael Porter

3. Mercantalism This theory specifies that Holding of country’s treasure primarily in gold constituted its wealth Countries should export more than they import & Receives the value of trade surplus in the form of gold from those countries which experience trade deficits Govt. imposed restrictions on imports & encouraged exports to get trade surplus. E.g. Colonial powers like UK with India, Srilanka etc It is a Zero Sum game. One party gains & other loses Criticism: Decay of gold standard reduced validity of this theory Wealth of a nation is based on its available goods & services rather than gold It restricts international trade

4. Theory of Absolute Cost Advantage As per Adam Smith Free trade among countries increase a country’s wealth Theory based on division of labour Countries to specialize in production of those goods where they have cost advantage over other countries & Exchange these products with other products produced cheaply by other countries Skilled labour & specialization Advantage : Countries have absolute cost advantage due to Suitability of labour skill It leads to higher productivity Economies of scale would further reduce costs

5. Theory of Absolute Cost Advantage Natural Advantage : Countries do have natural advantage due to : Climatic conditions, natural resources – soil, minerals, rivers Acquired Advantage : Countries acquire advantages through technology & skill development. E.g. Japan , Taiwan Assumptions of the Theory : Trade is between two countries Only two commodities are traded Free trade exists between the countries The only element of cost of production is labour

6. Theory of Absolute Cost Advantage Criticism : No Absolute Advantage : In reality most developing countries have no absolute cost advantage in a product & yet they participate in international trade Country size : It doesn’t deal with country by country differences in specialization Variety of Resources : This theory deals in labour resource only Transport cost : It plays great part in international trade. But ignored Scale Economies : Large scale economies reduce cost & become part of absolute advantage. But ignored by theory Absolute advantage for many products : Some countries may have absolute advantage in many products. But ignored in theory

7. Comparative Cost Advantage Theory David Ricardo’s Assumptions : There exists full employment Labour is only element of cost of production There are no trade barriers Trade takes place between two countries Only two products are traded There are no costs of transport It states that a country should produce & export those products for which it is relatively more productive than other countries. Import those goods for which other countries are more productive It is based on relative productivity differences & incorporates the concept of opportunity cost

8. Comparative Cost Advantage Theory Criticism: Two Countries: Transport cost Two products Full Employment Division of gains Mobility: Free movement of resources internationally Services

9. Factor Endowments Theory Heckscher -Ohlin Factor endowments are land, capital, natural resources, labour , climate etc Factor Endowments vary among countries If labour is available in abundance then cost of labour will be low compared to price of land & capital. Vice versa in countries in countries where labour is in short supply Relative factor costs will lead countries to produce at low cost Countries have comparative advantage based on the factors endowed Countries acquire comparative advantage in those products where factors endowed by countries are used as inputs Therefore countries export those products in which they have comparative advantage due to factors endowed Import other products which they can produce at high cost

10. Factor Endowments Theory Heckscher -Ohlin Land – labour relationship : e.g. countries where land available is less compared to labour , go for multi storied factories & light weight products - Hongkong , Agro products in Australia, India Labour – Capital relationship : e.g. countries where labour is abundant compared to capital export labour intensive products & vice-versa Leontief Paradox : USA Technological complexities: Technological advancements make it possible to produce in different methods. E.g. Agro These are countries based theories rather than firm based.

11. Country Similarity Theory International trade also takes place within each industry between 2 countries E.g. Toyota & BMW Economic similarities of developed countries that are same stage of economic development provide scope for intra-industry trade among countries. E.g. India – China Motorcycles Companies develop new products for domestic market, export surplus products to those countries at similar level of development Most part of global trade takes place among developed countries However developing countries don’t trade among themselves Similarity of location: Countries export to neighbouring countries to take advantage of less transport cost Cultural similarity: Countries prefer to export to countries having similar culture. E.g. SAARC Similarity of political & economic interests: e.g. India – Russia.

12. Product Life Cycle Theory - Raymond Vernon This theory explains the variations & reasons for change in production & consumption patterns among various markets over a time period Stages of International Product Life Cycle 1. New product Introduction : New inventions happen in developed countries due to high R&D Costs Since price is higher in initial stage firms market it in other developed countries 2. Growth : As demand increases, there is increased competition in developed markets, the firm establishes production in developed countries 3.Maturity : At this stage product becomes standard. Due to economies of scale reduction in cost of production. Producers start locating plants in developing countries to take advantage of lower labour costs 4. Decline : At this stage Mfrs concentrate on less developed countries as market. Customers in developed countries shift their demand to further new products. Exports decline & original country may become net importer

13. National Competitive Advantage Theory - Michael Porter ( Porter Diamond) Competitive Advantages : Theory concentrates on firm’s home country environment as the main source of competencies & innovation. Study concludes that competitive superiority is derived from 4 factors: Factor Conditions : It refers to how well endowed a nation is in resources – created or inherited like human, capital, natural, physical, technological infrastructure Demand conditions : Sophistication of demand conditions in the domestic market & pressure from domestic buyers makes firm to upgrade its products. Related & supporting industries : Availability & quality of local suppliers & related industries, site of development of clusters are critical for competitiveness of a firm. The cost-efficiency, quality & speedy delivery of inputs influence firm’s competitiveness Firm strategy, Structure & Rivalry : Extent of corporate investment, type of strategy & local rivalry. Differences in management styles, organization skills, create advantage in industries. Intensity of domestic rivalry affects firm’s competitiveness.

14. Porter’s Diamond Govt Chance

15. Porter’s Diamond on I.T. industry Govt. No intervention, Lobbying for IT Chance Y2K,Covid

16. Porter’s Diamond in Pharmaceutical Industry. Govt. Price control, Patents exemption, Incentives Chance Covid

17. External factors Chance : Occurrences that are beyond control of firms, industries & govt are termed as chance. E.g. War, innovations, major technological breakthroughs Govt.: Role in formulating policies related to trade, foreign exchange, infrastructure, labour , etc