Adam Smiths and David Ricardos Theories of International Trade - Assignment Example

What do you consider to be the major differences between Adam Smith's and David Ricardo's theories of international trade' Adam Smith talks about the absolute advantage that countries enjoy over one another; whereas David Ricardo talks about the comparative advantage in the production of goods over one another. According to Adam Smith's concept absolute advantage is enjoyed in the trade by a country when the country uses fewer resources to produce goods relative to the other country. On the other hand, comparative advantage in the production occurs when one country can produce some goods at lower cost than the other goods. The background of the two dates back to the theory of Mercantilism. According to this economic philosophy each and every country's economic health was measured by the amount of gold and silver that the countries hold. To earn the wealth countries need to trade and maximize the difference in their balance of trade by maximizing exports that is a source of generating revenue and minimize imports that cost it to pay. There were two types of manufacturers; one who were export oriented and others who were domesticated with their products. Export oriented manufacturers favored the mercantilist approach and believed in subsidies, tax rebates etc. to increase their sales to foreign countries. But the domestic manufacturers foresee threats to their produces and wanted tariff quotas and stringent policies to restrict the trade. This mercantilist theory was before Adam Smith's. Then came the theory of absolute advantage; according to Adam Smith countries should export goods in which they have an absolute advantage and import other goods from countries that have absolute advantage in producing them i.e. goods in which they are more productive. Adam Smith's criticism to Mercantilists approach was that it confused the accumulation of treasure with the accumulation of wealth. The gold and silver that the country holds is not the wealth of the country. Wealth of a country according to him is measured by the wealth that the nationals of the country hold. And thus use the term absolute advantage to compare the productivity of people with other people, firms with other firms or between nations. The contemporary of Adam Smith was David Ricardo, who gave the concept of comparative advantage; according to Ricardo if there is no difference in productivity then there is no absolute advantage and hence no trade will take place amongst countries. There are some subtle and slight differences among the absolute and the comparative advantage theories, but it is important to take into account the differences. Firstly, as the term absolute and the comparative in the name themselves suggests that Adam Smith's theory takes absolute measures of productivity to compare and David Ricardo's relative measures to compare the productivity amongst the nations. Therefore if absolute productivity is same then trade should not occur according to Adam Smith but Ricardo suggests that it is important to look at the relative productivity for the trade to occur or not. Adam Smith's trade theory does not incorporate any differences that might arise from the different use of technology or probably the difference in the combination of the labor or capital input used. David Ricardo's model has an inherent assumption and a more practical approach that tells that countries differ in their usage of production technologies such that obviously one country will be more productive in use of its resources than the other. And therefore if both the countries specialize in their production areas then output for both the countries can increase. This increase in output would be because of enhanced productivity even when no more inputs are put into the production process. Then countries can contract between themselves and trade goods that are there specialty i.e. import products in which other country specializes and export in which it has its specialization. Then both countries can benefit from one another. Adam Smith's absolute advantage theory of international trade does not take into consideration that some countries may also simply lack the absolute advantage because they may not have the technology that provides them an edge over another country and cannot therefore compete with other companies in the global market and benefit from any free trade economy. Whereas, David Ricardo's model suggests that technologically deprived or countries weak on this front can compete internationally because of their competencies such as lower wages; thus making it clear that absolute advantage is not the necessary requirement to compete on a global scale. But no matter still Adam Smith's absolute advantage is still required to explain the trade flows between countries as the income and wage levels differ widely among them. And it explains that due to these differentials in wage rates and income levels companies prefer to produce in countries where they find cheap labor and thus also try o outsource there manufacturing t such countries. To conclude the international trade theory of Adam Smith and David Ricardo, we can state simply that a country has a comparative advantage in production when it can produce at lower marginal cost of production. And thus it should specialize in production of goods where it has a comparative advantage over the other. But unless the countries trading with one another has the same cost, they do not need to specialize and can only be advantageous when costs are same. But absolute advantage theory in itself does not suggest whether trade should take place between countries or not. But, it simply would be able to tell whether a certain country is richer than the other or not. Why should the fund management industry welcome the use of hedge funds' Discuss. Hedge funds are funds that are structured like private partnerships where, portfolio manager acts as the general partner and makes the investment decision whereas, investors act as limited partners who only invest in the fund. Unlike mutual funds, hedge fund managers are allowed to use strategies such as short selling i.e. selling of a security that is not owned, arbitraging which in lay man language is profiting from buying and selling a security in different markets because a certain price differential occurs. Hedge funds can also use a hedging process which involves buying and selling on a certain security to offset investment losses and hedge funds can also make use of leverage i.e. borrowing money to for investments. Hedge funds can take both short and long term positions. To make clear what really are hedge funds it is important to note that fund mangers investing in hedge funds does not imply that hedging strategy is used every time. The main purpose of using hedge funds is to reduce the volatility and the risks associated with any downturns or the anticipation of corrections in overheated stock markets. Today, as the investment horizons broaden and investors are faced with more avenues to invest fund managers see aggressive and cut throat competition in getting customers; to offer the investors huge returns to remain competitive. Some key characteristics of hedge funds make them attractive both to fund managers and investors. Firstly, hedge funds can access both financial and non-financial (commodities) market; and also has access to multitude of other sectors in the economy such as energy, currencies and other commodities as told. Secondly, hedge funds are quite flexible in their investment strategies because of available moves such as short selling, arbitrage and leverage. And these hedge funds can make use of variety of financial instruments that are available to minimize risk and increase the returns. Most of the hedge funds today require consistent returns instead preservation of capital rather than increasing magnitude of returns over a period of time. Thus, many benefits can be derived by the fund management industry if they invest in hedge funds; hedge funds strategies mostly generate positive returns in both bullish and bearish equity and bond markets. Hedge funds broaden the options and hence allow diversification of investment areas and allow fund managers to balance the portfolio by reducing the overall portfolio risk and volatility and increase in returns. So far hedge funds have escaped many regulations as it is still loosely regulated vehicle and are generally private investment so many of the rules and regulations are not applicable. Therefore benefits of hedge funds can be summed up in to three i.e. performance, non-correlation and diversification. There are many types of hedge fund from which to choose from and the hedge fund's history dates back to 1949 and over these years they have proved to be quite a safe bet, excepting that it also depends on how savvy the fund manager is himself. There are several classifications of hedge fund. Some are as follows: Aggressive growth hedge funds: These funds invest in equities that are likely to have high earnings per share and are therefore likely to result in high capital gains. The hedge funds benefits by shorting equities that give disappointed earnings result. Distressed securities: This hedge fund buys stocks, bonds or trade claims from companies that are facing deep financial crisis, are in stage of bankruptcy or reorganization. Here, the benefit is derived from foreseeing the potential profit that the business can earn and hence the bright future may result in appreciation of deeply discounted security. Emerging markets: Markets that are highly volatile and face high inflation rates, in these markets investments are made. Fund of funds: The hedge fund of funds is a pool or a mix of different funds. The profitability or high returns results from selecting the right mix and ratio of strategies employed. Income fund: The income hedge fund invests only in fixed income securities and the returns are relatively stable relying on yield rather than solely on capital gains. Short selling: This involves selling securities today which are not owned and buying them at a future date in anticipation of the falling prices probably because securities are today overvalued. Value: These are securities that are selling at deep discount because market has quite undervalued it. Investing in them gives stable and positive returns if these are held in a portfolio for quite a long time. Thus, to conclude we can say that hedge funds are appealing since over the years they have produced dazzling returns. But the most distinguishing characteristic is the stable, consistent and absolute positive returns over the market cycle. Some others also generate high returns owing to leverage. But investing by taking a leveraged position sometimes get risky if the investment declines in value as the cost of borrowing also enhances a part of the loss. But the success of hedge funds far and wide depends on the managerial skills. The market risk and also manager risk need to be considered prior to investing in any of the hedge fund. Lastly, it can be said that investing in hedge funds is not merely a fad but the success has been driven by several forces in the economy and moreover, the positive returns that it generates is the greatest contributor. And a well managed hedge fund delivers pretty decent returns, is tolerant of highly volatile market conditions and lastly, its characteristic that these hedge funds are low in correlation with the bond and the stock market. Hedge funds do not exploit any market inefficiency but generate returns that correspond to taking huge risks. References "International Trade Theories" "The theory of comparative advantage" 22 August 2007 "About Hedge Funds." Magnum Funds. 22 Aug 2007 . "The Benefits of Hedge Fund." (2006) August 22, 2007 Read More