International Trade Theories - Case Study Example

International Trade Theories Trade barriers have either blurred or fallen through as a result of national policies. Regionalism has begun to be seen as strength for negotiating with more power. All over the world a new order has come to prevail in economic terms and that is promotion of regional economic powers through what is known as Free Trade Areas (FTA). With expansion of trade between several countries these agreements involved more countries and this was the birth of FTA. They are the new drivers of growth and development.  They make use of country comparative advantages, encourage specialisation and division of labour, expand the size of export markets, and promote efficiency and competitive environment within the region. Efficiency results in competitiveness and improves performances. This in turn increases customers and creates more jobs. Inefficient firms close down or are merged into efficient firms who look for enhancing capacities. This also results in temporary loss of jobs, but jobs are quickly re-created by expanding efficient firms. This report will therefore seek to determine whether India as a country is in need for regional alignments for competitive advantage and to leverage this to overcome the global recession. The Nature of FTA It is often easier to understand a problem if it is viewed objectively and compared to another external environment that has already faced a similar situation. Reference should be drawn from the European Union. The oldest FTA was the former European Economic Community (EEC) that was formed by six nations, Belgium, France, Germany, Italy, Luxembourg, and the Netherlands. The intention was to form a designated group of countries that agreed to eliminate tariffs and restrictions on most goods traded between themselves to promote greater economic benefit. When others realized the benefits of this association, they too joined and the EEC expanded and became an economic bloc that negotiated uniformly as one unit with other nations to set quotas and preferences for the benefit of EEC members. It has now expanded to become the European Union (EU) with more things in common besides free trade between its members. The EEC became a Custom Union when its members opted to have a common external policy towards non member nations. But by1990 it took another giant step by becoming a Common Market when it allowed free movement of labour and capital between its members. Now it is working towards becoming a Monetary Union by having a common currency, the Euro. It is also becoming a Political Union by working towards having common laws for its member states. The result is there for all to see. Per capita incomes and GDP are rising in all member states, more jobs are being created every year and the entire Union is in a better bargaining position with other countries and regions benefitting its consumers. The EEC and its Common Market has become a model for formation of other FTA’s around the globe. Benefits of FTA Being part of a trade bloc is beneficial to a country especially during the current recession as it can at least enjoy the advantages of being a member state. This can make possible a quicker recovery from the after effects of the loss of other external markets. This is not to say that the bloc as a group will not suffer in a recession but the burden will not be as high as that of an individual country that depends on another country or region for most of its trade. A country has to either join a group of like minded countries with common commercial objectives or to stand apart and act as an independent force that can achieve economic viability. In the first case there are examples of the ECC, NAFTA, ASEAN and the APTA. In the second case China and India stand out as good examples. There are scores of FTA’s around the world of lesser consequences and mostly formed on the basis of becoming Economic Blocs. Such associations are of limited value as they help the members only on facilitation of trade and commerce and are little more than bilateral or multilateral trade agreements to reduce tariffs amongst themselves. Their economic value is therefore limited and they do not have special negotiation value with other groups. The benefits remain within the group but as a result the members become more competitive with outside world as they are able to bring efficiencies and cost benefits for their own industries. ASEAN is a prime example of such a group where its six members enjoy free trade between themselves and such pooling of resources makes each of them more competitive in the word market. However ASEAN as a group exerts no pressure on other similar groups or even over another country. The EEC in contrast is the apex form of FTA as not only all its members enjoy free transit of goods and resources between themselves but they, as a bloc, are able to negotiate agreements, tariffs and even quotas with other blocs and countries on behalf of their members. This economic clout gives them a great leverage in getting benefits for their members that they could not have achieved individually. In addition since they now have a common currency called the Euro, they are in a unique position to safeguard this against the vulnerability of exchange rate fluctuations, especially in the global economic recession. The India Story The current worldwide recession has affected all countries although some have fared better than the others. Those most affected are the US and European nations that were involved in the financial disaster due to the sub-prime crises. Prior to that the world economy was cruising at great speed, led by emerging economies like China and India which has the best of both worlds due to their own liberalisation policies and the eagerness of the developed economies on the lookout for greater markets, efficient low cost production centres and safe destinations for investments of their funds. For India as an emerging economy the loss of jobs at home and markets abroad due to the global had a negative effect on home-grown industry for about a year. It also felt the economic crunch as first its growth rate stagnated and then slipped by a third compared to a year ago. But by mid 2009 industrial output has again picked up. Despite this recession the growth rate has fallen to about 6% from 9% a year ago but is far from being negative as is the case with many developed countries. India is already a major member of the South Asian Association for Regional Cooperation (SAARC) agreement that comprises of a total of eight countries viz. India, Pakistan, Bangladesh, Sri Lanka, Maldives, Bhutan and Afghanistan. Although it is the largest such association in the world covering 1.5 billion people, it is of no value as the members have not yet agreed to implement SAFTA (the FTA between them) due to political differences between them. India is not part of any other major trade bloc and as such cannot fall back upon this cushion to cover for the losses due to world-wide recession. For several years India has attempted to become a member of ASEAN but that group has blocked its entry as they fear its size and clout. They have made India an observing member since 2008 and may accept it as a full member in the next few years. The question that arises now is whether it is in India’s interest to joint ASEAN or any other trade bloc? Theories of Production The prime reason for forming alliances in business is the pursuit of competitive advantage (Porter 1985). It is the same for a country. No one country is self sufficient or efficient by itself. It has to have trade relations with others with a view of getting OLI (Dunning 1993,1998, 2001) advantages for its industries. According to Behrman (1972), Dunning (1995) and Rugman (1984) companies are motivated to align with others in different countries in search of resources, efficiency, markets and strategic resources. The same can be said for countries as they too realize that associations open up these possibilities for their home industries. Cost effective production is the foundation of competitive advantage (Dunning 2001). For over two centuries beginning with The Absolute advantage theory by Adam Smith (1776), all writers have proposed that one should produce in a place where one can be most efficient and should trade where production is marked by inefficiency. The Comparative Advantage theory states that production should be decided on basis of relative advantage and if advantage is unavailable one should import rather than produce even if efficiency is more than that of the exporting nation. (Ricardo 1817). Progressively Heckcher (1919) and Ohlin (1933) theorized that one should produce and export goods from locally abundant factors of inputs and import those goods for which these factors are costly locally. Wassily Leontief (1953) developed his Paradox theory that states that Government policies affect availability of input factors as well as capital and labour. The Country Similarity theory advocated by Linder (1961) extended the previous theories by adding that nations with similar demand pattern trade with each other. The Product Life Cycle theory by Vernon (1966) concluded that there are four stages of lifecycle of a product and international trade is related to them. In the first innovation stage the product is developed in its home country; in the second when it reaches its growth level it is produced in another developed country; when it is in maturity it is produced in a developing country and in the last stage where it reaches the declining stage of its life it may be produced just anywhere. This is how international trade in a product takes place even today. Lancaster (1980) projected that in his Market Imperfection theory the nation gains from its vantage point of specialisation and economies of scale and having the first mover advantage takes centre stage with the assistance of the government. Here the use and need of the government factor is the limiting factor. Porter (1990) put forward the Diamond Theory in which he stated that Basic Factors like natural resources, climate/location, and demographics when added to Advanced Factors like communications, skilled labour and technologies help in efficient production. This product is in high demand by sophisticated consumers looking for quality and innovations and firms cater to them and each feeds on the other to create International trade. These factors contribute to a company’s competitiveness. The Indian Viewpoint On analysis all these theories point to the need and benefits of having trade pacts and FTA agreements on national level between countries that can share resources, markets and strategies to benefit economically. This will be a natural protection if other regions suffer for some reason or the other and would lessen the impact of global recession. But does this apply to India as well? India, like China, is a unique example that defies the theories of the past. It has a huge internal market and its share is barely 1% in the total global trade. It possesses most resources, except oil that it has in insufficient quantity. But to offset this it is buying stakes in external oilfields. With liberalisation it has already converted its 350 million strong middle class into a vast pool of customers. This has created jobs, increased industrial output and has contained inflation through good fiscal management. The global recession hit India as well but did not damage the economy as it did in developed countries. India’s exposure to derivatives like the sub-prime was negligible and its forex reserves are comfortable. Then why should it worry too much if it does not have FTA’s with other nations? It really does not need close ended alliances like ASEAN or the EEC. The only Achilles heel that India has is its agricultural output. This sector is too dependant on good monsoon rains and is too fragmented. Most of India lives in and is dependant on agriculture. If it fails in a year, not only those in this sector suffer but the industries too suffer as up to 50% of their output is consumed by the clients of this sector. India also suffers from poor infrastructure that can impede faster growth. The fact is that India’s neighbors among the South Asian countries are wary of India’s clout in the market hence they will not accept India as their partner in FTA as they fear an overrun by the Indian Industry and its entrepreneurs. Yet they all have keen desire to be a partner in India’s growth and progress due to is vast market. In such a scenario it might well be in India’s favour to be a partner with all but not to limit itself in smaller regional alliances as this will be discriminatory against other potential partners. Since India cannot be ignored by others it is in a safe position and does not really need FTA agreements to survive competition. It possesses the inherent strength on its own to negotiate with any country on mutually favourable terms. Bibliography Behrman, J. N. (1972). The Role of International Companies in Latin America: Autos and Petrochemicals. Lexington, MA: Lexington Books. Dunning, J. H. (1993). Multinational Enterprises and the Global Economy. New York: Addison-Wesley. Dunning, J.H. (1995). ‘Reappraising the eclectic paradigm in an age of alliance capitalism’, Journal of International Business Studies, 26/3, pp 461-491 Dunning, J. H., (1998). ‘Location and the multinational enterprise: A neglected factor?’ Journal of International Business Studies, 29(1), 45–66. Dunning, J. H. (2001). ‘The eclectic (OLI) paradigm of international production: Past, present and future’. International Journal of the Economics of Business, 8(2), 173–90. Heckscher, E. (1919). The effect of foreign trade on the distribution of income. EkonomiskTidskriff, 497–512. Translated as chapter 13 in American Economic Association Lancaster, Kelvin. (1980) “Intra-Industry Trade Under Perfect Monopolistic Competition.” Journal of International Economics, 10(2): 151-175 Leontief, Wassily. W. (1953), Domestic Production and Foreign Trade: The American Capital Position Re-examined, Proceedings of the American Philosophical Society, September 1953, 97 (4), pp 332-49, reprinted in Richard E. Caves and Harry G. Johnson, Readings in International Economics, Homewood, Illinois, Irwin 1968 Ohlin, B. (1933). Interregional and International Trade. Cambridge, Mass.: Harvard University Press, 1966 Porter, M. E., (1980). Competitive Advantage. New York: Free Press: Porter, Michael. E. (1990). The Competitive Advantage of Nations.  New York:  Basic Books Ricardo. David. (1817). The principles of political economy and taxation Rugman, Alan M., (1985) “Internalization is still a general theory of foreign direct investment”, Weltwirtschaftsliches Archiv, 121, pp. 570-575 Smith. Adam. (1776). The Wealth of Nations, London Vernon, Raymond (1966). The Quarterly Journal of Economics, MIT Press Read More