Recent Developments in International Trade Theory - Coursework Example

Recent Developments in International Trade Theory Name Institution Recent Developments in International Trade Theory International trade refer to the trade that results when citizens or companies of one country buy or/and sell from and to their counterparts from a different country (Krugman & Obstfeld 1992). This kind of relationship is necessitated by diversity, whereby countries will naturally be endowed to produce different products in quantities that they cannot consume. On the other hand they require products which they either cannot manufacture or are very expensive to manufacture in comparison to another country and hence choose to import. The patterns of trade are influence by many factors and different theories attempt to explain these determinants. The practice of international trade is old and has undergone numerous transformations with time and age. This paper presents the recent developments in the pattern of international trade. The concept of comparative advantage forms the basis of discussion. A number of models as formulated by various authors will be present the today’s rationale of countries to do business with one another. International trade theory provides explanations concerning the rationale of international trade and the benefits that accrue to countries when they engage in the same (Krugman & Obstfeld 1992). In today’s business context, the tone of international relations is bent primarily on free or liberal trade. Under this system countries are to allow free of factors of productions from regions of their concentration to places where they are on demand. Capital, labour and raw materials are exchanged between countries with the prime aim of coming up with finished goods and services that can trade competitively in the international scene. Economists attempt to answer many questions under international trade theory regarding why countries trade with one another, whether it is beneficial to trade and what determines the direction of flow of goods and services between countries. To present the ideology of international trade theory, economists use the concept of comparative advantage. This concept is based on buy low sell high. Comparative advantage theory compares the relative price differences of commodities between nations. The country with the lower price of a commodity is said to have a comparative advantage in that commodity. Going by the concept of buy low sell high, that country will choose to export that commodity in which it has comparative advantage (Krugman & Obstfeld 1992). This theorem explains why a country will choose to specialize in production of one or a group of commodities and remain silent on others. It also explains why a country will opt to import commodities or which it has the potential to produce. The reasoning of comparative advantage assumes that every country must have comparative advantage in some good. Other forces, such as environmental standards, exchange rate manipulations and labour standards that cause national differences in levels of factors that do not enter market system are diluted by focus on relative prices. Prices of these factors adjust in general equilibrium such that each country will eventually have a competitive or absolute cost advantage in the good in which it has a comparative advantage (Deraniyagala & Fine 2003). Comparative advantage differences among countries are not human imposed. Rather they are determined exogenously, by national characteristics of a country. Labour, for example, differs in productivity among countries. The labour requirements for different goods differ so comparative labour productivity advantage is a meaningful predictor of trade patterns as explained by Ricardian trade theory. The facto proportions theory added relative factor endowment differences to the exogenous explanation of comparative advantage. Countries with abundant capital resources have higher labour productivity, but the advantage gained relative to the less abundant countries varies with the relative capital intensity of the good’s technology. When endowment differences and technology are combined, the actual trade patterns are accounted for at greater extent (Davis & Weinstein 2002). Ricardian model has, however, been criticized for being static. Critics argue that it is based on a given state of economy with a definite production function and do not allow for any change. Trade theory also puts into consideration creation endogenous differences between countries, for example, economies of scale. A country gain cost advantage as a result of exploitation of relatively wider market. The efficiency gained due to large scale production enable a country to offer more competitive prices hence enhancing its position as the leading producer of a certain product. Monopolistic competition is another attribute that defines the pattern of trade whereby consumers prefer products from a certain country, out of many differentiated products from different countries (Deraniyagala & Fine 2003). This characteristic is propagated by both the producers, as they design specialized models of products and consumers as they seek to follow their tastes and preferences. Major recent developments in international trade theory favour the essence of comparative advantage theory. Various thinkers in this field of economics contend that trade is guided primarily by differences in relative prices of products between countries and the benefits that citizens of a country would get from international trade. The factor proportions model as formulated and presented by Heckscher-Ohlin predict that a country would have a comparative advantage in the good which made relatively intensive use of its abundant factor (Leamer 1995). This means that if a country is highly endowed with capital, then it would have comparative advantage in the good which used capital relatively intensively. In the same vein, a country with relatively abundant labour will have comparative advantage in the good that uses labour relatively intensively (Feenstra 2003). Ohlin’s theory, however, has a number of limitations. It assumes a case of only two countries which is not possible in practical terms since a country will do business with many countries and will make buy and sell decisions guided by many considerations and alternatives as presented by various countries. The theory is also one sided since it assumes that demand plays insignificant role price setting and that supply has a more influential role in price determination. Also, just like the case is with Ricardian theory, this theory is static in nature. In real life changes are inevitable and hence an all round model should allow room for changes (Leamer 1995). There are adverse factor endowment differences internationally. Some of the factors are immobile, and this is made up for by trade in goods. Trade patterns enable citizens of different countries to consume factor services as if the world is completely integrated. Recent empirical work has gained unprecedented success in combining factor endowment differences with technology differences as an explanation of observed trade patterns (Davis & Weinstein 2002). Generally countries will import commodities that would be relatively expensive in the absence of trade. Under the general model, consumers are perceived to always strive to minimize expenditure while maximizing on utility gained from goods and services they buy. This typifies downward sloping demand curve. Producers on the other hand, strive to maximize national product by organizing the resource endowments in a manner to optimize net returns and reduce production costs. This leads to an upward sloping supply curves. However, this assumption gets violated once the aspects of economies of scale and imperfect competition are introduced into the general model (Anderson & Eric 2004). Various economists have tried to bring to board the concept of absolute advantage in international trade theory. Absolute cost advantage holds that a country exports those products that are more expensive abroad while importing those that are cheaper abroad. The essence of this proposition is the fact that a rational buyer will assess the prices of a certain commodity in various destinations and based on information gathered will opt to buy form the least cost seller. This attribute, however, becomes difficult to place in the context of macro-economic where a country rather than an individual need to choose what products to manufacture locally and those that it should import. Prices of commodities will vary significantly over time due to market forces and external pressures, such as political instability. It would, therefore, be difficult for a country to make long term decisions based on current information of market prices of finished products. For this reason, some economists have disputed the whole idea of absolute advantage terming it as absolute advantage fallacy. Differences in comparative advantage and absolute advantage fallacy can be illustrated by comparing the growth in productivity between two nations. A percentage improvement in productivity will secure a proportionate cost advantage for the producer. In contrast a percentage improvement in a country’s total productivity relative to another country is unlikely to change comparative advantage since other costs will accrue such as increased wages to support the increased production. Conversely, a percentage drop in a country’s productivity due to endogenous forces such as environmental regulations will be unlikely to alter the comparative advantage since the returns on factors of production will fall. Many of the commodities that trade on international scale are exchanged because they are available only in certain geographical locations. Minerals are the best example of such items. Such items are said to exhibit exogenous characteristics. On the contrast, endogenous availability arises from the economic interaction of nations. Majorly endogenous advantage arises from competitive advantage and economies of scale. However, the two attributes cross routes at some point. A country could be producing on large scale simply as a matter of chance. Where a country is well endowed with a valuable mineral it will have exogenous advantage and when it ends up producing at large scale it creates competitive advantage out of the endogenous advantage. Recently, third world countries have realized that rich countries hold much of the comparative advantage due to historical factors that positioned them at better places of human evolution and development. They try to adopt economic policies to counter their dominance by adopting protective measures. For instance, they may start production of commodities for which they do not possess comparative advantage, and sell it only to the local market. They then impose quotas, total bans and tariffs to protect the local industry from international competition. They groove the industries for some time and finally open up to international market. This is however, proving difficult enough due to market liberalization initiatives of the twenty first century (Gresser 2002). Michael Porter extends his model of value chain analysis of an organization to fit the context of a country. He contends that a country gains competitive advantage as a result of what he calls main activities and support activities. Main activities entail the attributes that give a country cost advantage in production of a certain commodity relative to other countries producing the same commodity. For a country to have cost advantage Porter argues that it must have great efficiency in the productions systems. He then enlists four factors that come into play to bring efficiency and they represent the main activities. These are logistics, production, marketing and services. Logistics refer to the ease with which factors of production can be easily transformed and employed in the production process due to advancement in infrastructure. Both transportation and communication networks make the work of logistics management easier. Such enable the transfer of both the movable factors of production as well as finished products. They also entail the services and terms of suppliers and the quality and ease of access to raw materials (Kohler 2003). Production refers to the ease with which raw materials are transformed into finished products. Presence of skills and expertise enhance the production process. When a country is endowed with expertise then it will be able to pursue its comparative advantage goal with greater zeal. Marketing refers to all the activities that that enable the finished product to move from the hands of the producer to the consumer. In the context of nations, the international relations and trade agreements between countries will further the course of this goal. A country that is at peace with neighbours and overseas nations will be better placed to move its products to those countries as opposed to one that has strained relations with other countries. Today, for example, many Eastern countries are unable to reach their full capacity in international trade due to their position and ideology on international terrorism and human rights. In Africa on the other hand, some countries are unable to market their products in Western countries due to dictatorial leadership. Services refer to the presence and advancement in auxiliary facilities such as banking, credit facilities and other forms of facilitation. A country with a developed financial industry will have strong companies that can compete on the international scene. The cost of credit as determined by a country’s monetary and fiscal policies will also have a significance influence on how well it will create competitive advantage (Guesnerie 2001). Support activities enhance quality advantage such that a country’s brand of products will be preferred over similar products from other countries. Porter highlighted other four major factors that enhance quality advantage at firm level. These are firm infrastructure, human resource management, stock supply and technological development (Melitz 2003). Firm infrastructure that supports smooth running of operations promotes efficiency. This majorly refers to the organizational structure of an entity and how operations follow one another. This is with respect to physical environment, power systems, leadership styles and reporting responsibilities (Melitz 2003). Human resource management encompasses recruitment, training, development, remuneration and motivation of the workers. A country’s labour policy will have a great dimension on how employees are motivated to work and their level and willingness to innovation. Policies such as minimum wage rate may help to reduce exploitation of works but at the same time may lender so many citizens jobless thus reducing the innovation levels of a country’s labour force. Education systems adopted in a country determines whether a country will be able to supply itself with the technical expertise required for production and technological transformation (Melitz 2003). A country that imports labour on large scale will find it difficult to create comparative advantage since the cost of doing that may cancel out the cost advantage that should result from specialization. Stock supply entail the ease with which finished products can be ferried from the country of production to the country of sale. Countries with natural habours will enhance their advantage. Land locked countries will find it difficult since they may incur extra costs of using another country’s port. A country with developed transport system will be better positioned since it can exploit its own transport and airline companies to ferry its goods (Kohler 2003). Technological development determines the pace of transformation and efficiency in production. Better technology gives quality products at reasonable cost. Modern technology produces commodities of higher value that are more differentiated and hence are easy to market in international markets. For a country to beat international competition, then it must embrace modern technology and allow use of capital intensive methods of production even if such may be relatively more expensive to hire (Melitz 2003). Porter’s theory commonly referred as ‘diamond’ is based on a system of determinants which include: the capacity of internal factors, domestic competition advantage, the links between industries and the specific of the domestic market (Guesnerie 2001). In practical terms, modern patterns of international trade are greatly influenced by political factors and trade agreements. In this regard a country may not buy from the least price seller due to strained political relations with that country. For example, USA will not buy petroleum products from Iran despite, Iran having comparative advantage on its production. In the same vein countries enter bilateral and multilateral agreement to trade with one another. In such cases a country may buy a product not because of comparative advantage but just in honour of the pact signed. Some of the reasons that influence the signing of these agreements is the tax waivers on goods traded within the trading block (Keen & Wildasin 2004). From the analysis presented on international trade theory, a conclusion can be formulated with regard to the contribution of international trade to economic development. When a country follows its comparative advantage and realizes the gains from trade, it will be on its optimal development path. Recent developments in international trade practices would further assist to realize this goal thanks to the massive and extensive adoption of trade liberalization policies. Theoretical perspectives on the concept of comparative advantage and international trade theory find its roots from the classical trade theory, neo-classical trade theory and the recent theories of international trade. The extensive work of Porter in the field of strategic management with specific reference to creating organization’s competitive advantage contribute significantly to the advancement of contemporary theories on international trade. The model helps to break down the various factors that influence a country’s position in international trade participation as well as highlighting the effect each factor has to the pattern of production. In general, there are two major sets of characteristics that determine the country’s comparative advantage – endogenous factor as well as exogenous factors. In essence, management of international trade policy at national level would entail creating comparative advantage by influencing the endogenous factors, such as labour laws, fiscal policies, environmental standards so as to optimize on the endowment of the exogenous factors such as minerals, geographic location among others. References Anderson, JE & Eric W 2004, ‘Trade Costs,’ Journal of Economic Literature, Vol. 42, pp. 691- 751. Davis, DR & Weinstein DE 2002, ‘An Account of Global Factor Trade,’ American Economic Review, Vol. 91, pp. 1423-53. Deraniyagala, S & Fine, B 2003, ‘New Trade Theory versus Old Trade Policy: A Continuing Enigma,’ Cambridge Journal of Economics, Vol. 25, no.6, pp. 809-825. Feenstra, RC 2003, Advanced International Trade: Theory and Evidence, Princeton: Princeton University Press. 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