Theories of International Trade - Essay Example

? INTERNATIONAL ECONOMICS AND FINANCE Table of Contents Summary 3 David Ricardo: Ricardian theory of international trade 3 Heckscher-Ohlin - Heckscher Ohlin theory of international trade 5 Controversies in international trade and current policy problems: Practical examples 6 Conclusion: Opinion on international trade 8 Reference 9 Summary International trade can be explained as the exchange of goods, services and capital between different countries in the international platform. International trade is, therefore, an international exchange of a country’s product or services with another country. International trade contributes to a large portion of the Gross Domestic Product in many countries all over the world. In recent times, international trade has gained large importance in terms of social, political and economic aspects. The two eminent theories of Heckscher-Ohlin and Ricardian theory of international trade by David Ricardo have been discussed below. An introspection of the two theories provides an insight of the main controversies in the field of international trade and the current problems in policy that is affecting international trade. The Ricardian model explains comparative advantage in international trade by taking into account factors like natural resources and technology advancements of a country. The factors of comparative labour and capital have not been considered by Ricardo while explaining comparative advantage. The Heckscher-Ohlin model of international trade on the other hand assumes that the labour and capital are abundant resources that vary from one country to another and technology in long term prospects are assumed to be same. Heckscher-Ohlin derived that a country exports such goods that make optimal utilisation of local factors and imports those goods which could not make use of available factors. David Ricardo: Ricardian theory of international trade International trade is necessary for the sustenance of globalization. The countries would be restricted to the goods and services produced within the borders of their own country in absence of international trade. The theory of international trade by David Ricardo proposes that the difference in international trade varies due to the difference in the natural resources and technology base of the nations and place little weightage to the factors like comparative capital and labour present in the countries. Ricardian theory, however, holds the underlying assumption that the labour is the primary input for production and the trade at international stage occurs due to relative ratios of labour of the different nations (Rivera-Batiz and  Oliva, 2003, p.4). The other assumptions in the Ricardian model of international trade says that the labour as an input of production of the countries is also inelastic and there is no cost of transportation and no international trade barriers. The theory of comparative advantage has been explained by two factors namely, the opportunity cost and the production possibility frontier. The opportunity cost of the countries can be determined as the loss incurred for a certain production due to increase in another production. In international trade theory, the opportunity cost to a country is the decrease in cost of production arising out of scarcity of some factors for which the country imports goods and services from another country where those factors are present. The countries would carry out international trade in such a way that the opportunity cost is high. This could be done by international exports of goods that have abundant factors available in the boundary of the country and through import of goods that have scarcity of factors in the national boundaries. The production possibility frontier explains that the output of the country remains same for a certain level of technology and international trade takes place due to difference in outputs as a result of different levels of technology achieved by different countries. Heckscher-Ohlin - Heckscher Ohlin theory of international trade Capital and labour are readily available inside the borders of a country. The cost of utilising labour and capital present with the boundaries of the country is much less than mobilising it across international borders in order to increase the factors of production. Swedish economists Eli Heckscher and Bertil Ohlin proposed the Heckscher-Ohlin model which explains that international trade between the countries occur due to varying levels of production arising out of difference in labour and capital present in different countries. According to Heckscher-Ohlin model, the country will export goods and services that have abundant labour and capital required to produce those goods and the country will import goods and services that has scarcity of required labour and capital for producing those goods and services. The pattern of international trade in Heckscher-Ohlin model is determined by the difference in the factors of production like labour and capital. The theory explains two concepts of factor abundance and factor intensity. This means that the country exporting its goods and services to another country not only has abundant supply of required labour and capital within the country in comparison to the country that imports it but also uses the factors of production like capital and labour in the most intensive manner. Heckscher-Ohlin model take into consideration two inputs of production namely capital and labour. It may happen that one country may have a larger proportion of one of the factors to another country. In that case the absence of returns to scale for the other factor will not contribute to the international trade between the two countries. The other factor will be significant for the importing country with respect to international with another nation. The Heckscher-Ohlin essentially builds on the Ricardian theory of comparative advantage by taking into account the factors of production like labour and capital for predicting the pattern of international trade. Controversies in international trade and current policy problems: Practical examples The theory on international trade by David Ricardo emphasizes that the international trade is a result of the difference in productivity and comparative technology levels producing different outputs, thereby giving rise to opportunity cost for the countries to import goods and services whose factor of production are scarcely available in the boundaries of the country. Heckscher-Ohlin built on the model of David Ricardo which states that the comparative difference in the levels of production in goods and services arise out of the difference in availability of capital and labour. While the Ricardian theory assumes the factor endowments to be constant, the Heckscher-Ohlin model assumes the technology level in the countries to be constant in the long run. The Ricardian theory of international trade takes into account the labour as the only input for production. This is a major drawback of the theory as a major part of the international trade occurs due to difference in production arising with the intermediary goods as input. Yeats observed that around 30% of the international trade in manufacturing happens with intermediate goods as input. Jafee and Bardhan observed that 37% to 38% of the imports by US during 1992 to 1998 have intermediate goods as input. Controversies have occurred from the point of view of establishment or question of validity of Heckscher-Ohlin model as well. A practical example can be cited which indicates that the United States of America is more capital intensive than labour intensive. Thus the exports of US goods and services need to be more capital intensive. In 1953, Wassily Leontief found that the US imports are more capital intensive than its exports. Learner tried to emphasize that Leontief has not interpreted the model correctly and has ended up discarding the theory. Various researches carried out all over the world suggest possible rejection of the Heckscher-Ohlin model. Several writers like Obstfeld, Krugman, Hollander, Bowen and Viane are all proponents against the theory of Heckscher-Ohlin. The international trade attained significance because it helped in disseminating the positive effects of globalization as apart from adding to the countries GDP, the international trade shaped the growth of the developing economies and their culture. Trade liberalisation has spread to South Asia, East Asia, Latin America and Europe and to lesser extent in Africa. Controversies though exist in international trade whether it leads to economic growth or reduces poverty, etc. Despite controversies on international trade, the following facts can be derived by looking at the statistical facts and figures. With the reduction in trade barriers and openness to international trade, the GDP of the countries in international trade have increased significantly. A practical example can be cited in this aspect. United States of America being lesser labour intensive than China may undergo policy reforms where it would import labour intensive goods from China in spite of importing labour from China. This opportunity cost of international trade would help USA in increasing its GDP. Controversies exist on international trade as it cannot guarantee growth but are undoubtedly an opportunity for attaining growth. It is to be kept in mind that the economic growth also takes into account other factors like infrastructure, human resource and the macro-economic environment. There is a heterogeneous bag of current policy reforms on international trade that the countries have undertaken looking into their economic, social and political constraints. Depending on these constraints, the countries determine their policies on international trade at different time and at different pace or rate of growth. Examples could be cited for India and Bangladesh that have undertaken policy reforms for international trade in different sectors with different limits at different points of time. Some countries like China and Mauritius have followed the policy of establishing export processing zones for the purpose of encouraging international trade. In some countries like Estonia, policy reforms have been undertaken to combine unilateral trade reforms with participation in regional trade. It is, however, difficult to separately identify the growth effects of the current policies on international trade as it involves cross-sectional effect of other factors like human capital, infrastructure, etc. Needless to mention that government policies on protectionism took various forms as the governments introduced subsidized capital, monopoly rights, protection against imports. At the start of the industrial revolution, government policies imposed tariff on imports in the range of 30 to 50%. Keeping in mind the protectionism towards domestic industries in order to maintain a competitive advantage for the indigenous products, it could, however, be identified that economies which grown recently have adopted openness in policy reforms on international trade. Conclusion: Opinion on international trade International trade is an important aspect in the world economy. Apart from the exchange of products and increase in GDP of the countries, the exchange of currency between the countries also happens as a result of international trade. The international trade helps in determining the exchange rates between the nations. Moreover, international trade helps to continue the aspect of globalization. The two theories on international trade proposed by David Ricardo and Heckscher-Ohlin have been discussed. Although the assumptions of the two models on international trade are different, Heckscher-Ohlin model is built as an addition to the model suggested by David Ricardo. David Ricardo’s theory on comparative advantage suggests that the comparative advantage on international trade happen due to comparative advantage on the technology levels of the two countries assuming that the labour is the only unit of capital and is inelastic. The country would export goods and services whose productivity would be high on the goods and services exported due to availability of higher technology levels. The pattern of international trade would also be determined by the opportunity cost. The theory faced controversies as there would be more than one endowment factor related to the production in a country. Heckscher-Ohlin proposes that the international trade would occur due to a comparative advantage on the availability of labour and capital. This theory has been discarded by many researchers. An example of international trade between USA and China does not support this theory. The factor of international trade cannot, however, be restricted as there are lot of intermediary inputs for production as well. International trade can benefit a country to grow in economic aspects. For this the government should allow openness in the policy reforms to reap the benefits of international trade. Several economic social and political constraints should be kept in mind while framing policies on international trade. The timing and pace of reforms need to be judged by the economies participating in international trade. The growth effect of international trade is difficult to be singled out as the rate of growth of the countries take into account other factors like human capital, infrastructure, etc. Reference Rivera-Batiz, L. A. and  Oliva, M. A. 2003. International trade: theory, strategies, and evidence. Oxford University Press; Great Britain. Read More