The Presence of International Trade between the Nations - Essay Example

International trade Contents Contents 2 Introduction 3 Theories 3 Controversies in current situation 4 Opinion 7 Conclusion 8 Reference List 10 Introduction International trade theory has been one of the most significantly researched topics in economics as it deals with the exchange of goods and services across the international borders. Trade has been present in economic history from time immemorial; but, on account of globalization and industrialization, the importance of international trade in contemporary societies and economies are profound. This paper directs focus on the Ricardian model and the Heckscher-Ohlin model of international trade. These two theories have been thoroughly researched in the later years and they have stood the test of time. Most of the literature that has come up in modern times has been heavily inspired from these models. Both of these models have propagated the development of free trade. However, present scenario of world trade signifies that despite welfare maximization logic of the trade models, most of the countries in the world are following protectionist trade policies even while propagating the benefits of free trade. [s] This essay discusses the controversies that surround the theoretical proposition that was made by economists and understand the rationale behind the crisis. The rift between developing and developed countries mainly arises from the issue of liberalization of the agricultural sector for which this problem has been highlighted. Lastly, final section of the essay highlights opinion of the writer regarding the concerned topic. Theories British economist, David Ricardo had pioneered the theory of international trade by introducing concepts of comparative costs and opportunity costs. Ricardian theory of comparative advantage states that even if a country has higher productivity over another country in terms of both the goods it produces, the weaker country can still gain from free trade if it has comparative advantage in the production of at least one good. Ricardo had explained this with the help of opportunity cost concept. He had shown that if the opportunity cost of a country in producing a good is lower than other country, then the former has a comparative advantage over the latter. This implies that if a country devotes all of its resources to the production of only one good that it can produce most effectively, then it must only produce that particular good. The rate of exchange between the countries will depend on demand for the products, post-trade. This has been one of the most powerful results in the theory of international trade, owing to the fact that this was a major departure from the theory of absolute advantage proposed by Adam Smith; Smith’s theory had propagated that if a country has no absolute advantage over the other country, then there will be no trade between those two as the weaker country will not be able to gain any advantage from such a trade. Ricardo had explained his theory on the basis of only one factor of production, which is labour (Goodwin, et al., 2009). Ricardo’s one factor model of trade became a limitation in itself. In order to resolve the problem, Eli Heckscher and Bertil Ohlin generalized the theory proposed by Ricardo and included multiple factors of production in their mathematical model. They had researched on the pattern of trade between countries when they had different endowments of multiple factors of production, namely labour, land and capital. This assumption was a significant departure from the Ricardo’s model of trade as the Ricardian model had assumed that technological difference between countries is a major factor of trade between them. Heckscher and Ohlin, on the other hand, had pointed out the relative factor difference between countries as the main reason for trade between them. Based on these assumptions, Heckscher and Ohlin had come up with their result. They assumed that countries differ in terms of endowment of resources. Each country has one factor of production that is relatively abundant compared to the other country. Heckscher and Ohlin had shown that when such a situation exists, then the country will export that good in which it has relative factor abundance. This implies that if a country is capital intensive, then it will export capital intensive goods and import the labour intensive ones; whereas, the country that is labour intensive will export the labour intensive goods and import the capital intensive ones. One of the very important results of the Heckscher-Ohlin model had shown that benefits of trade do not accrue evenly to all sectors of an economy. This signifies that there can be positive or negative impacts on the economy, but the country as a whole will gain from trade (Findley, 2006). Controversies in current situation Though Ricardo had propagated the model of free trade between countries and had shown that imposition of tariffs is bound to entail inefficiencies and distortions in the systems; yet, a large number of economists argue that free trade is not the best way to conduct trade between countries. There are various controversies regarding international trade and finance based on models that have been developed by world class economists. It has been observed that most of the developing as well as developed countries opposes free trade policy as this neglects the social, political, institutional and environment context. The ones who oppose the notion suggest that these differences contribute negatively to the well-being of nations (Krugman, 1997). Most countries in the contemporary world follow the protectionist trade policies in order to guard infant industries in their nascent stage. The rationale behind these protectionist measures is to restrict import or encourage exports of few specific products produced by the countries. This is done to reduce speed of adjustment of economic activities, which would otherwise be promoted by international trade. Protection of the trade was facilitated through government intervention so that income and employment generation of the protected sector can be enhanced (Krugman, 1997). It has been observed that a large number of developed countries also employ protectionist trade measures to safeguard their industries. For example, U.S.A. guards Southern cotton, Mid-western sugar beets and North-eastern timber. This is done to protect the domestic industries from the heat of foreign producers who can produce these goods at a lower cost. Main instruments that are used for exercising these policies include tariffs, quotas and government subsidies. This philosophy is completely different from that of Ricardo who had demonstrated that free trade between nations leads to more efficient allocation of resources. By following a protectionist approach, each country wants to maximize its own level of production at the cost of other countries; owing to such conditions, this policy has been termed as “beggar thy neighbour” policy (Howard, 2011). The ‘beggar thy neighbour’ policy can come into effect only when other countries do not react to the protectionist trade measures by imposing such measures themselves. So, in order to prevent economic deprivation, most countries adopt these policies, thereby protecting their own interests; this in turn leads to a trade war. Such a situation was observed in 1930s during the Great Depression, when Smoot Hawley tariff imposed by U.S. reduced the entire global trade as trading partners of U.S. retaliated by hiking their own tariff rates (Cass, 2000). The producers in U.S. had found it increasingly difficult to sell their products. In order to promote the trade between nations as freely as possible, World Trade Organization was set up in 1995 after replacing the General Agreement on Tariffs and Trade, which had operated since 1948 (Mattoo, and Subramanian, 2004). The primary purpose of this organization was to liberalize international trade to the greatest extent. This was perhaps in line with the results demonstrated by Ricardo and Heckscher-Ohlin that free trade is always better than regulated trade. However, ever since its inception, WTO has been criticized mainly on the grounds of formulation of trade policies against the poorest countries. It has been observed that over the years, participation from small and developing countries have increased in WTO; but, their interests are “imperfectly aligned” with that of the system. The main problem is that poorest countries due to their small size and weaker financial status do not have much to offer to their trading partners, which in turn places them at lower end of the reciprocity nature that is at the core of functioning of WTO. In a research that has been conducted by IMF, it has been revealed that the feasible way to improve conditions of the small and developing countries would be to provide them with non-preferential access into markets of developed countries, along with financial and technical assistance. Even so, political protests on part of both the donor and the recipient make it difficult to follow this approach (Mattoo, and Subramanian, 2004). More recently, the global economic crisis has heightened controversies in the arena of international trade. Since 1990s, most developing as well as developed countries have been propagating advantages of free trade and focusing on the policy of trade liberalization. According to recommendations of World Trade Organization in the past decade, most of the countries are concentrating on opening up their trade. However, in reality, the picture is slightly different in relation to policies of the countries on paper and course of actions taken by them. For instance, it has been observed that United States had revoked North American Free Trade Agreement (NAFTA), which had particularly been benefitting U.S. and creating problems in Mexico (Hartman, 2010). Mexico gained very little from the agreement as the country has been experiencing high unemployment levels and weak gains from trade. U.S.A. had also imposed regulations on import of Chinese tires. U.S.A. had even sued China in WTO over rare earths, which are used in high-technology products. These actions show that countries are subtly maintaining their trade barriers, regardless of propagating ideas of trade liberalization. The economies of U.S.A. and China are, therefore, in a deep trade dispute over these matters as U.S.A. claims that this action by China has raised production costs for American firms (Martin and Elmquist, 2012). Guatemala is another country that has been protesting against unfair trade practices of the European trade policies of 2006. The country strongly believed that trade polices devised by the European Union were only favouring them and in turn Guatemala was losing out on benefits of trade. The trade policy of Europe had stated that European corporations should have unquestioned access to raw materials from developing countries, including Guatemala and also that these corporations should face minimum regulations in Guatemala. The trade policy also stressed on the fact that developing countries should open up their markets to European trade for the purpose of deriving benefits of trade. Guatemala is of the view that by propagating this “free trade” policy, Europe was simply stealing raw materials from them (World Development Movement, 2014). Most of the countries in Sub-Saharan Africa have been heavily marginalized because of trade policies of developed countries. The differences in trade policies of the African countries have helped certain nations within Africa to emerge as winners and others as losers. In the wake of the global economic crisis, the problem of trade liberalization versus trade protection had become increasingly important. For instance, the Doha Agreement that was launched in November 2001 and is the latest round of WTO Agreements had consistently been promoting liberalization of trade policies (Klug, 2006). However, discussions have not yet materialized because of the attitude of developed countries towards liberalization of agriculture. As the developed countries continue to protect their agricultural sector through tariffs and subsidies to farmers, this distorts global prices of agricultural products. The comparative advantages of developing countries are directly jeopardized through such activities, thereby leading to inconclusive results from the WTO rounds. This often results in heated arguments between developing and developed countries. The developed countries had put forward a condition that they will slacken their agricultural protectionist measures, only if developing countries do the same in a phased manner. Developed countries, on the other hand, are of the opinion that their agricultural policies do not need any amendments. Such arguments prevent these countries from reaching a common consensus and the dilemma between free trade and protectionist trade looms large (Coughlin, 2002). Opinion According to my opinion, difference in the level of economic development between countries weakens the concept of free trade. The developed countries often use their financial power in order to attain greater benefits at the cost of developing countries. The example of Guatemala has revealed that the country has been heavily marginalized by trade practices of Europe. The policies of developed countries on the agricultural front, according to me, are most grave impediments to the gains from trade. Developed countries like, USA and Europe, along with fast developing countries like, India and China, should recognize the fact that protectionist policies in all these countries will hamper welfare of the global economy. This is mainly because of the reason that since advent of aggressive globalization from the period of 80s, economies all countries have become highly integrated with one another. In such a scenario, selfish policies followed by financially stronger countries will only lead to depletion of welfare of weaker economies. A classic example of this is the inconclusive results of Doha Round of WTO. It can be seen that though the round was launched in 2001, it had not reached any conclusive results as of 2008. This is primarily because of difference in opinions between developed and developing countries. The developed countries should definitely lower their agricultural supports as they have other sectors to rely on. Even so, as agriculture is the major profession for developing countries, they are bound to depend on this sector. Finally, from the trade relations between Mexico and U.S.A. dominated by NAFTA, it has been seen that illegal migration from Mexico has increased and unemployment level in the latter has heightened. This in turn points out exploitative nature of the trade relations. Conclusion This paper has discussed presence of international trade between the nations. The theory of international trade is largely derived from models that were developed by Ricardo and Heckscher-Ohlin. The common understanding of both of these models was that free trade between nations will lead to maximum welfare. Decades later, formation of WTO vindicates the original results that were proposed by economists. However, ever since the formation of WTO, there have been major controversies regarding policies followed by it. It has been criticized that developed countries have benefitted most from the trade arrangements, while the poorest ones are still struggling. Free trade can often lead to less than optimal resource allocation than that provided in theoretical studies. The experiences of Mexico, Guatemala and some African countries have reflected that their free trade policies greatly benefit their developed trading partners. This proves that even though free trade is beneficial, yet differences in levels of economic development of countries makes it difficult to realize the gains from free trade as is promoted by WTO. Finally, the interests of each nation to maximize their own benefits are also undermining development of global trade. Reference List Cass, R. A., 2000. The Trade Debate’s Unlevel Playing Field. Cato Journal, 19(3), pp. 449-57. Coughlin, C. C., 2002. The controversy over free trade: the gap between economists and the general public. Federal Reserve Bank Of St. Louis. Available at: [Accessed 27 March 2014]. Findley, R., 2006. Eli Heckscher, international trade, and economic history. Hong Kong: MIT Press. Goodwin, N., Nelson, J. A., Harris, J., Roach, B. and Devine, J., 2009. Macroeconomics in context. M.E. Sharpe. Hartman, S. W., 2010. NAFTA, the Controversy. The International Trade Journal, 25(1). pp 5-34. Howard, F., 2011. Free-trade agreements. [online] Available at: [Accessed 27 March 2014]. Klug, A., 2006. Theories of international trade. Routledge: London. Krugman, Paul. 1997. What Should Trade Negotiators Negotiate About? Journal of Economic Literature, 35(1), pp. 113-20. Martin, E. and Elmquist, S., 2012. U.S. to file WTO complaint over china rare-earth export caps. [online] Available at: [Accessed 27 March 2014]. Mattoo, A. and Subramanian, A., 2004. The WTO and the poorest countries: the stark reality. [pdf] International Monetary Fund. Available at: [Accessed 27 March 2014]. World Development Movement, 2014. Europes unfair trade deals. [online] Available at: [Accessed 27 March 2014]. Read More