Krugmans Trade Theory, Foreign Direct Investment, Trade Restriction, and Other Economics Questions - Assignment Example

Topic 1: Krugman’s Trade Theory

Paul Krugman made immense contributions to international trade study through his fundamental theory. The findings by the economist have a significant influence on contemporary and future global trade, considering the implications of his theory. In essence, Krugman’s Trade Theory focused on how returns to scale could go up as opposed to remaining constant, as most economists had theorized before the mid 20the century. The network effects are also bound to rise, according to the theory. The theory was contrary to the protectionist agenda that was meant to protect the dominant industries and suppress the rise of the infant industries. Subsequently, increasing returns to scale through the network effects enhances industrial planning. However, trade as a massive impact on product diversity and firm scale, particularly in a monopolistic economy (Kunz 2012, p. 17).

Krugman’s Trade Theory has a significant impact on such trade factors as supply, transport, and demand. The less varieties of commodities at the national level occasioned by the Krugman’s argument results in more demand in the importing countries and a subsequent reduction in supply of the same good at the national level. Contrary to Krugman’s supposition, the conventional theory cited the comparative advantage present in all countries. However, Krugman’s Trade Theory recognized that countries could engage in intra-industry trade by producing similar commodities, although such a trade fetched little international benefit, considering the transport costs. Besides, the challenges of intra-industry trade authenticate the home market argument (Edwards & Lawrence 2013, pp. 86-90).

According to Bae and Richardson (2011, p. 91), the Home market argument emphasizes on the essence of promoting one industry for the benefit of another that is not interchangeable. In his famous manufactures Report, Hamilton delved in the concept of home-market although henry Clay made more contributions to the argument when the tariffs debate was at its peak in 1824. Fundamentally, the home-market argument insists that large countries like the United States ought to focus on one industry with the aim of creating market for other industries. This concept largely integrated monopolistic competition during the 19th century when the United States conducted trade with New England (Taussig 2007, p. 507).

Topic 2: Foreign Direct Investment (FDI)

According to Moran (2011, p. 1), Foreign Direct Investment (FDI) is a form of investment where a foreign business entity or company invests in a domestic business entity or company. Unlike indirect investments that involve foreign companies investing in local shares, the company investing in foreign direct investment (FDI) with a local company has insignificant influence over the company’s operational policies. Highly regulated economies have led FDI when compared to their counterparts with liberal labour policies. Examples of FDI include acquisitions & mergers, reinvesting the revenues earned from foreign businesses operations, constructing new facilities, and engaging in intra company loans (Acharyya & Kar 2014, p. 72).

Foreign Direct Investment (FDI) Differs significantly from Foreign institutional Investor (FII) in the sense that FDI involves the physical infrastructures including buildings, factory, and electricity while FII entails investing in intangible investments such as pension, k, insurance, and the stock exchange. Most governments prefer FDI to FII owing to the relative stability of FDI as opposed to FII whose stability is governed by market dynamics. Accordingly, FDI comes in two major forms including Greenfield and Brownfield, depending on the nature of business acquisition (Shrivastava 2012, p. 176)

Greenfield investment involves a parent company that sets up its subsidiary in a foreign country by constructing new facilities and laying down new operational procedures in that country. On the other hand, Brownfield investment is a type of FDI where a company buys existing facilities in a foreign country to continue with production. Although both Greenfield and Brownfield investment are FDI, they differ significantly as far as the management of markets and resources is concerned (Gruda 2013, pp. 7-8).

Topic 3: Political Factors

Liberal democracies represent countries where the governance is based on competitive free and fair elections and the law protects the rights of every individual, including the minority groups. Liberalism means that the majority have their views implemented while the minorities have avenues to access justice (Perry 2010, p. 61). The protection of Civil rights, human rights, political freedoms, and civil liberties are the benchmarks of liberal democracies. Canada, United States, India, and France are some of the examples of liberal democracies. Liberal democracies may be represented by constitutional republics, constitutional monarchies, parliamentary systems, or presidential systems. Contrary to authoritarian regimes that exercise full power and control over their citizens and jurisdictions, liberal democracies embody political disclosure, individual freedoms, and popular sovereignty (Gunlicks 2011, pp. 65-111).

Authoritarian regimes such as Venezuela, Iran, Mexico, and Uganda differ greatly from their liberal democracies counterparts like the United States in many forms. However, the ability to conduct free and fair elections besides allowing individual parties to enjoy full freedom is the key factors to consider in the differences. Invariably, authoritarian regimes suppress parties with numerous checks and balances, especially when it comes to trade whereas the liberal democracies have few restrictions (Brancato 2009, p. 10). Additionally, Liberal democracies are voted in and out by citizens and the choice of political parties, right to own and buy assets, permanent/impartial civil service, and a wide range of personal freedoms attract investors such as Toyota, Volkswagen, and Shell to the United States. However, Apple Inc. has faced significant challenges in exporting its products to South Korea, which is an authoritarian regime with numerous trade restrictions (Pepinsky 2009, p. 264).

Topic 4: Trade Restriction

Trade restriction encompasses the control of trade between two or more countries by the restriction of the commodities that come in and out of individual countries. Trade restriction employs specific measures to implement the control on imports and exports. However, such restrictions may be ambiguous in the sense that a country may term certain trade measures as being restrictive while the acting country may be acting in the best interest of her citizens. The issue of dumping is prevalent among the developed economies in the sense that some foreign producers are prone to sell their goods at low prices on the domestic market as a way of disposing off such goods. This practice calls for retaliatory measures that include quotas, embargoes, and fines (Mankiw 2012, p. 418).

Dumping, among other reasons, may necessitate a country to impose restrictive measures on its trade with other countries. Some countries may impose trade restrictions to protect their citizens from buying or using inferior commodities imported from unscrupulous foreign traders. Additionally, countries may impose trade restrictions such as high tariffs on imports to protect domestic infant industries against unhealthy competition (Kinnaman, & Takeuchi 2014, pp. 86-87). When foreign traders cover a significant chunk of the market, foreign-based monopoly may result, and this may eventually affect the local industries adversely. Foreign-based dominance may create externalities that may be resolved through trade restrictions while countries make efforts to spread their risks in dynamic markets. Governments may also use trade tariffs to regulate consumer tastes, and this practice is predominant in the automobile trade industry (Kerr & Perdikis 2014, p. 138).

Topic 5: Exchange Rates

Exchange rate entails the rate at which the currency of one country or region exchanges for another. For example, US$1 exchanges for ¥119, implying that the US Dollar is stronger than the Japanese Yen. Although exchange rates vary significantly across various currencies, the market conditions play an important role in the fluctuation of such currencies (Evans 2011, p. 86). The law of demand and supply apply to exchange rates in the sense that a given currency may fluctuate appreciably when its demand is higher than its supply, subsequently increasing the value of such currency relative to other currencies. Accordingly, the two major currency regimes namely the free-floating and fixed regimes, affect the exchange rates, depending on the risks involved and market dynamics (James, Marsh, & Sarno 2012, p. 12, 49).

In a free-floating exchange regime, the market forces, including the law of demand and supply, govern the fluctuation of currencies relative to one another. It means that the market is responsible for the correction of all discrepancies in the currency in that a particular currency’s values depreciates with a corresponding drop in demand. Businesses operating in free-floating exchange regimes enjoy such benefits as the absence of unnecessary central bank interventions and international management of exchange rates. Besides, the free flow of capital ensures that business can operate efficiently in the global context, considering that they stay unaffected by economic woes of some countries (Ho & Yuen 2003, p. 33).

When it comes to the fixed exchange rate areas, the situation may require risk management because governments, through central banks, set a fixed exchange rate by which they operate. More often than not, the pegged exchanged rate is against a major currency such as the Dollar or the Euro. Governments such as the Chinese government attain this objective by purchasing and selling the Chinese currency in the market with the motive of obtaining the rival currency. This type of exchange regime is harmful to international trade and multinationals because such business entities are forced to trade with a devalued currency. For instance, it would be cheaper to export goods from China to the United States than importing the same because China has devalued her currency against the U.S. Dollar. Similarly, the cost of importing raw material and exporting finished goods is low with devalued currencies although the risks and uncertainties are high (Ho & Yuen 2003, p. 61).

Topic 6: Comparative Advantage

The concept of comparative advantage entails a scenario where one firm, business entity, individual, or country can produce commodities more efficiently relative to other firms, business entities, individuals, or countries, particularly when it comes to the opportunity cost involved in such a production. It means that the entity with the comparative advantage cam sell her produce at a much lower cost compared to other entities within the same industry. Besides, the firm or country with a comparative advantage is likely to attain greater sales margins. However, the use of comparative in the explanation of trade may be skewed because of the dynamics of international trade (Schumacher 2012, p. 49). 

Comparative advantage makes certain assumptions that attract criticisms from various economists. Fundamentally, the concept of comparative advantage assumes that countries and business entities should specialize, which is not always the case. Additionally, a globalized world and economy would not operate well through the comparative advantage because the concept inhibits free capital flow across the globe. Accordingly, comparative advantage inhibits the growth of returns to scale by creative a static trade as opposed to a dynamic one. The concept requires a diversification policy to check the transport costs and exchange rates, according to Krugman’s Trade Theory (Schumacher 2012, p. 50).

Reference List

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Gruda, J 2013, Wine industry - France and Australia, Oxford University Press, Oxford.

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Perry, M J 2010, The political morality of liberal democracy, Cambridge University Press, Cambridge.

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