Questions in International Business Economics - Essay Example

International Business Economics Question: To what extent can current world trade be explained by traditional ical/ neo ical trade theories International trade involves the exchange of goods and services across countries boundaries. The classical school of economists included the following theorists: Adam smith-1723-1790, David Ricardo-1772-1823, Thomas Math us and John Stuart mill. They were called classical because of their wide spread popularity and their unquestionable authority like the Bible, the school brought tremendous changes to economic thinking, they brought order to the chaotic state of economic enquiry and finally because all the critical schools that have emerged after them have borrowed a leaf from the classical thoughts. They argued that economic growth depended upon capital accumulation which depended on savings and investments; they advocated for free trade and favourable balance of trade. Theories of Trade According to Adam Smith absolute advantage would be realised as long as cost of production differed from between countries, one or both countries would gain by trading. An example to illustrate this is a situation where we have two countries A and B which produce two similar goods X and Y. The figures show labour cost in hours for producing one unit of good X Y Country A 40 50 Country B 80 60 Country A has absolute advantage in the production of both good X and good Y. David Ricardo formulated the theory of comparative advantage and argued that even if a one country is more productive in both lines of production it would be still profitable to trade. Country A is more productive in both lines of production but it will still be profitable to trade with country B, this is shown by first stating that country A is more advantaged in production of good X, therefore when wee calculate the comparative advantage country A will specialise in the production of good X and country B will produce good Y and they will gain by trading. (Hardwick, 1997) The Hecksher-ohlin trade model states that trade is based on the difference in factor endowment, a labour rich country will produce and export labour intensive good, and it will also import capital intensive goods. A capital rich country will produce and export capital intensive goods; it will also import labour intensive goods. Country one is more abundant in capital while country two is labour rich. this is indicated by the production possibility curves. According to the factor equalization theory, if we have a situation where factors of production cannot move from one country to another but there is free movement of goods, then the free movement of goods will eventually equalize factor prices. Point Q is the equilibrium point of producing both goods for country one, point P is the point of equilibrium for country two in producing both goods. The movement of goods will cause a shift in equilibrium points and case price equalization. Equilibrium shift as shown by the arrow. According to the Rybczynski theory an increase in factor of production and the other factor remains constant in a country , then the output of the good using the factor of production intensively increase while the output of the other good will decrease in absolute amount provided factor and output prices remain constant. (Jagdish, 1987) The countries original equilibrium is at point P, after increase in labour the new equilibrium is at point P'. According to the Stolper Samuelson theory, he argues that a tariff imposed on import goods causes an income distribution. He argues that a tariff on an import causes domestic prices to rise; this causes an increase in domestic production as firms emerge to capture the profits caused by the price in this goods. This effect is called the import substitution; Stolper argues that this will cause an income distribution as producers tend to substitute capital for labour or vice versa as one factor price increases. (Kenen, 1994) P shows price before tax and it represents the price of a good in the world market, When a tax is imposed the price shift to P+t. World trade today. There has been the process of regional integration in world trade; it entails removal of trade barriers such as tariffs, quotas and export restraints. They include-P.T.A (preferential trade area), F.T.A (free trade area), C.U (customs union), U.T.L (unilateral trade liberation), C.M (common market) and C.E.I (complete economic integration). Although trade between countries has existed for many years the C.E.I has not been achieved. The existence of free trade is in accordance to the classical economists in that they advocated for free trade which would help countries realize absolute and comparative advantage. According to the Hecksher-ohlin, factor endowment determines the existence of trade; this is evident in our world today where the capital rich European countries produce capital intensive goods example production of computers, cars and machinery. In the labour endowed African countries labour intensive goods are produced. African countries produce agricultural goods example tea and coffee that are labour intensive and they export them to European countries, they import goods that are capital intensive. In reference to the Rybczynski theory where an increase in one factor of production causes an increase in output of the good using the factor intensively, then this is evident where African countries have experienced an increase in labour supply due to high population growth. This as a result has caused increased production of agricultural goods that are labour intensive while the production of capital goods has gone down. This is because the new labour goes to the labour intensive industry and it need capital which is shrinking from the capital intensive industry. There are various trade organisations in the world they include, European market and the Organisation of the petroleum exporting countries (OPEC), OPEC is an organisation for producing petroleum products to the rest of the world, its members include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Arab Emirates, Saudi Arabia and Venezuela. These countries hold about a third of the world's oil reserves and produce 40% of the oil needs. These countries have specialized in the production of oil which they export to the rest of the world. They import the goods that they do not produce mostly food products. Another good example to demonstrate the Ricardian comparative advantage theory is the comparison of England and Portugal, they both produce wine and clothes. Portugal has absolute advantage in the production of both goods but it is more efficient in the production of wine, therefore both countries may specialize in production of the two goods where Portugal produces wine, and England produces clothes and both countries will gain by trading. Adam smith (1873-1890) in his book on the enquiry of wealth of nations, he emphasised the importance of trade as a means of widening markets and enhancing division of labour. According to the classical economist international trade was regarded not only as a source of inventing surplus but also as a source of division of labour under the exploitation of comparative advantage. Although the European countries are endowed with capital they also produce labour intensive goods by adopting capital intensive methods in their production. The classical theorist are criticised for considering only two factors of production and ignoring the role of technology in production. This is evident in the development of Japan through technological advancement. According to the Canada statistics on exports, they export large amounts of forest products this is due to the factor endowment; the forest products are the largest exports in the country. Its exports also include machinery which amounted to 94641.2 million dollars compared to wheat 2698 million dollars which is a labour intensive good in the year 2005.this scenario is in accordance with the classical theorist. (http://www40.statcan.ca/l01/cst01/gblec04.htm) According to my view international trade has played a major role in the development of economies, the has been the formulation of various rounds in order to promote free trade example the Doha round, Kennedy round, Tokyo round .the formation of free trade areas has also led to the development of trade, although the countries want to liberalize trade they are indifferent between protecting infant industries, the introduction of import substitution industries strategies and the export expansion strategies. many African countries have failed to attain high levels of growth as a result of trade due to the fact that they produce similar goods and which are not diversified, they overproduce this goods therefore the law of demand pushes prices downward and that the European countries can now also produce agricultural goods through capital intensive means. African countries should therefore diversify their exports, shift from labour intensive means of production to mechanised production, the introduction of import substitution industries strategies that aim at improving balance of trade and this strategy would be recommended because the market exists. International trade also builds relationships between trading partners, this is evident where in case of a natural disasters trading partners of a country are the first to assist without hesitation. The trading partners also allow balance of payment and also give funds in terms of loans to its partners in case of an economic recession or depression. International trade has enabled countries to develop, this is demonstrated by the mercantile school of thought, and they argued that developed countries developed as a result of foreign trade, these countries put much weight on retaining and acquiring gold. They considered foreign trade as the only source of gold. They advocated for the expansion of sources of raw materials and new markets and favourable balance of trade as a source of development. References Hardwick P, Khan B, Lang mead J, (1997), An Introduction to Modern Economics, 4th edition, Longman Group UK Limited, New York. International Network for Economic Method (1996): Journal of Economic Methodology Volume 3, Number 2, December 1996 Jagdish N. Bhagwati (1987) international trade 2nd edition, MIT publishers, London. Kenen, P. B (1994); The International Economy, 3rd Edition, Cambridge University press, New York. Kirkaldy, A. W. (1929); The Romance of Trade, 2nd Edition, Devonshire Press, Torquay, Britain. Maria Oliva and Luis A. (2003) International trade theory, strategies and evidence, Oxford university press. New York. Schiller, B. R. (1980); The Macro Economy Today, 7th Edition, New York, Von Hoffman Press Statistics Canada (2006): Canada's national statistical agency, available at http://www40.statcan.ca/l01/cst01/gblec04.htm, accessed on 8/8/2006. Read More