unit 2 trade_theory-new[1]

8/7/2019 Unit 2 trade_theory-new[1]

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Unit 2

International Trade Theory


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Kept lowering tariffs on manufactured goods.Created incentives to export (trade).

Reduced quotas.

Reduced subsidies.

1950s: 77% of employment in agriculture. Now 20%.Manufacturing GNP went from 10% to over 30%.


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1st British African colony to win independence (1957).

Nkrumah espousedpan African socialism.

High tariffs.

Anti export (trade)policy.


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The Impact of Trade Policies

Ghana

1970GNP/capita

$2501992GNP/per capita

$450

GNP Growth/year

1.5%Shift from productive uses(cocoa) to unproductive uses(subsistence agriculture).

Korea1970

GNP/per capita

$2601992

GNP/per capita

$6790GNP Growth/year

9%Shift from non-comparativeadvantage uses (agriculture) toproductive uses (labor-intensivemanufacturing).

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ReasonsGhana was not involved in international trade

South Korea actively participated in international

trade (trade account to 74% south Korea's GNP)


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Mercantilism: mid-16th century

A nations wealth depends on accumulated treasure

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Gold and silver are the currencyof trade.

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Theory says you should have a trade surplus.

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Maximize exportsthrough subsidies.

Minimize imports through tariffsand quotas.

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Thomas Mun(1630) was one of theproponent of thetheory.

The classical economist David Hame (1752)pointed

our the inherent inconsistency in this doctrine.A nations wealth depends on accumulated treasure

Gold and silver are the currency of trade.


Maximize exports through subsidies.Minimize imports through tariffsand quotas.

Flaw: zero-sum game.

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Theory of Absolute AdvantageAdam Smith: Wealth of Nations (1776).

Capability of one country to producemore of aproduct with thesame amount of input thananother country.

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Produce only goods where you aremost efficient,tradeforthose where you are not efficient.

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Produce only goods where you aremost efficient,tradeforthose where you are not efficient.

Assumes there is an

absolute advantage balance among nations, e.g.,Ghana/cocoa.

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TheTheory of Absolute Advantage and the Gains from

Trade (200 Units of Resources)

Production and Consumption without Trade

S. Korea 2.5 10.0

Total production 20

S. Korea 6.0 14.0

Resources Required to Produce 1 Ton of Cocoa and RiceCocoa Rice

Ghana 10 S. Korea 40 10

Ghana 10.0 5.0

Total production 12.5 15.0Production with Specialization

Ghana 20 S. Korea 0

Consumption after Ghana Trades 6Tof Cocoa for 6TSouth Korean RiceGhana 14.0 6.0

Increase in Consumption as a Result of Specialization andTrade

Ghana 4.0 1.0S. Korea 3.5 4.0


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Theory of Comparative AdvantageDavid Ricardo: Principles of Political Economy (1817).

Propounded by David Ricardo in his 1817 bookPrinciples of political economy.

Should trade even if countryis more efficient in theproduction than its trading partner.

Assumptions: (200 unitsof resourceseach)

1. Ghana requires10 resourcesto produce 1 tonofcocoa and 131/3 resourcesto produce 1 tonof rice.

2. South Korea requires40 resourcesto produce 1 tonof cocoa and 20 resourcesto produce 1 tonof rice.

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Comparative Advantage and the Gains from Trade

S. Korea 40 20

S. Korea 2.5 5.0

S. Korea 0.0 10.0

S. Korea 4

Resources Required to Produce 1 Ton of Cocoa and Rice

Ghana 10 .33

Production and Consumption without TradeGhana 10.0 7.5

Total production 12.5 1Production with Specialization

Ghana 15 3.75

Total production 15 Consumption after Ghana Trades 4Tof Cocoa for 4TSouth Korean Rice

Ghana 11 .75

Increase in Consumption as a Result of Specialization andTradeGhana 1.0 0.25S. Korea 1.5 1.0

Cocoa Rice


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Heckscher (1919)-Olin (1933)Theory

Labor is not the only Factor of production. Weneed to account for land, capital, and

technology.

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Factorendowments: extent to which a countryis endowed with such resources as land, labor,

and capital.

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Export goods that intensively use factorendowments which are locally abundant.

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Export goods that intensively use factorendowments which are locally abundant.

Corollary: import goods made fromlocally scarce factors.

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Patterns of trade aredetermined bydifferences in factorendowments - not

productivity.Remember, focus on relative advantage, notabsolute advantage.

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The Leontief Paradox, 1953

Disputes Heckscher-Olin in some instances.

Factorendowments can be impacted bygovernment policy - minimum wage.

US tends to export labor-intensiveproducts, butis regarded as a capital intensive country.

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Product Life-CycleTheory(Raymond Vernon, 1966)

Article in the Quarterly Journal of Economics.

Asproductsmature, both location of salesand optimalproduction changes.

Affectsthedirection and flow of importsandexports.

Globalization and integration of theeconomy makesthistheory lessvalid.

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The New

Trade

Theory

Began to berecognized in the 1970s.

Deals with thereturns on specialization wheresubstantial economies of scale arepresent.

Specialization increases output, ability to enhanceeconomies of scale increase.

In addition to economies of scale, learning effects alsoexist.

Learning effects are cost savings that come fromlearning by doing.

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Porters Diamond(Harvard Business School, 1990)

The Competitive Advantage of Nations.

Looked at 100 industries in 10 nations.

Thought existing theories didnt go farenough.Question: Whydoes a nation achieve internationalsuccess in a particular industry?

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Determinants of NationalCompetitive Advantage

Factorendowments:nations position in factors ofproduction such as skilled labor or infrastructurenecessary to compete in a given industry.


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Demand conditions:the nature of homedemand for theindustrys product or service.


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Demand conditions:the nature of homedemand for theindustrys product or service.

Related and supporting industries:thepresence orabsence in a nation of supplier industries orrelated

industries that are nationally competitive.


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Factorendowments:nations position in factors ofproduction such as skilled labor or infrastructure necessaryto compete in a given industry.Demand conditions:the nature of homedemand for theindustrys product or service.Related and supporting industries:thepresence or absencein a nation of supplier industries orrelated industries thatare nationally competitive.

Firm strategy, structure andrivalry:the conditions inthe nation governing how companies are created,organized, and managed and the nature of domesticrivalry.


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Porters DiamondDeterminants of National Competitive Advantage

Factor Endowments

Firm Strategy,Structure and

Rivalry

Demand Conditions

Related andSupportingIndustries

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The Diamond

Success occurs where these attributes exist.

More/greater the attribute, the higher chance ofsuccess.

Thediamond is mutually reinforcing.

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Determinants ofNational Competitive Advantage

GovernmentGovernment

Company Strategy,Structure,and Rivalry

DemandConditions

Relatedand Supporting

Industries

FactorConditions

ChanceChance

Two externalfactors thatinfluence thefourdeterminants.

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Factor Endowments

Taken from Heckscher-OlinBasic factors:

natural resourcesclimate

locationdemographics

Advanced factors:communications

skilled laborresearchtechnology

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Advanced Factor Endowments

More likely to lead to competitiveadvantage.

Are theresult of investment by people,companies, government.

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Relationship of Basic to AdvancedFactors

Basic can provide an initial advantage.Must be supported by advanced factors tomaintain success.

No basics, then must invest in advanced factors.

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Demand ConditionsDemand creates the capabilities.

Look for sophisticated anddemanding

consumers.impacts quality and innovation.

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Related and Supporting IndustriesCreates clusters of supporting industries that areinternationally competitive.

Must also meet requirements of otherparts of eDiamond.

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Firm Strategy, Structure andRivalry

Management ideology can either help or hurt you.Presence of domestic rivalry improves a companyscompetitiveness.

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unit 2 trade_theory-new[1]

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