09 June 2005

International Trade Theories

An international trade theory can be seen as a measure to address problems in a country with a weak macro economy, high unemployment and inflation. International commitment to a free market economy will bring prosperity to the world economic system. Since 1970, the time of Adam Smith, economists have shown that free trade is efficient and leads to economic welfare.

Mercantilism – This trade theory suggested that a government can improve economic well being of the country by increasing exports and reducing imports, but turned out to be a flaw strategy.

Absolute Advantage – A country has an absolute advantage over it trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources. In the case of Zambia, the country has an absolute advantage over many countries in the production of copper. This occurs because of the existence of reserves of copper ore or bauxite. We can see that in terms of the production of goods, there are obvious gains from specialisation and trade, if Zambia produces copper and exports it to those countries that specialise in the production of other goods or services.

Comparative Advantage – A country has a comparative advantage in the production of a good or service that it produces at a lower opportunity cost than its trading partners. Some countries have an absolute advantage in the production of many goods relative to their trading partners. Some have an absolute disadvantage. They are inefficient in producing anything, relative to their trading partners. The theory of comparative costs argues that, put simply, it is better for a country that is inefficient at producing a good or service to specialise in the production of that good it is least inefficient at, compared with producing other goods.

Factor Endowment Theory - ‘Hecksher Ohlin’ theory powerfully supplements the theory of comparative advantage by bringing consideration to the endowment and cost of factors of production. The theory states that countries like China with big labour force will focus on labour intensive goods, and Sweden with more capital will focus on producing goods that are capital intensive. However the theory is criticised when taken the following into consideration:

1. Other factors – like minimum wage laws which leads to higher prices for relatively abundant labour - therefore making it cheaper to import rather than export.
2. Leontiff paradox – The United States makes export more labour intensive, this is due to the high tech products with high labour quality input rather than man hours of work e.g. level of education will also affect a country's advantage rather than its scarcity or abundance.

International Product Life-Cycle Theory (Verrons) - This theory states how a country's export can later become its import through different stages:

1. New Product stage – Initial consumption in home countries where price is inelastic and profits are high, which then go on to being sold to those willing to pay a premium price. This then goes on to being exported once local consumption runs out.

2. Maturing Product stage – Sales achieved through exports, and substitutes are being produced by local competitors. As substitute’s come into to the market, the demand for original product will fall. The firms with the new product switch from production to market protection, and tapping markets in less developed countries.

3. Standardized Product stage – Technology becomes widely diffused and available. Production shifts to low cost locations. Product becomes generic and price will become the sole determinant for demand. It is very likely that the same product may be at different stages with different versions for example cars (Japanese Toyota Avensis cars being imported into Japan).

Other considerations are government regulations, monetary valuation, currency for reporting profits, consumer tastes and branding.


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Anonymous said...

Hi, great blog, congratulations.
How do you think, undet which theory falls the launch of Apple's iPhone? Just curious, I was thinking about the international product life-cycle theort, but not sure :)

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