Session 5: International Trade Theories Flashcards
Trade Surplus vs. Trade Deficit
Trade Surplus: Exports > Imports
Trade Deficit: Imports > Exports
US imposed 25% tariff on imports of steel, 10% on imports of aluminium, why?
+ Protect industries key for national security
+ Create/protect manufacturing jobs
+ Achieving a trade surplus (the country’s exports exceed its imports)
- Some of the US largest exporters hit by higher costs of inputs (e.g. Boeing)
- Only 140K American employed in steel and aluminium manufacturing vs 6.5 million in industries using those as inputs
- Free international trade traditionally linked to economic growth
Is trade surplus good or bad?
Trade surplus may lead to economic and employment growth within a nation, but it can also result in increased product prices and interest rates that could affect internal industrial activities, domestic currency value in the foreign markets, and export capacity.
Trade Policy
- domestic industries, employment, and prices
- international competitiveness of national actors, currency, export capacity
Promoting either free trade or protectionist measures as means to increase/decrease trade deficit (or surplus)
International Trade Policies:
Shaped by Centuries of International Trade Theory
Mercantilism definition
Mercantilism advocated that governments
should simultaneously encourage exports and
discourage imports.
Mercantilism
- Gold and silver the currency of trade between countries and foundational of national wealth and commerce
- Maintaining a trade surplus is crucial: it allows accumulating gold and silver (and therefore power and wealth)
- Trade Policies:
✓ Government intervention to achieve surplus
✓ Volume of trade does not matter
✓ Export maximization and import minimization through tariffs and quotas
Mercantilism: Rooted in Colonialism
England, France, Spain, Portugal: Extract as much wealth as possible from the colonies without investing much into them.
→Monopoly of extraction, shipping, and marketing of goods from the colonies
→Economic activities in the colonies contributing to positive trade balance
Examples:
* Strict Mercantilism: Maximization of resource extraction from New France (Quebec)
* Moderate Mercantilism: English colonies (Canada and US) under the Hudson’s Bay Company (a monopoly by the English crown on trading rights in all the land whose rivers drained into Hudson Bay)
What are the key limitations of mercantilism?
- Constant inflow of gold and silver resulting in rising domestic inflation over time
- Higher domestic prices making domestically produced
goods too expensive for foreign buyers, deteriorating export capacity - Vision of trade as a zero-sum game: You either win or lose
→ Delaying socio-economic development of colonial territories and determining uneven growth
Adam Smith’s theory of absolute advantage
- Proposed in 1776, Smith’s theory was the first to explain why unrestricted free trade is beneficial to a country.
- Free trade refers to a situation where a government does not attempt to influence what its citizens can buy and sell
→ Comparing to mercantilism: I don’t care about trade surplus of deficit, but rather about growing the volume of trade
What does the theory of absolute advantage state?
- Case of the English textile industry and French wine industry
- A country has an absolute advantage in the production of a product when it is more efficient than any other country at producing it.
- Countries should specialize in producing goods for which they have an absolute advantage and then trade those products with other countries.
- A country should never produce goods at home that it can buy for lower prices abroad
Building on Smith’s work are additional theories:
- Theory of comparative advantage, by David Ricardo
- Heckscher–Ohlin theory, which refines Ricardo’s work
Comparative Advantage (Ricardo, 1817)
- It makes sense for a country to also buy goods from other countries that it could produce more efficiently itself. Why?
- A country could have absolute advantage at producing multiple goods; but it might be comparatively more efficient at producing just one of those goods. It could make sense to focus on producing the good for which it has comparative advantage, while importing other products for which it has less advantage
Heckscher-Ohlin Theory (1919-1933)
- Predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce.
- The theory highlights the importance of factor endowments: the extent to which a country is endowed with resources (land, labour, capital)
→ The more abundant a factor, the lower its cost - Like Ricardo’s theory, the Heckscher–Ohlin theory argues that free trade is beneficial.
- Unlike Ricardo’s theory, the Heckscher–Ohlin theory argues that international trade patterns are determined by differences in factor endowments, not differences in productivity
Relevance
The great strength of the theories of Smith, Ricardo, and Heckscher–Ohlin is that they identify with precision the specific benefits of international trade and help explaining trade patterns.
