Trade theory Flashcards
Trade theory definition
trade theory explains why trade occurs and the patterns of trade.
Trade theories
Mercantilism, Absolute advantages (Smith), Comparative advantage (Ricardo), Product life cycle (Vernon), National diamond of competitiveness (Porter), Heckerscher-Olhin.
Mercantilism
- Idea that politics and economics go hand in hand.
- Countries should export more and import less - aim for balance of trade surplus where the value of exports exceeds the value of imports.
- some countries are accused of neo-mercantilism like China and USA.
How is China Mercantilist?
China tries to devaluate its currency so goods become cheaper to people in other countires. This makes exports more competitive.
Dangers of Mercantilism
- Trade war risk
- In the long term can be a zero sum deal.
eg. Apple making and selling in China: exporting becomes cheaper as manufactured cheap so sell for cheap. Apple need fewer dollars in US then translate to your sales in home currency. In a market with a devalued currency you may be able to sell more but it actually compares to less in US dollars.
Absolute advantages
- Countries should produce what they are most efficient at
- Beginning of positive-sum - gains from trade as you focus on your efficiency.
- Specialise in what you are good at and leave other things to other countries.
- Do not make at home what you can make cheaper elsewhere.
- theory can be problematic - some countries are efficient at everything.
Comparative advantage
- Focus more on relative efficiency - abolute power
- Both countries gain so positive sum game again
- World welfare and production greater with specialisation and free trade than without.
- Theory underpinned by lots of assumptions - no exchange rates, no cost of transportation
Absolute Vs Comparative advantage example
Max output Japan, cars -120m, motorcycles - 400m
Max output US, cars - 100m, motorcycles - 50m
japan has an absolute advantage over the US in both cars and motorcycles but has a better comparative advantage in motorcycles so Japan should produce motorcycles and import cars from the US.
Heckscher-Ohlin Theory
- Absolute and comparative advantage based on productivity and productive efficiency.
- HO theory based on factor endowments - countries specialise in goods in which their factory endowments give them a competitive advantage.
- competitive advantage arises from differences in national factor endowments. e.g China exports labour-intensive products.
Leontif’s Paradox (1953)
- Weak empirical evidence of the HO theory, US is a capital-intensive country and imports more capital-intensive goods than it exports.
- Why? producing in the US is more expensive than in other countries then importing back into your home country.
- The paradox says that as a result of globalization, you actually have a lot of outsourcing to cheaper countries.
Product life cycle (Vernon)
- Explains the pattern of trade - how exporting countries become importers over time.
- Tracks the cycle of new products.
- Different stages = different strategic and trade implications.
- Some limited explanatory power today - not every innovation starts in advanced countries.
What challenges do the trade theories pose to countries?
Absolute advantage: challenges for developing countries to break entry
Trade blocs - expensive
All theories emphasize specialisation for countries which mean they are dependant on other countries which comes with its own issues.
dutch disease - discovery of natural resources and focus on those resources so they detriment other sectors of the economy.
Strategic trade policy
- Policies adopted to affect the strategic interaction between firms in the international arena.
- Governments can implement policies to enhance a nation’s competitive advantage
Embraer’s story
- Large makers of airplane jets created out of a military coup where the govermment invested in this company because they did not trust airplanes coming from outside of Brazil.
- They became a dominant player in the airline industry, 3rd largest producer of civil aircraft.
- Initiative taken by the Brazilian government is an example of strategic trade policy.
Porter’s diamond: National competitive advantage
- Shows four attributes of a nation that shape the environment in which local firms compete.
- Attributes promote or impede the creation of competitive advantage.
- Explains why some countries are more ocmpetitive than others in certain industries or products/services.
- Four attributes can be affected by chance and government policy: firm strategy structure and rivalry, demand conditions, factor endowments, related and supporting industries.
all these four factors must be present in a country for it to dominate a market.
