Revised Edition: 2016 ISBN 978-1-280-15700-4 © All rights reserved. Published by: College Publishing House 48 West 48 Street, Suite 1116, New York, NY 10036, United States Email: [email protected] Table of Contents Chapter 1 - Introduction to International Trade Chapter 2 - Heckscher-Ohlin Model Chapter 3 - New Trade Theory and Gravity Model of Trade Chapter 4 - Mercantilism Chapter 5 - Balance of Trade Chapter 6 - Absolute Advantage and Comparative Advantage WT Chapter 7 - International Trade Law and Monopolistic Competition in International Trade Chapter 8 - Globalization Chapter 9 - Proto-globalization Chapter 10 - International Trade Chapter 11 - Free Trade Chapter 12 - Free Market ____________________WORLD TECHNOLOGIES____________________ Chapter- 1 Introduction to International Trade WT Global Competitiveness Index (2008-2009): competitiveness is an important determinant for the well- being of states in an international trade environment. International trade is exchange of capital, goods, and services across international borders or territories. In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders. ____________________WORLD TECHNOLOGIES____________________ International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture. WT International trade uses a variety of currencies, the most important of which are held as foreign reserves by governments and central banks. Here the percentage of global cummulative reserves held for each currency between 1995 and 2005 are shown: the US dollar is the most sought-after currency, with the Euro in strong demand as well. Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in goods and services can serve as a substitute for trade in factors of production. Instead of importing a factor of production, a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the ____________________WORLD TECHNOLOGIES____________________ import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor. International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics. WT Ancient silk road trade routes across Eurasia Models Several different models have been proposed to predict patterns of trade and to analyze the effects of trade policies such as tariffs. ____________________WORLD TECHNOLOGIES____________________ Ricardian model WT The Panama Canal is important for international sea trade between the Atlantic Ocean and the Pacific Ocean. The Ricardian model focuses on comparative advantage, perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods. Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The main merit of Ricardian model is that it assumes technology differences between countries. Technology gap is easily included in the Ricardian and Ricardo-Sraffa model. The Ricardian model makes the following assumptions: 1. Labor is the only primary input to production (labor is considered to be the ultimate source of value). ____________________WORLD TECHNOLOGIES____________________ 2. Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to scale, and simple technology.) 3. Limited amount of labor in the economy 4. Labor is perfectly mobile among sectors but not internationally. 5. Perfect competition (price-takers). The Ricardian model measures in the short-run, therefore technology differs internationally. This supports the fact that countries follow their comparative advantage and allows for specialization. Heckscher-Ohlin model In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the Heckscher- Ohlin theory. The Heckscher-Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since those theories focus on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialize production and export using the factors that are most abundant, and thus the cheapest. Not to WT produce, as earlier theories stated, the goods it produces most efficiently. The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory. The theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. Empirical problems with the H-O model, known as the Leontief paradox, were exposed in empirical tests by Wassily Leontief who found that the United States tended to export labor intensive goods despite having a capital abundance. The H-O model makes the following core assumptions: 1. Labor and capital flow freely between sectors 2. The production of shoes is labor intensive and the production of computers is capital intensive 3. The amount of labor and capital in two countries differ (difference in endowments) 4. Free trade 5. Technology is the same across countries (long-term) 6. Tastes are the same. The problem with the H-O theory is that it excludes the trade of capital goods (including materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to each country. In a modern economy, capital goods are traded internationally. Gains from trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001). ____________________WORLD TECHNOLOGIES____________________ Reality and Applicability of the Heckscher-Ohlin Model The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists, because it makes fewer simplifying assumptions. In 1953, Wassily Leontief published a study, where he tested the validity of the Heckscher-Ohlin theory. The study showed that the U.S was more abundant in capital compared to other countries, therefore the U.S would export capital- intensive goods and import labour-intensive goods. Leontief found out that the U.S's export was less capital intensive than import. After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or either by new interpretations. Leamer emphasized that Leontief did not interpret HO theory properly and claimed that with a right interpretation paradox did not occur. Brecher and Choudri found that, if Leamer was right, the American workers consumption per head should be lower than the workers world average consumption. Many other trials followed but most of them failed. Many famous textbook writers, including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model. After examining the long history of empirical research, Bowen, Hollander and Viane WT concluded: "Recent tests of the factor abundance theory [H-O theory and its developed form into many-commodity and many-factor case] that directly examine the H-O-V equations also indicate the rejection of the theory." Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems. The assumptions of HO are less realistic with respect to N-S than N-N (or S-S) trade. Income differences between North and South is the one that third world cares most. The factor price equalization [a consequence of HO theory] has not shown much sign of realization. HO model assumes identical production functions between countries. This is highly unrealistic. Technological gap between developed and developing countries is the main concern of the poor countries. Specific factors model In this model, labor mobility between industries is possible while capital is immobile between industries in the short-run. Thus, this model can be interpreted as a 'short run' version of the Heckscher-Ohlin model. The specific factors name refers to the given that in the short-run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms; in other terms, the international trade is the biggest network on the earth. Additionally, owners of opposing specific factors of production (i.e. labor and capital) are likely to have opposing agendas when lobbying for controls over immigration of labor. Conversely, both owners of capital and labor profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade. ____________________WORLD TECHNOLOGIES____________________ New Trade Theory New Trade Theory tries to explain empirical elements of trade that comparative advantage-based models above have difficulty with. These include the fact that most trade is between countries with similar factor endowment and productivity levels, and the large amount of multinational production (i.e. foreign direct investment) which exists. New Trade theories are often based on assumptions like monopolistic competition and increasing returns to scale. One result of these theories is the home-market effect, which asserts that, if an industry tends to cluster in one location because of returns to scale and if that industry has high transportation costs, the industry will be located in the country with most of its demand to minimize. Gravity model The Gravity model of trade presents a more empirical analysis of trading patterns rather than the more theoretical models discussed above. The gravity model, in its basic form, predicts trade based on the distance between countries and the interaction of the countries' economic sizes. The model mimics the Newtonian law of gravity which also considers distance and physical size between two objects. The model has been proven to be empirically strong through econometric analysis. Other factors such as income level, diplomatic relationships between countries. WT Ricardian theory of international trade (modern development) The Ricardian theory of comparative advantage became a basic constituent of neoclassical trade theory. Any undergraduate course in trade theory includes expansions of Ricardo's example of four numbers in for form of a two commodity, two country model. This model was expanded to many-country and many-commodity cases. Major general results were obtained by the beginning of 1960's by McKenzie and Jones, including his famous formula. It is a theorem about the possible trade pattern for N-country N-commoditty cases. Let a be the ij labor input coefficent for a country i and for the industry j (or for the production of good j). If a trade pattern i country specialises in i industry, then the product a a ... a 11 22 NN is strictly smaller than any permutation products of the form a a ... a 1σ(1) 2σ(2) Nσ(N) for any perumutation σ except the identity permuation which transforms i onto i. Contemporary theories Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and Samuelson. This formulation is employed for example by Matsuyama and others. These theories uses the special property which is applicable only for the two country case. ____________________WORLD TECHNOLOGIES____________________