Trade theories in International Business

International Trade Theories
Presented By:
Jatin Vaid
jatinvaid@gmail.com
1International Business - Jatin Vaid

Introduction
 Trade theories explain trade patterns
(Quantity, range of products and countries)
 Laissez – faire approach: Allows market forces
to determine trade relations
 Interventionist approach: Propagates
government intervention.

Theories
I. Mercantilism
II. Absolute Advantage
III. Comparative Advantage
IV. Heckscher – Ohlin Theory
V. International Product Life Cycle Theory
VI. New Trade Theory

I. Mercantilism
 England – Mid 16th century
 A country’s wealth is measured by its holdings
of gold.
 Countries should export more than they
import.
 Gold empowered governments to invest in
armies & national institutions.
 Intended to benefit colonial powers.

.
 It was in best interest of countries to maintain
trade surplus.
 Imports limited by tariffs; Exports subsidized.
 IB treated as a zero – sum game (i.e., win –
loss)

II. Absolute Advantage
 Adam Smith in his book “Wealth of nations”,
1776.
 Real wealth of nation consists of goods &
services available to its citizens, in their quality
of living.
 Different countries produce some goods more
efficiently than other countries.
 Global efficiency can increase through free
trade.

.
 Buy V/S Build : Buy whatever you can’t
produce efficiently than others.
 Such specializations will give a country
competitive advantage.
 National resources will shift to more efficient
industries.
 Overall efficiency will increase due to :
i. Economies of specialization
ii. Labor time saved from job switching
iii. Economies of scale

.
 Natural Advantage: Climatic conditions, access
to natural resources, etc.
 Acquired Advantage: Product / process
technology, Research & Development, Skilled
manpower, etc.

III. Comparative Advantage
 David Ricardo, 1817.
 Global efficiency gains may still result from
trade if a country specializes in those products
it can produce more efficiently than other
products – regardless of whether other
countries can produce those same products
even more efficiently.

.
 A country gains if it concentrates its resources
in producing products it can produce most
efficiently.
 Trade considered to be a positive – sum game.

IV. Heckscher – Ohlin Theory
• Swedish economists, Eli Heckscher & Bertil
Ohlin (1991 – 1993)
• Patterns of international trade is determined
by differences in factor endowments, rather
than differences in productivity.
• Comparative advantage arise from difference
in national factor endowment.

.
 Factor endowments: the extent to which a
country is endowed (gifted) with resources
like land, labour and capital.
 Commonsensical approach to free trade.
 E.g., USA – Exporter of agricultural goods
(abundance of agricultural land);
China – Exporter of textiles and footwear
(Abundance of low cost labour)

.
 Factor endowment theory suggests 3 types of
relationships:
i. Land – Labour relationship
ii. Labour – capital relationship
iii. Technological complexities

V. International Product Life Cycle
Theory
 Raymond Vernon, 1996
 International markets tend to follow a cyclical
pattern due to a variety of factors over a
period of time, which explains the shifting of
markets as well as the location of production.

.
 It explains the variations & reasons for change
in production and consumption patterns
among various markets over a time period.

.

Thank You!

Trade theories in International Business

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Trade theories in International Business