INTRODUCTION:
Economic theories of international trade are a sub-field of economics used to describe, frame and understand the international trade and analyses the dynamics of international trade, its roots and the consequences for its welfare.
CLASSICAL THEORIES OF INTERNATIONAL TRADE:
(1) Mercantilism:
The term Mercantilism was coined and made famous by economist Adam Smith. The term describes the close link between economy of a nation and trade. The mercantilist theory was developed in the 16th century and was popular and used till the 17th century. This theory was meant for a nation’s welfare i.e. has a nationalist outlook. Mercantilism boosted nation’s economy through centralised economic activities and few beneficial state regulations.
According to the mercantilism theory, a country’s wealth can be described by its stock of precious metals like gold and silver. The more accumulation of these metals meant that is country is rich, wealthy, prosperous and powerful and the country maintained this position by importing less gold and silver and exporting more.
The underline principle of mercantilism was that one gains at the cost of others or in other words one’s gain is the loss of another. According to this theory, the nation and its government should take all possible steps to increase the export of gold and silver and reduce the import. Not all nations had the same amount of resources so for mercantilists, the objective of foreign trade was considered to be achievement of surplus in the balance of payments. Hence, they advocated achieving as high trade surplus as possible. When trade is done few, trade related relevant issues
are to be addressed i.e. gains from the trade and term and structure of the trade. The theory of mercantilism failed to address and answer these trade issue as the basic drawback of mercantilism was the it counted export surplus of precious metals as an indicator of economic position and welfare.
(2) Absolute Cost Advantage Theory
Adam Smith came up with the theory of Absolute Cost Advantage Theory and is based on the principle of absolute advantage. This theory first came up with the idea and the importance of mutually beneficial and free trade among trading nations for increasing wealth of these nations. According to this theory, a nation should specialise and trade a commodity or service in which it experiences maximum absolute cost advantage. Absolute advantage can be the basis for large gains from trade between producers of different goods with different absolute advantages. The theory of absolute cost advantage is based on few assumptions made by Adam Smith and it therefore has a few drawbacks to it.
The production of a commodity or service has multiple factors associated to it and according to Adam Smith these factors of production won’t change in a country by the influence of other country. The theory also assumes that there would exist no trade barriers between two countries and there will also be a trade balance in terms of surpluses or trade deficits between two trading nation.
The major drawback of this theory was that it assumes that each and every trading nation has an absolute cost advantage in some commodity which is not always true especially in the case of developing countries and does not considers that point that a nation can have specialisation in one or more commodity but not absolute advantage and this assumption had caused a setback for trade in developing nations.
(3) Comparative Cost Advantage Theory
David Ricardo formulated the theory of comparative cost advantage in the year 1817 in his publication Principles of Political Economy and Taxation. The theory is based on the principle of
comparative cost and it states that a nation should export a commodity in which it has the greatest comparative cost advantage and import the rest i.e. least comparative cost advantage. It may overstate the benefits of specialisation by ignoring a number of costs. These costs include transport costs and any external cost associated with trade, such as air and sea pollution.
David Ricardo’ theory failed to work in the practical world for long because it assumes the world to be a place of perfect competition and it assumes that the factor of production won’t change over time and country to country. It also fails to accommodate the extra costs of production in its theory like transport cost or lost product cost. The theory also failed to comment on what the terms of the trade would be i.e. reciprocal trade wasn’t acknowledged, understood and inculcated in the theory thus, making this a major drawback. It was J. S. Mill who discussed this issue in detail his theory of reciprocal demand. It is the reciprocal demand that determines the terms of trade which, in turn, determines the relative share of each country.
MODERN THEORY OF INTERNATIONAL TRADE
Swedish Economists Eli Hecksher and Bertil Ohlin formulated the extended theory of comparative advantage called the Heckscher and Ohlin theory. The Hecksher and Ohlin theory is the one which introduced the capital as a factor of production and stated that the differences between the factor endowments in two nations leads to comparative advantage. Although factor endowments is meant in relative terms and the theory itself is based on few assumptions such that no consideration of transport cost and that the wants of people of each country is same and the factors of production are immobile.
According to the theory, the nations will import and export two types of goods labour extensive and capital intensive. The countries where labour is largely available and is cheap, they will export capital intensive goods and import labour extensive goods and the countries where cost of production is low and revenue is high but labour is costly will export labour intensive goods and import capital intensive goods. The theory is based on the concept of prize equalization which concludes that free international trade leads to equal prices in terms of commodities and factors.
NEW THEORIES OF INTERNATIONAL TRADE
The new theories of trade were based on technical innovations and gaps across firms, trade between identical countries which are exporting & importing similar but differentiated products and these theories are based on policies that cause national economic welfare and protection of home markets.
a) Kravis Theory of Availability- Kravis came with a new theory of trade called the Kravis theory in 1956 which emphasized and formulated the idea and concept that trade is done according to the availability of goods in the nations. The availability of a good in a country depends on its natural resources’ other resources. Goods that are produced domestically and have an elastic supply in a country are exported by the country. According to Kravis, the trade among nations occurs because not all goods have elastic supply in each and every country, the difference of supply in countries leads to international trade demand. Therefore, in conclusion, the goods that are exported in a country are those will be in abundance and readily available and import of non-available goods are done.
b) Posner’s Technological Gap Theory- M.V. Posner developed and formulated the theory in the year 1961which on based on the concept that technological change is a continuous process and it was termed as Posner’s technological gap theory. According to the theory, trade arises due to the technological gaps that are present between two countries even if the two countries have the same needs and wants for a commodity and also possess the same factors of production. This theory is based on few assumptions such as trade occurs only between two countries at a time and that these countries have similar to identical demands and factor endowments although they have different techniques.
c) Vernon’s Product Cycle Theory- Vernon developed the theory of product cycle and is based on a concept that each and every product that is in production has its very own life cycle or lifespan that it goes though during the time of development. Some products linger in one stage longer than others, but they all eventually progress through the cycle from start to finish. Vernon’s model is a generalization and extension of the technological gap model.
Author – Aditi Kamble Symbiosis Law School, Pune
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