Essay on International Trade !
Economic relations among different countries are considered as international economics. External economics or international economics deal with those international forces which influence the domestic economic conditions as well as those which shape the economic relationship among nations. The external economics deals with the foreign trade, foreign exchange markets, balance of payments and the international monetary system which is related with exchange rates and international resource flows. International or foreign trade is an important aspect of International Economics.
International Trade:
In modern times no country is self sufficient and has to depend on other countries for the import or export of raw materials and other essential and capital goods for the proper development of its economy. Trade among different countries is considered to be ‘international trade’, ‘foreign trade’, ‘world trade’ or ‘global trade’.
Adam Smith:
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In support of International Trade, Adam Smith the father of economics says that trade between the countries would be mutually beneficial if one country could produce one commodity at an absolute advantage over the other country and the other country could, in turn, produce another commodity in an absolute advantage over the first.
Basing on free trade, Adam Smith explains the advantage of trade between countries through his Absolute Cost Theory. He observes, “Whether the advantage which one country has over another, be natural or acquired is in this respect of no consequence. As long as the one country has those advantages, and the other wants them, it will always be more advantageous for the latter, rather to buy of the former than to make”.
According to his theory, if France produces 10 units of wine and 4 units of cloth per a unit of labour and the England produces 3 units of wine and 7 units of cloth per a unit of labour, France has an absolute advantage in the production of wine over England and England has an absolute advantage in the production of cloth over France.
Hence, according to Adam, France should specialise in the production of wine and meet its requirement of cloth through import from England. On the other hand, England should specialise in the production of cloth and should obtain wine from France. Such trade would be mutually beneficial.
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According to Smith, three kinds of advantages accrue to a country from international trade:
(i) Productivity gain (ii) absolute cost gain, and (iii) vent for surplus gain.
David Ricardo:
Later, David Ricardo also supported the International Trade by his ‘Comparative Cost Theory’. He maintained that if trade is left free, each country, in the long run, tends to specialise in the production and export of those commodities in whose production it enjoys a comparative advantage in terms of real costs, and to obtain by importation those commodities which could be produced at home at a comparative advantage in terms of real costs and that such specialisation is to the mutual advantage of the countries participating in it.
Ricardo illustrates the Comparative Cost Theory, using a two-country and two-commodity model, shows that trade between nations can be profitable even if one of the two nations can produce both the commodities more efficiently than the other nation, provided that it can produce one of those commodities with comparatively greater efficiency than the other commodity.
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The law of comparative advantage indicates that a country should specialise in the production of those goods in which it is more efficient and leave the production of the other commodity to the other country. The two nations will then have more of both goods by engaging in trade.
Ricardo explained his theory through a hypothetical example of production costs of cloth and wine in England and Portugal. England produces a unit of cloth with 100 units of labour and a unit of wine with 120 units of labour while Portugal produces a unit of cloth with 90 units of labour and a unit of wine with 80 units of labour. From this, it seems that Portugal has an absolute superiority in production of both cloth and wine.
However, a comparison of the ratio of the cost of production of wine (80/120) with the ratio of the cost of production of cloth (90/100) in both the countries reveals that though Portugal has an absolute superiority in both the branches of production it will pay her to concentrate on the production of wine in which she has comparative advantage over England, while importing cloth from England which has a comparative advantage in cloth production. England will gain by specialising in producing cloth and selling it in Portugal in exchange for wine.
According to Ricardo’s Comparative Cost Theory, free and unrestricted trade among nations encourages specialisation on a large scale and brings the following advantages.
(i) The most efficient allocation of world resources as well as maximisation of world production.
(ii) A redistribution of relative product demands resulting in greater equality of product prices among trading nations; and
(iii) A redistribution of relative resource/demands to correspond with relative product demands, resulting in relatively greater equality of resource prices among trading nations.
The Ricardian theory of comparative costs has been elaborated with reciprocal demand and with the introduction of money, Gottfried Haberler has attempted to restate the theory of comparative costs in terms of opportunity costs.
Heckscher — Ohlin:
Eli Heckscher and Bertel Ohlin developed the ‘factor Endowment Theory’ or ‘general Equilibrium Theory’ of International Trade. Paul Samuelson and Wolfgang Stolper have further developed this theory. They have traced the cause of cost differences to relative factor endowments and relative factor intensities. They have put forward the view that since countries differ in their factor endowments and also employ factors for production of exports in different intensities, there is scope for gains in international trade. According to this theory, a country will specialise in the production and export of goods whose production requires a relatively large amount of the factor with which the country is relatively well endowed.
Regions or countries differ from one another in respect of resource endowments or availability of factors. One country may have an absolute of capital while labour may be scarce. On the opposite, there may be an abundance of labour in another country while capital may be scarce. According to this theory, countries which are rich in labour will export labour – intensive goods and those which are rich in capital will export capital – intensive goods.
The factor price equalisation theorem states that free international trade equalises factor prices between countries relatively and absolutely, and this serves as a substitute for international factor mobility. International trade increases the demand for abundant factors (leading to an increase in their prices) and decreases the demand for scarce factors (leading to a fall in their prices) because when nations trade, specialisation takes place on the basis of factor endowments.
W.F. Stolper and Paul A. Samuelson states that “international trade necessarily lowers the real wage of the scarce factor expressed in terms of any good”. In short, free international trade will benefit the relatively abundant factor and hurt the relatively scarce factor of production.