Study of Classical and Modern theories of International Trade alongwith important MCQs !
Before proceeding to the topic let's see the relevance of this topic in the new syllabus of UGC Net Commerce examination issued by NTA.
Unit I – Business Environment and International Business
Theories of international trade tend to explain the nature and movement of international trade. Such theories can be classified into:
Classical Country-Based Theories: Mercantilism, Absolute Advantage, Comparative Advantage and Heckher-Ohlin Theory.
Modern Firm-Based Theories: Country Similarity, Product Life Cycle, Global Strategic Rivalry and Porter's National Competitive Advantage.
• This trade theory prevailed during 16th to 19th centuries.
• The wealth of a nation is measured based on its accumulated wealth in terms of gold and silver.
• Nations should accumulate wealth by encouraging exports and discouraging imports.
• Theory of mercantilism aims at creating trade surplus and in turn accumulate nation’s wealth.
• Origin in Adam Smith, ‘An Enquiry into the Nature and Causes of the Wealth of Nations’, 1776.
• When one country can produce a unit of good with less cost than another country, the first country has an absolute (cost) advantage in producing that good.
• Example - In a hypothetical two-country world, if Country A could produce a good cheaper or faster (or both) than Country B, then Country A had the advantage and could focus on specializing on producing that good. Similarly, if Country B was better at producing another good, it could focus on specialization as well.
• There is international benefit from trade – Everyone better off without making anyone worse off.
• His theory stated that a nation’s wealth shouldn’t be judged by how much gold and silver it had but rather by the living standards of its people.
• Origin in David Ricardo’s ‘The Principles of Political Economy & Taxation’, 1817.
• Nations can still gain from trade even without an absolute advantage.
• Facilitator – Difference in opportunity cost.
• A country has a Comparative Advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country compared to other countries.
• Comparative advantage focuses on the relative productivity differences, whereas absolute advantage looks at the absolute productivity.
• According to this theory, a nation will export the commodity whose production requires intensive use of the nation’s relatively abundant and cheap factors and import the commodity whose production requires intensive use of the nation’s scarce and expensive factors.
• Thus, a country with an abundance of cheap labour would export labour-intensive products and import capital-intensive goods and vice versa.
• 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. The level of innovation and technology, resources, size of market, and competitive structure influence trade patterns.
• In addition, the gap in technology and preference and the ability of the customers in international markets also determine the stage of international product life cycle (IPLC).
As propounded by Michael Porter in The Competitive Advantage of Nations, the theory of competitive advantage concentrates on a firm’s home country environment as the main source of competencies and innovations. The model is often referred to as the diamond model, wherein four determinants, interact with each other.