International Trade: A Comprehensive Guide to Comparative Advantage and New Trade Theory
Causes of World Trade Growth
Decline in Transport Costs
Technological Progress
Decrease in Trade Restrictions
The Benefits of Global Free Trade
1. Absolute Advantage
– A country has an absolute advantage over others when it can produce more goods with the same amount of resources. For example, Saudi Arabia has an absolute advantage over many countries in oil production.
– Countries benefit when they export goods in which they have an absolute advantage and import goods in which they have an absolute disadvantage.
2. Comparative Advantage
– A country can benefit from international trade even if it is less efficient in all industries than other countries. (That is, even if it has an absolute disadvantage in all industries).
– Countries benefit from international trade by exporting goods in which they have a comparative advantage, specializing in the production of these goods.
What the Theory of Comparative Advantage Does Not Imply
- Not all countries benefit equally.
- Not all individuals benefit equally from trade.
- Not all countries become rich. The standard of living does not equate.
Analyzing the Theory of Comparative Advantage
– “Free trade is only beneficial to countries productive enough to withstand international competition.”
Empirical Evidence on the Theory of Comparative Advantage
The Heckscher-Ohlin Model: What Determines Comparative Advantage?
1. The HO Model Analyzes Two Facts:
- What determines comparative advantage?
- The effects of free trade on income distribution.
What Determines Comparative Advantage?
– Under certain circumstances, the HO model predicts that:
One country has a comparative advantage in goods whose production uses intensively the relatively abundant factor of production in the country.
Determine the Effects of Free Trade on Income Distribution
– The HO model predicts that:
A country benefits by exporting the good that uses intensively the relatively abundant factor of production in the country and importing the good that uses intensively the relatively scarce factor in the country.
– How is the distribution of income affected within the country?
The owners of an abundant factor in the country gain from international trade, and owners of a scarce factor in the country lose. (This result explains why trade unions in developed countries with capital-intensive industries oppose free trade with LDCs.)
– Example: USA-Mexico capital-intensive and labor-intensive. As a result of free trade, wages in the U.S. would decrease and increase in Mexico, and the rental price of capital would increase in the U.S. and decrease in Mexico.
– How is the distribution of income affected between countries? The equalization theorem of factor prices.
“In the HO model, free trade equalizes the relative price of goods and consequently also equalizes the price of production factors.”
“In the real world, factor prices are not equal, and there is a very wide range of salaries between countries (difficult to explain only by differences in the qualifications of the job). The explanation is that some crucial assumptions of the model are not met in the real world.”
The “New Trade Theory”
– The previous models (comparative advantage, HO) cannot explain the fact that trade data suggest that much trade occurs between industrialized countries in the same industry, e.g., motor cars, French wine for Italian wine, etc. Previous models suggest that international trade should be by industry and not intra-industry.
– Intra-industrial trade (IIT):
Intra-industry trade is two-way trade (exports and imports) of the same goods or similar goods. This trade represents over 50% of trade.
“IIT implies that trade is in goods whose production requires a very similar combination of factors. This trade occurs between countries that generally have very similar factor endowments.”
– The NTC suggests that a country can identify industries where it has a comparative advantage. Government policy (protection against imports, export subsidies) can develop an industry in the country to develop a comparative advantage.
“There are many models in the NTC. In models based on imperfect competition and increasing returns to scale, it is concluded that the protection of trade increases the wealth of Europe, contrary to what the theory of comparative advantage says.”
Analysis Patterns and Trade by Competitive Factors
What should each country “export?” The structure of world trade can be distinguished:
- Trade sectors: absolute and relative advantages
- Intra-sectoral trade: new trade benefits, enterprise-country strategies
Trade benefits (traditional): each country must export in the sector where it is most competitive, i.e., where its ability to export the product or service is better than its competitors (export product prices are lower than the national international price). It can be distinguished:
- Absolute advantage: each country is more competitive than any other country. It is also competitive in another product.
- Comparative advantage: potential for exchange even if a country has absolute advantages in all products if there are price differences due to differences in wages and production between countries.
The Determinants of Comparative Advantage:
- Ricardian classical model: technological differences between sectors and countries. The difference lies in being competitive in price (relative wage-productivity differed relative).
- Factor endowment model: differences in endowment and intensity of factors (labor and capital). Each country exports in the sector using intensively the factor that it has in abundance.
- Countries very gifted in labor: will be competitive in labor-intensive sectors (skilled and non-skilled)
- Countries gifted in capital: capital-intensive sectors
For example, Germany has very high salaries but is very productive technologically.
Countries with high wages compete through greater productivity.
Countries with low productivity compete through lower production costs.
Determinants of New Business Advantages/Strategies (Intra-Flows)
- Location advantage
- Dynamic commercial advantage
- Economies of scale
- Delocalization strategies
- Product differentiation
- Monopolistic competition
- Other strategies: advantages of internationalization/export
Factors Currently Internationally Competitive
- Country competitiveness
- External competitiveness
- Aggregate competitiveness
Basic Approaches for the Analysis of Competitiveness
- Traditional approach: competing prices
- Structural approach: structural competitiveness