2 International Trade Theory

1. Dominant trade theory in the 1600s and 1700s

2. International trade seen as a zero-sum game

3. Main goal: maintain a trade surplus (export more than import)

4. Accumulation of gold and silver as source of national wealth

5. Largely discredited today, but trade balance is still used as a performance indicator

1. A country has an absolute advantage if it can produce a good more efficiently (higher productivity) than another country

2. Countries specialize in goods where they have an absolute advantage

3. Trade benefits all countries through specialization

Criticism:

4. Macroeconomic perspective (countries, not firms)

5. Only two countries and two products

6. Ignores transport costs, information costs and exchange rates

1. A country has a comparative advantage if it has a lower opportunity cost in producing a good

2. Trade is beneficial even if one country is less efficient in all goods

3. Countries specialize where they are relatively less inefficient

Criticism:

4. Macroeconomic perspective

5. Only two countries and two products

6. Assumes full specialization and ignores real-world complexities

1. Countries develop comparative advantage based on their abundant factors of production

2. Countries export goods that use their abundant factors intensively

3. Typical factors: labor, capital, land

4. Example: India → labor-intensive services (call centers)

1. Empirical test of the Heckscher–Ohlin (factor endowment) theory in the early 1950s

2. Hypothesis: Capital-abundant countries (like the USA) export capital-intensive goods

3. Finding: The USA exported labor-intensive goods instead of capital-intensive ones

4. This contradiction between theory and reality is called the Leontief Paradox

5. Explanation: US labor is highly skilled (human capital) and Leontief measured labor quantity, not productivity

1. First dynamic trade theory – explains how trade patterns change over time

2. Countries are divided into three categories:

   • Lead innovation nation

   • Other developed nations

   • Developing nations

3. Products pass through three stages:

   • New

   • Maturing

   • Standardized

4. Production initially takes place in the innovating country, then shifts to other developed and later to low-cost developing countries

Criticism:

5. Not every technology is attractive outside the country of origin

6. No empirical insight into the exact length of stages

7. Assumptions are partly outdated (simultaneous global product launches possible)

1. Suggests that government intervention in trade can be legitimate

2. Applies to industries with high entry barriers (capital-intensive, high R&D costs)

3. Governments may use subsidies to help domestic firms gain or keep a competitive advantage

4. Focuses on industries with strong first-mover advantages (e.g. aircraft industry)

Criticism:

5. Impractical: assumes governments have detailed cost information

6. Assumes governments make fully rational decisions

7. Difficult to distinguish strategic vs. non-strategic industries