Faculty of Law, Aligarh Muslim University, Aligarh

International Trade Law Assignment No. 1 on

“Theories of International Trade Law”

Submitted to-

Dr. Gaurav Varshney

Submitted by

Tushar Varshney

16 [Link].B- 69

GH5631

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 CONTENT

1. Introduction

2. Theories of International Trade-

 Absolute Cost Advantage Theory

 Illustration

 Comparative Cost Theory

 Illustration

 Modern Theory

3. Conclusion

4. Bibliography

5. Webography

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 Introduction

International trade theories are simply different theories that explain international trade. Trade is
the concept of exchanging goods and services between two people or entities and it can be
among nations also.1 International trade is well known for the concept of exchange of goods
between people and entities or entities or people and two different countries.

People or entities trade with other nations because they believe that they may get some benefits
from the exchange of goods and services.2 They may need or want the goods or services. While
at the surface, this may sound very simple, there is a great deal of theory, policy, and business
strategy that constitutes international trade. An Exchange of goods across borders of a country is
known as International Trade. Different countries are good in their products and services relating
to trades. Moreover, countries rarely follow the trade structure of other nations rather they evolve
their product portfolios and trade patterns for exports and imports of commodities. The trade
patterns of a country are dynamic nature and not a static phenomenon. Moreover, the product
profile and trade partners of a country do change by time due to some seen or unseen reasons.

Theories of International Trade-

Following are the classical theories of international trade law -

1-Absolute Cost Advantage Theory

Adam Smith was the person who emphasized the importance of free trade in increasing the
wealth of all trading nations. He had a strong belief that mutually beneficial trade is based on the
principle of absolute advantage. This theory of him is based upon the assumption that there are
two trading countries, two commodities and one factor (labour) of production. Adam Smith’s
theory is based on labour theory of value, which asserts that labour is the only and important
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 [Link]
students/explore-legal-careers/practice-areas/international-trade-law/
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Dr. S.R. Myneni, International Trade Law 18(Allahabad Law Agency, Allahabad, 3 rd edn., 2014)

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factor of production of a country and that in a closed economy goods exchange for one another
according to the relative amounts of labour they concretize. A country will specialize and export
a commodity in which it has an absolute cost advantage over it is the principle of the absolute
cost advantage theory.3

Adam Smith focused on productivity and advocated free trade as a means of increasing global
productivity. As per his principles, a country’s standards of living can be intensified by
international trade with other trading countries either by importing goods not produced by such
countries or by producing large quantities of goods through specialization and exporting the
surplus. Adam Smith’s doctrine of laissez-faire is the term on which the theory of absolute
advantage is based. Laissez-faire means ‘make trade free’.4

Illustration

Let us take the example of two countries to understand the concept of absolute advantages, such
as the UK and India. Let us assume that both the countries have an equal amount of resources,
say 100 units, such as land, labour, capital, and other things required for production, which can
be employed either to produce tea or rice.

However, the production efficiency is supposed to vary between the countries because to
produce a tonne of tea, the UK requires 100 units of resources whereas India requires only 50
units of resources. On the other hand, for producing one tonne of rice, the UK requires only 40
units of resources whereas India needs 100 units of resources (Table 1.1). Since India requires
less quantity of resources in comparison to the UK for the production of tea, it is relatively more
efficient in tea production. On the other hand, since the UK requires fewer resources compared
to India for the production of rice, it is comparatively more efficient in producing rice than India.

3
. Raj Bhala, International Trade Law: An Interdisciplinary Non-Western Textbook 97 (Lexis Nexis, vol. 1, 2015)
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ibid

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Table 1.1- Absolute advantage: An Illustration

Goods UK India
Units required to produce 1 tonne of tea 100 50
Units required to produce 1 tonne of rice 40 100

Here each country possesses an equal quantity of resources but production possibilities for each
country would vary which is based on production efficiency and utilization of available
resources.

Although each country is assumed to possess equal resources, the production possibilities for
each country would vary, depending upon its production efficiency and utilization of available
resources (Fig.1).

C Production possibility curves

200
India

UK

100 A
Tea
B
50

100 200
50 125 250

Rice

Fig. 1- Production possibilities under absolute advantage

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Suppose the country UK wishes to produce one tonne of tea, it has to decrease the production of
25 tonnes of rice. If the UK wants to produce one tonne of rice it has to relinquish the production
of 4.0 tonne of tea.5

Table 1.2- Gains of specialization and trade under absolute advantage

Goods UK India Total UK India Total

Tea(tonnes) 50 100 150 0 200 200
Rice(tonnes) 125 50 175 250 0 250
325 450

Thus, both countries can mutually gain from trading between them.

2-) Comparative Cost Theory

The theory was first formulated by the English famous economist David Ricardo in his book
“Principles of Political Economy and Taxation” published in the year of 1817. Later it was
refined by Marshall, J. S. Mill, Taussig, others. Ricardo had a view that it is not the absolute but
the comparative differences in costs of good that determine trade relations between two trading
countries. According to Ricardo, the basis of international trade between countries is differences
in comparative costs. The law of comparative advantage shows that each country will specialize
in the production of those goods in which it has the greatest comparative advantage or the least
comparative disadvantage from other countries. Thus, a country will export those goods in which
its comparative advantage is the greatest and import those goods in which its comparative
disadvantage is the least.

Comparative advantage may be defined as the inability of a nation to produce a commodity more
efficiently than other countries, but its ability to produce that commodity more efficiently
compared to the other commodity. Thus the country may be at an absolute disadvantage

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concerning both the commodities but the absolute disadvantage is lower in one commodity than
another. 6

Illustration

To illustrate the concept, let us assume a situation where the UK requires 100 units of resources
for producing one tonne of tea and 50 units for one tonne of rice whereas India requires 50 units
of resources for producing one tonne of tea and 40 units for one tonne of rice (Table 1.2). In this
case, India is more efficient in producing both commodities (tea and rice). Thus, India has an
absolute advantage in the production of both the products in comparison to the UK.

Table 2.1- Comparative advantage: An illustration

Goods UK India
Units required to produce 1 tonne of tea 100 50
Units required to produce 1 tonne of rice 50 40

Here the UK does not have an absolute advantage in any of these commodities but it has a
comparative advantage in the production of rice as it can produce rice more efficiently. Countries
also gain from trade by increasing their resources for the production of goods in which they are
relatively more efficient.

In case there is no foreign trade between India and the UK (Table 2.2) and both the countries are
assumed to use equal (50:50) resources for production of each commodity, UK would produce
50 tonnes of tea and 100 tonnes of rice as shown at point A, whereas India would produce 100
tonnes of tea and 125 tonnes of rice at point B in Fig. 2.2.

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trade/17910

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Table 2.2- Gains of specialization and Trade under competitive advantage.

UK India Total UK India Total UK India Total

Tea(tonnes) 50 100 150 0 150 150 0 180 180
Rice(tonnes 100 125 225 200 62.5 262.5 200 25 225
)
375 412.5 405
If the UK utilizes all its resources for the production of rice in which it is more efficient than the
other, India can produce the same quantity of tea, i.e., 150 tonnes by utilizing only 75 units of its
resources. It can utilize the remaining 25 units of its additional resources for producing 62.5 units
of rice, which would raise the total rice production from 225 tonnes without trade to 262.5 tonnes
after a trade (Table 2.2). 7

Production possibility curves

200 UK

180 E
India

150 C

B
Tea 100

50 A

62.5 125 250

25 100 200

Rice
Fig. 2.2 Production possibilities under comparative advantage

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Alternatively, the UK can employ its entire resources (i.e., 100 units) to produce 20 tonnes of
rice and India can use only 10 units of its resources to produce 2.5 tonnes of rice to produce the
same quantity of rice, i.e., 22.5 tonnes.8

The remaining 90 units of resources may be used by India for the production of tea, resulting in
an increase in tea production from 15 tonnes without trade to 18 tonnes with trade as shown at
Point E. Hence, it is obvious from the illustrations that countries gain from trade even if a
country does not have an absolute advantage in any of its products as the total world output
increases.

3) Modern Theory

One of the main drawbacks of David Ricardian theory of comparative cost is that it did not
explain why differences in comparative costs exist. In 1919- Eli Heckscher propounded the idea
that trade consequences from differences in factor endowments in different nations. The idea was
further taken forward and brought to the world by Bertil Ohlin in the famous book of him “Inter-
regional and International Trade.” This book of Ohlin forms the basis for the Heckscher – Ohlin
theory or modern theory of international trade.

Their theory is based on a country’s production factors such are —

 land,

 labour and

 capital

They provide the funds for investment in plants and equipment and determined that the cost of
any factor or resource was a function of supply and demand of a nation. Factors that were in
great supply relative to demand would be cheaper in cost; factors in great demand relative to
supply would be more expensive in cost. This theory of him is also known as the factor

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proportions theory which stated that nations would produce and export goods that required
resources or factors that were in great supply and, therefore, cheaper production factors. In
contrast, countries would import products that required resources that were in less supply, but
higher demand.

For example, China and India have a cheap and large number of labour home to cheap, large
pools of labour. Therefore these two countries have become the optimal locations for labor-
intensive industries like textiles and garments.

Conclusion

Theories of international trade have gone significant change over a period of time. Prior to1970
international trade focused only two products, two commodities, two factors, two countries,
perfect competition, constant returns to scale, constant technology, etc. But after 1970 new
theories which are developed based on more realistic assumptions like – change in technology,
imperfect competition, changing returns to scale, etc. Therefore, the new theories which are
developed after 1970s and 1980s are quite capable of explaining the pattern of world trade today.
Economists like Krugman & Obstfeld have stated that about one – fourth of world trade consists
of intra – industry trade. The gains from intra – industry trade are considered to be over and
above that from comparative advantage. It is also believed that in future, intra – industry trade
may be dominant between countries which have same level of economic development.

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Bibliography

1. Raj Bhala, International Trade Law: An Interdisciplinary Non-Western Textbook (Vol 1)

Lexis Nexis (2015).

2. Dr. S.R. Myneni, International Trade Law (International Business Law) (3rd edn.)
Allahabad Law Agency (2014).

Webography

1. [Link]
development/for-jd-students/explore-legal-careers/practice-areas/international-trade-law/
2. [Link]
[Link]

3. [Link]
of-international-trade/17910

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