INTERNATIONAL TRADE
THEORIES
BY
DR. ANUSUYA BISWAS
ASSOCIATE PROFESSOR
DEPT. OF ECONOMICS – ALLIANCE UNIVERSITY
International Trade
Theories
Classical Neo-Classical
Theories Theories Modern Theory
Mercantilism Heckscher- New Trade
Ohlin Th Theories
Absolute Cost Product Life Competitive
Advantage Cycle Advantage
Comparative
Cost Advantage
Dr. Anusuya Biswas
MERCANTILISM (1550-1776)
• Mercantilism refers to an economic policy or trade system wherein a country focuses on
maintaining a favorable trade balance by maximizing exports and minimizing imports with
other countries.
• Its purpose is to empower a nation via wealth and resource acquisition while improving its
military and political might.
• Xenophobia / home biasness
• Philosophy – National Wealth Materializes not in economic activities but accumulation of
wealth (Gold) & trade was the prime vehicle for sourcing currency
• Ensure Higher Exports than Imports – some winners other losers zero sum propositions
• Main motive of any nations – are to accumulate surpluses
Dr. Anusuya Biswas
MERCANTILISM (1550-1776)
• Many European nations, including Great Britain and France, were among the
firsts to adopt the practice between the 16th and 18th centuries.
• Colonialisation - Under the mercantilism policy, a mother country established
colonies in other nations to import cheaper raw materials and export finished
products back to them in exchange for gold and silver.
• Countries imposed tariffs, reduced trade deficits, offered subsidies, formed
monopolies, and created trade surpluses to expand their precious metals reserves.
Dr. Anusuya Biswas
Dr. Anusuya Biswas
EXAMPLES OF MERCANTILISM
• England Navigation Act of 1651 prohibited foreign vessels engaging in coastal trade.
• All colonial exports to Europe had to pass through England first and then be re-
exported to Europe.
• Under the British Empire, India was restricted in buying from domestic industries and
were forced to import salt from the UK. Protests against this salt tax led to the ‘Salt
tax revolt’ or Dandi March led by Gandhi.
• In seventeenth-century France, the state promoted a controlled economy with strict
regulations about the economy and labour markets
• Rise of protectionist policies following the great depression; countries sought to reduce
imports and also reduce the value of the currency by leaving the gold standard.
• Some have accused China of mercantilism due to industrial policies which have led to
an oversupply of industrial production – combined with a policy of undervaluing the
currency.
Dr. Anusuya Biswas
CRITICISMS OF MERCANTILISM
• Adam Smith’s “The Wealth of Nations” (1776) – argued for benefits of free trade and criticised the inefficiency of
monopoly.
• Mercantilism is a philosophy of a zero-sum game – where people benefit at the expense of others. It is not a
philosophy for increasing global growth and reducing global problems. Trying to impoverish other countries will
harm our own growth and prosperity. By contrast, if we avoid zero-sum game of mercantilism increasing the
wealth of other countries can lead to selfish benefits, e.g. growth of Japan and Germany led to increased
export markets for UK and US.
• Incentivizing Govt.: Mercantilism which stresses government regulation and monopoly often lead to inefficiency
and corruption.
• Mercantilism justified Empire building and the poverty of colonies to enrich the Empire country.
• Mercantilism leads to tit for tat policies – high tariffs on imports leads to retaliation (present Tariff-war).
• Consumer suffered from higher price for goods
• Producers pays extra cost – tax evasion and capital flight
• The growth of globalisation and free trade during the post-war period showed possibilities from opening markets
and respecting other countries as equal players.
• Economies of scale from specialisation possible under free trade.
Dr. Anusuya Biswas
ABSOLUTE ADVANTAGE THEORY – 1776
Dr. Anusuya Biswas
ASSUMPTIONS OF ABSOLUTE COST ADVANTAGE
THEORY
(2*2*1 MODEL)
(i) There are only two countries producing two goods.
(ii) Labour is the only factor of production and cost of production is measured in terms of
the labour input.
(iii) All units of labour are homogeneous.
(iv) A situation of constant returns to scale prevails in the economy.
(v) Factors of production are perfectly mobile within the country but are perfectly
immobile between two countries.
(vi) There is no cost of transportation.
(vii) Laissez faire economy i.e. International trade is free from all government controls.
(viii) There is full employment in countries engaged in international trade.
(ix) There is perfect competition in both goods market as well as in factor market.
Dr. Anusuya Biswas
• Factors of production cannot move between countries. This assumption excludes the
possibility of migration between countries, as well as presence of multinational companies.
It also imply that the PPF of each country will not change after the trade and there is no
reason to expect wages (measured in the same currency) be the same after trade.
• No barriers to trade in goods.
• Exports must be equal to imports. This assumption means that we exclude trade
imbalances, trade deficits or surpluses.
• Labor is the only relevant factor of production.
• Production exhibits constant returns to scale.
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
Dr. Anusuya Biswas
