International Trade and investment theories
Introduction
• Trade theories helps managers and government policymakers to
decide
What product should they import and export
How much should they trade
With whom should they trade
• Some trade theories prescribe that governments should influence
trade patterns and others propose a laissez-faire treatment of trade
International Operations and Economic
Connections
Laissez-Faire versus Interventionist
Approaches to Exports & Imports
• Interventionist theories
Mercantilism
Neo-mercantilism
• Free-trade theories:
Absolute advantage
Comparative advantage
Theories of Trade Patterns
• Explaining trade patterns:
• Country size
• Factor proportions
• Country similarity
• Trade competitiveness:
• Product life cycle theory
• Porter diamond
What the major trade theories Do and
Don’t discuss
Mercantilism and Neo-mercantilism Theory
Mercantilism theory proposed that a country should try to achieve a
favorable balance of trade (export more than it imports)
Prevailed from 1500-1800
Neo-mercantilism policy also seeks a favorable balance of trade, but
its purpose is to achieve some social or political objective
Theory of Absolute Advantage
• In 1776 Adam smith declared that a country’s well
being is its citizen’s access to goods and services
rather than its ownership of gold.
• Suggests specialization through free trade because
consumers will be better off if they can buy foreign-
made products that are priced more cheaply than
domestic ones
• A country may produce goods more efficiently
because of a natural advantage or because of an
acquired advantage
Cont..
• Theory of absolute advantage
• different countries produce some goods more efficiently than others
• Free trade brings
• Specialization
• natural advantage
• acquired advantage
• product technology
• process technology
• Greater efficiency
• Higher global output
Theory of Absolute Advantage
Production Possibilities under Conditions of Absolute
Advantage
Theory of Comparative Advantage
• Theory of comparative advantage
• free trade can increase global output even if one country
has an absolute advantage in the production of all products
• Consider
• comparative advantage
• absolute disadvantage
Cont..
• Production Possibilities under Conditions of Comparative Advantage
Theories of Specialization: Assumptions
and Limitations
• How free trade improves global efficiency
• Theories of specialization make assumptions that may not be
valid
full employment
economic efficiency
division of gains
Two countries two commodities
transport costs
statics and dynamics
Services
production networks
Trade Pattern Theories
• Distinguish factors affecting national trade patterns
What Types of Products Does A Country
Trade?
• Factor proportions theory
• factors in relative abundance are cheaper than factors that
are relatively scarce
• But
• production factors are not homogenous
• labor
• Production technology: capital versus labor
Product technology
Worldwide Trade by Major Sectors
Factor Mobility Theory
• Detect why production factors, especially labor and capital,
move internationally
Why Production Factors Move
• Factor mobility theory
• focuses on why production factors move, the effects of
that movement on transforming factor endowments, and
the impact of international factor mobility on world trade
• Capital and labor move internationally to
• gain more income
• flee adverse political situations
Effects of Factor Movements
• Factor movements alter factor endowments
• Factor movements can be substantial for some countries, and
insignificant for others
• The movement of labor and capital are intertwined
• Pros and cons of outward and inward migration
• Brain drain
• Remittances
Trade and Factor Mobility
• Describe the relationship between foreign trade and
international factor mobility
• There are pressures for the most abundant factors to move to
areas of scarcity
• The lowest costs occur when trade and production factors are
both mobile
• Factor mobility through foreign investment often stimulates
trade because of
• the need for components
• the parent’s ability to sell complimentary products
• the need for equipment for subsidiaries
Trade and Factor Mobility
Unrestricted Trade, Factor Mobility, and the Cost of Tomatoes
5-21
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