Lavanya Goinka
Introduction
Trade involves the exchange of goods and services among entities. International trade, therefore, refers to this exchange between two distinct countries. Entities engage in trade with the belief that it will be mutually beneficial. While this concept may seem straightforward, it involves various procedures related to theory, policy, and business strategies. This article delves into the theories of international trade, particularly focusing on the classical theory.
What is International Trade
International trade is experienced daily when purchasing goods such as Lays chips, Cadbury chocolate, or a can of Coca-Cola from a supermarket. It enables access to products and services that may not be readily available domestically. International trade, as noted by Wasserman and Haltman, plays a crucial role in global economic activities, fostering growth for both developed and developing nations. Disparities in conditions like resource availability, climate, and production costs motivate trade between countries, ultimately contributing to improved living standards worldwide.
Theories of International Trade
Since the 18th century, economists and thinkers have debated the patterns, causes, and effects of global trade. The classical theory of international trade, developed by Adam Smith and David Ricardo, is one of the earliest subfields in economic theory. It revolves around the exchange of goods based on the relative amounts of labor embodied in them. The classical theory is further divided into sub-theories, including Mercantilism, Absolute Cost Advantage, and Comparative Cost Advantage.
Modern Theory of International Trade
The modern or firm-based theory emerged post-World War II, evolving with the growth of multinational firms. This theory incorporates factors such as customer loyalty and technology in addition to products. It includes theories like Country Similarity, Product Life Cycle, Global Strategic Rivalry, and Porter’s National Competitive Advantage.
Classical Theory of International Trade
Developed by Adam Smith and David Ricardo, the classical theories emphasize specialization, efficient resource allocation, and the benefits of foreign trade. The Mercantilism theory, Absolute Cost Advantage theory, and Comparative Cost Advantage theory are integral components of the classical approach. These theories highlight the advantages of free trade, efficient production, and mutual benefits for nations involved.
Mercantilism Theory
Originating in the 17th and 18th centuries, the Mercantilism theory advocates a nation’s focus on exports to accumulate wealth, primarily in the form of precious metals. It emphasizes protectionist policies, promoting exports while restricting imports. This theory has historical examples, such as British colonial practices, where wealth was generated through exports and controlled trade.
Absolute Advantage Theory
Introduced by Adam Smith in 1776, the Absolute Advantage theory challenges Mercantilism. Smith advocates for free trade, suggesting that countries should produce goods in which they have an absolute advantage, focusing on efficiency and cost advantages.
Comparative Advantage Theory
Developed by David Ricardo in 1817, the Comparative Advantage theory proposes that nations should focus on producing goods in which they have a comparative cost advantage. It encourages trade to be mutually beneficial, assuming labor is the only factor of production and there are no trade barriers between countries.
Heckscher-Ohlin Theory
Also known as the Factor Proportion Theory, Heckscher-Ohlin theory, developed in the 1900s, asserts that countries should export goods based on the factors abundant in their country. This theory considers factors like land, labor, and capital, emphasizing that production costs depend on supply and demand.
Essentials of Classical Theory
The classical theory guides national policy by focusing on the production of goods suited to a country’s climate, soil quality, and available natural resources. It centers on the labor cost theory of value, stating that goods should be traded based on the labor embodied in them. While providing a systematic framework for understanding international trade, the classical theory has faced criticism for its assumptions, including the unrealistic assumption of constant returns and the disregard for other factors of production.
Conclusion
The classical theory, developed by economists like Adam Smith and David Ricardo, has played a significant role in comprehending international trade. While historical perspectives like Mercantilism dominated earlier centuries, newer theories, including the product life cycle theory, acknowledge changes in factors influencing trade. The focus on producing goods efficiently and the encouragement of free trade for mutual benefit remain essential principles in understanding international trade dynamics.
