Ch. 5 International Trade

Modern Free Trade Theories

1) Product Life Cycle (Vernon) 2) Porter's Diamond Theory 3) Hecksher-Ohlin Theorem (HOT)

Six major theories of international trade

1) mercantilism 2) absolute advantage 3) comparative advantage 4) product life cycle 5) strategic trade 6) national competitive advantage of industries

Local content requirement

A requirement stipulating that a certain proportion of the value of the goods made in one country must originate from that country

Import tariff

A tax imposed on imports

Product life cycle theory (Vernon)

A theory that accounts for changes in the patterns of trade over time by focusing on product life cycles; omparative advantage initially resides with the lead innovation nation and go to others as the product goes through its life cycle stages

Theory of comparative advantage

A theory that focuses on the relative (not absolute) advantage in one economic activity that one nation enjoys in comparison with other nations

Factor endowment theory (Heckscher-Ohlin theory)

A theory that suggests that nations will develop comparative advantages based on their locally abundant factors

Strategic trade theory

A theory that suggests that strategic intervention by governments in certain industries can enhance their odds for international success

Theory of national competitive advantage of industries (Porter's diamond theory)

A theory that suggests that the competitive advantage of certain industries in different nations depends on four aspects that form a "diamond"

Theory of Mercantilism

A theory that suggests that the wealth of the world is fixed and that a nation that exports more and imports less will be richer; It is in a country's best interest to maintain a trade surplus - to export more than it imports; believed in protectionism; viewed trade as zero-sum game; the international finance system at that time was based on gold/silver standard

Theory of absolute advantage

A theory that suggests that under free trade, a nation gains by specializing in economic activities in which it has an absolute advantage; Capability of one country to produce more of a product with the same amount of input than another country; Produce only goods where you are most efficient, trade for those where you are not efficient (therefore trade is more beneficial)

What happens to trade if one country has an absolute advantage in both products?

According to a theory of absolute advantage, no trade would occur in "this" circumstance. According to comparative advantage, countries should produce and export those goods and services for which it is relatively more productive than other countries AND import those goods and services for which other countries are relatively more productive

Trade surplus

An economic condition in which a nation exports more than it imports

Trade deficit

An economic condition in which a nation imports more than it exports

Voluntary export restraint (VER)

An international agreement that shows that exporting countries voluntarily agree to restrict their exports

Adam Smith

Argued in his book Wealth of Nations that specialization increases productivity, and exchange allows for benefits of specialization (Absolute Advantage)

Resource mobility

Assumption that a resource used in producing a product for one industry can be shifted and put to use in another industry

Leontief Paradox

Based on Hecksher-Ohlin, US should import labor-intensive and export capital-intensive; But the opposite happens: export (skilled labor intensive) software; import capital intensive heavy machinery. This is known as...

The Benefits to Open Trade and Investment

Benefits of "this": win-win situation where From a "free trade" perspective, best not to see world as "us" vs. "them" Instead, "free trade" theory suggests that everyone is better off over the long run through free trade Better to open rather than close borders

Trade

Better use of resources; more total output

Administrative policy

Bureaucratic rules that make it harder to import foreign goods

Importing

Buying from abroad

Opportunity cost

Cost of pursuing one activity at the expense of another activity, given the alternatives (other opportunities).

Subsidy

Government payment to domestic firms

Strategic trade policy

Government policy that provides companies a strategic advantage in international trade through subsidies and other supports

U.S. Trade

Huge trade deficit: value of exports has gone down because we're buying more local (drilling oil domestically; etc) and value of imports has gone down.

Services

Intangible services being traded

Deadweight cost

Net losses that occur in an economy as a result of tariffs

Assumptions of the Smith-Ricardian theory of trade

Only two countries and two goods No transportation costs Countries have similar prices and values Fixed amounts of resources No effects on income distribution within countries

Comparative advantage

Relative (not absolute) advantage in one economic activity that one nation enjoys in comparison with other nations

Import quota

Restriction on the quantity of imports

Exporting

Selling abroad

Different types of nontariff barriers

Subsidies / 'cheap' exports...In US we subsidize cotton and in Europe they're subsidizing $2 per cow a day) Trade-related aspects of intellectual property rights (TRIPs); Patent protection is essential to the recovery of R&D costs Problems with lack of enforcement / keep companies from trading Trade-related investment measures (TRIMs) Local content requirements (e.g. NAFTA and 62.5% rule for automobiles)

Merchandise

Tangible products being traded

Antidumping duty

Tariffs levied on imports that have been "dumped" (selling below costs to unfairly drive domestic firms out of business)

Balance of trade

The aggregation of importing and exporting that leads to the country-level trade surplus or deficit

Infant industry argument

The argument that if domestic firms are as young as "infants" in the absence of government intervention, they stand no chances of surviving and will be crushed by mature foreign rivals

Absolute advantage

The economic advantage one nation enjoys that is absolutely superior to other nations

Factor endowment

The extent to which different countries possess various factors of production such as labor, land, and technology

Free trade

The idea that free market forces should determine how much to trade with little or no government intervention.

Protectionism

The idea that governments should actively protect domestic industries from imports and vigorously promote exports; Government should intervene to achieve a surplus in the balance of trade

Classical trade theories

The major theories of international trade that were advanced before the 20th century, which consist of (1) mercantilism, (2) absolute advantage, and (3) comparative advantage

Modern trade theories

The major theories of international trade that were advanced in the 20th century, which consist of (1) product life cycle, (2) strategic trade, and (3) national competitive advantage of industries

Nontariff barrier (NTB)

Trade barrier that relies on nontariff means to discourage imports

Tariff barrier

Trade barrier that relies on tariffs to discourage imports

Reality of trade

Trade does not always balance (look at US trade), trade patterns (Leontief Paradox)

Smith-Ricardian theory of trade

Why countries should trade according to "this" theory: Simple proof that specialization and trade leads to greater overall welfare... ... even if one producer is more productive in all goods! Think of opportunity costs!

David Ricardo

Wrote The Principles of Political Economy and Taxation and argued that efficiency of resource utilization leads to more productivity; Should import even if country is more efficient in the product's production than country from which it is buying (Comparative advantage)

Autarky

no trade, poor employment of resources