International Trade Theory and the World Trading System

EVOLUTION OF THE THEORY OF INTERNATIONAL TRADE EVOLUTION OF THE THEORY OF INTERNATIONAL TRADETheorists: Adam Smith (1776) David Ricardo (1817) Eli Heckscher (1919) / Bertil Ohlin (1933) Wassily Leontif (1953) Raymond Vernon (1966) Paul Krugman and others (1980s & 1990s) Michael Porter (1990)

ABSOLUTE ADVANTAGE - ADAM SMITH Two countries - Two products Each country can produce one product more efficiently than the other. They should specialize and trade.

COMPARATIVE ADVANTAGE - RICARDO Two countries - Two products One country can produce both products more efficiently than the other country. Each should specialize in the product in which it has a RELATIVE advantage and trade for the other product

FACTOR ENDOWMENT - HECKSCHER-OHLIN Countries are differently endowed with each of the factors of production (LAND, LABOR, CAPITAL; ENTREPRENEURSHIP & TECH) Countries should specialize in those products that utilize the factors of production with which they are abundantly endowed

FACTOR SUBSTITUTABILITY - LEONTIEF'S PARADOX Countries which have a scarcity of particular factor inputs may be able to compensate by using more abundant inputs. Technology (and capital) is usually the most effective medium through which this compensation takes place. For example, India and USA both produce textiles, but India uses its abundant cheap labour while USA uses high technology.

INTERNATIONAL PRODUCT-LIFE CYCLE (IPLC) - RAYMOND VERNONPRINCIPLE Original innovation of a particular product generally occurs in a country with favorable demand conditions. Trade and location of production will shift depending on the stage of the PLC. Countries lead or lag each other in terms of their position on the PLC for a particular product.

INTERNATIONAL PRODUCT-LIFE CYCLE (IPLC) - RAYMOND VERNON LIMITATIONS OF THE THEORY There are too many exceptions to the theory, eg, luxury products, products with very short life cycles, non-traded products. Product differentiation may keep the production from shifting to the next tier of countries. Companies with global strategies develop products and services for global markets and set up production in least-cost countries. The theory did not differentiate between FDI and licensing for a new foreign production site. (This conceptual limitation meant the IPLC did not provide a satisfactory theory for FDI.)

Most theories have attempted to answer the question, “Why do countries trade?” However, the real question is: “Why do companies trade?” THEORIES ORIENTED ON FIRMS/INDUSTRIES: New Trade Theory National Competitive Advantage

NEW TRADE THEORY - PAUL KRUGMAN and others PRINCIPLE First Mover Advantages will create Barriers to Entry (Economies of scale & Experience curve) Rationale for governments to pursue Strategic Trade Policy (i.e., Some firms in specific industries are favored, nurtured, promoted and protected from international competition.) (See Strategic Trade.doc.)

NATIONAL COMPETITIVE ADVANTAGE - PORTER FACTOR ENDOWMENTS Basic (natural resources; climate; location) Advanced (specialized infrastructure; skilled labor; tech.) DEMAND CONDITIONS Nature of home demand (concentrated, sophisticated, demanding home customers push firms to be globally competitive) RELATED & SUPPORTING INDUSTRIES Strong spill-over effects from related industries create internationally competitive clusters of industries FIRMS' STRATEGY, STRUCTURE & RIVALRY Organization, management and domestic rivalry of firms in a country. (Vitality of domestic environment prepares firms for international competition) GOVERNMENT POLICIES Government policies on each of the above factors promotes or suppresses ability of domestic firms to compete internationally.

THE POLITICAL ECONOMY OF WORLD TRADE History of the free trade movement origins: end of “mercantilism” in Europe in 17 th century post WWII: under the auspices of GATT GATT (GENERAL AGREEMENT ON TARIFFS AND TRADE) created in of 3 major institutions created to guide the “free world” purpose: multilateral negotiating forum to achieve free trade GATT championed TRADE LIBERALIZATION and a 16-fold increase in world trade in 50 years. Mercantilism: exports good, imports bad; to accumulate gold

GATT PRINCIPLES 1.Non-discrimination – MFN MFN - If country A gives country B "most-favored nation” concessions, must give the same to all member countries. 2.Reciprocity 3.Exceptions to GATT rules: Regional Blocs - EU, NAFTA, etc. - exempt from giving MFN to non-member countries. Less-developed countries (LDCs) generally did not participate and were not expected to reciprocate for concessions offered by developed countries.

GATT NEGOTIATIONS Datenameoutcome 1947Genevatariffs (45000 tariff concessions) 1949Annecytariffs Torquaytariffs Genevatariffs Dillontariffs Kennedy35% tariff reduction; anti-dumping Tokyo34% tariff reduction; NTB codes Uruguay complex international business package

URUGUAY round Initially 15 negotiating groups for new areas, including: tariffs and NTBs* foreign investment services agriculture textiles tropical products intellectual property anti-dumping countervailing duties etc * NTB: non-tariff barrier, ie, everything else. eg, subsidies, quotas, administrative policies * NTB: non-tariff barrier, ie, everything else. eg, subsidies, quotas, administrative policies

WORLD TRADE ORGANIZATION – WTO WTO inaugurated on 1/1/1995 Will there be a new “round”? unresolved issues for the WTO: unfinished business from Uruguay Round the environment labor standards and human rights harmonization of domestic policies regional and bilateral negotiations

GOVERNMENT INTERVENTION IN INTERNATIONAL TRADE Justification: (generally rejected by classical economists) protecting jobs and industries national security infant industry various political reasons, eg, bargaining tool strategic trade policy (see Strategic Trade.doc) What is it? It refers to domestic policies to create new industry to compete internationally. (industrial policy)