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EF310: International Trade
and Business
Theories of International Trade
Overview
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Why trade?
Efficiency arguments
WTO 10 benefits…
‘Real World’ -- protectionism…
Welfare Analysis… demonstrating the benefits of
trade
• Theories of trade:
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Absolute Advantage -- Adam Smith
Comparative Advantage -- David Ricardo
Heckscher-Ohlin Theory -- factor endowments
Intra-industry trade… Paul Krugman’s New Trade
Theory
Why do countries trade with each other?
In very simple terms…
• Imports:
– Increase choice for consumers (increased consumer utility)
– More competition reduces prices
– Goods not available domestically (natural resources, food &
drink, goods we do not have expertise to produce…)
• Exports:
– Needed to pay for the imports!
– Access to bigger markets -- potential to expand
production/output, earn higher incomes…
Efficiency arguments for trade
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Adam Smith saw the division of labour (specialisation) as
the source of economic growth…
Increased capital accumulation
 allows Division of labour (specialisation)
 leads to increased productivity
 Greater output
 Greater wealth
Efficiency arguments for trade
Division of labour… according to Smith:
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Purpose is ‘to make a smaller quantity of labour produce a greater
quantity of work’
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The ‘trifling manufacture’ of a pin … (how many could you make if you
had to do every element of the process yourself, without specialist
tools/machines…??)
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The individual ‘stands at all times in need of the co-operation and
assistance of great multitudes…’
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‘It is not from the benevolence of the butcher, the brewer, or the baker,
that we expect our dinner, but from their regard to their own interest.’
(quotes are from Adam Smith’s ‘Wealth of Nations’, 1776)
Efficiency arguments for trade
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Trade takes the division of labour and specialisation to the
international level… enables countries to specialise in the production
of those goods and services in which they are most efficient (Smith’s
theory of Absolute Advantage)
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Specialisation  increased efficiency  higher productivity  higher
incomes
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Trade expands the potential market… allows firms to grow and reach
critical mass/scale… achieve economies of scale and therefore
greater efficiencies
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Scale economies allow firms to produce at lower average costs of
production
Efficiency arguments for trade
The essential economic argument for free trade is greater efficiency…
 again, refer to Smith…
 markets allocate resources efficiently…
(i.e. where productivity/returns are highest)
 Smith’s ‘invisible hand’…
 requires free movement of goods, capital and labour
 free trade
Smith on Free Trade
• Free trade required for market (i.e. demand) to keep pace with
expanding production
• Free Trade justified on basis of reduced prices for consumers - Smith
saw protectionist policies as placing “a new tax” on workers for the
“necessaries of life”
• The ‘peace dividend’ of trade
• British trade restrictions were “impertinent badges of slavery” imposed
on the American colonies “without any sufficient reason, by the
groundless jealousy of the merchants and manufacturers of the mother
country.”
 Britain as ‘a nation of shopkeepers’!
10 benefits of the WTO trade system…
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The system helps promote peace
Disputes are handled constructively
Rules make life easier for all (equality)
Freer trade cuts the cost of living
It provides more choice of products and qualities
Trade raises incomes
Trade stimulates economic growth
The basic principles make life more efficient (e.g. common
standards, rules etc.)
Governments are shielded from lobbying
The system encourages good government
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(WTO propaganda!)
Economic benefits of trade
• Can demonstrate the economic benefits of opening up to free trade…
• Will look at this in some detail -- welfare analysis; the benefits to
consumers/producers
• Can also show the costs imposed by protectionist policies (explicit
barriers to trade: tariffs and quotas) -- both in abstract terms and by
observing costs in the ‘real world’ in terms of higher prices etc.
• And yet, protectionist policies remain commonplace in global trade…
why??
Protectionism
• Anti-globalization movement
Reaction to ‘hard-nosed capitalism’
• Costs of opening up to free trade?…
– Distinguish between economic and non-economic costs…
• Economic costs:
– Adjustment costs -- unemployment as traditional/weak sectors
decline in face of competition
– Countries get ‘locked in’ to particular production patterns… the
‘poverty trap’… low-wage/low-income sectors
– In face of global competition, building up strong indigenous industry
can be difficult or impossible
Protectionism
• Non-economic costs of free trade:
– Traditional domestic culture can be weakened as international
tastes dominate
– Economic imperialism and external domination… trade dependence
can lead to political/economic vulnerability… (gas and oil supplies)
– Specific export success can worsen relations with the importing
countries (cars from Japan in USA, textiles from China in EU)…
suspicion or resentment of the more efficient producer… (“stealing
our jobs”!)…