Introduction
Different types of concepts used to explain international trade are simply referred to as trade theories. Exchanging or trading commodities and services between nations is what is meant by the term “international trade.” Theories of international trade assist in describing how items are traded among different countries and which goods are suitable for trading.
For example – India excels at producing spices, while the United States excels at manufacturing cars, therefore both nations can export their advantages to other nations.
Theories
International Trade Theories
- Mercantilism Trade Theory
- Comparative Advantage Theory
- Absolute Advantage Theory
- Leontief Paradox Theory
- Factor Endowment Theory
Mercantilism Theory
- Thomas Mun proposed this hypothesis, which gained popularity in the 16th and 18th centuries.
- At that time, the stock of gold and other types of metals was used to gauge a country’s wealth. The main objective is to buy gold to make the country richer.
- According to this view, a nation should boost its gold production by encouraging exports while restricting imports.
- The system is zero-sum game-based. Zero-sum trade occurs when only one country benefits from exports and the other loses money on imports.
Assumptions
1. The world’s resources, such as gold, are finite.
2. A country can only develop if other countries spend money on it or import commodities.
3. A country should work to establish and keep a positive trade balance ( exporting more than its import).
Disadvantages
1. The theory of mercantilism focuses solely on the production and export of products. This gave little thought to the welfare of workers, which encourages worker exploitation.
2. Mercantilism was only going one way. It emphasizes export but not import, therefore being self-sufficient is difficult. Many European nations are unable to support themselves, which has made their misery worse.
Comparative Advantage
a) David Ricardo invented it in 1817.
b) The extension of the absolute advantage theory is this theory. For example, if a nation produces two commodities more efficiently than another, compare the two products.
c) Create and export products that can be made more effectively.
For Example – Although China is capable of producing both cars and trucks with efficiency, it must compare the two to determine which product is more effective for export. China should make and export manufactured cars if car production is more efficient.
Disadvantages
1. This theory falls short of demonstrating how free trade can benefit two nations when one can produce all items.
2. Free trade cannot benefit any country that lacks an absolute advantage.
3. National differences in climate and natural resources won’t result in an absolute advantage.
Absolute Advantage Theory
a) Adam Smith proposed this theory in 1776. He opposed mercantilist theory and claimed that it does not increase commerce.
b) The expansion of commerce and a positive-sum game form the foundation of this trade theory. A positive-sum game is one in which commerce benefits both nations. In this, both nations export commodities that give them a distinct edge over one another.
c) Absolute advantage refers to a nation’s ability to manufacture a good more cheaply and easily than other nations due to its abundance of natural resources.
d) The export of goods from both countries should outweigh their respective imports of commodities with a production disadvantage.
For Instance – Brazil and India both have distinct advantages in the production of coffee and cotton, respectively. In this, both nations should provide one another a production advantage.
Leontief Paradox Theory
a) According to this hypothesis, observations were in conflict with those made by Wassily Leontief in 1973 and the Heckscher-Ohlin theory.
b) He learned that the United States (US) is the nation with the most capital. exported products with higher labor than capital intensity.
b) Leontief draws the conclusion that the US should adjust its competitive policy to reflect its economic realities in light of this finding.
Disadvantages
Leontief ignored inputs from natural resources and only took into account inputs from capital and labor. In actuality, however, natural resources and capital are combined to produce commodities.
Factor Endowment Theory
It was proposed by Eli Heckscher and Berlin Ohlin in 1993.
b) Also known as Heckscher & Ohlin theory or factor Proportion theory.
c) This idea is based on the production resources that a nation has access to, such as land, labor, capital, etc.
d) It was said that nations would develop and export those commodities that heavily rely on readily accessible local resources. Import the components, however, that are scarce locally or in short supply.
Disadvantages
1. Assumes that unemployment is nonexistent
2. Emphasizes the supply of that commodity rather than the demand for it.
3. Ignores pricing variations, transportation expenses, scale economies, external economies, etc.
