8 Theories of International Trade: Explained, PPT Available

Content of International Trade Theories
1. Overview of trade theories
2. 8 Trade Theories 
3. Download PPT 

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1. Intro- International Trade Theories

Trade theories are simply different types of theories to explain international trade. The meaning of International Trade is exchanging or trading goods & services between Countries.

International Trade theories help to explain how goods are traded among various nations & which goods are advantageous for trading.

For example- To export goods, the USA has the advantage in car manufacturing, India in spices, etc. so they both can export their advantages to other countries.

2. International Trade Theories

These are the types of International Trade Theories.

1. Mercantilism Trade Theory
2. Absolute Advantage Theory
3. Comparative Advantage Theory
4. Factor Endowment Theory
5. Leontief Paradox Theory
6. Product Life Cycle Theory
7. New Trade Theory
8. Porter’s Diamond Theory

1. Mercantilism Theory

• This theory was given by Thomas Mun and was Popular in the 16th and 18th Centuries.
• During that time, the Wealth of nations was measured by the stock of gold and other kinds of metals. The primary goal is to increase the wealth of the nation by acquiring gold.
• This theory says that a country should increase gold by promoting exports and discouraging imports.
• It is based on a zero-sum game. Zero-sum means only one nation gets benefits by exporting and the other gets a loss by importing goods.

Assumptions
1. There is a limited amount of wealth i.e. Gold in the world.
2. A nation can only grow when other nations do expenses or import goods.
3. A nation should try to achieve & maintain a favourable trade balance ( exporting more than its import).

Disadvantages
1. Mercantilism theory only thinks about producing and exporting goods. This hardly paid attention to the welfare of workers which leads to the exploitation of workers.
2. Mercantilism was one-way traffic. It focuses on export but not import, it is not easy to be self-sufficient. Many countries of Europe fails to be self-sufficient which increased their miseries.

2. Absolute Advantage Theory

a) This theory was given by Adam Smith in 1776. He argued for mercantilist theory & said that theory doesn’t expand trade.
b) This trade theory is based on a positive-sum game and expansion of trade. A positive-sum game means both countries get benefits in trade. In this, both countries export absolute advantage goods to each other.
c) Absolute advantage means when a country can produce a product more effectively ( less cost, more natural resources to produce easily ) than other countries.
d) Both nations should export goods of production advantage and import goods of production disadvantage.

For example – India has an absolute advantage in producing cotton and brazil has in producing coffee. In this, both countries should supply production advantages to each other.

Disadvantage
1. This theory Fails to explain how free trade can be advantageous to two countries when one country can produce all goods.
2. Any nation not having an absolute advantage can’t gain from free trade. 
3. Differences in climatic conditions & natural resources in nations won’t lead to absolute advantage.

3. Comparative Advantage

a) It is developed by David Ricardo in 1817.
b) This theory is the extension of the absolute advantage theory. i.e. If a country has an advantage in the production of two commodities, then compare the efficiency of both goods.
c) Produce and Export the good which can be produced more efficiently.

Example – India can produce both trucks and cars efficiently but for export, India needs to compare these goods with each other to find which goods have more efficiency. If car production has more efficient then India should produce and export manufactured cars.

Disadvantages
1. This theory was based on only two countries & only two commodities, but international trade is among many countries with many commodities.
2. The Assumption of full employment helps theory to explain comparative advantage. The cost of production in terms of labour may change when the employment level increases or decreases.
3. Even if any country stopped production, nobody in the industry wants to lose their job.
4. Another disadvantage is that transportation costs are not considered in determining comparative cost differences.

4. Factor Endowment Theory

a) Given by Eli Heckscher and Berlin Ohlin in 1993.
b) Also known as factor Proportion theory or Heckscher & Ohlin theory.
c) This theory is based on a country’s available production factors i.e. land, labour, capital, etc. in the country.
d) It stated that countries would produce and export those goods which make intensive use of factors that are locally available in large quantities. In contrast, import those factors that are in short supply or locally scarce.

For example – India has large quantities of labour so India should export labour-intensive goods i.e. coal mining, large production, and import capital-intensive goods i.e. oil.

Disadvantages
1. Assumes that there is no unemployment
2. Gives more importance to supply and less importance to the demand of that commodity.
3. Ignores price differences, transport costs, economies of scale, external economies, etc.

5. Leontief paradox Theory

a) In this theory Findings were contradictory to predictions of Heckscher-Ohlin’s theory and Given by Wassily Leontief in 1973.
b) He found out that the United States (US) – The most capital-abundant country in the world. Exported commodities that were more labour-intensive than capital-intensive.
c) Leontief concludes from this result that the US should adopt its competitive policy to match its economic realities.

Disadvantages
1. Leontief considered only capital & labour inputs, leaving out natural resource inputs But in reality, capital & natural resources are used together in the production of commodities.

6. Product Life Cycle Theory

a) It is given by Raymond Vernon in Mid 1960s and the Theory consists of technology-based products.
b) A product goes through the life cycle i.e. Introduction, Growth, Maturity, and Decline.
c) Country where the product is first launched is Innovator and At the end of the cycle, the innovator becomes the importer.
d) This theory says that an innovator country should produce goods according to the product life cycle of goods. When the demand grows, that country should move production factories to a developing country to meet demands at less cost.
e) Now that innovator country should export goods from developing country and completes demand. So this will be beneficial for both countries.

Example- America has started production of any new product that is introduction phase after some time company has reached into a growth phase where the demand has increased and starts export. In last, that product becomes a global standard product to meet global demand and decrease the cost of goods. America starts to produce goods in developing countries like India for mass production and starts importing goods from India to meet demand.

Disadvantages
1. Most appropriate for technology-based products
2. Another disadvantage is some products are not easily characterized by stages so it’s become difficult to follow this theory.
3. Most relevant to products produced through mass production.

7. New Trade Theory

a) It is given by Paul Krugman in 1980.
b) This theory tells about some of the necessary factors. A country having one of these factors can become an exporter.

Those three necessary factors are
Economies of scale –  Making production at a large scale for Reduction in per-unit cost 
Product differentiation – Difference in colour, durability, brand, etc.
First mover advantage – Capturing the market by introducing a new product or market.

Disadvantages
1. Only applicable when there are many firms with different production processes so it can change products easily.
2. Assumes that all firms are well-formed, which may not be true in every case.

8. Porter’s Diamond Theory

a) Introduced by Michael Porter in his book ‘The Competitive Advantage of Nations in 1990.
b) It is also known as National Advantage Trade Theory.
c) Explains factors that are available to a nation. These factors can give a competitive advantage to the economy of a country.
d) Four factors together form “PORTER’S DIAMOND MODEL”.
1. Factor Condition – Factors available like labour, capital, land, etc
2. Related & Supported Industries – Supporting companies to get raw material, transportation, etc
3. Strategy, Structure, Rivalry- How many Competitors and what structure they are using in the sale, marketing, etc
4. Demand Condition- How much demand for goods are there, what are the needs of people, country, etc
e) Export goods from that industry where the diamonds are favourable.

Disadvantages
1. In his book, Porter was optimistic about the future of Korea & less optimistic about the future of others.
2. Other factors may influence success – there may be events that could not have been predicted, such as new technological developments or government interventions.

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