Classical International Trade Theory

Mercantilism thoughts and ideas steered trade in Europe from the beginning of the sixteenth century until the end of the eighteenth century. In the beginning of the nineteenth century Adam Smith’s trade theory started to gain acceptance. According to mercantilism, welfare was based on the possession of gold and silver. Trade was seen as something good for a country. The disadvantage of mercantilism was that people thought that having more exports than imports, meant a better welfare for your country, as payment was made in metals. A surplus in exports would then mean more gold and silver. According to mercantilism it was believed that one country’s winnings would lead to another country’s losses, which meant that the economic policies were aimed at supporting export and putting restrictions on imports.

As mentioned earlier, Adam Smith’s trade theory was first accepted at the beginning of the nineteenth century. You could say that it was Adam Smith and David Ricardo that laid the foundation for the theory behind international trade. It was Adam Smith who introduced the concept of the invisible hand. He fought against the mercantile ideas and created theories on how specialization increased efficiency. Adam Smith meant that, depending on the producers different strengths and weaknesses, together they could increase production as well as real-income (commodities and services that one has at one’s disposal are seen as real-income).

In Adam Smith book The Wealth of Nation (1776) he compares a country’s situation with a family’s decision to either buy or produce the product themselves. To get an understanding of Adam Smith’s theory one can make the following assumption: Assume that the U.S and UK produce wheat and textile. If the UK is better at producing textiles compared with the U.S, whilst the U.S is better at producing wheat, then these two countries should trade with each other. This assumption means that the UK has absolute advantage when producing textile and should therefore only produce and export textile whilst importing wheat from the U.S. The U.S should do the same but the other way around. If these countries trade, wealth will then increase for both of them. Adam Smith’s theories brought about many thoughts, for example, what would happen if a country did not possess any absolute advantages for their products. Would this country have no trade?

David Ricardo had the answers for these questions, with his theory of opportunity-cost that goes hand-in-hand with the theory of comparative advantage. Comparative advantage means that a country should export products that they have the lowest alternative cost for and import products which they have the highest alternative cost for.

What this means, is that, trade occurs between two countries who tend to have international differences, in production technique and productivity. A country benefits from production-specialization if their collected real-income or consumption-possibilities are greater than with self-maintenance.

2. Heckscher–Ohlin theorem

The Heckscher–Ohlin theorem is one of the four critical theorems of the Heckscher–Ohlin model. It states that a country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively. In the two-factor case, it states: "A capital-abundant country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good."

The critical assumption of the Heckscher–Ohlin model is that the two countries are identical, except for the difference in resource endowments. This also implies that the aggregate preferences are the same. The relative abundance in capital will cause the capital-abundant country to produce the capital-intensive good cheaper than the labor-abundant country and vice versa.

Initially, when the countries are not trading:

the price of the capital-intensive good in the capital-abundant country will be bid down relative to the price of the good in the other country,

the price of the labor-intensive good in the labor-abundant country will be bid down relative to the price of the good in the other country.

Once trade is allowed, profit-seeking firms will move their products to the markets that have (temporary) higher price. As a result:

the capital-abundant country will export the capital-intensive good,

the labor-abundant country will export the labor-intensive good.

The Leontief paradox, presented by Wassily Leontief in 1951,[1] found that the U.S. (the most capital-abundant country in the world by any criterion) exported labor-intensive commodities and imported capital-intensive commodities, in apparent contradiction with the Heckscher–Ohlin theorem. However, if labor is separated into two distinct factors, skilled labor and unskilled labor, the Heckscher–Ohlin theorem is more accurate. The U.S. tends to export skilled-labor-intensive goods, and tends to import unskilled-labor-intensive goods.

Date: 2015-04-20; view: 919