International trade and Foreign Direct Investment (FDI) equity flows are the two primary methods in which international business occurs and are amongst the most substantial drivers of present time globalisation. With consecutive rounds of multilateral dialogues at the World Trade Organisation (WTO), barriers to trade globally, have been done away with significantly. Likewise, the relaxation and liberalisation of developed countries' capital markets during the 1980s has brought about a brand-new age of global capital mobility whereby Foreign Direct Investment is a primary and vital facet to trade globally. Both experiential and theoretical frameworks have incidentally thrived to explicate and predict these patterns in international business, as well as the determinatives and affects of International Trade and FDI flows for both the host and home countries.
International Trade is the exchange of capital, goods, and services across international borders or territories (dictionary.reference.com).
Foreign direct investment refers to the long-term engagement of a nation "A" into nation "B" for example. It normally requires involvement in expertise, know-how, joint-venture, management and transfer of technology, etc. There are two forms of Foreign Direct Investment: inbound FDI and outbound FDI, bringing about either a positive or negative net FDI inflow and stock of FDI equities, which is the total figure for a given period of time. It is important to note, however, that direct investment does not include investments made by means of purchasing shares.
Specialisation is the focus of labour in specified, limited duties and functions. It is the name ascribed to the prevalent system of economic consumption, production, and interlinked socio-economic progression and processes, in most industrialised nations ever since the late twentieth century.
In fact, trade exists as a result of specialisation and the division of labour, where most workers focus on a limited facet of production and trading, during the process, for different trade goods. Trade exists between various nations and trading blocs because different industries in diverse countries and regions globally have a comparative advantage in the manufacturing/production of certain tradable commodities/goods, or because different countries' sizes permit for the benefits of mass production. Intrinsically, trade at market prices amongst different countries/regions benefits both partners involved in the trade exchange.
International Trade Theory
Adam Smith (1723-1790) was a prominent Scottish economist and political thinker whose famed work "Wealth of Nations" (1776) set the pitch for work on economics and politics for many individuals and institutions even today. This was, as a matter of fact, the first extensive attempt to examine the nature of capital, the development of industry and the effects of large-scale commerce in Europe.
Adam Smith's fundamental argumentation was that people should be free and able to engage in their own private economic interests as much as possible just as long as they do not break the rudimentary rules of justice. In this manner, Smith believed, they would do far more good to advance and promote the public's welfare and interests, more than if the same people were to attempt to assist the public on purpose. Smith named this the "invisible hand" of the market, though everyone is performing in their own self-interest, they are led to accomplish the good for all like an 'invisible hand' of economic powers. Hence, outside intervention will unavoidably induce calamity. This later became renowned as "laissez faire" economic policy (economyprofessor.com).
Adam Smith ("Wealth of Nations") reasoned that economic specialisation could be beneficial to countries as to corporations, back in 1776. Due to the division of labour being limited by the market size, he argued that nations with access to bigger markets will be capable of splitting labour more productively and hence become more efficient in the long run. Smith however, failed to realise that the division of labour is also intrinsically limited by the technology in production coordination (Yu, Zhihao, 2005).
The theory of Absolute Advantage was introduced Adam Smith and is apparent between trade counterparts when a country is able to produce more of a commodity/product, with the same resources, than its partner can; it is therefore said to hold a position of Absolute Advantage in the production of that end product. If, however, the other country has an Absolute Advantage in producing a commodity/product that the its partner needs, each will be fortunate if they specialise and trade. Trade is normally mutually advantageous even if one country holds an absolute advantage over its partner country, in the production of both goods being traded.
The Heckscher-Ohlin (HO) model was first formed by Eli Heckscher (1919) and Bertil Ohlin, two Swedish economists. Eli's Heckscher's own student, Bertil Ohlin formulated and detailed the Factor Endowment Theory. He was not just a economics professor in Stockholm, but also a leading political figure in Sweden at the time. Fundamental concepts were further formulated and added subsequently by Ronald Jones and Paul Samuelson amongst others. Due to the difficulty of forecasting the trade of goods pattern in a globe with an abundance of goods, as an alternative to the Heckscher-Ohlin Model, the Heckscher-Ohlin-Vanek Theorem that prognosticates the factor capacity of trade has acquired attention in recent years (econ.iastate.edu).
The Heckscher-Ohlin Model explicated that countries of the same factor endowments would still trade due to the differences in technology, as this would induce specialisation and thus trade, in precisely the same manner as in the Ricardian Model.
Another theory that attempts to predict the patterns of trade is that of the Law of Comparative Advantage (David Ricardo) in the goods with the lower opportunity cost. David Ricardo (1772-1823), during the early 19th century, saw that the theory of Absolute Advantage was a moderate and restricted instance of a more dynamically broad theory. Ricardo, in essence, was sort of a replacement and continuation to Adam Smith's prominent position in British economics. His work went on to shape and influence the aims and methods of the discipline all through the nineteenth century. In spite of his personal substantial work experience, his written material can sometimes come across as being very abstract and often hard to understand. His main stress was on the principles of diminishing returns linked to land rental, which he thought also regulated capital profits. He tried to derive a theory of value from labour application, but found it hard to separate the effects of changes in technology from changes in distribution.
The scarceness of natural resources globally, one of the more fundamental concepts of economics, requires that there be tradeoffs, and these tradeoffs lead to an opportunity cost. Whilst the price of a good or service is often-times thought of in terms of currency, the opportunity cost of taking a decision is based on what good or service must be forgone, which would be the next best option, as a consequence of taking the decision. Decisions that require having to choose between two or more options are said to have an opportunity cost.
The Law of Comparative Advantage explicates how nations can take advantage of and exploit specialisation and trade. Given any two goods/commodities, the nation manufacturing the good/commodity with the lower opportunity cost is said to have a comparative advantage. In simple terms, it is the capability of a nation to produce a product at a lower cost than others can produce it. Specialising provides that nation with a comparative advantage vis-à-vis other trade players. The basis of trade activities must be directed in a way where each country cuts the opportunity costs of the goods being swapped in their trade exchanges.
Heckscher and Ohlin's theory, adapted from Ricardo's comparative advantage model, suggested that different costs were the result not only of dissimilar labour endowments between countries, but also of different capital and land endowments. For example, a country like Saudi Arabia is much more amply endowed with oil than say France. France, on the other hand, has a rich abundance of skilled labour and capital equipment in the defence industry. Hence the theory would suggest that Saudi Arabia would specialise in producing oil, France in producing defence equipment and that the two countries will trade one product for the other (Anderton, Alain, 2004).
Advantages of International Trade and Specialisation
Some advantages of International Trade include monetary benefits to the respective countries participating in trade, it can also improve relations between countries and allow for a great cultural exchange. It also allows for more of a choice and assortments of goods that are affordable (value for money) and readily acquirable for consumers, better quality goods, enhanced and increased competition both at the global and national level, closer links and affiliations amongst countries globally, more of an exchange of technical expertise, technology and synergistic know-how, producers locally will endeavour to better the quality of their products, as well as an increase in employment nationally.
In the same way domestic trade encourages economic development and prosperity, so does International Trade. International commerce gives rise to specialisation, where a producer produces the good at the lowest cost of opportunity and production to them and thereafter trades for goods that are produced at a higher opportunity or production to them.
Not only does International Trade lead to shared benefits by permitting various nations to specialise their industries of those products/commodities they produce at top-quality, but it also lets them import products that international producers are inclined to provide at a lower cost than national producers are willing. Resources do vary between nations and provide certain nations with an advantage of producing certain goods over other ones and turn out to be more profit-making and beneficial to all. By permitting for International Trade, nations can specialise in those products that they can produce efficiently and at the lowest cost and then supply them to consumers at a low-cost, more inexpensive, and more economic price. Additionally, by importing those products from other nations and then exporting goods to those nations, both partners, involved in the trade exchange, benefit in a win-win state of affairs.
It is crucial to take note, however, the case of absolute advantage. As mentioned before, absolute advantage is a scenario where a country, due to its natural endowments and or prior experiences, can manufacture more of a product/commodity, with the same quantity of resources, than another country can. However, this does not imply that only because one country has an absolute advantage, the countries trading with this nation will not benefit from the trade. Yes, they still can benefit, in point of fact, that is, conditional upon the relative production costs varying.
Advantages of specialisation include increasing rewards and profit returns due to economies of scale, gains from exploiting an absolute or comparative advantage, through which specialisation is explained, more efficiency and productivity as well as focus for producers, less cost to the producer as well as the consumer, better quality end products and a wider range of choice for the consumer, and last but not least, through specialisation in production, countries can increase their income, as well as expand and develop their economies.
A strong argument put forward in favour of the concept of free trade would be that it is rather clear and apparent that free trade is beneficial to all partners involved. It helps nations attain a comparative advantage and corporations/industries to focus on specialisation, both of which result in economic benefits, growth, and prosperity. Furthermore, these two concept are big revolutionary contributors to the sophisticated and progressive state of the globe's nations in the present time. Without them, we would be decades behind in various ways, particularly from a technological standpoint. Participating in these activities proves beneficial for all trade partners and results in economic prosperity and wealth, therefore, improving peoples' standards of living (Rose, Phantom, 2009).
Disadvantages of International Trade and Specialisation
Some disadvantages of trade include a heavy reliance on a particular nation,
national production may also be hindered as national industries may be excelled and eclipsed by their international competitors, affluent nations may have more powers in influencing political issues in other nations and acquire control over weaker ones, and what is more, ideological clashes may come about amongst trading partner countries regarding the processes in trade activities for example.
Specialisation in itself, however, can hinder trade. For example, if a nation is too reliant on one specific industry and the prices dip in that industry, then unemployment will take place dramatically. This is an occurrence in several developing nations and is also applicable, for example, to the West Midlands, UK, a region that is heavily reliant on the auto industry. Factors of productions cannot be easily shifted from one area to another, this is known as "factor immobility". For instance, if after International Trade, country/company A would diminish the production of product B, then the labour producing product B cannot easily be shifted and re-trained to produce an additional product C, therefore, unemployment will take place.
International trade can also pose as a harm to birth industries in the home nation as well, due to their production costs being high in the infant, early stages. Over-specialisation may have devastating effects if, for example, a war breaks out in a country and imports/exports cease. Therefore, the nation never specialises wholly due to political/strategic factors. In addition, if imports exceed exports, the balance of trade payments would be in the red (negative territory), which, in turn, will harm the home country's economy and may also result in the devaluation of its currency.
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