International Trade And Comparative Advantage Economics Essay
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Published: Mon, 5 Dec 2016
International Trade is the exchanging process of goods, and services across the international border. In 2010, the value of international tread achieved 19 trillion (US) dollars that is about 30% of the world GDP (Abedini, n.d.). That is nearly one third of production of goods and services are exchanged internationally around the world. International trade is the exchange between two people or entities in two different countries. International trade theories are different type of theories that explain international trade (New Charter University, 2012).
People want to exchange goods and services because they believe that they get benefit from the exchange. Many economists believe that the participation in international trade increase productivity. Trade theoretical work suggests that the level of productivity and growth may increase through its effects on technology. There are many portion of international trade, which lead to technological change and this increased the rate of economic growth. There are mainly three mechanisms by that technology change: increased competitive pressure, embodiment in imports and knowledge transfer by commercial contacts (Sjöholm 1997)
Economists have developed theories to explain the mechanisms of global trade. The main historical theories are called classical theory. This is based on country. After some time theories began to move to explain trade from a firm or company based not a country perspective. This is known as modern theory(New Charter University, 2012).
Classification of different theories:
COUNTRY BASED THEORIES
This theory is the earliest theory which developed in the sixteenth century. According to this theory a country’s wealth is determined by the amount of its gold and silver holding(New Charter University 2012). Mercantilist believed that a country should increase its gold and silver by the increase of export and discouraging the import (7). The main purpose of each country was to have trade surplus, and avoid a trade deficit. Through a form of neo-mercantilism countries such as Japan, China, Singapore, Taiwan, and even Germany still favor exports and discourage imports(New Charter University, 2012).
Adam smith offered a new theory called absolute advantage. This theory stated that a country focus on the ability to produce a good more efficiently than another nation (New Charter University, 2012). He said that trade should follow naturally according to market forces. For example if one country produce a good cheaper and faster as compare to other so it is better to focus on specialization on producing that good. Smith’s theory said that increase the specialization in both countries would benefit for both countries and trade should be also encouraged (7). This theory state that a country wealth cannot be measure by how much gold and silver it had but by the living standards of its people can be measure.
David Ricardo, introduce the theory of comparative advantage in the 1817(New Charter University 2012). This theory stated that if only one country had the absolute advantage in the production of more than one product, specialization and trade could still occur between two countries.
When a country cannot produce a product more efficiently than the other country than comparative advantage occurs. It can produce that product better and more efficiently than it does other goods (Voss & Voss, 2008). This theory explains that how countries through imports can increase their welfare by simultaneously selling goods and services in international market (7). Two countries can get benefit even if one country could produce all goods with fewer resources. The other, provide the relative efficiency with which goods can be produce differs between the two countries. (John Sloman)
Heckscher-Ohlin Theory (Factor Proportions Theory)
Eli Hechscher and Bertil Ohlin, focused their attention on how a country could gain comparative advantage by producing products(New Charter University, 2012). This theory mostly focuses on country’s production factors like land, labor, and capital, which provide funds for investment in plant and equipment. This theory said that the cost of any resource depend on supply and demand. This theory is also known as factor proportions theory. Countries would import goods that were in short supply, but higher demand. For example, in China and India labor cost is cheap hence these countries have become the optimal location for labor intensive industries (Lee, Qian, Julie, and Ying, 2004).
Modern or Firm-Based Trade Theories
These theories came out after Second World War. Large part of these theories is developed by business school professors, not economist. The firm-based theories incorporate other product and service factors that include brand and customer loyalty, technology and quality, into the understanding of trade flows.
Country similarity theory
This theory devolved in 1961 by the Steffan Linder (New Charter University, 2012). Linder’s theory said that consumers in countries that are in the same or similar stage of development would have similar preferences. This theory stated that companies first produce for domestic consumption. It is very difficult to find out similar market as like domestic one, on the basis of customer preference. This theory is useful in decision-making and purchasing processes in understanding trade in goods where brand name and product reputations are most important factors in the buyers’.
Product life cycle theory
This theory stated that every product life cycle has three distinct stages: new product, maturing product, and product decline. This theory developed by Harvard Business School professor Raymond Vernon(New Charter University, 2012).
Global strategic rivalry theory
Economist Paul Krugman and Kelvin Lancaster introduce this theory in 1980(New Charter University, 2012). This theory based on MNCs and their efforts to gain a competitive advantage against other global firms in there industry.
Porter’s national competitive advantage theory
In 1990 Michael Porter of Harvard Business School developed a new model of explain national competitive advantage(New Charter University, 2012). This said that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. Porter identified four determinants that he linked together (Smit, 2010). The four determinants are local market resource and capabilities, local market demand conditions, local supplier and complementary industries and local firm characteristics.
Assumptions of comparative advantage:
Comparative advantage theory is helpful to make a number of assumptions.
This theory said that there are no transportation costs or can say transportation cast are ignored.
Mostly all costs are invariable and there are no economies of scale.
There are only two economies creating two goods.
This theory assumes that all traded goods are homogeneous.
This theory assumes that factors of production are assumed to be perfectly mobile.
This theory assumes that no tariffs or other trade barriers.
This theory provides perfect knowledge, so that every buyers and sellers know where they can get cheapest goods internationally.
This theory assumes labor is perfectly mobile within the country but perfectly immobile between countries.
Doubling the inputs in each country leads to a doubling of total output of company.
New Zealand is heavily dependent on international trade. Currently import protection of New Zealand is low. Vernon was the first to who alert to rising importance of codified knowledge and key skill as a platform for the product cycle, outsourcing, off shoring and franchising. New Zealand has wage ratios that are less or more typical of the North. So there is one question came out, how can New Zealand firms and government plan future trade capability in this global market environment? The large countries not depend on the external sector as much as the small countries. Small countries depend on the external sector to achieve higher economic growth and maintain a higher living standard.
New Zealand’s is also not potential to generate good economic it is also dependent on its international competitiveness. New Zealand is dependent on export achieve sustainable growth. The major portion of New Zealand’s external trade of export income comes from bulk commodities such as meat and dairy products, wood and pulp(9). Primary commodities still dominate New Zealand’s export- in the 60’s the share of primary commodities was over 85%. Now days, New Zealand’s land-based export is 67%.(9) In other developed countries the primary export share is decreasing as manufacturing but service exports are rising.
New Zealand produces a large quantity of primary commodities because of good natural resource endowment. The primary sector of New Zealand to export is agricultural, horticultural, and forestry industries(9). The homogenous nature of the New Zealand agribusiness and forestry sectors and New Zealand focus in research, development and innovation in these sectors that can improve the export competitiveness.
This focus has positive implication for economies of scale. Between 1999 and 2007 the New Zealand gained and lost comparative advantage in more than 200 products(10). This information suggests that New Zealand exporters want to change market demands and opportunities. Beyond the primary product sector New Zealand has not diversified.
New Zealand’s economic developments start since the late 1890s by the opportunity to sell primary product products like wool, dairy products and meat to the United Kingdom and other industrialized countries(9). But after the Second World War the demand for food and industrial raw materials was increased. This demand increased export activities of many countries including New Zealand.
Analysis of export and import of New Zealand
Export and import can be a great way to inter into new market and expand business. New Zealand context, policy-induced distortions are perhaps less prominent on the imports side than the exports side. New Zealand exports statistics measure sales by resident firms and individuals to non-residents. The incomes of New Zealand include in investment income rather than exports in balance of payment statement. New Zealand is heavily dependent on agricultural products. More than one-third of the world’s international dairy trade leads by New Zealand.
More than 100 million people feed dairy product. New Zealand dairy industry contributes 25% of export earnings(12). In 2009 New Zealand’s total exports amounted to $26.25 billion, its total imports came in at $24.29 billion (11). In December 2011 New Zealand total export grew by 9.6% to reach $47.7 billion. Australia is the largest exports market for New Zealand, taking 22.7% of New Zealand’s exports. New Zealand’s second largest market for export is China. New Zealand nearly export 12.3% to china and New Zealand’s export to the china grew by over $1 billion in 2011(13). New Zealand export to the USA 8.4% of its total export.
In the year of December 2011 the total imports of New Zealand, valued at $44.5 billion. China has good market and New Zealand imports from china were valued at $7.049 billion. New Zealand sourced 15.8%of its total imports from china. The import from Australia fell by $ 300 million to $7.039 billion. The main factor contributed to this decline was the drop in NZ’s mineral fuel import. New Zealand import valued from the USA at $4.8 billion. New Zealand import 10.7% of its total import from the USA.
New Zealand has strongest revealed comparative advantage in product based on the agriculture, horticulture, fishing or forestry industries. These include number of product like dairy product, in particular milk, milk powder butter and cheese. These include meat, frozen sheep, beef offal and many more seafood like mussels, crayfish, and frozen fish. These also include many kind of wool like combed, yarn and greasy wool (10). Some horticultural based products including fresh fruit, clover, frozen vegetable, onions, and honey and ryegrass seeds included in comparative advantage.
A number of wood products these primary-based products rely on relatively sophisticated innovation inputs such as research and development. Dairy products are a good example in New Zealand’s innovation in production, processing, packaging, distribution, logistics (10). New Zealand also has expertise in these areas to develop a high comparative advantage in certain elaborately transformed manufactures. These contain machines for cleaning, sorting, grading, and dairy machinery, agricultural and bee-keeping plant, and milking machines. New Zealand has very good comparative advantage in a verity of manufacturing product and these manufactures are intermediate or capital good used by businesses rather than households (10)
The aim of this text is to provide more insight on the concept of international trade and its impact in global economy. Several theories have been forwarded to explain the dawn of this global phenomenon influencing the New Zealand trade and businesses around the world. Although the theories have started from the classical view point stemming from the fact that trade has it is based on countries, it should evolved to encompass the idea that organizational perspective seems more feasible. The continuum explaining the advent of international trade started mercantilism advocating the need to encourage export and discourage import but with many criticisms from the forefather of Economics Adam Smith with his Absolute advantage theory which seemed much avant-gardes at that time.
The relatively recent theory adding to the literature of International Trade is that of Porter’s national competitive advantage theory preaching the importance of national competitive theory of an industry to constantly innovate. Theories proposed by great researchers have been numerous – each criticizing or adding to the existing literatures. However, it cannot be denied that in this era of globalization and interdependency of nations, international trade has become the buzzword of most economists. Despite criticisms and its certain drawbacks, International Trade is now a dominant factor in the global marketplace and nearly-if not all-countries have adopted it. As an ending word, it can be said that International Trade is here to stay.
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