Major Trade Theories Essay

Major Trade Theories Essay

In standard economic theory, partial equilibrium analysis of international trade place the foremost role in understanding how the world operates through the eyes of economists. In fact, it falls under the umbrella of the standard trade theory which modern students of analytical economics based their further studies from. It is the objective of this paper to compare the three major international trade theories which have served as the major blocks for further research and analysis of modern economics. And although many economists disagree with such theories, and in fact many other economists have those alternatives to such partial equilibrium analysis that had their first propagated by the Chicago school of economics, these models are still considered the dominant models and those which are accepted into classic new economic thought. It is therefore the objective of this paper to understand, indicating, and analyze these three theories of absolute advantage, comparative advantage, and the Heckscher-Ohlin factor endowment of international trade.

The first major theory of international trade — that absolute advantage — which first conceptualized by agent Smith and considered to be the first theory relation to trade. According to the theory of absolute advantage, countries and economies could not conceptually be classified under perfectly competitive models, because of the fact that some countries have specific resources that are more abundant as compared to the that are found in other economies. As compared to the resources that are found in other economics (O’Brien, 2003). according to the international trade theory of the father economics, absolute advantage is the condition where in a country or an economy is better able to produce a good using fewer resources as compared to another country or economy. Furthermore, absolute advantage points out that the resources that are being used — the inputs that are required in order to reduce a good — are basically the same for both countries. In line with this, a country would be exporting goods or services where they have absolute advantage in. This theory is extremely useful in the area of international trade because it provides an explanation why countries import — and what are the specific goods that a country with import or export — depending on what could they have an absolute advantage in producing. However, the essential question that this trait theory does not answer is what if a country is not that absolute advantage in producing anything, and that entries and economies other than their own absolute vantage in the production of a good service making it possible for them to export to those economies.

To answer this question, the second international trade theory that was proposed by Adam Smith successor, David Ricardo, was the theory of comparative advantage. Previously, the analysis of Adam Smith took into consideration in the production of a good or service the various absolute costs that are involved in pursuing such a production enterprise. However, it was Ricardo who captured the concept that if a country does not have absolute advantage in producing a specific goods, this does not necessarily mean that they should not export altogether. Instead, Ricardo’s theory of comparative advantage highlights that other than the absolute costs involved in the production of a good, there is the concept of opportunity cost (Greenaway & Torstensson, 2000). In the theory of comparative advantage, the unit cost — or what economists have come to call the marginal cost — is the essential factor that has to be considered. In the theory of comparative advantage, all other goods that could be produced by economies are taken into consideration and a country or an economy that has comparative advantage in the production of a specific goods or service is a country that could produce at lower marginal cost as compared to other goods it can produce. Therefore, according to this theory of international trade, a country should export a good that it could produce in a comparative advantage in import that good from a foreign country in which it does not have comparative advantage from.

The third theory of international trade is called the Heckscher-Ohlin factor endowment model and was named after the international trade economists Heckscher and Ohlin. Like the other theories of international trade, this factor endowment model also uses a partial equilibrium analysis in order to explain how international trade occurs. This model makes use and modify the comparative advantage model of David Ricardo but rather brings into focus that a country and an economy with export a good in which it has relatively under factor endowment — or its inputs are larger and cheaper — as compared to another country or economy (Schott, 2003). What model basically claims is that it would be exporting goods and services in which it is cheaper to produce them because the resources that are required at inputs in order to produce these goods and services are more abundant and therefore less scarce than that of another country or economy.

We had earlier pointed out that the theories of international trade are done in an economic partial equilibrium analysis — meaning that constraints are relaxed and all things are equal with only considering the essential variables and factors that the theory to be those that significantly affect the model. however, as those who study real-world and applied economics would know, problematic scenario with this type of analysis is that it fails to apply to actual events in international trade because it is almost impossible to consider international relations and negotiations of exports and imports in economic vacuum. Rather, upon the relaxation of the theory, it is immediately evident to the student that such factors including political conditions, negotiations, behavior, financial reasons, and a host of other variables all play a significant and interconnected role in the decision-making process of international trade. Let us, take for example, the comparative advantage model of David Ricardo. If all the assumptions are held, and it is indeed true that in the playing fields of international trade all things can be held to quality, then it is indeed a ideal model for trade. However, as research and economic trade has been made in academic institutions all around the world, the comparative advantage model which considers the marginal cost in the production of good which would eventually decide it’s volume of export would be an ideal trading scenario for countries because no two countries and economies have the same demographics, population, and resource endowment than the other — and therefore each country would have a comparative advantage producing a specific good. However, political institutions, legislations, and even international relations significantly affect the decision of policymakers to undergo international trade and economy. For example, North Korea and South Korea reason may have comparative advantage at producing separate goods which each country is willing to import. Even the fact that they are geographically near to each other and therefore significantly lower transportation costs could be a great incentive in order for these two countries to participate in international trade. However, because of the dangerous political conditions and interactions between these two countries, and the fact that neither one of them is willing to trade with another, then the comparative advantage model is violated.

In fact, even using other theories that international trade one would eventually discovered that no international trade theory no matter how complicated can capture the various variables of political, economic, and financial conditions between countries which should have played and participated in international trade in there or not such variables that has to be taken into consideration. Other than these three, modern economics — and especially the Chicago school of economics — has formulated various models and theories regarding how countries facilitate international trade. However, these partial equilibrium models — and even simultaneous equilibrium models being developed in other economic academic institutions around the world — could not even begin to capture without a grain of salt — the actual trading conditions of countries and economies around the world.

References:

Greenaway, D., & Torstensson, J. (2000). Economic geography, comparative advantage and trade within industries: evidence from the OECD. Journal of Economic Integration, 15(2), 260-280.

O’Brien, D. P. (2003). Classical Economics. A Companion to the History of Economic Thought, 112.

Schott, P. K. (2003). One size fits all? Heckscher-Ohlin specialization in global production. American Economic Review, 93(3), 686-708.

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