c
 
c 


c
à

c

 

In the 1600 and 1700 centuries, mercantilism stressed that countries should
simultaneously encourage exports and discourage imports. Although mercantilism is an old
theory it echoes in modern politics and trade policies of many countries. The neoclassical
economist Adam Smith, who developed the theory of absolute advantage, was the first to
explain why unrestricted free trade is beneficial to a country. Smith argued that 'the invisible
hand' of the market mechanism, rather than government policy, should determine what a
country imports and what it exports. Two theories have been developed from Adam Smith's
absolute advantage theory. The first is the English neoclassical economist David Ricardo's
comparative advantage. Two Swedish economists, Eli Hecksher and Bertil Ohlin, develop the
second theory.

The Heckscher-Ohlin theory is preferred on theoretical grounds, but in real-world


 

According to Wild, 2000, the trade theory that states that nations should accumulate
financial wealth, usually in the form of gold, by encouraging exports and discouraging imports
is called mercantilism. According to this theory other measures of countries' well being, such
as living standards or human development, are irrelevant. Mainly Great Britain, France, the
Netherlands, Portugal and Spain used mercantilism during the 1500s to the late 1700s.

Mercantilistic countries practised the so-called zero-sum game, which meant that world
wealth was limited and that countries only could increase their share at expense of their
neighbours. The economic development was prevented when the mercantilistic countries paid
the colonies little for export and charged them high price for import. The main problem with
mercantilism is that all countries engaged in export but was restricted from import, another
prevention from development of international trade.

 





The Scottish economist Adam Smith developed the trade theory of absolute advantage in
1776. A country that has an absolute advantage produces greater output of a good or service
than other countries using the same amount of resources. Smith stated that tariffs and
ÿuotas should not restrict international trade; it should be allowed to flow according to
market forces. Contrary to mercantilism Smith argued that a country should concentrate on
production of goods in which it holds an absolute advantage. No country would then need to
produce all the goods it consumed. The theory of absolute advantage destroys the
mercantilistic idea that international trade is a zero-sum game. According to the absolute
advantage theory, international trade is a positive-sum game, because there are gains for
both countries to an exchange. Unlike mercantilism this theory measures the nation's wealth
by the living standards of its people and not by gold and silver.

There is a potential problem with absolute advantage. If there is one country that does not
have an absolute advantage in the production of any product, will there still be benefit to
trade, and will trade even occur? The answer may be found in the extension of absolute
advantage, the theory of comparative advantage.

The most basic concept in the whole of international trade theory is the principle of
comparative advantage, first introduced by David Ricardo in 1817. It remains a major
influence on much international trade policy and is therefore important in understanding the
modern global economy. The principle of comparative advantage states that a country should
specialise in producing and exporting those products in which is has a comparative, or
relative cost, advantage compared with other countries and should import those goods in
which it has a comparative disadvantage. Out of such specialisation, it is argued, will accrue
greater benefit for all.

In this theory there are several assumptions that limit the real-world application. The
assumption that countries are driven only by the maximisation of production and
consumption, and not by issues out of concern for workers or consumers is a mistake.

m
 
 


In the early 1900s an international trade theory called factor proportions theory emerged
by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the
Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should produce
and export goods that reÿuire resources (factors) that are abundant and import goods that
reÿuire resources in short supply. This theory differs from the theories of comparative
advantage and absolute advantage since these theory focuses on the productivity of the
production process for a particular good. On the contrary, the Heckscher-Ohlin theory states
that a country should specialise production and export using the factors that are most
abundant, and thus the cheapest. Not produce, as earlier theories stated, the goods it
produces most efficiently.
 The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists,
because it makes fewer simplifying assumptions. In 1953, Wassily Leontief published a study,
where he tested the validity of the Heckscher-Ohlin theory. The study showed that the U.S
was more abundant in capital compared to other countries, therefore the U.S would export
capital- intensive goods and import labour-intensive goods. Leontief found out that the U.S's
export was less capital intensive than import.

º





Raymond Vernon developed the international product life cycle theory in the 1960s. The
international product life cycle theory stresses that a company will begin to export its product
and later take on foreign direct investment as the product moves through its life cycle.
Eventually a country's export becomes its import. Although the model is developed around
the U.S, it can be generalised and applied to any of the developed and innovative markets of
the world.

The product life cycle theory was developed during the 1960s and focused on the U.S since
most innovations came from that market. This was an applicable theory at that time since the
U.S dominated the world trade. Today, the U.S is no longer the only innovator of products in
the world. Today companies design new products and modify them much ÿuicker than before.
Companies are forced to introduce the products in many different markets at the same time
to gain cost benefits before its sales declines. The theory does not explain trade patterns of
today.



Contribution of international trade theories in functioning of international business:

There are several trade theories of international business that attempt to explain the
basis of international trade. These theories attempt to explain how the benefits a ccrue to
the trading countries.

à? Mercantilism proposed that a country should try to export more than it imports, in
order to receive gold. The main criticism of mercantilism is that countries are
restricted from import, a prevention of international trade.
à? Adam Smith developed the theory of absolute advantage that stressed that a country
should produce goods or services if it uses a lesser amount of resources than other
countries.
 à? David Ricardo stated in his theory of comparative advantage that a country should
specialise in producing and exporting products in which it has a comparative
advantage and it should import goods in which it has a comparative disadvantage.
à? Hecksher-Ohlin's theory of factor endowments stressed that a country should produce
and export goods that reÿuire resources (factors) that are abundant in the home
country. Leontief tested the Hecksher-Ohlin theory in the U.S. and found that it was
not applicable in the U.S.
à? Raymond Vernon's product life cycle theory stresses that a company will begin to
export its product and later take on foreign direct investment as the product moves
through its life cycle. Eventually a country's export becomes its import.

º c ! "!c! #!$ 

What is the Diamond Model?

The Diamond Model of Michael Porter for the competitive advantage of Nations offers a model
that can help understand the comparative position of a nation in global competition. The
model can also be used for major geographic regions.

Traditional country advantages

Traditionally, economic theory mentions the following factors for comparative advantage for
regions or countries:

1. Land

2. Location

3. Natural resources (minerals, energy)

4. Labor, and

5. Local population size.

Because these 5 factors can hardly be influenced, this fits in a rather passive (inherited) view
regarding national economic opportunity.

Porter says that sustained industrial growth has hardly ever been built on above mentioned
basic inherited factors. Abundance of such factors may actually undermine competitive
advantage! He introduces a concept called "clusters" or groups of interconnected firms,
suppliers, related industries, and institutions, that arise in certain locations.

Porter Diamond Nations

According to Porter, as a rule competitive advantage of nations is the outcome of 4

PORTER argued that a nation can create new advanced factorendowments such as skilled
labor, a strong technology and knowledge base, government support, and culture. PORTER

used a diamond shaped diagram as a basis of a frameworkto illustrate the determinants of

countries establish for their industries.The points of the diamond are described as follows

1.FACTOR CONDITIONS

-a country creates its own important factors such as skilledresources and technological base.

-these factors are upgraded / deployed over time to meetthe demand.

-local disadvantges force innovations. new methods and hence comparative advantage.

2.DEMAND CONDITIONS

-a more demanding local market leads to national advantage.

-a strong trend setting local market helps local firms anticipateglobal trends.

3.RELATED AND SUPPORTING INDUSTRIES.

-local competition creates innovations and cost effectiveness.

-this also puts pressure on local suppliers to lift their game.

4.FIRM STRATEGY , STRUCTURE AND RIVALRY.

-local conditions affect firm strategy.

-local rivalry forces firm to move beyond basic advantages.

THE DIAMOND AS A SYSTEM

-it is a self-reinforcing system.

THE ROLE OF THE GOVERNMENT IN THIS MODEL

-to encourage

-to stimulate

-to help to create

growth in industries.

=============================================

In terms of application, you can take the example of two industries in INDIA,

1. BPO BUSINESS.2. KPO BUSINESS.

BPO IS ESTABLISHED AND IS ON THE DEVELOPMENT STAGE.KPO IS ON THE THRESHOLD O F

IF you are on the lookout of establishing business in these two areas,then you would conduct
a cluster analysis.THE PASSIVE ANALYSIS OF

1. Land-available in pleanty.

2. Location-strategic locations are available.

3. Natural resources (minerals, energy)-apart from energy, all other resources are available

4. Labor, and-skilled and unskilled labors are available in plenty.

5. Local population size -local market size has the potential to absorb any excess production.

THE ACTIVE / PROACTIVE ANALYSIS OF

1.FACTOR CONDITIONS-INDIA has created its own important factors such as skilled

resources and technological base for expanding BPOs / KPOs

-INDIA is upgrading / deploying resources over time to meetthe demand.

2.DEMAND CONDITIONS

-a more demanding local/ global market has given INDIA the international / national
advantage.

-a strong trend setting local market has helped local firms anticipateglobal trends.

3.RELATED AND SUPPORTING INDUSTRIES.

-local competition has created innovations and cost effectiveness for the INDIAN BPOs AND
KPOs.

-this has also put the pressure on local suppliers to lift their game.

4.FIRM STRATEGY , STRUCTURE AND RIVALRY.

-local conditions have affected various firms strategy.

-local rivalry have forced firms to move beyond basic advantages examples INFOSYS , WIPRO
AND TCS [ TATAS]

5. THE ROLE OF THE INDIAN GOVERNMENT IN THIS MODEL

-INDIAN GOVERNMENT is encouraging more BPOs / KPOs.

-INDIAN GOVERNMENT IS stimulating with paperwork reforms.

-INDIAN GOVERNMENT is helping to create more skilled labors.

-INDIAN GOVERNMENT is providing infrastructures to attractmore industries.