Evaluation of trade theory

The age of mercantilism

The age of mercantilism, spanning roughly from the 16th to the 18th centuries, was an
economic doctrine characterized by a focus on accumulating wealth through a favorable
balance of trade. Nations sought to export more than import, hoarding precious metals and
establishing colonies to secure valuable resources. Governments played a significant role, using
policies like tariffs and subsidies to boost exports and maintain economic dominance.

Mercentalism

Mercantilism was an economic theory and practice predominant in Europe from the 16th to the
18th centuries. Central to this doctrine was the belief that a nation's wealth and power were
determined by its accumulation of precious metals, primarily gold and silver. Governments
actively intervened in the economy to promote exports, discourage imports, and amass bullion.
The emphasis on a positive balance of trade and state control over economic activities defined
mercantilism, influencing policies that aimed to strengthen national economies through
strategic trade practices and colonial expansion.

Classical trade theory

The theory of absolute advantage

The theory of absolute advantage, proposed by economist Adam Smith in the late 18th century,
asserts that a country should specialize in producing goods or services in which it has an
absolute efficiency or productivity advantage over other nations. According to the theory,
nations should focus on producing the goods they can produce most efficiently, and through
mutually beneficial trade, global wealth can be maximized as each country capitalizes on its
unique strengths.

The theory of comparative advantage

The theory of comparative advantage, formulated by economist David Ricardo, builds on the
concept of absolute advantage. It posits that even if one country can produce all goods more
efficiently than another, both nations can still benefit from trade if each specializes in producing
the goods for which it has a lower opportunity cost.

Classical trade theory contributions

Adam Smith division of labour

Adam Smith's concept of the division of labor, outlined in his seminal work "The Wealth of
Nations" (1776), emphasizes the efficiency gained when tasks are broken down and assigned to
specialized individuals. Smith argues that by dividing the production process into distinct and
specialized tasks, workers can become more skilled and efficient in their specific roles, leading
to increased overall productivity.

David Ricardo comparative advantage

David Ricardo's theory of comparative advantage, articulated in the early 19th century, posits
that nations should specialize in producing goods or services where they have a lower
opportunity cost relative to other nations. He argued that even if a country is less efficient in
producing all goods compared to another, there are still gains from trade if each nation focuses
on what it can produce with a comparative advantage.

Gains from trade

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Factor proportions trade theory

The factor proportions trade theory, developed by economists Eli Heckscher and Bertil Ohlin in
the early 20th century, explores how differences in factor endowments, specifically labor and
capital, influence comparative advantage and international trade patterns. The theory suggests
that countries will specialize in and export goods that intensively use their abundant factors of
production, while importing goods that require the use of their scarce factors

The leontief paradox

The Leontief Paradox, named after economist Wassily Leontief, emerged when he conducted
an input-output analysis of the United States in the 1950s. Contrary to the predictions of the
Heckscher-Ohlin model, which suggests that a capital-abundant country like the U.S. would
export capital-intensive goods, Leontief found that the U.S. was actually exporting more labor-
intensive goods and importing more capital-intensive ones. This unexpected result raised
questions about the applicability of the factor proportions theory and sparked debates among
economists. Various explanations have been proposed, including the role of technology and the
specific nature of capital in the traded goods.

Overlapping product range theory

The overlapping product range theory, also known as the Linder hypothesis, was proposed by
economist Staffan Linder in the 1960s. This theory suggests that countries with similar levels of
per capita income are likely to have overlapping preferences for certain goods and, as a result,
engage in substantial trade with each other. Linder argued that consumer demand plays a
crucial role in determining trade patterns, asserting that nations with comparable income levels
tend to produce and consume similar products. According to this theory, trade is driven not
only by factor endowments or comparative advantage but also by the similarities in consumer
preferences across nations.

Product cycle theory

The product cycle theory, developed by economist Raymond Vernon in the 1960s, aims to
explain the life cycle of products and their impact on international trade. According to Vernon,
products go through distinct stages – innovation, maturation, and standardization. In the initial
stage, innovation occurs in the home country, and the product is exported to other nations. As
the product matures, production shifts to other countries to take advantage of lower
production costs. Eventually, the product becomes standardized, and the country initially
exporting it may become a net importer. The product cycle theory emphasizes the dynamic
nature of international trade, highlighting the evolution of a product's life cycle and its
implications for the global distribution of production.

Stages of product cycle

Innovation Stage: The product originates in the home country, where innovation and
development take place. During this phase, the product is often unique, and the home country
serves as the primary exporter.

Maturity Stage: As the product gains acceptance and demand increases, production expands,
and manufacturing may shift to other countries.

Decline Stage: In this final stage, the product becomes standardized, and its manufacturing is
dispersed globally. The initial innovating country may even become a net importer as
production facilities are established in various locations to meet global demand.

The new trade theory

Strategic trade

The New Trade Theory, pioneered by economists like Paul Krugman, challenges traditional
views by incorporating economies of scale and imperfect competition into the analysis of
international trade. Within this framework, strategic trade refers to government intervention
aimed at enhancing a nation's competitive position in global markets. Governments may
employ policies such as subsidies, trade barriers, or investment in research and development to
create a strategic advantage for domestic industries. Strategic trade theory suggests that in
certain situations, targeted government intervention can lead to improved economic outcomes,
fostering the growth of industries that might not have thrived in a purely free market.

Michael porter's completitive clusters

Michael Porter's concept of competitive clusters, introduced in his work on economic

development and competitiveness, emphasizes the importance of geographic concentrations of
interconnected companies and institutions within a particular industry. Clusters are
characterized by a network of suppliers, related industries, and institutions that support and
reinforce each other. Porter argues that these clusters enhance the productivity and innovation
of firms by creating a mutually beneficial environment where companies can share knowledge,
infrastructure, and skilled labor.

The theory of international investment

The theory of international investment encompasses various perspectives on how and why
capital flows across national borders. At its core, it seeks to explain the motivations behind
foreign direct investment (FDI) and portfolio investment. Factors influencing international
investment include market-seeking behavior, where firms invest to access new consumer
markets; resource-seeking, where companies seek natural resources or lower production costs;
and efficiency-seeking, aiming to capitalize on specific skills or technological advantages in
another country. Additionally, the theory considers the role of government policies, economic
conditions, and global market dynamics in shaping international investment patterns.