International Business and International Marketing

Chapter 3 : International Trade

Chapter Summary

Adam Smith proposed the theory of Absolute Advantage in 1776. According to this theory, countries should produce and export surpluses of goods in which they have absolute advantage and buy whatever else they need from other countries. Adam Smith believed that this would lead to specialization and the resultant increase in productivity. David Ricardo, an English economist, came out with the Theory of Comparative Advantage in 1817.

According to this theory, each country should produce that good, in which it has a comparative advantage. A country will be better off by concentrating on the production of goods in which it has the lower relative labour costs, or higher relative labour productivity. Ricardo’s theory was based on only one factor of production-labour and was criticized because it ignored other factors of production such as land and capital. The Hecksher-Ohlin theory aimed to remedy this deficiency by explaining trade in terms of relative factor intensities.

This theory proposed by Posner, considers the possibility of trade between two countries having the same factor endowments and consumer tastes. According to this theory, improvement in technology is a continuous process and the resulting inventions and innovations in existing products give rise to trade between these countries. The International Product Life-Cycle (IPLC) theory, proposed by Vernon, explains various stages in the life of a product and the resultant international trade.

According to this theory, innovations are generally made in the richer, more developed countries. In the early stages of a new product's life cycle, it is produced and exported by the country which introduced the innovation. In the second stage of the life of the product, production may shift to other developed countries, where the factors of production are available in abundance and thus offer a cost advantage.

In the third and the final stage, production shifts to less developed countries and the country that originally exported the goods now becomes the importer. The WTO came into existence on 1st January 1995 but its origins lie in the General Agreement on Tariffs and Trade (GATT) that was in force since 1948. GATT evolved through many rounds of negotiations. While GATT was limited to issues related to trade in goods, the WTO goes further to include trade in services, and in traded inventions, creations and designs (intellectual property).

The WTO agreements are based on a few fundamental principles. These principles form the basis of the multilateral trading system. There are many benefits of WTO. Some of the benefits are that it helps in maintaining peace, makes life easier with a system based on rules rather than on power, lowers the cost of living, broadens choice, boosts incomes and employment, and protects governments from narrow interests.

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