Topic 3 Modern Trade Theories PDF

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Discussion Questions 2: Modern Trade Theories Q1.Outline using a numerical example, the theory of comparative advantage. What are the benefits of international trade according to Ricardo? Explain how the factor endowment theory differs from the Ricardian theory of comparative advantage in explaining international trade patterns Factor endowment theory = H/O theory - Ultimate determinants of CA: Tech, resources endowments and demand Assume: Tech and demand are similar between countries - Resource endowment are biggest advantage import the product which uses in production with highest opportunity cost. - Resource affect end prices e.g. producing products in China, cheap labour - US: abundant in Human Capital, scientific skills and engineering Scarce: Unskilled labour - Change overtime e.g. South Korea – start simple and develop. Q2. Discuss the implications of the factor price equalization theory of international trade. Use an example to illustrate your answer. How does the Stolper-Samuelson theory extend the analysis? FPE theory: Forcing product prices into equality, international trade tends to force factor prices to equality also. - Re-direct demand - Trade = FPE - Cheap resource becomes expensive Real world: no full factor-price equalization - Uneven ownership of Human Capital - Not all countries have the same Technology - Transport costs and trade barriers Stolper-Samuelson – Extension to FPE - Increase in relative price = increase in return to the factor Q3. Evaluate how the Leontief paradox challenges the overall applicability of the factorendowment model. Leontief Paradox challenges - America comparative advantage was something else than capital – intensive goods. - Exports of the US is not intensive in physical capital but in human capital (skills) - Countries with educated workers will focus on exporting products that required skilled/educated labour. Q4. Outline the Overlapping Demands Theory of international trade. Does the theory adequately explain international trade patterns? Overlapping Demand theory - Produce goods for which there is a large domestic market. - High per capita income = high Quality manufactured goods (depends on GDP)

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Similar GDP = Similar Demand Wealthy trade with wealthy (Vice Versa)

Q5. Discuss the impact of internal and external economies of scale on a country’s trade pattern. Decrease in total production cost, proportionally - Internal = Country - External = Industry - Average Cost decrease as output increases (External)  Concentration  More Specialized workers  Knowledge skill-over (Silicon Valley)  Bigger more focused R&D efforts E.g. University partner with companies - Silicon Valley (Tech Industry) - Hollywood (movie Industry) - Dalton, Georgia (Carpet Manufacturing) Q6. Critically evaluate the usefulness of industrial policy in creating comparative advantages in trade in specific industries. Use a country example. Ricardo’s theory of competitive advantage over looks the fact that additional resources can be made available to the trading nation because they can be created or imported. The Japanese were among the first to recognize that CA in a particular industry can be created through the mobilization of skilled labour, technology and capital. In addition to the business sector, government can establish policies to promote opportunities for change through time. Such a process is known as dynamic CA. When government are actively involved in creating CA, the term industrial policy applies.    

Industrial policy is a strategy to revitalize, improve and develop an industry. Government enact policy that encourages the development of emerging “sunrise” industries (Such as high-tech) Resources are directed to industries in which productivity is highest, linkages to the rest of the economy are strong (Semi -Conductors) Domestic economy will enjoy increased average productivity and more competitiveness as a result of policy.

Examples of government intervention: - Antitrust immunity - Tax incentives - R&D subsidies - Loan Guarantees - Low interest rate loans - Trade protection

Creating CA requires government to identify the ‘winners’ and encourage resources to move into industries with the highest growth prospects. Japan: After WWII, Japan invested in basic industries including steel, autos and later electronics, including computers.  From a SR static perspective, Japan appeared to pick the wrong industries  From a LR perspective, those were the industries where tech progress was rapid, labour productivity rose quickly and unit costs decreased with the expansion of output.  The aim was to decrease costs by increasing productivity. The causal factor in Japanese industrial success is unclear. Some of the government targeted industries are more competitive than they would have been in the absence if government assistance. Effectiveness:  If all trading nations took the route of using a combination of trade restrictions on imports and subsidies on exports, a “beggar-thy-neighbor” process of trade-inhabiting protectionism would result.  Politically powerful industries receive government assistance  In a free-market, profit maximising businesses have the incentive to develop new resources and technology that change a countries CA. It’s questioned whether government or private sector does a better job in creating CA.  Export subsidies can benefit the domestic/exporting economy (Decrease poverty)  Subsidies are funded by consumers and tax payers, are they getting ‘bang for their buck’ Q7. Assess the impact of transportation policies on trade patterns. Transportation costs refer to the costs of moving goods, including freight charges, packing and handling expenses and insurance premiums. - These costs are obstacles to trade and impede the realization of gains from trade liberalisation. - Differences across countries in transportation costs are a source of comparative advantage and affect the volume and composition of trade. 

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With the introduction of transportation costs, the low-cost exporting nation produces less, consumes more, and exports less; the high-cost importing nation produces more, consumes less and imports less. The degree of specialization in production between the two nations decreases, as do the gains from trade. Transportation costs tend to reduce the volume of trade, the degree of specialization in production among nations concerned, and thus the gains from trade. A product will be traded internationally as long as the pre-trade price differential between the trading partners is greater than the cost of transporting the product between them.

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A decline in the relative cost of transportation makes imports more competitive, contributing to higher volumes of trade. Falling transportation costs have been due largely to technological improvements, including the development of large dry-bulk containers, large scale tankers, containerisation and widebodies jets. Moreover, technological advances in telecommunications have reduced the economic distances among nations

One factor behind the trade boom has largely been unnoticed: the declining costs of getting goods to the market. Today, transportation costs are less severe obstacles, finished goods dominate the flow of trade, and therefore less transportation is required for every dollar’s worth of exports and imports. Increased productivity of transporting goods has resulted in falling costs and increased trade. E.g. Port of Prince Rupert was funded by government through improved roads and rail when negotiations broke down during a labour dispute resulting in congestion on the borders causing days/weeks of delays, exporter began sending goods via alternative routes which has resulted in an increase in trade between Canada and Asia’s economies....