Theories of International Trade, Tariff and Non-tariff barriers and Trade BlocksInternational Business Management

Mrs. Charu Rastogi Asst. Prof.

AgendaTheories of International TradeTariff & Non-tariff Barriers Trade Blocks

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THEORIES OF INTERNATIONAL TRADE

Adam SmithRicardoOhlin & Heckscher

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Evolution of Trade Theories

MercantilismAbsolute advantage (Classical)Comparative advantageFactor Proportions Trade International Product CycleNew Trade TheoryNational competitive advantage

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Mercantilism: mid-16th century

Theory assumes that a nation’s wealth depends on accumulated treasure◦ Gold and silver are the currency of trade

Therefore, this theory holds that nations should accumulate financial wealth, in the form of gold or silver by encouraging exports and discouraging imports

Theory says you should have a trade surplus. ◦ Maximize export through subsidies.◦ Minimize imports through tariffs and quotas

Flaw: restrictions, impaired growth

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Assumptions of Absolute Advantage and Comparative Advantage Theories2 countries, 2 commodity modelLabor as the only inputSingle currency assumed thereby eliminating

effects of exchange rate changesHomogeneous factors of production – All labor

units are of same type. They can be freely moved from production of cloth to production of bread and vice versa. i.e. No specialized labor.

Units of production are divisible in compact units.

All factors of production are fully employed.No government restrictions on free trade

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Theory of absolute advantage

Adam Smith: Wealth of Nations (1776) argued:◦ A country should produce only goods where it is

most efficient, and trade for those goods where it is not efficient

◦ Export those goods and services for which a country is more productive than other countries

◦ Import those goods and services for which other countries are more productive than it is

Trade between countries is, therefore, beneficial

Assumes there is an absolute balance among nations

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Theory of absolute advantage… destroys the mercantilist idea since there

are gains to be had by both countries party to an exchange

… questions the objective of national governments to acquire wealth through restrictive trade policies

… measures a nation’s wealth by the living standards of its people

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Theory of absolute advantagePPF – Production Possibility

Frontier

Ghana

South Korea

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Absolute Advantages and Gains from Trade

Assume total amount of resources at 200. In the absence of trade resource is used equally for both products; 100 for cocoa and 100 for Ghana

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Criticism of Absolute Cost Advantage TheoryMost of the criticisms from absolute advantage

theory would arise because of the unrealistic nature of its assumptions.

However, an important incompleteness in the theory was the fact that it addressed only a situation wherein one country enjoyed an absolute advantage in production of a commodity over another country. It was pointed out that such situations are rare.

Quite often the advantage is not an absolute advantage but a comparative one as would be clear from the Ricardian Theory of Comparative Cost Advantage.

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Theory of comparative advantage

David Ricardo: Principles of Political Economy (1817)◦ Extends free trade argument◦ Efficiency of resource utilization leads to more

productivity◦ Should import even if country is more efficient

in the product’s production than country from which it is buying.

Produce and export those goods and services for which it is relatively more productive than other countries

Import those goods and services for which other countries are relatively more productive than it is

Makes better use of resources

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Theory of comparative advantage

PPF – Production Possibility Frontier

Ghana

South Korea

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Comparative Advantage and Gains from Trade

Assume total amount of resources at 200. In the absence of trade resource is used equally for both products; 100 for cocoa and 100 for Ghana

100-100 for both products

SK:100-100 Ghana: 150 for Cocoa and 50 for Rice

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Limitation of Comparative Advantage TheoryDriven only by maximization of production

and consumptionOnly 2 countries engaged in production and

consumption of just 2 goods?What about the transportation costs?Only resource – labour (that too, non-

transferable) No consideration for ‘learning theory’

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Mrs. Charu Rastogi Asst. Prof.

Comparative advantage: Bollywood

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Mrs. Charu Rastogi Asst. Prof.

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Factor proportions theoryHeckscher (1919) - Olin (1933) TheoryExport goods that intensively use factor

endowments which are locally abundant◦ Corollary: import goods made from locally

scarce factors Note: Factor endowments can be impacted by

government policy - minimum wagePatterns of trade are determined by

differences in factor endowments - not productivity

Remember, focus on relative advantage, not absolute advantage

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Factor proportions theory

… trade theory holding that countries produce and export those goods that require resources (factors) that are abundant (and thus cheapest) and import those goods that require resources that are in short supply

Example:◦ Australia – lot of land and a small population

(relative to its size)◦ So what should it export and import?

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Factor Proportions Trade Theory:Considers Two Factors of Production

Labor

Capital

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Factor Proportions Trade Theory A country that is relatively labor abundant

should specialize in the production and export of that product which is relatively labor intensive

A country that is relatively capital abundant should specialize in the production and export of that product which is relatively capital intensive

A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance◦ China: labor◦ Saudi Arabia: oil◦ Argentina: wheat

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TRADE BARRIERSTariff and Non-Tariff Barriers, Trade Blocks

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Trade Barriers Countries use protectionist measures to shield a

country’s markets from intrusion by foreign competition and imports

Protectionism is implemented through the imposition of trade barriers, which include tariff barriers and non-tariff barriers

Reasons for protectionism:◦ Maintain employment and reduce unemployment◦ Increase of business size◦ Retaliation and bargaining◦ Protection of the home market ◦ Need to keep money at home◦ Encouragement of capital accumulation◦ Maintenance of the standard of living and real wages◦ Conservation of natural resources◦ Protection of an infant industry◦ Industrialization of a low-wage nation◦ National defense

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TariffTariff in international trade refers to the

duties or taxes imposed on the import traded goods when they cross the national borders. 

Different rate of duty for different goodsCustoms Tariff Structure for 2012-13:

http://www.cbec.gov.in/customs/cst2012-13/cst1213-idx.htm

Example: There is a 100% duty on importing private cars/vehicles

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Non-Tariff BarriersA form of restrictive trade where barriers to trade are

set up and take a form other than a tariff. Forms of NTBs

Specific Limitations on Trade:◦ Quotas

sets a physical limit on the quantity of a good that can be imported into a country in a given period of time

Example: Russia has quotas on the number of tons of beef (315,000) and chicken (1.05 million) that can be imported each year. If the quotas are reached, the state then charges an additional 60-80% tax.

◦ Import Licensing requirements Each license specifies the volume of imports allowed, and the total

volume allowed should not exceed the quota. Licenses can be sold to importing companies at a competitive price, or simply a fee.

◦ Proportion restrictions of foreign to domestic goods (local content requirements)

◦ Minimum import price limits◦ Embargoes

An embargo is the partial or complete prohibition of commerce and trade with a particular country, in order to isolate it.

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Non-Tariff Barriers Customs and Administrative Entry Procedures:

◦ Valuation systems◦ Antidumping practices◦ Tariff classifications

◦ a classification assigned by government officials that affects the size of a tariff and the imposition of import quotas.

◦ Example: The U.S. Customs Service only charges an 8.5% tariff on imported leather or “non rubber” shoes, while it charges anywhere from 20-67% for imported rubber shoes like athletic footwear or waterproof shoes

◦ Documentation requirements◦ Fees

Standards:◦ Standard disparities◦ Intergovernmental acceptances of testing methods and

standards◦ Packaging, labeling, and marking

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Non-Tariff Barriers Government Participation in Trade:

◦ Government procurement policies◦ Export subsidies◦ Countervailing duties

A duty placed on imported goods that are being subsidized by the importing government

◦ Domestic assistance programs Charges on imports:

◦ Prior import deposit subsidies◦ Administrative fees◦ Special supplementary duties◦ Import credit discriminations◦ Variable levies◦ Border taxes

Others:◦ Voluntary export restraints◦ Orderly marketing agreements

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Trade BlocksA trade block is a type of intergovernmental

agreement, often part of a regional intergovernmental organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminated among the participating states

Criteria for formation of Regional Trade Blocks –◦ Neighboring countries◦ Similar resource endowments and production structures –

and hence possibility of cartelization in International market for buying / selling

OR◦ High degree of mutual dependence – hence large gains

through mutual free trade◦ Political will

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Major Trade BlocksEuropean Union (EU)North American Free Trade Agreement

(NAFTA)Singapore American Free Trade Agreement

(SAFTA)Organization of Petroleum Exporting

Countries (OPEC) Association of South East Asian Nations

(ASEAN)South Asian Association of Regional Co-

operation (SAARC)

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Levels of integrationTrade

Concessions•Special Tariffs•Relaxation in NTBs•Only for select commodities and services

Free Trade Area •Complete removal of restrictions on movement of goods•Quite often leading to Customs Union

Common Market •Adoption of common standards – environment, labor, etc.•Common external trade policy

Economic Union•Common Economic Policy•Common Currency and Monetary Policy•Free movement of factors

Political Union •Common Governing Body•Common Laws

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Possible QuestionsTheories of International TradeExplain Adam Smith’s theory of absolute

advantage. How does Ricardo’s theory of comparative advantage differ from theory of absolute advantage ?

Explain the concept of trade barriers. What are different types of tariff and nontariff barriers?

Explain the term Globalisation. Discuss various stages in Globalisation.

What are the barriers to international trade ? List and explain all the types of barriers to international trade.

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Thank You!!Any Questions??

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