Theories of International Trade: Classical to Modern Insights

Theories of international trade have evolved from classical principles to modern frameworks that include technological innovation and economies of scale. The theories of absolute advantage, comparative advantage and factor endowments provide the classical foundations for apprehending why international trade occurs. The newer trade theories offer extra insights into the tough facts of trade in today's globalized thrift. Together, they stress how global trade allows nations to maximize welfare economics by specializing in what they can make best. The basic theories of global trade are- the theory of absolute advantage, the theory of comparative advantage, the Hecksher-Ohlin theory, new trade theories, etc.

The theory of international trade is one topic which queries are surely asked in the UGC-NET Commerce Examination.

In this topic, the learners will be able to learn about the following topics:

• What is the Theory of International Trade?
• Explanation of Theories of International Trade
• Factor Endowment Theory of International Trade
• Haberler Theory of International Trade

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What is the Theory of International Trade?

International trade theories attempt to rationalize why trade exists between countries and how it benefits them. International trade is when countries buy and sell goods and services to each other. Countries do this because they have different resources like food, energy, or technology. Trade helps countries get things they don’t have or can’t make easily. There are different theories that explain why countries trade with each other. One theory is called ’Absolute Advantage’, where a country is better at making a certain good than others. Another theory is ‘Comparative Advantage’, which says countries should focus on what they do best, even if they aren’t the best at everything. ‘Heckscher-Ohlin Theory’, explains that countries will export goods based on their resources, like land or labor. According to the ‘Product Life Cycle Theory’, countries first make a new product and later start importing it when it becomes common. These theories help us understand how trade benefits countries in different ways. By following these ideas, countries can make the most out of what they produce and get what they need.

Fig: theories of international trade

Let us now explain the key theories of international trade and how each contributes to global economic interaction. International trade happens when countries exchange goods and services. Theories of international trade help us understand why countries trade with each other and how it benefits them.

Absolute Advantage

Smith’s theory of international trade introduced the concept of specialization based on production efficiency. This theory says that some countries are better at making certain goods than others. If a country can produce something more efficiently, it should make that product and sell it to other countries. For example, if a country can grow a lot of wheat quickly, it can sell wheat to countries that don’t grow much. This way, both countries can get what they need. Absolute Advantage helps countries save time and resources. It also helps them get products at lower costs.

Comparative Advantage

This theory says countries should focus on making things they are best at, even if they aren’t the best at everything. If a country is good at making wheat but better at making rice, it should focus on rice. Even if another country is better at making everything, both countries can still benefit by trading. This way, both countries can get what they need at lower costs. It’s about doing what each country does best. By trading, both countries can have more goods than if they tried to do everything themselves.

Classical Theory of International Trade

The ‘Classical Theory of International Trade’, was formed by economists such as Adam Smith and David Ricardo. The classical theory of international trade, led by Smith and Ricardo, focused heavily on efficiency and specialization. According to this theory, nations must specialize in the products they are better at producing. If a nation specializes in making some products, it can then exchange those products with other nations. Other nations can then provide the products each nation requires. This is referred to as ‘comparative advantage’. Through trade, nations are able to acquire more goods and services than they would if they produced everything themselves. The theory assumes that free trade makes nations richer. It also illustrates how trade is good for all nations, even if one nation is more powerful than the other. Unlike newer models, the classical theory of international trade assumes perfect competition and ignores scale economies.

Mercantilism Theory of International Trade

The ‘Mercantilism Theory’, is an older concept regarding international trade. It explains that a nation becomes powerful by gathering as much silver and gold as they can. As per this theory, nations should export more than import. In this manner, they get more money and store it within their nation. Mercantilists felt that trade must only occur if it adds to the wealth of the nation. They also believed that the government must regulate trade and guard domestic businesses. The theory viewed trade as a means by which nations can grow richer and stronger. It calls upon nations to develop a strong economy by exporting products.

Heckscher-Ohlin Theory of International Trade

This theory says countries will export goods that use their most available resources. For example, a country with lots of land will export things that grow in the ground, like crops. A country with lots of workers might export things that need a lot of labor to make, like clothes. The theory explains why some countries make certain products based on what they have most. It helps countries decide what to produce and trade. By doing this, countries can use their resources wisely.This theory of international trade revolutionized how we interpret trade based on a country's resource availability.

Product Life Cycle Theory of International Trade

Among the newer international trade theories, the Product Life Cycle Theory stands out for emphasizing innovation and market diffusion. This theory explains how products change over time. When a new product is invented, the country that made it will produce and sell it first. Over time, other countries learn how to make it too, and the original country starts to import the product. This happens because the product becomes common and easier to make. As a product becomes old or less special, the original country stops making it and buys it from other countries. This shows how trade changes as products get older.

Factor Endowment Theory of International Trade

The Factor Endowment Theory, also known as the Heckscher-Ohlin Theory, is a model of international trade that was developed by two economists, Eli Heckscher and Bertil Ohlin, in the early 20th century. Heckscher-Ohlin is among the most widely accepted international trade theories based on resource endowment. This theory suggests that countries should specialize in and export goods that require resources which are abundant and cheaply available, whereas they should import goods that require resources that are in short supply within their borders.

While the Factor Endowment Theory has been a significant contribution to the field of international trade, it has its limitations. For example, it doesn't account for economies of scale, assumes perfect competition, and overlooks the role of technology and innovation. Despite these caveats, the theory helps clarify why certain countries tend to specialize in and export certain types of goods.

Haberler Theory of International Trade

Gottfried Haberler, an accomplished Austrian-American economist, provided a notable contribution to the theory of international trade. He challenged some of the traditional viewpoints on the subject and introduced the Opportunity Cost Theory of International Trade. Haberler’s contribution redefined the traditional theory of international trade by introducing opportunity costs.

The traditional trade theory, also known as the Labor Theory (Adam Smith and David Ricardo), suggests that labor is the only factor of production and it differs in efficiency across countries. This makes the labor theory quite impractical in reality as it only takes one factor (labor) into consideration.

Haberler critiqued this aspect and proposed the Opportunity Cost Theory. In this theoretical framework, Haberler stated that what truly matters in determining the production of goods for trade is not just the labor efficiency, but the alternative that must be forgone, also known as the opportunity cost.

Haberler's theory has been seen as one of the critical developments in international trade theory. It's broader and more versatile compared to the labor theory. It takes into account not only labor but also all the factors of production like land, labor, capital, etc. Furthermore, it can be applied to all goods and services, whether they are agricultural, manufactured, or services.

Conclusion

Although each of the theories of international trade offers unique insights, comparative advantage remains a recurring theme across them all. Theories on why nations trade have changed over time. Older theories focused on the costs of production and resources. Newer theories consider real things like economies of scale, consumer choices and trade barriers. Even today, the classical theory of international trade holds relevance in explaining trade based on cost efficiency. Though theories have changed, the comparative advantage remains vital. Nations will trade when they can make something at a lower relative cost. The neoclassical theory mixes ideas from old and new theories. It says comparative advantage is key, but other factors also matter. Overall, theories give useful insights into what drives trade.

Theories of international trade is a vital topic per several competitive exams. It would help if you learned other similar topics with the Testbook App.

Major Takeaways for UGC NET Aspirants Introduction to Theories of International Trade: International trade is when countries buy and sell goods and services to each other. Countries do this because they have different resources like food, energy, or technology. Explanation of Theories of International Trade Absolute Advantage: This theory says that some countries are better at making certain goods than others. Comparative Advantage: This theory says countries should focus on making things they are best at, even if they aren’t the best at everything.  Classical Theory of International Trade: The ‘Classical Theory of International Trade’, was formed by economists such as Adam Smith and David Ricardo. Remember, the classical theory of international trade is built around absolute and comparative advantage Mercantilism Theory of International Trade: The ‘Mercantilism Theory’, is an older concept regarding international trade. It explains that a nation becomes powerful by gathering as much silver and gold as they can. Heckscher-Ohlin Theory: This theory says countries will export goods that use their most available resources. Product Life Cycle Theory: This theory explains how products change over time. When a new product is invented, the country that made it will produce and sell it first.  Factor Endowment Theory of International Trade: The Factor Endowment Theory, also known as the Heckscher-Ohlin Theory, is a model of international trade that was developed by two economists, Eli Heckscher and Bertil Ohlin, in the early 20th century. Haberler Theory of International Trade:Gottfried Haberler, an accomplished Austrian-American economist, provided a notable contribution to the theory of international trade. UGC NET aspirants must thoroughly understand the theories of international trade, as it is a frequently asked topic in the exam.

Theories of International Trade Previous Year Questions

A difference in relative commodity prices between two nations can be based upon a difference in________.

Options. A. Factor Endowment

• Technology
• Tastes
• All of the above

Ans. A. Factor Endowment