International Trade Theory

The traditional and the most developed form of international economic relations is international trade. The contemporary international economic relations, characterized by the active development of world trade introduce many new and specific aspects in the process of national economies development. There are many models which are concerned with the theorizing the international trade and the two that I should consider is Ricardian model and Heckscher-Ohlin theory. Both theories differ, although having many common elements, in explaining the patterns of international trade. David Ricardo established the pattern of international trade stating that it is in the interest of each nation to specialize in production, in which they have the most advantage or the least weaknesses, and for which the comparative advantage is the greatest. Such findings were reflected in the so called theory of comparative advantage (Suranovic, 2006b).

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The Heckscher-Ohlin theory differs in that it addresses the main disadvantage of the Ricardian theory, which is explaining the reasons behind the formation of comparative advantages. In that regard, Heckscher-Ohlin theory addresses production in terms of two factors, i.e. capital and labor, and assumes that production technologies are identical. Thus, the pattern of international trade can be seen in that countries might produce several goods, rather than specialize in one, will export the products which are dependent on the abundant factors in the country, stating that such abundance results in the distribution of income (Suranovic, 2006a).

The latter can be explained through one of the results of the Heckscher-Ohlin theory, which is the Stolper-Samuelson Theorem. The theorem states that if the price of the goods, which are heavily dependent on a particular factor such as labor, capital or land rises, then the price for that factor will rise as well, while the prices for other factors will decline (Suranovic, 2006a). For example taking the production of grain in country B, which is land abundant, maximizing its production of grain, the demand for land will increase, and considering the limited supply, the rental payment for land will rise as well. Grain is similarly relied on labor, which will lead to that the demand on labor will rise, which will subsequently will lead to an increase of the wages in that sector. Accordingly, it can be stated that the price of the remaining factor will decrease, i.e. rental rate on capital. Following such example with an assumption that the same country imports cheap sugar from another country specialized in sugar, the price of sugar will fall, which lead to a decrease in production. The latter will lead to the decrease in demand in labor, which subsequently will be reflected in the wages. The changes caused by the international trade will lead to changes in the structure of the production, where fast growing sectors will demand additional resources, which will be released from the sectors, in which the production decreases. In the long term the redistribution will affect the grain producing country, where the increase in the supply of the labor and the land, because of the released resources form the production of sugar, will lead to that the wages and land rents will gradually decrease. Generally, the production in the export sector will lead to the increase in their income, while the income of the sectors competing with the import will decrease (Suranovic, 2006a).

Despite the logical basis in Heckscher-Ohlin theory, the empirical observations of the real world refuted the reliance on the abundant factors in exporting nations, leading to what is called Leontief paradox. Leontief used the 1947 input-output table of the US economy, and found that US, the most capital abundant country, exported labor intensive goods and imported capital intensive goods, a paradox that contradicted Heckscher-Ohlin theory. Such paradox was not limited to the United States, where observations and tests performed by other economists and scholars found that the same paradox is evident with other countries, which largely put the factor-endowment model in doubt. Further examination of international trade revealed an interesting phenomenon called Factor Intensity Reversal, which states that “If a commodity is produced by a labor-intensive process in the labor-rich country and also by the capital-intensive process in the capital-rich country, then factor intensities are reversed in the production of that commodity” (“Leontief Paradox,”). An example can be shown through assuming that the same commodity is relying on different factors in different countries, e.g. technology is labor intensive in China and Capital intensive in Japan. Thus, if Japan imports technology, the paradox occurs in Japan, because it is a capital intensive country importing capital intensive product. Similarly, if China imports technology, the paradox occurs in China. Although Factor intensity has not been empirically tested enough, it can be said that such phenomenon occurs in the trade patterns between developed and developing economies.

Following the paradox refuting the Heckscher-Ohlin theory, Staffan Linder provided an explanation that combined the two patterns of the international trade. Linder stated that the Heckscher-Ohlin theory is applicable to the primary products and agricultural goods, where the factor-endowment model is working well for them (Carbaugh, 2008, p. 104). For manufacture, Linder provided another explanation, which is based on the structure of demand in trading countries. Linder argued that the demand can be represented through the average income, which the household spends on various products, i.e. a function of the income per capita. In that regard, Linder argued that countries with similar demands, which can be rephrased into similar income per capita, are likely to do more trade with each other. The explanation can be seen in that producers initially produce products for the local market. When exporting the product, after the domestic market becomes satiated, the producers seek markets with the same demand, and where a consideration to determine such markets is sought through countries with similar levels of income per capita (Grimwade, 2000, p. 56).

A specific tariff is fixed amount of money paid per physical unit. The advantages of such tariffs include the fact that it is easy to apply and administer, which is usually applied to standardized commodities, and the protection it offers the domestic producers during the recessions. The disadvantages include the correlation of the protection it offers with the changes in imported prices (Carbaugh, 2008, p. 111).

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Ad valorem tariffs are duties paid through percentages applied to products’ value. The advantages include the differentiation of the duties paid, according to the price of the product, which leads to maintaining constant degree of protection for domestic producers during the periods of changing the prices. The disadvantages might be seen through the administrative complexities in determining the value of the imported product as well as the variation of the methods used between different systems applied in different countries and regions (Carbaugh, 2008, p. 111).

Compound tariffs are duties applied to manufactured products which consist of raw materials that are also subject to tariffs. In that regard, each compounding tariff protects particular sectors of domestic productions, i.e. the suppliers of raw materials through specific tariff and the producers of finished goods through ad valorem tariffs. Accordingly, the advantages and disadvantages can be seen through the combination of the advantages and disadvantages of specific and ad valorem tariffs (Carbaugh, 2008, p. 112).

References

Carbaugh, R. J. (2008). International economics (12th ed.). Mason, OH: South-Western Cengage Learning.

Grimwade, N. (2000). International trade : new patterns of trade, production & investment (2nd ed.). London New York: Routledge.

Leontief Paradox. Iowa State University, 2009. Web.

Suranovic, S. (2006a). The Heckscher-Ohlin (Factor Proportions) Model Overview. International Trade Theory and Policy. Web.

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Suranovic, S. (2006b). The Theory of Comparative Advantage – Overview. International Trade Theory and Policy. Web.

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