Theories of International Trade, Tariff and Non-tariff barriers and Trade Blocks

International Business Management

Mrs. Charu Rastogi Asst. Prof.

Agenda
Theories of International Trade Tariff & Non-tariff Barriers Trade Blocks

Mrs. Charu Rastogi Asst. Prof.

Adam Smith Ricardo Ohlin & Heckscher

THEORIES OF INTERNATIONAL TRADE

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Evolution of Trade Theories

Mercantilism Absolute advantage (Classical) Comparative advantage Factor Proportions Trade International Product Cycle New Trade Theory National competitive advantage

Mrs. Charu Rastogi Asst. Prof.

Mercantilism: mid-16th century

Theory assumes that a nations 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 Theories 2 commodity model 2 countries,
Labor as the only input Single currency assumed thereby eliminating effects of exchange rate changes Homogeneous 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 freeAsst. Prof. Mrs. Charu Rastogi trade

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 nations wealth by the living standards of its people

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Theory of absolute advantage

PPF Production Possibility Frontier

Ghan a

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 Mrs. Charu Rastogi Asst. Prof. equally for both products; 100 for cocoa and 100 for Ghana

Mrs. Charu Rastogi Asst. Prof.

Mrs. Charu Rastogi Asst. Prof.

Mrs. Charu Rastogi Asst. Prof.

Criticism of Absolute Cost Advantage Theory

Most 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 products 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 Charu Rastogi Asst. Prof. Mrs.

Theory of comparative advantage

PPF Production Possibility Frontier

Ghan a

South Korea

Mrs. Charu Rastogi Asst. Prof.

Comparative Advantage and Gains from Trade

100-100 for both products SK:100100 Ghana: 150 for Cocoa and 50 for Rice

Assume total amount of resources at 200. In the absenceMrs. Charu Rastogi Asst. Prof.equally for of trade resource is used both products; 100 for cocoa and 100 for Ghana

Limitation of Comparative Advantage Theory

Driven only by maximization of production and consumption Only 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

Mrs. Charu Rastogi Asst. Prof.

Mrs. Charu Rastogi Asst. Prof.

Comparative advantage: Bollywood

Mrs. Charu Rastogi Asst. Prof.

Mrs. Charu Rastogi Asst. Prof.

Mrs. Charu Rastogi Asst. Prof.

Factor proportions theory

Heckscher (1919) - Olin (1933) Theory Export 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 wage

Patterns of trade are determined by differences in factor endowments - not productivity Remember, focus on relative advantage, not absolute advantage

Mrs. Charu Rastogi Asst. Prof.

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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Tariff and Non-Tariff Barriers, Trade Blocks

TRADE BARRIERS

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Trade Barriers
Countries use protectionist measures to shield a countrys 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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Tariff

Tariff 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 goods Customs Tariff Structure for 2012-13: http://www.cbec.gov.in/customs/cst201213/cst1213-idx.htm Example: There is a 100% duty on importing private cars/vehicles

Mrs. Charu Rastogi Asst. Prof.

Non-Tariff Barriers
A 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
Mrs. Charu Rastogi Asst. Prof.

Trade Blocks

A 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 Blocks

European 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)

Mrs. Charu Rastogi Asst. Prof.

Levels of integration
Trade Concessions
Special Tariffs Relaxation in NTBs Only for select commodities and services Complete removal of restrictions on movement of goods Quite often leading to Customs Union Adoption of common standards environment, labor, etc. Common external trade policy Common Economic Policy Common Currency and Monetary Policy Free movement of factors Common Governing Body Common Laws

Free Trade Area

Common Market Economic Union Political Union

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Possible Questions
Theories of International Trade Explain Adam Smiths theory of absolute advantage. How does Ricardos 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.

Mrs. Charu Rastogi Asst. Prof.

Mrs. Charu Rastogi Asst. Prof.