With the world becoming a global village, every aspect of human life has also been integrated and trade has not been left behind either. The free movement of goods and services has been facilitated by the agreement between world economies; in the need and the benefits of promoting free international trade leading to trade liberalization.
To facilitate international trade, first there was the formation of General Agreement on Tariffs and Trade (GATT) in the early 1940s after the 2nd world war since it was observed that the next cause of a world war could possibly result from trade. With many challenges, the GATT tried to ensure that trade was conducted freely with no barriers but it was only in 1998 the GATT was formed into a world to its current name – the World Trade Organization.
Although many view international trade as a boost to the world economies growth and development, critics against the international trade have been arguing that the international trade works to the advantage of the developed economies while the less developed economies are left lagging behind. They argue that the international trade only facilitates the availability of surplus goods and services in the developed economies to the detriment of less developed industries, which have not acquired the superior technologies to achieve economies of scale.
Thus, when the imports from the developed economies flood the market, the prices of locally produced goods decline leading to the home industries incurring losses.
What they fail to understand is that with international trade, the less developed economies are adopting new technologies faster than the developed economies did and due to that, the less developed economies do not have to go through the full cycle of industrialization. It is important to note that with specialization, any country can achieve economies of scale and reap the benefits of international trade (Kim, Mabele & Schultheis 171).
Benefits of International Trade
Morgan and Katsikeas (1) when quoting Adam Smith’s 1776 contribution to the benefits on international trade indicate that countries need to export goods and services in order to generate enough revenue to finance for imports which they cannot produce locally. This is in line with the fact that international trade influences a country’ Gross Domestic Product. It was for this reason that economists have come up with theories of international trade such as the export led growth thesis.
The theory assumes that GDP of a nation will rise to provide a stimulus to improved economic well being and society prosperity. The export performance stimulates effect through out a country’s economy and this leads to most successful economies to rely on export led growth rather than domestic demand induced expansions (Davidson 218).
The spill-over benefits are then spread to the rest of the economy. These spill-over benefits are felt due to the fact that international markets demand “improved efficiencies and supports product and process innovation activities, while increases in specialization encourage profitable exploitation of economies of scale”, (Morgan & Katiskeas 1).
The benefits of international trade have also been explained by use of several theories such as the Ricardian theory or the theory of comparative advantage, neoclassical theory, Heckscher- Ohlin theory and the Absolute advantage theory.
According to the Ricardian Theory, the main assumption is that nations export the goods and services which they have the highest comparative advantage and import those goods and services which have the least comparative advantage. This means that most countries engaging in international trade tend to specialize in what they can produce cheaply and efficiently thus achieving economies of scale and then importing those products which other countries produce cheaply (Deardorff 8).
According to this theory, if every country specialized in the goods and services it can produce cheaply without much capital investments, the economies of scale would be easily achieved due to the huge volumes of production and this would result in countries exporting goods and services cheaply as well as importing goods and services cheaply due to the little costs of production that were involved (Caravale & Tosato 69).
However, the problem with the Ricardian theory is its strict unrealistic assumptions which include; that countries should have fixed endowments of resources of which is hard to happen in real life situation since as we all know countries are all resources differently endowed. The other assumption the model assumes is that the factors of production are completely mobile between the alternative uses while completely immobile externally.
This assumption assumes that while resources can be moved from one location to the other within the country, such resources cannot move outside the country. With the assumptions that there are no obstacles and that the transportation costs are zero, the theory fails to capture the issues of costs involved during the production process as well as exporting and importing of goods and services (Widodo 59).
Due to the strict assumptions of the Ricardian model, economists came up with a new theory which could explain the benefits of international trade which had some more realistic assumptions. The neoclassical theory was then introduced which was a modification of the Ricardian model. The theory replaced the constant cost assumption as applied in the Ricardian theory with an increasing marginal cost.
The theory provided the concavity of the production possibility frontier and showed that for a country to benefit from international trade, each would gain by applying the possible terms of trade available that had the highest returns. The different resource endowments will always lead to one country producing cheaply than the other and thus the need to specialize in that good or service that can be produced most cheaply (Gandolfo 33).
Another international trade theory predicting the advantages of international trade is the Heckscher- Ohlin theory. The theory predicts that a country will always have an advantage if it trades in the good or service which makes intensive use of the abundant factor of production whether capital or labour since the factor of production would not be idle or less productive (Fedotovs 52).
For example, a Less Developed Country can intensively use its labour force due to its availability compared to the developed economies which are more capital oriented. Engaging in international trade compensates for international immobility of the factors of production.
According to this theory, the trade patterns allow each country to use all goods and services as it was integrated in the world and in return bring the trading countries in a platform thereby eliminating the differences in national factor endowments.
The comparative advantage is more general compared to the other theories though its assumptions and predictions about how countries are likely to trade weaken with generalizations. Thus, it is expected that countries import goods which would be relatively expensive to produce in absence of international trade (Anderson 5).
The absolute advantage fallacy arises when traders compare the cost of similar goods drawn from different production locations. The absolute cost advantage arises when a nation imports goods which are cheaper abroad in the same time exporting goods which are more expensive abroad (Mankiw 54).
The absolute advantage addresses the question on which good should be purchased and it makes more sense than the comparative advantage theory for example if you take a hypothetical case where two countries had equal wages before the opening to the international trade. The country starting the trade would have a competitive or absolute advantage in both the exporting and importing goods.
The traders within these countries would be afraid as they would all be driven out of the market but due to the differences in wages earned, international trade serves as an advantage.
Finally, countries which engage in trade do so in order to access those goods and services which are not available in their countries. Some kinds of availability are exogenous to the interactions of nations for example commodities such as oil is produced in certain countries. In contrast, endogenous advantage is driven by the advantages arising from the economic interaction.
The endogenous coexists with the comparative advantage. Most economic theories focus on the endogenous advantages which are brought about by the economies of scale (Yang 294). The scale economies are usually in two forms: external to the firm and internal to the firm. The external scale of economies is described by the specialized labour markets while the external scales are not location specific.
Companies within trading countries benefit from international trade by specializing in certain line of production thereby creating monopolies. An example of an external scale of economies is a country like Japan which specializes in production of automatic Toyotas.
While Japan is not the only maker of automatic vehicles they possess the rights for Toyota cars thus creating economies of scale. An internal scale of economy occurs within a specific company, a particular firm is the only allowed producing unit of certain products (McGuigan, Moyer, &Harris 316).
With globalization, everything in the world has been made easier and especially the benefits that the trade sector has reaped from globalization are enormous though some critics still argue against it. The benefits of international trade have been explained using several trade theories with the comparative advantage indicating that countries tend to export those goods and services which are well endowed with the resources to produce.
The Heckscher- Ohlin theory explains that the major benefit of international trade is the fact that it allows countries to produce those goods and services in which their country members can use intensively and import goods and services where they do not have factors of production to intensively produce the goods and services as a result goods and services are traded easily and cheaply.
The other theory which explains the benefits of international trade is the absolute advantage theory where countries achieve monopoly by specializing in certain production lines thus achieving economies of scale.
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