International Trade Theories Assignment Example | Topics and Well Written Essays - 2750 words

International Trade Theories - Assignment Example A brief discussion of the classical trade theories will provide a backdrop of the detailed examination of the modern trade theories and how these could be viewed in the present patterns of international trade. Classical theories Mercantilism During the 17th and 18th centuries, the theory of mercantilism was widely practised in international trade. Essentially, mercantilism saw international trade as a zero-sum proposition. French statesman Jean-Baptiste Colbert, who pioneered this theory, believed that the wealth of the world was essentially fixed and that trade was a closed system, so that those nations which exported more and imported less acquires more of the world’s wealth and becomes richer, and vice-versa. While mercantilism is the oldest of the trade theories, this does not mean that it is obsolete. Even today, the effects of mercantilism are evident in policies of trade protectionism, and makes the argument that rather than import from other countries and risk a trade deficit, a country would be economically better off if it were self-sufficient (Peng, 2010, p. 149). Absolute Advantage Advocated in 1776 by British economist Adam Smith, the theory of absolute advantage stated that the force of the free market should best determine the economic activities of a nation and, inclusively, the level of international as well as domestic trade. Smith’s theory of free trade (also called laissez faire) relied on forces of the free market to operate unrestricted, to enable free trade to seek out the most efficient means for value creation. The absolute advantage in the creation of a product or service is that which is attained by the nation that is able to produce that good or service most efficiently. The implication of this theory is that (1) the principle of self-sufficiency is best abandoned because no country could efficiently produce all goods and services; and (2) countries would best specialize in production of good and services where they hav e the advantage. International trade ceases to be a zero-sum case, and becomes a win-win proposition. Comparative advantage In 1817, British economist David Ricardo developed the theory of comparative advantage. The theory saw the ability of countries to efficiently produce goods and services not in absolute terms but in relation to which country they trade with. Comparative advantage is the relative advantage in one economic activity possessed by one nation over other nations. Net gains from trade may be realized when countries specialize in producing goods and services where they have comparative advantage. There is a trade-off, however, known as the opportunity cost, which is the cost incurred by a producer in choosing to give up production of a good or service in favour of concentrating on another (p. 152). The three foregoing theories, while useful in conceptualizing trade relations, make the necessary but unrealistic assumption that trade is static. Through time, factor endowm ents and trade patterns change, necessarily debunking the theory that trade is static. This gave way to the modern trade theories of the mid-twentieth century, also known as the dynamic theories, which aim to account for the change in trade patterns over time. New theories Product life cycle Product life cycle was developed by Raymond Vernon, an American economist, in 1966. Vernon saw the world’s trading nations as consisting of three categories: (1) the lead innovation nation which is usually assumed to be the US, (2) other developed nations, and (3) the developing nations. Aside from distinguishing among the nations, Vernon also classified products according to three life cycles: (1) new, (2) maturing, and (3) standardized. New products commanded a higher price (price premium)