International trade

theory
 What are the rules of the IB game?

Learning goal: Before joining any game, it is important to

understand the rules regulating that game. In this session, we will
learn from the fundamental rules to the updated rules set by the
governments
1. Mercantilism (mid-16th century)

national wealth,
accumulate
prestige, and power

The main currency of trade

❖ Mercantilism suggests that it is in a country’s best interest to maintain a

trade surplus—to export more than it imports

Why mercantilism promote export and limit import?

→ A country could earn gold and silver by exporting goods. Conversely, importing
goods from other countries would result in an outflow of gold and silver to those
countries
 1. Mercantilism
What is the problem with this theory?

The first European banknotes were issued in 1661

a balance-of-trade surplus

David Hume (1752)

➔the French to buy
fewer English goods
and the English to buy
more French goods
➔Deteriorate English
BOT and improve
France BOT
➔English Surplus is
eliminated
1. Mercantilism
Do you think the mercantilist doctrine has disappeared?

The mercantilist doctrine is by no means dead

Neo-mercantilists

= =

Political power Economic power

 ✓ BOT surplus
✓ Government
power/control
✓ Zero-sum game
When thinking about
Mercantilism, what are the
main points you need to
remember?
 2. Absolute Advantage

Adam Smith (1776)

❖ A country has an absolute advantage in the
production of a product when it is more efficient
than any other country in producing it
→ Countries should specialize in the production of goods for
which they have an absolute advantage and then trade
these goods for goods produced by other countries
→ a country should never produce goods at home that it can
buy at a lower cost from other countries
 2. Absolute Advantage
Ghana South Korea

200R 200R

10R → 1 ton → 20 tons 40R → 1 ton → 5 tons

20R → 1 ton → 10 tons 10R → 1 ton → 20 tons

2. Absolute Advantage

Without Trade

200R 200R

100R 100R 100R 100R

10 tons 5 tons 2.5 tons 10 tons

Ghana:
10R -> 1 ton cocoa
➔ Combination of both countries (without Trade): 20R -> 1 ton rice
12 tons cocoa South Korea
15 tons rice 40R -> 1 ton coca
10R -> rice
2. Absolute Advantage

Specialize and
Trade

200R 200R

20 tons 20 tons

➔ Combination of both countries (with Trade):

20 tons cocoa Ghana:
20 tons rice 10R -> 1 ton cocoa
➔ Combination of both countries (without Trade): 20R -> 1 ton rice
12 tons cocoa South Korea
15 tons rice 40R -> 1 ton coca
10R -> rice
2. Absolute Advantage

Specialize and
Trade

200R 200R

14 tons 6 tons 6 tons 14 tons

1:1

Ghana:
10R -> 1 ton cocoa
20R -> 1 ton rice
South Korea
40R -> 1 ton coca
10R -> rice
 ✓ One country specializes
in one good
✓ Encourage free trade
✓ A positive sum game

When thinking about Absolute

Advantage, what are the main
points you need to remember?
If only one country has an absolute advantage in
the production of all goods, will it still enjoy the
benefits of international business?
3. Comparative Advantage

❖Countries should specialize in the production

of those goods they produce most efficiently
and buy goods that they produce less
efficiently from other countries
➢ even if this means buying goods from other
countries that they could produce more efficiently
David Ricardo (1817) themselves
 3. Comparative Advantage

200R 200R

10R → 1 ton → 20 tons 40R → 1 ton → 5 tons

13.5R → 1 ton → 15 tons 20R → 1 ton → 10 tons

3. Comparative Advantage

Without Trade

200R 200R

100R 100R 100R 100R

10 tons 7.5 tons 2.5 tons 5 tons

Ghana:
10R -> 1 ton cocoa
➔ Combination of both countries (without Trade): 13.5R -> 1 ton rice
12.5 tons cocoa South Korea
7.5 tons rice 40R -> 1 ton coca
20R -> rice
3. Comparative Advantage

Specialize and
Trade

200R 200R

10 tons
150R 50R

15 tons 3.75 tons

➔ Combination of both countries (with Trade):

Ghana:
15 tons cocoa
10R -> 1 ton cocoa
13.75 tons rice
13.5R -> 1 ton rice
➔ Combination of both countries (without Trade): South Korea
12.5 tons cocoa 40R -> 1 ton coca
7.5 tons rice 20R -> rice
 3. Comparative Advantage

Specialize and
Trade

200R 200R

11 tons 7.75 tons 4 tons 6 tons

1:1

Ghana:
10R -> 1 ton cocoa
13.5R -> 1 ton rice
South Korea
40R -> 1 ton coca
20R -> rice
3. Comparative Advantage
Can the simple model of comparative advantage reflect the reality?

Unrealistic assumptions in the simple model of comparative advantage

1. only two countries and two goods
2. no transportation costs
3. Ignore exchange rates
4. freely mobile of resources
5. Ignore diminishing and increasing returns to specialization
6. Ignore dynamic changes in a country’s stock of resources
7. Ignore the effects of trade on income distribution
3. Comparative Advantage
Another problem

Free Trade

Rich country Poor country

Despite the short-term adjustment costs

associated with adopting a free trade
regime, trade would seem to produce
greater economic growth and higher living
standards in the long run
 ✓ Produce most efficient
goods
✓ Encourage free trade
✓ a positive sum game
When thinking about
Comparative Advantage, what
are the main points you need to
remember?
Exercises about Absolute Advantage and Comparative Advantage

250R 250R

5R: 1 ton 10R: 1 ton

15R: 1 ton 10R: 1 ton

Absolute Advantage
Exercises about Absolute Advantage and Comparative Advantage

250R 250R

5R: 1 ton 10R: 1 ton

10R: 1 ton 30R: 1 ton

Comparative Advantage
Factor endowment theory/ Heckscher-
Ohlin Theory
 4. Factor Endownment Theory

❖Comparative advantage arises from

differences in national factor
endowments (like land, labor, and
capital)
Eli Heckscher (1919) Bertil Ohlin (1933) ➢ the more abundant a factor, the lower its
cost
➢ Countries will export those goods that make
intensive use of factors that are locally
abundant, while importing goods that make
intensive use of factors that are locally
scarce
 4. Factor Endowment Theory
The US was relatively abundant in capital compared to other
nations → According to Factor endowment theory, the U.S. would
be an exporter of capital intensive goods. Is it true?

The US has a special advantage in producing new products or

goods made with innovative technologies which are less
capital intensive

→ He found that U.S. exports were

less capital intensive than U.S.
imports → Leontief Paradox
Wassily Leontief (1953)
 Factor endowment theory/ Heckscher-
Ohlin Theory

✓ Comparative advantage
based on factor
endownments
✓ Leontief Paradox When thinking about Factor
Proportions Theory, what are
the main points you need to
remember?
 5. Product Life-Cycle Theory

➢ Most of the twentieth century a very large proportion of the world’s new
products had been developed by U.S. firms

➢ The new product is sold first in the U.S. market & only high-income groups
in other advanced countries → export from US to other advance countries

➢ Over time, demand for the new product starts to grow in other advanced
Ray Vernon in the mid-1960s countries → foreign producers to begin producing for their home markets +
US firm might set up production facilities in those advanced countries →
export from US reduce

➢ Product become standardized → price becomes the main competitive

weapon → producers start to think about the costs → producers in
advanced countries with low cost export back to the US → The US lost even
goes further when developing countries offer cheaper labor cost →
producers move to developing countries and they become the exporters
5. Product Life-Cycle Theory
1. Xerox was first developed in the
United States; sold initially to U.S.
users & exported to Japan and
western Europe

2. Demand grew, Xerox entered into

joint ventures to set up production
1 2 3 in Japan (Fuji-Xerox) and Great
Britain (Rank-Xerox).

Foreign competitors
began to enter the market (e.g.,
Canon in Japan and Olivetti in Italy)
→ exports from the United States
declined

3. Japan have begun to switch

production to developing countries
such as Thailand for lower costs
 5. Product Life-Cycle Theory

❖As products mature both the location of

sales and the optimal production location
will change affecting the flow and direction

Ray Vernon in the mid-1960s of trade

➢ The country where the product is innovated
switches from being an exporter of the product
to an importer
5. Product Life-Cycle Theory
Does the theory still valid until today?

The globalization and integration of the world economy has made this
theory less valid today
➢ the theory is ethnocentric (i.e. new products are developed and
introduced in the US)
➢ production today is dispersed globally
➢ products today are introduced in multiple markets simultaneously
When thinking about Product ✓ Exporter of new
Life-cycle Theory, what are the product→ importer in
main points you need to the long run
remember?
6. New Trade Theory Paul Krugman & new
trade theorists

The scale of production are

economies of scale
Without Trade limited by the size of the
is not achieved
domestic market

each nation
specialize in a
a larger attain
narrower range of
With Trade world economies
products +
market of scale
Exchange with each
other

Thus trade offers an opportunity for mutual gain even

when countries do not differ in their resource increase the variety
endowments or technology + lower the costs
6. New Trade Theory
Will the market have enough space for everyone capture economies of scale?

❖ The global market may be able to support only a small number

of enterprises
➢ First-movers dominate certain products in world trade →
The ability to capture scale economies ahead of later
entrants → benefit from a lower cost structure
6. New Trade Theory
Example for First-mover advantages
Commercial aerospace industry

New superjumbo jet called A380 of Airbus costs $15 billion

The firm had to sell:
+ at least 250 planes to break even
+ more than 350 planes to get profit

The total demand of the global market over the next 20 years:
between 400 and 600 units

→ global market can probably profitably support only one

producer of jet aircraft in the superjumbo category
6. New Trade Theory
What help the firm become the first-mover?

entrepren innovation
eurship

First-mover

government
luck CONFLICT?
intervention
 6. New Trade Theory
What help the firm become the first-mover?

➢ Cars imported to Vietnam have to suffer from high taxes from 56%-
74%
➢ Normal firm’s income tax is 20%, but Vinfast will only be charge 10%
➢ Workers in Vinfast can enjoy a reduce of 50% income tax
➢ Land rent is free in Hai Phong for Vinfast

https://diendandoanhnghiep.vn/nhung-chinh-sach-uu-
dai-cho-thuong-hieu-san-xuat-o-to-viet-vinfast-
Electric cars 139960.html

Vinfast in Las Vegas: https://www.youtube.com/watch?v=WIesuezKkyU

6. New Trade Theory
What is the possible conflict in New trade theory?

Achieve
Encourage government
economies First-mover
free trade intervention
of scale

Conflict
When thinking about New Trade ✓ Economies of scale
theory, what are the main ✓ First-mover advantages
points you need to remember?
7. National Competitive Advantage: Porter’s Diamond

Michael Porter (1990)

 7. National Competitive Advantage: Factor Endowment

e.g., natural resources,

basic factors climate, location, and
demographics

Factor initial
competitive
endowments advantage/
pressure advantage
e.g. communication
advanced infrastructure,
factors sophisticated and skilled
labor, research facilities

Which kind of factors create a country’s competitive advantage?

7. National Competitive Advantage: Demand condition

shaping the
pressures for
Home attributes of competitive
innovation
demand domestic advantage
and quality
products

For example, Porter notes that Japan’s sophisticated and

knowledgeable buyers of cameras helped stimulate the
Japanese camera industry to improve product quality
and to introduce innovative models.
7. National Competitive Advantage: Related and
supporting industries

Investment in
knowledge
Related and one industry
can flow competitive
supporting can spill over
between the advantage
industries to another
firms
industry

German textile and apparel sector, which included high-

quality cotton, wool, synthetic fibers, sewing machine
needles, and a wide range of textile machinery
7. National Competitive Advantage: Firm strategy,
structure, and rivalry
Firm management
strategy, ideologies competitive
structure, advantage
and rivalry
vigorous look for ways
domestic to improve
rivalry efficiency

For example, the predominance of In contrast, a predominance of

engineers in top management at people with finance
German and Japanese firms. → backgrounds leading many U.S.
these firms’ emphasis on improving firms → lack of attention to
manufacturing processes and improving manufacturing
product design. processes and product design
 ✓ Factor endowments
✓ Home demand
When thinking about National ✓ Related and supporting
Competitive Advantage, what industries
are the main points you need to ✓ Strategy, structure and
remember? rivalry
✓ BOT surplus
✓ Government
power
✓ Zero-sum
game
✓ Factor
✓ One ✓ Comparative endownments
✓ One ✓ Exporter of ✓ Economies
country advantage ✓ Home demand
country has new of scale
specializes based on ✓ Related and
absolute product→ ✓ First-mover
in one factor supporting
advantage importer in advantages
good endownments industries
✓ Free trade the long
✓ Free trade ✓ Leontief ✓ Strategy,
✓ a positive run
✓ a positive Paradox structure and
sum game
sum game rivalry