Chapter 4 Outline

Chapter Summary

This chapter has reviewed a number of theories that explain why it is beneficial for a country to engage in international trade and has explained the pattern of international trade that we observe in the world economy. We have seen how the theories of Smith, Ricardo, and Heckscher-Ohlin all make strong cases for unrestricted free trade. In contrast, the mercantilist doctrine and, to a lesser extent, the new trade theory can be interpreted to support government intervention to promote exports through subsidies and to limit imports through tariffs and quotas.

In explaining the pattern of international trade, the second objective of this chapter, we have seen that with the exception of mercantilism, which is silent on this issue, the different theories offer largely complementary explanations. Although no one theory may explain the apparent pattern of international trade, taken together, the theory of comparative advantage, the Heckscher-Ohlin theory, the product life-cycle theory, the new trade theory, and Porter's theory of national competitive advantage do suggest which factors are important. Comparative advantage tells us that productivity differences are important; Heckscher-Ohlin tells us that factor endowments matter; the product life-cycle theory tells us that where a new product is introduced is important; the new trade theory tells us that increasing returns to specialization and first-mover advantages matter; and Porter tells us that all these factors may be important insofar as they affect the four components of the national diamond.

The following points have been made in this chapter:

1. Mercantilists argued that it was in a country's best interests to run a balance-of-trade surplus. They viewed trade as a zero-sum game, in which one country's gains cause losses for other countries.

2. The theory of absolute advantage suggests that countries differ in their ability to produce goods efficiently. The theory suggests that a country should specialize in producing goods in areas where it has an absolute advantage and import goods in areas where other countries have absolute advantages.

3. The theory of comparative advantage suggests that it makes sense for a country to specialize in producing those goods that it can produce most efficiently, while buying goods that it can produce relatively less efficiently from other countries--even if that means buying goods from other countries that it could produce more efficiently itself.

4. The theory of comparative advantage suggests that unrestricted free trade brings about increased world production; that is, that trade is a positive-sum game.

5. The theory of comparative advantage also suggests that opening a country to free trade stimulates economic growth, which in turn creates dynamic gains from trade.

6. The Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce.

7. The product life-cycle theory suggests that trade patterns are influenced by where a new product is introduced. In an increasingly integrated global economy, the product life-cycle theory seems to be less predictive than it was between 1945 and 1975.

8. The new trade theory argues that a country may predominate in the export of a certain product simply because it had a firm that was a first mover in an industry that will profitably support only a few firms because of substantial economies of scale.

9. Some new trade theorists have promoted the idea of strategic trade policy. The argument is that government, by the sophisticated and judicious use of subsidies, might be able to increase the chances of domestic firms becoming first movers in newly emerging industries.

10. Porter's theory of national competitive advantage suggests that the pattern of trade is influenced by four attributes of a nation: (i) factor endowments, (ii) domestic demand conditions, (iii) relating and supporting industries, and (iv) firm strategy, structure, and rivalry.

11. Theories of international trade are important to an individual business firm primarily because they can help the firm decide where to locate its various production activities.

12. Firms involved in international trade exert a strong influence on government policy toward trade. By lobbying government bodies, firms can help promote free trade or trade restrictions.