Theories of International Trade, Tariffs and Trade Blocks

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


Adam Smith
Ricardo
Ohlin & Heckscher

THEORIES OF
INTERNATIONAL TRADE


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


Mercantilism: mid-16th century

 Theory assumes that a nation‟s 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

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


 … 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 nation‟s wealth by the living
standards of its people


PPF – Production Possibility
Frontier

Ghan
a

South
Korea


Absolute Advantages and Gains
from Trade

Assume total amount of resources at 200. In the absence of trade resource is used
equally for both products; 100 for cocoa and 100 for Ghana

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.


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 product‟s 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 resourcesrs. Charu Rastogi Asst. Prof.
M

Theory of comparative
advantage
PPF – Production Possibility
Frontier

Ghan
a

South
Korea


Comparative Advantage and Gains
from Trade

100-100
for both
products

SK:100-
100
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‟


Comparative advantage:
Bollywood


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


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?


Factor Proportions Trade Theory:
Considers Two Factors of Production

 Labor

 Capital


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


Tariff and Non-Tariff Barriers, Trade Blocks

TRADE BARRIERS


Trade Barriers
 Countries use protectionist measures to shield a
country‟s 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

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/cst2012-
13/cst1213-idx.htm
 Example: There is a 100% duty on importing
private cars/vehicles


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.


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


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


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 Mrs. Charu Rastogi Asst. Prof.

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)


Levels of integration
• Special Tariffs
Trade Concessions • Relaxation in NTBs
• Only for select commodities and services

• Complete removal of restrictions on movement of
Free Trade Area goods
• Quite often leading to Customs Union

• Adoption of common standards – environment,
Common Market labor, etc.
• Common external trade policy

• Common Economic Policy
Economic Union • Common Currency and Monetary Policy
• Free movement of factors

• Common Governing Body
Political Union • Common Laws


Possible Questions
 Theories of International Trade
 Explain Adam Smith‟s theory of absolute
advantage. How does Ricardo‟s 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.

Theories of International Trade, Tariffs and Trade Blocks

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