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Friday, February 15, 2013

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INTERNATIONAL TRADE

This article about international trade comprises four main sections.

The first, THEORY OF INTERNATIONAL TRADE, describes the attempts of 18th- and 19th-century classical economists and their 20th-century successors to explain the benefits of international trade and the flow of particular goods from nation to nation. It also briefly defines the most important terms used in discussions of international trade. CONTEMPORARY WORLD TRADE, the second section, assesses the importance of international trade in the economies of different kinds of countries and characterizes the different kinds of goods these countries send abroad. It also shows how colonialism, foreign policy, and producers’ cartels like OPEC, among other things, influence trade patterns, so that they cannot be wholly accounted for by economic theory. The third section, OBSTACLES TO TRADE, outlines the measures of protection—tariffs, quotas, and exchange controls—many nations employ to limit imports of foreign goods; it also considers the rationale for protection in different economic circumstances. Finally, the HISTORY OF INTERNATIONAL TRADE reviews the fluctuations of international exchange from the start of the modern era in the 16th century up to the currency devaluations and oil price rises of the 1970′s.

THEORY OF INTERNATIONAL TRADE

Mercantilism. The first account of international trade was provided in the 16th and 17th centuries by the Mercantilists, who assumed that in the world as a whole the supply of the “factors of production”—land (including raw materials), labor, and capital—is more or less fixed. From this it followed that the interests of every nation, region, and town were absolutely incompatible, for the gain of one would be the other’s loss. Each nation was advised to accumulate the largest possible quantities of the factors of production and, in particular, the largest possible quantities of gold and silver. Since the Mercantilists believed that a nation’s stock of precious metals embodied its real wealth, they also believed that foreign trade is properly carried on solely in order to enlarge these stocks. This in turn made them suspect foreign trade, for it is sometimes necessary to pay for imports from abroad with gold and silver.
The Classical School. By the mid-18th century, however, population, supplies of raw materials, investment capital, and output had all increased dramatically. The Mercantilists’ central assumption was therefore undermined. Economic thinkers no longer regarded the interests of different nations as inherently incompatible. They also decided that a nation’s real wealth does not consist in the mere heaping up of gold and silver but rather in the capacity to produce goods and services. Many economists (and, later, many statesmen) concluded that if every nation devoted itself to producing only those things it could make most cheaply, all countries would reap an “absolute advantage” because more of everything would be produced and at a lower cost. The flow of international exchanges of goods, like the flow of domestic exchanges, would be guided by prices, for every consumer would buy in the cheapest market, abroad or at home. The greatest and most influential exponent of these views was Adam Smith, a British economist whose Wealth of Nations was published in 1776.

What is it, however, that enables one nation to produce a good more cheaply than another nation? In 1817, Smith’s greatest disciple, David Ricardo, published his Principles of Political Economy and Taxation, which attempted to answer this question. Ricardo (following Smith) suggested that in the long run the value of a product is determined (with a great many qualifications) by the quantity of human labor embodied within it. An article taking, say, 10 hours in all to produce would therefore (on average) be twice as expensive as an article produced in five hours. Now in some countries, labor efficiency is greater than in others. In these countries, all goods are cheaper than in places where labor is used inefficiently. Moreover, labor is almost everywhere used more efficiently in certain branches of production than in others. Ricardo (in his “theorem of comparative costs”) argued that every country could maximize its benefit from international trade by specializing in the export of those goods it produced least inefficiently and importing those it produced most inefficiently.

Postclassical Theories. Ricardo’s theory only took into account the supply of goods from producing nations; “effective demand” among consumers—demand backed by money, or purchasing power—was left out. Moreover, it was based on only one factor of production: labor. Later in the 19th century, effective demand was introduced into international trade theory by John Stuart Mill and Alfred Marshall. International exchange obviously cannot take place if the importing countries do not require imports. But international exchanges also cannot take place unless the export-

ing countries require imports. A country must pay for its imports with money earned by exporting its own goods; otherwise its reserves of precious metals and foreign currencies will be depleted, and it will become dependent on loans, something that cannot go on forever. A nation’s purchase of imports, therefore, helps foreign nations to buy its own exports.

After World War I, two Swedish economists, Eli Heck-scher and Bertil Ohlin, proposed another theory that broadened understanding of trade by taking into account two factors of production, labor and capital. Capital, for the purposes of this theory, is money invested in buildings and machinery. In different production processes, the proportion of the total expense that must be devoted to purchases of machinery, on the one hand, and labor, on the other, will vary a good deal. Production processes that employ a high amount of machinery relative to labor are “capital intensive.” Of course, the production processes of some countries are more capital intensive than are those of others. Heckscher and Ohlin suggested that countries possessing more capital than labor—for example, the United States—have a comparative advantage (to use Ricardo’s term) in the production and export of capital-intensive goods. Yet in 1953 Wassily Leontief, an American economist, showed that U.S. exports (as opposed to U.S. production as a whole) tend to be less capital-intensive than U.S. imports.

Mass Production. In any case, capital-intensive production usually means mass production, and this can only occur if effective demand is strong enough to purchase the quantity of goods so produced. Staffan Lindner argued that countries export goods for which they themselves have large domestic markets. Such a large market ensures the manufacturer a sufficiently large volume of sales to make mechanization worthwhile; exports, which are less stable, would not ordinarily provide such an assurance.

But how much of a competitive advantage is conferred by mass production? In modern economies the expenses of research and development account for a substantial part of total costs. It may therefore make sense to spread that cost over a larger number of units. The savings realized by mass production are called “economies of scale.”

Developed and Developing Economies. Economies of scale tend to be achieved in those countries that first make a certain product, for they have the greatest experience in manufacturing it and the most receptive markets. Different countries therefore find it easier to realize economies of scale in different products, and this in part helps to explain the specialization of the advanced countries’ economies. Since these countries tend to produce goods at the lowest cost, trade between them accounts for a very high proportion of international trade.

In contrast, exports from developing to industrialized countries have so far consisted mainly of primary products— raw materials, fuels, and tropical foods and beverages. The exporting countries cannot use most of their primary products themselves and therefore sell them abroad. International trade is thus often described as a “vent for surplus.” — The “Gain from Trade.” These explanations of trade all assume that flows of products across international boundaries are guided by prices, as each buyer seeks to obtain what he needs at the lowest possible cost. Though price theory in fact provides only an incomplete explanation of the actual functioning of international trade, it does explain the “gain from trade.”

The explanation hinges on what is called “allocational efficiency.” In national markets, competition tends to equal-
ize the prices charged by different producers, no one of whom can charge much more than the others without losing customers. Producers must seek to increase their profits through lower production costs—that is, through a more efficient use of their resources—and the most efficient producer ought to have the lowest costs, the lowest prices, and, in consequence, the largest sales and the largest income. Competition therefore promotes allocational efficiency by directing the factors of production to the efficient producers, who have more money to spend and can outbid the inefficient producers for the factors of production.

The gain from trade stems from the widening of the scope of allocational efficiency over the borders of individual countries. Nations seek to sell their own goods abroad and buy goods from other nations for the same reason that individuals sell some items and purchase others instead of absolute advantage. An increase in the production and consumption of goods and services that results directly from international trade. Adam Smith, a famous 18th-century British economist, argued that such an absolute advantage is realized through trade because different nations produce different goods at different levels of efficiency, ff every nation were to specialize in the production of those goods it makes most efficiently, and then exchanged its surplus for imported goods produced under similar conditions, more of everything would be produced at a lower cost.

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