Would people ever stop wondering why some countries simply do better than others? Stop wondering why people move from one country to another just to live a better life? Probably not! It is believed that the concepts of specialization and international trade have helped ensure that certain countries enjoy a relatively high standard of living while other countries look rather exploited as a result of this, and rightly so. But why does this occur? Is it just because first-world countries specialize and participate in the profitable aspect of international trade? If so then why don’t the second and third-world countries just follow in this path? Apparently it does not seem as easy as it sounds for different reasons from different perspectives. Before one can figure out why this is so, the perception of specialization must first be understood. So what is specialization?
In general, “specialization is a method of production where a business or country focuses on the production of a limited scope of products or services in order to gain greater degrees of productive efficiency within the entire system of businesses or sector. Many countries specialize in producing the goods and services that are native to their part of the world. This specialization is the basis of global trade as few countries produce enough goods to be completely self-sufficient. Specialization can also refer to production, for example when in a factory an assembly line is organized in a specialized manner rather than producing the entire product at one production station.” [Investopedia.com (N.D) (Online)]
A lot of first-world countries tend to utilize the concept of specialization when participating in international trade. This is so because when a country specializes on a business area in international trade, it guarantees the required production efficiency needed to create a sense of monopoly regarding a commodity’s international trade affairs. So what is international trade?
“International trade is the interchange of goods and services between countries. This can be bilateral or multilateral trade. It is bilateral if it involves two nations trading with each other and multilateral if the trading involves more than two nations. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events. Political amendments in Asia, for instance, can cause a rise in the price of labour, thus escalating the cost of production for a British gym shoe firm established in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at a local mall. A decrease in the cost of labour, on the other hand, would result in having to pay less for new tennis shoes. ” [Studymode.com (N.D) (Online)]
“Trading globally gives consumers and countries the opportunity to be exposed to goods and services not available in their own countries. Almost every kind of product can be found on the international market: food, clothes, spare parts, oil, jewellery, wine, stocks, currencies and water. Services are also traded: tourism, banking, consulting and transportation. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country’s current account in the balance of payments.” [Ezinearticles.com (N.D) (Online)]
INCREASED EFFICIENCY OF TRADING GLOBALLY
“Global trade allows wealthy countries to use their resources – whether labour, technology or capital – more efficiently. Because countries are endowed with different assets and natural resources (land, labour, capital and technology), some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain the item by trading with another country that can. This is known as specialization in international trade.” [Ezinearticles.com (N.D) (Online)]
Assume both Country A and Country B produce cotton sweaters and wine. “Country A produces 10 sweaters and six bottles of wine a year while Country B produces six sweaters and 10 bottles of wine a year. Both can produce a total of 16 units. Country A, however, takes three hours to produce the 10 sweaters and two hours to produce the six bottles of wine (total of five hours).” [Scribd.com (N.D) (Online)]
“Country B, on the other hand, takes one hour to produce 10 sweaters and three hours to produce six bottles of wine (total of four hours). But these two countries realize that they could produce more by focusing on those products with which they have a comparative advantage. Country A then begins to produce only wine and Country B produces only cotton sweaters. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products.” [Scribd.com (N.D) (Online)]
“It can then be seen that for both countries, the opportunity cost of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both sweaters and wine is 20 units of both products (after trading). Specialization reduces their opportunity cost and therefore maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease, thus giving an advantage to the end consumer as well.” [Scribd.com (N.D) (Online)]
“Note that, in the example above, Country B could produce both wine and cotton more efficiently than Country A (less time). This is called an absolute advantage, and Country B may have it because of a higher level of technology. However, according to the international trade theory, even if a country has an absolute advantage over another, it can still benefit from specialization.” [Scribd.com (N.D) (Online)]
FURTHER LIKELY ADVANTAGES OF TRADING INTERNATIONALLY
“International trade not only results in increased efficiency but also allows countries to participate in a global economy, encouraging the opportunity of foreign direct investment (FDI), which is the amount of money that individuals invest into foreign companies and other assets. In theory, economies can therefore grow more efficiently and can more easily become competitive economic participants.” [Ezinearticles.com (N.D) (Online)]
For the receiving government, FDI is a means by which foreign currency and expertise can enter the country. These raise employment levels, and, theoretically, lead to a growth in the gross domestic product. For the investor, FDI offers company expansion and growth, which means higher revenues.
INTERNATIONAL TRADE THEORIES
WHY COUNTRIES ENGAGE IN INTERNATIONAL TRADE
“Economist believes that if countries engage in international trade, they can mostly benefit under a free international trade environment. To get a clear perspective to this claim, I will glance though five major main theories on international trade-the Ricardian Comparative advantage Model on gains from specialization and opportunity cost theory, Heckscher-Ohlin model who believes that factor proficiency differences are the reasons why countries engage in international trade because of the gains from specialization and income distribution effects, the new international trade theory which examines the economies of scale and the Heterogeneous firms theory which explains why countries engage in international trade basing on a firm level perspective.” [Cartercentre.blogspot.com (N.D) (Online)]
REASONS FOR SPECIALIZATION BY DAVID RICARDO
“According to David Ricardo (1817), countries engage in international trade because they stand to gain if they specialize in the production of products with low opportunity cost. To Ricardo countries should understand their factor endowments then direct production to the best alternative in utilizing the available resources. A country undertaking such specialization would then engage in international trade with others countries to get those products which are of second best alternative in utilization of resources.” [Cartercentre.blogspot.com (N.D) (Online)]
“Ricardo emphasizes his point using the opportunity cost theory. Noting that resources are scarce, a country has to give up production of one product in order to produce the other. To know which one to give up, a country has to determine where it would have higher output if the same resource available was utilized in the production of either product. A country would specialize in production of that product whose utilization of the available resource produces the most output.” [Cartercentre.blogspot.com (N.D) (Online)]
“In opportunity cost terms, a country should specialize in production of that product whose cost for failure to produce it is higher than that of the second alternative.” [Cartercentre.blogspot.com (N.D) (Online)]
“To Ricardo, countries are endowed differently and so they have different opportunity costs. The difference in opportunity cost is what would enable countries to engage in international trade with each other so as to get the disadvantaged products.” [Cartercentre.blogspot.com (N.D) (Online)]
“Ricardo sums up the above with the use of what he called the absolute and comparative advantages. To him even if a country would produce more of the two products than the other country (the absolute advantage), it should specialize in producing that product in which it has an advantage in utilization of the available resources (comparative advantage).” [Cartercentre.blogspot.com (N.D) (Online)]
Next, this theory shall be examined using the following example.
The theory assumes that;
There are two countries to engage in international trade -Assume Nigeria and the U.K are used.
There are two products produced- i.e. Coffee and Computers
One factor of production exists- i.e. Labour
Factor productivity is constant
Perfect competition exists in the market
Homogeneous of factors-They have fixed and same abilities and productivity levels
Factors are perfectly mobile within country and between sectors -Can be shifted from production of one product to another and from one region to another
Factors are immobile between countries -Endowments in one country cannot move to another country.
Fixed level of technology
“The table below indicates the quantities of coffee and computers that would be produced by Nigeria and the U.K when a unit of labour is allocated in the production process. This table also indicates the situation pertaining in each country before the countries engage in international trade.” [Cartercentre.blogspot.com (N.D) (Online)]
“From the table, the U.K has an absolute advantage in the production of both coffee and computers per unit of labour employed. Next is to analyse the opportunity costs so as to determine their respective comparative advantages. This can be achieved by looking at the foregone benefit of not producing one product so as to produce the other. In the absence of international trade the opportunity cost is calculated as the ratio of the produced product to the foregone alternative.” [Cartercentre.blogspot.com (N.D) (Online)]
“In a situation of autarky (i.e.no trade), the (relative) price of a good equals the opportunity cost of producing that good in a country. Under free trade however, world (relative) prices are determined by world supply and demand across countries (i.e. they fall between the opportunity costs of the two countries)” [Cartercentre.blogspot.com (N.D) (Online)]
“If Nigeria specializes in coffee, it will have to forego 50/50,000 units of computers for each unit of coffee produced. If however Nigeria decides to specialize in computers, it would forego 50,000/50 = 1,000 units of coffee for every unit of computers produced. Likewise, if the U.K specializes in coffee, it will have to forego 400/100,000 = 0.004 units of computers for each unit of coffee produced. If however, the U.K decides to specialize in computers, it would forego 100,000/400 = 250 units of coffee for every unit of computers produced.” [Cartercentre.blogspot.com (N.D) (Online)]
The table underneath recapitulates the opportunity costs for Nigeria and the U.K if they both specialized in the production of one of the products.
Opportunity cost of Coffee
Opportunity cost of Computers
“From the table, it can be concluded that Nigeria has a comparative advantage in the production of coffee and the U.K has a comparative advantage in production of computers. For this reason, the U.K should specialize in production of computers and Nigeria in coffee and the two countries should engage in international trade and exchange the commodities in which they have a comparative advantage with those in which they are disadvantaged.” [Cartercentre.blogspot.com (N.D) (Online)]
“If the relative price of coffee is higher in the U.K than in Nigeria, it is profitable for the two countries if Nigeria exports coffee to the U.K and imports computers from there.” [Cartercentre.blogspot.com (N.D) (Online)]
“Now let us examine the effect of transferring one unit of labour to specialize in production of a product where each country has a comparative advantage. As one unit of labour is specialized in production of coffee, Nigeria foregoes (loses) 50 units of units of computers to gain 50,000 units of coffee. Likewise, as one unit of labour is transferred from the production of coffee to the production of computers, the U.K loses 100,000 units for a gain of 400 units. As the countries specialize in their respective comparative advantages, the changes in their outputs will look as follows;” [Cartercentre.blogspot.com (N.D) (Online)]
ALTERATIONS IN YIELDS AS A RESULT OF SPECIALISATION
“But both nations will still require the goods it has not produced. The U.K will request for the 100,000 units of coffee from Nigeria. For Nigeria to be able to produce that amount it will have to allocate 2 units of labour. The effect of this labour transfer is that Nigeria will forego production of 100 units of computers so as to meet the demand for coffee by the U.K. The U.K, still using its one unit of labour, will have to exchange its 50 units of computers with the 100,000 units of coffee from Nigeria. The table shows the international trade related changes in output as countries utilize their respective labour resource in the best alternative;” [Cartercentre.blogspot.com (N.D) (Online)]
ALTERATIONS IN PRODUCTION WITH SPECIALISATION SO AS TO PARTICIPATE IN INTERNATIONAL TRADE
Total change in output
“Due to specialization and trading based on comparative advantage, additional 250 units of computers are produced and consumed without reducing the quantities of coffee produced and traded in the international market. In general, countries gain from free trade because the output and consumption possibilities of both countries expand as opposed to no trade. Let us try to analyse the mechanism allowing countries to gain from trade.” [Cartercentre.blogspot.com (N.D) (Online)]
“If the world price of coffee is equal to $1and the price of a computer equals $500, Nigeria can buy 200 units of computers from the U.K by exporting 100,000 coffee units. As both countries engage in international trade, they end up consuming more computers and the same amount of coffee than in the situation without trade.” [Cartercentre.blogspot.com (N.D) (Online)]
“Therefore enabling countries to specialize their resources in the economic activities in which they have a comparative advantage and then engage in international trade to get products in which they have a comparative disadvantage does not only expand the size of global production, it allows for expanded ‘global consumption possibilities’.” [Cartercentre.blogspot.com (N.D) (Online)]
THE DOWNSIDE OF THE COMPARATIVE ADVANTAGE AS ADVANCED BY DAVID RICARDO
“The theory has been criticized mainly because of its assumptions which to some economists are not realistic. Below are some of the areas that the theory ignores.” [Cartercentre.blogspot.com (N.D) (Online)]
“Free international trade is beneficial not only to that country with a more productive sector than foreign countries but also to those countries that are able to avoid the high costs for goods that they would otherwise have to produce domestically.” [Cartercentre.blogspot.com (N.D) (Online)]
“The theory is not complex enough to examine income distributional issues within a country. For example free trade with countries that pay law wages can hurt high wage countries. Even though consumers benefit because they can purchase goods more cheaply, international trade may reduce wages for some workers, thereby affecting the distribution of income within a country. In effect international trade with such low wage countries erodes the incomes of the producers/workers that are earned using resources more efficiently and through higher prices/wage.” [Cartercentre.blogspot.com (N.D) (Online)]
“The assumption that all countries are identical except for their differences in technologies is farfetched. Countries differ in their endowments of important factors of production (inputs). Does that matter for trade?” [Cartercentre.blogspot.com (N.D) (Online)]
“The theory ignores the nature and form of transport in the different countries and the effect this has on the relative price for one good to any other. Transport costs differ in terms of cost and appropriateness in delivery mechanisms.” [Cartercentre.blogspot.com (N.D) (Online)]
“These differences have a bearing on the price of the product and do influence the terms of trade. In other words, a country with a comparative advantage say in using labour to produce coffee could find itself disadvantaged in the international market, if its transport sector is not well developed.” [Cartercentre.blogspot.com (N.D) (Online)]
“Factors of production are not necessarily homogeneous. Because they are not the same, they cannot necessarily move from the production of one good to another.” [Cartercentre.blogspot.com (N.D) (Online)]
Protectionism is a key concept in international trade. It can be defined as “an economic policy which is meant to benefit domestic producers of goods and services.” [wiseGEEK.com (N.D) (Online)] or it can also be defined “government actions and policies that restrain international trade, often done with the intent of protecting local businesses and jobs from foreign competition.” [Investopedia.com (N.D) (Online)]. Trade protection simply means preventing importation as stated through measure like tariffs, quotas and tax cuts.
TYPES OF PROTECTIONISM
Protectionism comes in different forms depending on the situation and its importance to the general welfare of a country. The following procedures are different ways in which protectionism can be practiced.
One of such ways is placing of tariffs. Tariffs are “A tax imposed on imported goods and services.” [Investopedia (N.D) (Online)]. Tariffs are placed to discourage the consumers in an economy from buying imports. The effect of tariffs on imports is that it increases the price of imports causing the home made products to seem cheaper than the imported goods. The problem with using tariffs is that it could cause other countries to retaliate by imposing even higher tariffs on their goods. The graph below shows that once tariffs are imposed, prices of imports increase and demand for import decrease.
Source: [mrski-apecon-2008 (N.D) (Online)].
Another method of protectionism is granting of subsidies to infant firms. A Subsidy is “A benefit given by the government to groups or individuals usually in the form of a cash payment or tax reduction.”[Investopedia.com (N.D) (Online)]
When subsidy is granted to smaller firms, cost of production and prices of goods are reduced which would cause consumers to increase demand for these goods rather than imports. Subsidy also helps infant firms to compete favourably with bigger firms in other countries. The disadvantage of using subsidy is that consumers indirectly pay for the subsidy by having to pay higher taxes which would be used to give the subsidies.
Another form of protectionism is imposition of quotas. Quotas are “A government-imposed trade restriction that limits the number, or in certain cases the value, of goods and services that can be imported or exported during a particular time period” [Investopedia.com (N.D) (Online)]. The effect of quotas is that the quantity of imports is reduced. Quotas really do not have any effect on the prices of the imports. The problem of quotas is the goods and services that quotas are placed on may be essential goods and services that the home country is unable to produce.
Source: [Nirmitkadakia (2012) (Online)].
Judging from the above graph, when quotas are placed, the world supply doesn’t change but the domestic supply of goods and services increases from Q to Q2 and domestic prices decrease from P to P2.
Embargo is another form of protectionism. Embargo is “A government order that restricts commerce or exchange with a specified country” Investopedia (N.D) (Online). Embargoes are usually placed on imports. When embargoes are placed on goods, those goods are not imported at all into a country. Embargoes are very effective for goods that are harmful in nature. An example of such goods is heroine- a hard drug that is dangerous to the health of the consumers.
PROS AND CONS OF PROTECTIONISM
As a group, the world’s economists are not known for consensus on most subjects. But they are nearly unanimous on one thing: Trade protectionism harms economic growth. Although global trends have moved toward freer trade, most countries continue to use a variety of protectionist measures, such as tariffs and import quotas, to protect domestic industries from foreign competitors. Although most economists prefer free trade, they acknowledge that protectionism benefits some players in the world economy.
PRO: PROTECT DOMESTIC JOBS
This is one of the leading arguments for protectionism; namely, that doing so protects domestic industries and their workers’ jobs. Labour unions and domestic industries often appeal to patriotism to marshal support for protectionist policies. “Buy American” has been a popular rallying cry, such as among the American auto industry when the Big Three automakers faced stiff competition from Japanese imports. Economists concede that free trade imposes costs and burdens on some industries and workers in the short run, but that in the long term, it is far more beneficial than protectionism, which they believe helps only a select few at the expense of the larger economy and society.
PRO: INFANT INDUSTRIES
Governments often justify protectionist policies by claiming that such policies are necessary to help industries that are in their infancy to develop. The validity of this argument, however, is undermined by the tendency for such policies to become permanent as the aided industry grows dependent on the support and even lobbies government officials to keep protectionist measures in place.
CON: HIGHER PRICES, LESS SELECTION
Protectionism restricts competition by limiting the availability of foreign goods, forcing consumers to buy more expensive domestic products. The costs of tariffs and other protectionist barriers are passed on to consumers in the form of higher prices for foreign goods. Free trade, in contrast, forces more competition among producers around the world, which lowers prices and increases the diversity of goods.
CON: SLOWER ECONOMIC GROWTH
Economists contend that protectionism limits economic growth by restricting the markets in which goods are available. They caution that a country that restricts goods from other countries may find its products similarly restricted, which slows growth by making it harder for industries to export their products.
CON: GLOBAL TENSIONS
When the government of one nation restricts another country’s imports through tariffs, import quotas, or other protectionist policies, the second nation may retaliate with similar actions against goods from the first country. Actions to restrict trade with other nations can develop into a “trade war,” as nations continually act against each other’s goods. In extreme cases, these tensions can escalate into armed conflict.
FREE TRADE VS PROTECTIONISM
“As with other theories, there are opposing views. International trade has two contrasting views regarding the level of control placed on trade: free trade and protectionism. Free trade is the simpler of the two theories: a laissez-faire approach, with no restrictions on trade. The main idea is that supply and demand factors, operating on a global scale, will ensure that production happens efficiently. Therefore, nothing needs to be done to protect or promote trade and growth, because market forces will do so automatically.” [Ezinearticles.com (N.D) (Online)]
“In contrast, protectionism holds that regulation of international trade is important to ensure that markets function properly. Advocates of this theory believe that market inefficiencies may hamper the benefits of international trade and they aim to guide the market accordingly.” [Ezinearticles.com (N.D) (Online)] Protectionism exists in many different forms, but the most common are tariffs, subsidies and quotas. “These strategies attempt to correct any inefficiency in the international market.” [Ezinearticles.com (N.D) (Online)]
THE BOTTOM LINE
“As it opens up the opportunity for specialization and therefore more efficient use of resources, international trade has the potential to maximize a country’s capacity to produce and acquire goods. Opponents of global free trade have argued, however, that international trade still allows for inefficiencies that leave developing nations compromised. What is certain is that the global economy is in a state of continual change, and, as it develops, so too must all of its participants.” [Scribd.com (N.D) (Online)]
In conclusion, when the benefits of free trade are compared to the benefits of protectionism, it can be seen that the benefits of free trade outweighs that of protectionism. Hence, it would be advisable for countries to engage in free trade so as to increase specialisation. Also countries should use these two concepts as a watch dog for each other so as to enable a controlled economy. Let us be aware that we cannot rule out protectionism absolutely from a country’s economy or else it will make the economy become a wishy-washy one which will allow anything in and out of the economy. This can be detrimental to the infant industries in the country and can turn the country to a dumping ground which is seriously not healthy for a proactive economy. Hence specialization should work or go hand in hand with the protectionism so as to have an equilibrium economy.