Most countries trade more on international markets today than ever before – both in absolute terms and as a proportion of their national output. How can we explain this phenomenal increase in international trade over the past few decades? Will the recent rise in oil prices reverse this trend of globalization?
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History provides us with a natural comparison. Beginning in the nineteenth century, the world saw a remarkable rise in international trade that came to a grinding halt during World War I and later on in the wake of the Great Depression. This “first wave of globalization” from about 1870 until 1913 led to a degree of international integration – measured by trade-to-output ratios – which many countries only achieved again in the mid-1990s.
Taking a comparative perspective, we juxtapose the first wave of globalization from 1870 to 1913 and the second wave after World War II. We also study the retreat of world trade during the interwar period from 1921 to 1939. We are interested in the driving forces behind these trade booms and trade busts. Was it changes in global output or changes in trade costs that explain the evolution of international trade?
I.2. INTERNATIONAL TRADE- DEFINED
International trade is exchange of capital, goods, and services across international borders or territories. In other word, to know what is happening in the course of international trade, governments keep track of the transactions among nations.
I.3. REASONS FOR INTERNATIONAL TRADE
The first theory section of this course contains explanations or reasons that trade takes place between countries. The six basic reasons why trade may take place between countries are summarized below.
Differences in Technology
Advantageous trade can occur between countries if the countries differ in their technological abilities to produce goods and services.
Differences in Resource Endowments
Advantageous trade can occur between countries if the countries differ in their endowments of resources. The factors mentioned in the resource endowments reason are described as follows:
The uneven distribution of resources around the world is the one of the basic reasons why nations began and continue to trade with each other.
Favorable climatic conditions and terrain are very important for agricultural produces.
Favorable geographic location and transport costs,
Insufficient production, some countries cannot produce enough items they need.
c) Economic reasons
In addition to getting the products they need, countries also want to gain economically by trading with each other.
d) Differences in Demand
Advantageous trade can occur between countries if demands or preferences differ between countries.
e) Existence of Economies of Scale in Production
The existence of economies of scale in production is sufficient to generate advantageous trade between two countries.
f) Existence of Government Policies
Government tax and subsidy programs can be sufficient to generate advantages in production of certain products.
II.0. FACTORS CONTRIBUTING TO THE RECENT GROWTH IN INTERNATIONAL TRADE
Trade facilitation procedures, industrialization, advanced infrastructure, technological advancement, globalization, multinational corporations, documentary procedure requirements, decrease level of regulations(tariffs and non-tariffs barriers), and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders.
II.1. Trade facilitation
Among the factors leading/contributing to the recent growth in international trade, trade facilitation is the critical issue debated under WTO and other multinational organizations.
It is said to be the critical issue, because it includes all other factors contributing to the recent growth of international trade.
It involves harmonization, standardization, integration, synchronisation of international trade procedures.
trade facilitation in global trade
No widely agreed definition. WTO defines it as simplification and standardization of International Trade Procedures. International Trade Procedures are defined as “activities, practices and formalities involved in collecting, presenting, communicating and processing data required for movement of goods in International Trade.
The mushrooming of industries all over the world caused by industrial revolution is another factor contributing to the recent growth in international trade. This factor is characterized by mass production, standardized and customized products.
II.3. Advanced infrastructure
It is a basic responsibility of the government to facilitate/support trade by improving physical, institutional and virtual infrastructures.
The physical infrastructures involve: roads, railways transport, sea transport, air transport, and multimodal transport.
Virtual infrastructure; this means facilitation through intermediaries such as, logistic agencies, insurance companies, and freight forwarders.
Institutional infrastructure, this involves universities/colleges,for business studies management.
The improvement of all these kind of infrastructures in many countries contributes/lead to the recent growth in international trade.
II.4. Technological advancement
The 21st century, is the era of technological advancement characterized by the stiff competition in E-commerce model, whereby the international business focus has changed significantly.
Technological advancement has been proven to be a vital factor in expanding the market and enabling businessmen to make the most effective use of information.
Modernized industries presently are enjoying economies of scale due to mass production, standardized and customized products leading to low cost of production and are becoming competitive in the global markets.
Currently, the world is connected and brought together as a small village; this is due to technological improvement.
From this point of view, it is proven that technological advancement is one among the critical factors contributing to the recent growth in international trade.
Globalization is integration in its concept, nowadays the world is integrated and people are connected. Goods and services are moving from one point of the globe to another in few hours. From this argument, we can say that the world has been turned into a sustainable village.
As a result, globalization has played a major role in contributing rapid growth in global trade.
II.6. Multinational organizations
These are international organizations dealing with the control of international trade policies and procedures.
Multilateral organizations that oversee Trade Facilitation include World Customs Organizations, IMF, UNCTAD, OECD, and WTO & World Bank.
II.7. Documentary procedure requirements
The process of documentary requirements in Export-Import transactions was very cumbersome, this in term of EXIM duties, export-import license, and global standards license, etc.
But, due to trade facilitation concept, the days of processing import goods are becoming reduced.
The relevant example is from Dar es-salaam port, the processes to clear import goods took three weeks to one month in the past years. Presently, the average days to clear cargos are 7 to 14 days. (This is due to implementation of using new equipments- cranes machines, and new systems- Automated System of Customs Data-ASYCUDA by TRA).
Another example is of PERU, this country has 19 ports along the literal of the Pacific Ocean.
In these ports no effective customs procedures. Cargo clearance time stakes about 15 to 30 days. As result, no transparence, no uniformity and consistence.
Due to the emphasis on documentary procedure by the multilateral organizations (WTO and World Bank), the release times under these ports came down from 15-30days up to 2-3days export-import perspective (World Bank studies on Trade facilitation, 2008).
III.1. THEORIES OF INTERNATIONAL TRADE
The principal objective of any theory of international trade is to explain the cause of trade. Two other objectives of a theory of international trade are to explain the composition and volume of external trade. A theory, which explains these three issues: cause, composition (structure) and volume of trade is conventionally said to be a “complete” theory of international trade. The two complete theories of international trade in existence are the Classical (also called Ricardian) theory and neo-classical theory.
III.2. THE CLASSICAL THEORY OF INTERNATIONAL TRADE
David Ricardo, the 18th century British economist was the author of the classical theory of international trade and the doctrine of comparative advantage. Ricardo was the first to demonstrate that external trade arises not from difference in absolute advantage but from difference in comparative advantage. By “comparative advantage” is meant by “greater advantage”. Thus, in the context of two countries and two commodities, trade would still take place even if one country was more efficient in the production of both commodities (provided the degree of its superiority over the other country was not identical for both commodities).
The Ricardian model focuses on comparative advantage, perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods.
Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The main merit of Ricardian model is that it assumes technology differences between countries. Technology gap is easily included in the Ricardian and Ricardo-Sraffa model (See the Ricardian theory (modern development)).
The Ricardian model makes the following assumptions:
Labor is the only primary input to production (labor is considered to be the ultimate source of value).
Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to scale, and simple technology.)
Limited amount of labor in the economy
Labor is perfectly mobile among sectors but not internationally.
Perfect competition (price-takers).
The Ricardian model measures in the short-run, therefore technology differs internationally. This supports the fact that countries follow their comparative advantage and allows for specialization.
III.3. NEO- CLASSICAL/RICARDIAN TRADE THEORY
The Neo-classical theory of trade evolved in an attempt to modify some unsatisfactory aspects of the classical theory. Thus, the Neo-classical theory, also called the modern theory, advanced a more satisfactory explanation for the existence of comparative cost differences between countries; introduced capital as a second factor of production; and allowed for international differences in the pattern of demand. The Neo-classical theory is therefore a 2*2*2 model i.e., it assumes the existence of two countries, two commodities, and two factors of production. The introduction of a second factor of production turns out to every important. This makes the approach of Neo-classical theory to be different n certain fundamental respects from the classical theory, namely, in handling of the relationship between factor allocation, income distribution and international trade.
Inspired by Piero Sraffa, a new strand of trade theory emerged and was named neo-Ricardian trade theory. The main contributors include Ian Steedman (1941-) and Stanley Met alfe (1946-). They have criticized neo classical international trade theory, namely the Heckscher-Ohlin model on the basis that the notion of capital as primary factor has no method of measuring it before the determination of profit rate (thus trapped in a logical vicious circle). This was a second round of the Cambridge capital controversy, this time in the field of international trade.
The merit of neo-Ricardian trade theory is that input goods are explicitly included to the analytical framework. This is in accordance with Sraffa’s idea that any commodity is a product made by means of commodities. The limit of their theory is that the analysis is limited to small country cases.
III.4. OTHER THEORIES IN INTERNATIONAL TRADE
III.4.1. HECKSCHER-OHLIN MODEL (FACTOR ENDOWMENT THEORY)
In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since those theories focus on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialize in production and export using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier theories stated, the goods it produces most efficiently.
The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory.
The 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. Empirical problems with the H-O model, known as the Leontief paradox, were exposed in empirical tests by Wassily Leontief who found that the United States tended to export labor intensive goods despite having capital abundance.
The H-O model makes the following core assumptions:
Labor and capital flow freely between sectors
The production of shoes is labor intensive and the production of computers is capital intensive
The amount of labor and capital in two countries differ (difference in endowments)
Technology is the same across countries (long-term)
Tastes are the same.
The problem with the H-O theory is that it excludes the trade of capital goods (including materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to each country. In a modern economy, capital goods are traded internationally. Gains from trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001).
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III.4.1.a. REALITY AND APPLICABILITY OF THE HECKSCHER-OHLIN MODEL
The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists, because it makes fewer simplifying assumptions. In 1953, Wassily Leontief published a study, where he tested the validity of the Heckscher-Ohlin theory. The study showed that the U.S was more abundant in capital compared to other countries; therefore the U.S would export capital- intensive goods and import labour-intensive goods. Leontief found out that the U.S’s export was less capital intensive than import.
After the appearance of Leontief’s paradox, many researchers tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or either by new interpretations. Leamer emphasized that Leontief did not interpret H- O theory properly and claimed that with a right interpretation paradox did not occur. Brecher and Choudri found that, if Leamer was right, the American workers consumption per head should be lower than the workers world average consumption.
Many other trials followed but most of them failed. Many famous textbook writers, including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model.. After examining the long history of empirical research, Bowen, Hollander and Viane concluded: “Recent tests of the factor abundance theory [H-O theory and its developed form into many-commodity and many-factor cases] that directly examine the H-O-V equations also indicate the rejection of the theory.” Heckscher-Ohlin theory is not well adapted to analyze South-North trade problems. The assumptions of H-O are less realistic with respect to N-S than N-N (or S-S) trade. Income differences between North and South is the one that third world cares most. The factor price equalization [a consequence of H-O theory] has not shown much sign of realization. H-O model assumes identical production functions between countries. This is highly unrealistic. Technological gap between developed and developing countries is the main concern of the poor countries.
III.4.2. SPECIFIC FACTORS MODEL
In this model, labor mobility between industries is possible while capital is immobile between industries in the short-run. Thus, this model can be interpreted as a ‘short run’ version of the Heckscher-Ohlin model. The specific factors name refers to the given that in the short-run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms.
Additionally, owners of opposing specific factors of production (i.e. labor and capital) are likely to have opposing agendas when lobbying for controls over immigration of labor. Conversely, both owners of capital and labor profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade.
III.4.3. NEW TRADE THEORY
New Trade Theory tries to explain empirical elements of trade that comparative advantage-based models above have difficulty with. These include the fact that most trade is between countries with similar factor endowment and productivity levels, and the large amount of multinational production (i.e. foreign direct investment) which exists. New Trade theories are often based on assumptions like monopolistic competition and increasing returns to scale. One result of these theories is the home-market effect, which asserts that, if an industry tends to cluster in one location because of returns to scale and if that industry has high transportation costs, the industry will be located in the country with most of its demand to minimize the costs.
III.4.4. GRAVITY MODEL
The Gravity model of trade presents a more empirical analysis of trading patterns rather than the more theoretical models discussed above. The gravity model, in its basic form, predicts trade based on the distance between countries and the interaction of the countries’ economic sizes. The model mimics the Newtonian law of gravity which also considers distance and physical size between two objects. The model has been proven to be empirically strong through econometric analysis. Other factors such as income level, diplomatic relationships between countries, and trade policies are also included in expanded versions of the model.
III.4.5. RICARDIAN THEORY OF INTERNATIONAL TRADE (MODERN DEVELOPMENT)
The Ricardian theory of comparative advantage became a basic constituent of neoclassical trade theory. Any undergraduate course in trade theory includes expansions of Ricardo’s example of four numbers in the form of a two commodity, two country model.
This model was expanded to many-country and many-commodity cases. Major general results were obtained by the beginning of 1960’s by McKenzie and Jones, including his famous formula. It is a theorem about the possible trade pattern for N-country N-commodity cases.
III.4.6. CONTEMPORARY THEORIES
Ricardo’s idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and Samuelson. This formulation is employed for example by Matsuyama and others. These theories use the special property which is applicable only for the two countries’ case.
III.5. CONCEPT OF TARIFF AND NON- TARIFF BARRIERS (NTBs) IN INTERNATIONAL BUSINESS
A tariff is simply a tax (duty) levied on a product when it crosses national boarders (boundaries). The most widespread tariff is the import tariff, which is a tax levied on imported product.
A less common tariff is an export tariff, which is tax imposed on an exported product.
NOTE: tariffs may be imposed for protection or revenue purposes.
A protective tariff is designed to insulate import competing producers from foreign competition. Protective tariff does pace foreign producers at a competitive disadvantage when selling in the domestic market.
A revenue tariff is imposed for the purpose of generating tax revenues and may be placed on either exports or imports
III.5.2. TYPES OF TARIFFS
Tariffs can be specific, ad valorem, or compound.
A specific tariff is expressed in terms of a fixed amount of money per physical unit of the impoted product.
An Ad valorem (of value) Tariff, much like a sales tax, is expressed as a fixed percentage of the value of the imported product.
Suppose that an ad valorem duty of 15% is levied on imported trucks. A US importer of the Japanese truck valued at $ 20,000 would be required to pay a duty of $ 3,000 to the government (20,000*15%) = 3,000.
A compound tariff is a combination of specific and ad valorem tariffs.
For example, a US importer of a television might be required to pay a duty of $ 20 plus 5% of the value of the television.
III.6.EFFECTIVE RATE OF PROTECTION
The main objective of an import tariff is to protect domestic producers from competition.
The norminal tariff rate
This kind of tariff rate does not always truly indicate the actual, or effective, protection given. This is because the nominal tariff rates apply only to the total value of the final import product.
The effective tariff rate
This is an indicator of the actual level of protection that a nominal tariff rate provides the domestic import-competing producers. It signifies the total increase in domestic productive activities (value added) that an existing tariff structure makes possible, compared with what would occur under free-trade.
III.7. TARIFF WELFARE EFFECTS
Small nation Model
To measure the effects of a tariff on a nation’s welfare, consider the case of a nation whose imports constitute a very small portion of the world market supply.
This small nation would be a price taker, facing a constant world price level for its import commodity.
NB: for a small nation, a tariff placed on an imported product is shifted totally to the domestic consumer via a higher product price. Consumer surplus falls as a result of the price increase.
The small nation’s welfare decreases by an amount equal to the protective effect and consumption effect, the so called deadweight losses due to a tariff.
Large nation model
Now consider the case of an importing nation that is large enough so that changes in the quantity of its imports, by means of tariff policy, influence the world price of the product.
Let’s take an example of the US which is a large importer of autos, steel, oil, and consumer electronics, and other economic giants such as Japan and the European Union (EU).
If the US imposes a tariff on automobile imports, prices increase for American consumers. The result is a decrease in the quantity demanded, which may be significant enough to force Japanese firms to reduce the prices of their exports.
NB: for a large nation, a tariff on an imported product may be partially shifted to the domestic consumer via a higher product price and partially absorbed by the foreign exporter via lower price.
The extent by which a tariff is absorbed by the foreign exporter constitutes welfare gain for the home country. This gain offsets some (or all) of the deadweight welfare losses due to the tariff’s consumption effect and protective effect.
III.8. NON- TARIFF TRADE BARRIERS (NTBs)
Policies other than tariffs that restrict international trade. NTBs encompass a variety of measures. Some have unimportant trade consequences; for example, labeling and packaging requirements can restrict trade, but generally only marginally. Other NTBs significantly affect trade patterns;
Voluntary export restraints (VERs),
Domestic content requirements.
These NTBs are intended to reduce imports and thus benefit domestic producers.
III.9. GLOBALIZATION AND INTERNATIONAL BUSINESS (How they affect each other)
In its broadest sense, Globalization refers to the broadening set of interdependent relationships among people from different parts of the world that happens to be divided into nations. The term sometimes refers to the integration of world economies through the reduction of barriers to the movement of trade, capital, technology, and people. Throughout record history, human contacts over ever wider geographic areas have expanded the variety of resources, products, services, and markets available to consumers. We have altered the way we want and expect to live, and we have become more deeply affected (positively and negatively) by conditions outside of our immediate domains.
Globalization enables us to get more variety, better quality, or lower prices. Our daily meals, for instance, contain spices that are not grown domestically and fresh produced that are out of season in one local climate or another.
III.9.a. The forces driving globalization
Measuring globalization, especially for historical comparisons, is problematic. First, the degree of two countries’ interdependence must be measured indirectly. Secondly, when national boundaries shift (consider the breakup of the former Soviet Union or the reunification of East and West Germany), domestic business transaction can become international transactions or vice versa. Nevertheless, various indicators assure us that globalization has been increasing.
Currently, about 25 percent of the world production is sold outside its country of origin, as opposed to about 7percent in 1950. Restrictions on imports have been decreasing, and foreign ownership of assets as percentage of world production has been increasing. In almost every year since World War II, world trade has grown rapidly than world production.
At the time, however, globalization is less pervasive than you might suppose. Much of the world, for example (especially in rural Africa, Asia, and Latin America), lacks the resources to establish more than the barest connection with anyone beyond the outskirts of the isolated worlds. Only a few countries-mainly very small ones-either sell over half their production abroad or depend on foreign output for over half their consumption. What this means is that most of the world’s goods and services are still sold in the countries in which they are produced. Moreover, the principal source of capital in most countries is domestic rather than international.
Granted, these measurements address only economic aspects of global interdependence. Various other study studies have relied on different indicators for comparison. One of the most comprehensive is the A.T. Kearney/Foreign Policy Globalization Index, which shows not only that some countries are more globalized than others but also that a given country may be highly globalized on one dimension and not on another. This index ranks 62 countries across four dimensions:
Economic-international trade and investment
Personal contact-international travel and tourism, international telephone traffic, and personal transfers of funds internationally.
Political-participation in international organizations and government monetary transfers.
In recent years, the index has ranked Singapore and Switzerland as the most globalized countries and India and Iran as the least globalized. The ranking of the United States, for example, shows how globalization can differ by dimension: The United States ranks first on technology scale but only 58th on the economic.
III.9.b. Factors increasing globalization
What factors have contributed to the increased growth in globalization in recent decades? Most analysts cite the following seven factors:
Increase in and expansion of technology,
Liberalization of cross-border trade and resource movements,
Development of services that support international business,
Growing consumer pressures,
Increased global completion,
Changing political situations,
Expanded cross-national cooperation.
III.9.c. Major Criticisms of globalization
Although we have discussed seven broad reasons for the increase in international business and globalization, we should remember that the consequences of these trends remain controversial. To thwart the globalization process, anti-globalization forces regularly protest international conferences (sometimes with attendant violence). There are many pertinent issues, but we focus on the three broad categories: threats to national sovereignty (i.e. countries lose sovereignty), growth and environmental stress (I.e. the resultant growth hurts the environment), and growing income inequality (i.e. some people lose both relatively and absolutely).
III.9.d. Threats to national sovereignty
You probably heard the slogan “Think globally act locally”. In essence, it means that the accommodation of local interest should prevail over global interests. Some observers worry that the proliferation of international agreements, particularly those that eliminate local restrictions on how good are bought and sold, will diminishing a nation’s sovereignty- that is, a nation’s freedom to “act locally” and without externally imposed restrictions.
III.9. e. Economic growth and environmental stress
Much anti-globalization criticisms revolve around issues of economic growth. According to one argument, as globalization brings growth, it consumes more nonrenewable natura