International trade theory

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International trade theory is a sub-field of economics which analyzes the patterns
of international trade, its origins, and its welfare implications. International trade
policy has been highly controversial since the 18th century. International trade theory
and economics itself have developed as means to evaluate the effects of trade
policies.

Contents

 1Adam Smith's model

 2Ricardian model
o 2.1New interpretation
 3Specific factors model
 4Heckscher–Ohlin model
o 4.1Stolper-Samuelson theorem
o 4.2Empirical Evidence for the Heckscher–Ohlin model
 5New trade theory
 6New new trade theory
 7Gravity model
 8Ricardian trade theory extensions
o 8.1Many countries, many goods
o 8.2Traded intermediate goods
o 8.3Global value chains
 9See also
 10References
 11External links

Adam Smith's model[edit]

Main article: Adam Smith
Adam Smith describes trade taking place as a result of countries having absolute
advantage in production of particular goods, relative to each other. [1][2] Within Adam
Smith's framework, absolute advantage refers to the instance where one country can
produce a unit of a good with less labor than another country.
In Book IV of his major work the Wealth of Nations, Adam Smith, discussing gains
from trade, provides a literary model for absolute advantage based upon the
example of growing grapes from Scotland. He makes the argument that while it is
possible to grow grapes and produce wine in Scotland, the investment in the factors
of production would cost thirty times than more than the cost of purchasing an equal
quantity from a foreign country.[3] The minimization of aggregate real costs and
efficient resource allocation through trade without strong consideration for
comparative costs form the basis of Adam Smith's model of absolute advantage in
international trade.[4]

Ricardian model[edit]
Main article: David Ricardo

The law of comparative advantage was first proposed by David Ricardo.

The Ricardian theory of comparative advantage became a basic constituent of

neoclassical trade theory. Any undergraduate course in trade theory includes a
presentation of Ricardo's example of a two-commodity, two-country model. For the
modern development, see Ricardian trade theory extensions
The Ricardian model focuses on comparative advantage, which arises due to
differences in technology or natural resources. The Ricardian model does not directly
consider factor endowments, such as the relative amounts of labor and capital within
a country.
New interpretation[edit]
The Ricardian model is often presented as being based on the following
assumptions:

 Labor is the only primary input to production.

 The relative ratios of labor at which the production of one good can be
traded off for another, differ between countries.
This is incomplete, because the Ricardian model can be extended to the situation
where many goods can be inputs for a production. See Ricardian trade theory
extensions below. Relative ratio of labor input coefficients has a valid meaning only
for simple cases such as two-country, many commodity case or many-country, two-
commodity case without no intermediate goods.[5]
As for the meanings of four magic numbers, a new interpretation became popular in
the 21st century. In 2002, Roy Ruffin pointed the possibility of new reading of
Ricardo's explanations.[6] Andrea Maneschi made a detailed account in 2004. [7] Now
the new interpretation has become almost as established as Ricardo's text, not only
for the first third of Chapter 7 but for all descriptions throughout his book concerning
international trade.[8]

Specific factors model[edit]

Main article: Richardo-viner
The specific factors model is an extension of the Ricardian model. It was due
to Jacob Viner's interest in explaining the migration of workers from the rural to urban
areas after the Industrial revolution.
In this model labor mobility among industries is possible while capital is assumed to
be immobile 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
assumption 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

Heckscher–Ohlin model[edit]
Main article: Heckscher–Ohlin model
In the early 1900s, a theory of international trade was developed by
two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory has
subsequently become known as the Heckscher–Ohlin model (H–O model). The
results of the H–O model are 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.
The H–O model makes the following core assumptions:

 Labor and capital flow freely between sectors equalising factor

prices across sectors within a country.
 The amount of labor and capital in two countries differ (difference in
endowments)
 Technology is the same among countries (a long-term assumption)
 Tastes are the same upon countries
Stolper-Samuelson theorem[edit]
According to the Stolper-Samuelson theorem, the export of a product which is
relatively cheap, abundant resource makes this resource more scarce in the
domestic market. Thus, the increased demand for the abundant resource leads to an
increase in its price and an increase in its income. Simultaneously, the income of the
resource used intensively in the import-competing product decreases as its demand
falls.
Simply put, this theorem indicates that an increase in the price of a product rises the
income earned by resources that are used intensively in its production. Conversely,
a decrease in the price of a product reduces the income of the resources that it uses
intensively. The abundant resource that have comparative advantage realizes an
increase in income, and the scarce resource realizes a decrease in its income
regardless of industry. This trade theory concludes that some people will suffer
losses from free trade even in the long-term.[9]
Empirical Evidence for the Heckscher–Ohlin model[edit]
In 1953, Wassily Leontief published a study in which he tested the validity of the
Heckscher-Ohlin theory.[10] The study showed that the United States was more
abundant in capital compared to other countries, therefore the United States would
export capital-intensive goods and import labor-intensive goods. Leontief found out
that the United States' exports were less capital intensive than its imports. The result
became known as Leontief's paradox.
After the appearance of Leontief's paradox, many researchers [who?] tried to save the
Heckscher-Ohlin theory, either by new methods of measurement, or by new
interpretations.[citation needed]

New trade theory[edit]

Main article: 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) that
exists. New trade theories are often based on assumptions such as 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 faces high transportation
costs, the industry will be located in the country with most of its demand, in order to
minimize cost.

New new trade theory[edit]

New new trade theory is a theory of international trade inaugurated by Marc Melitz in
2003.[11] It discovered that efficiency of firms in a country changes much and those
firms engaged in international trade have higher productivity than firms which
produce only for domestic market. As it is fitted to big data age, the research
produced many follows and the trend is now called New new trade theory in
comparison to Paul Krugman's new trade theory.

Gravity model[edit]
Main article: Gravity model of trade
The Gravity model of trade presents a more empirical analysis of trading patterns.
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 shown to have significant empirical validity. [12]

Ricardian trade theory extensions[edit]

According to Eaton and Kortum,[13] in the 21 century, "the Ricardian framework has
experienced a revival. Much work in international trade during the last decade has
returned to the assumption that countries gain from trade because they have access
to different technologies. ... This line of thought has brought Ricardo's theory of
comparative advantage back to center stage." The Ricardian trade theory was
expanded and generalized multiple times: notably to treat many-country many-
product situation and to include intermediate input trade, and choice of production
techniques. In Ricardian framework, capital goods (comprising fixed capital) are
treated as goods which are produced and consumed in the production.
Many countries, many goods[edit]
There were three waves of expansions and generalizations.
First phase: Major general results were obtained by McKenzie [14][15] and Jones.
[16]
 McKenzie was more interested in the patterns of trade specialisiations (including
incomplete specializations),[17] whereas Jones was more interested in the patterns of
complete specialization, in which the prices moves freely within a certain limited
range.[18] The formula he found is often cited as Jones' inequality [19] or Jones' criterion.
[20]

Second phase: Ricardo's idea was even expanded to the case of continuum of
goods by Dornbusch, Fischer, and Samuelson (1977) [21] This model is restricted to
two country case. It is employed for example by Matsuyama [22] and others. These
theories use a special property that is applicable only for the two-country case. They
normally assume fixed expenditure coefficients. Eaton and Kortum (2002) [23] inherited
Ricardian model with a continuum of goodsl from Dorbusch, Fischer, and Samuelson
(1977). It has succeeded to incorporate trade of intermediate products. Countries
have different access to technology. The bundle of inputs is assumed as the same
across commodities within a country. This means that all industries of a country
consume the same bundle of inputs and there is no distinction between petrol-
consuming and iron-consuming industries. This is the major reason why Eaton and
Kortum (2002) cannot be used as framework for analyzing global value chains. The
paper has gotten a big success as giving theoretical foundation for gravity model.
Third phase: Shiozawa [24] succeeded to construct a Ricardian theory with many-
country, many-commodity model which permits choice of production techniques and
trade of input goods. All countries have their own set of production techniques. Major
difference with H-O model that this Ricardian model assumes different technologies.
Wages determined in this model are different according to the productivity of
countries. The model is therefore more suitable than H-O models in analyzing
relations between developing and developed countries. Shiozawa's theory is now
extended as "the new theory of international values." [25]
Traded intermediate goods[edit]
Ricardian trade theory ordinarily assumes that the labor is the unique input. This has
been thought to be a significant deficiency for Ricardian trade theory since
intermediate goods comprise a major part of world international trade. [26][27]
McKenzie[28] and Jones[29] emphasized the necessity to expand the Ricardian theory to
the cases of traded inputs. McKenzie (1954, p. 179) pointed that "A moment's
consideration will convince one that Lancashire would be unlikely to produce cotton
cloth if the cotton had to be grown in England." [30] Paul Samuelson[31] coined a
term Sraffa bonus to name the gains from trade of inputs.
John S. Chipman observed in his survey that McKenzie stumbled upon the questions
of intermediate products and postulated that "introduction of trade in intermediate
product necessitates a fundamental alteration in classical analysis". [32] It took many
years until Shiozawa succeeded in removing this deficiency. The new theory of
international values is now the unique theory that can deal with input trade in a
general form. [33]
Based on an idea of Takahiro Fujimoto,[34] who is a specialist in automobile industry
and a philosopher of the international competitiveness, Fujimoto and Shiozawa
developed a discussion in which how the factories of the same multi-national firms
compete between them across borders.[35] International intra-firm competition reflects
a really new aspect of international competition in the age of so-called global
competition.
Global value chains[edit]
Main article: Global value chain
Revolutionary change in communication and information techniques and drastic
downs of transport costs have enabled an historic breakup of production process.
Networks of fragmented productions across countries are now called global value
chains.[36] The emergence of global production has changed the way we understand
the trade and international economy. [37] Still the core of international trade theory
continues to be dominated by theories which assume trade of complete goods. As
Grossman and Rossi-Hansberg put it, it needs a new paradigm to better understand
the implication of these trends.[38] Extended Ricardian trade model provides a new
theory that can treat trade of input goods and the emergence of global value chains.
[39]