What Is Mercantilism?

Mercantilism was an economic system of trade that spanned the 16th century to the 18th century.
Mercantilism was based on the principle that the world's wealth was static, and consequently,
governments had to regulate trade to build their wealth and national power. Many European
nations attempted to accumulate the largest possible share of that wealth by maximizing their
exports and limiting their imports via tariffs.

Understanding Mercantilism
Mercantilism was a form of economic nationalism that sought to increase the prosperity and power
of a nation through restrictive trade practices. Its goal was to increase the supply of a
state's gold and silver with exports rather than to deplete it through imports. It also sought to
support domestic employment.

Mercantilism centered on the interests of merchants and producers (such as England's East India
Company and the Dutch East India Company) and protected their activities as necessary.
Mercantilism had several noteworthy characteristics.

1. The Belief in the Static Nature of Wealth

Financial wealth was considered limited (due to the rarity of precious metals). Nations that sought
prosperity and power needed to secure as much wealth as possible, at the expense of other nations.

2. The Need to Increase the Supply of Gold

Gold represented wealth and power. It could pay for soldiers, seafaring exploration for natural
resources, and expanding empires. It could also protect against invasion. A lack of gold meant the
downfall of a nation.

3. The Need to Maintain a Trade Surplus

This was integral to building wealth. Nations needed to focus on selling their exports (and collecting
the associated revenue) more than on spending on imports (and sending gold out of countries).

4. The Importance of a Large Population

Large populations represented wealth. Increasing a nation's population was integral to supplying a
labor force, supporting domestic commerce, and maintaining armies.
5. The Use of Colonies to Support Wealth

Some nations needed colonies for raw materials, a labor supply, and a way to keep wealth within its
control (by selling colonies the products their raw materials helped to produce). Essentially, colonies
increased a nation's wealth-building power and national security.

6. The Use of Protectionism

Protecting a nation's ability to build and maintain trade surpluses encompassed prohibiting colonies
from trading with other nations and imposing tariffs on imported goods.

History of Mercantilism
First seen in Europe during the 1500s, mercantilism was based on the idea that a nation's wealth
and power were best served by increasing exports and limiting imports.

Mercantilism replaced the feudal economic system in Western Europe. At the time, England was the
epicenter of the British Empire but had relatively few natural resources.

To grow its wealth, England introduced fiscal policies that discouraged colonists from buying foreign
products and created incentives to buy only British goods. For example, the Sugar Act of 1764
raised duties on foreign refined sugar and molasses imported by the colonies. This increased taxation
was meant to give British sugar growers in the West Indies a monopoly on the colonial market.

Similarly, the Navigation Act of 1651 forbade foreign vessels from trading along the British coast
and required colonial exports to first pass through British control before being redistributed
throughout Europe.

Programs like these resulted in a favorable balance of trade that increased Great Britain's national
wealth.

Under mercantilism, nations frequently engaged their military might to ensure that local markets
and supply sources were protected. Mercantilists also believed that a nation's economic health could
be measured by its ownership of precious metals, such as gold or silver. Their levels tended to rise
with increased new home construction, increased agricultural output, and a strong merchant fleet
that serviced additional markets with goods and raw materials.

French Mercantilism
Arguably the most influential proponent of mercantilism, French Controller General of Finance
Jean-Baptiste Colbert (1619-1683) studied foreign-trade economic theories. He was uniquely
positioned to execute on mercantilist ideas. A devout monarchist, Colbert called for an economic
strategy that protected the French crown from a rising Dutch mercantile class.

Colbert also increased the size of the French navy, on the belief that France had to control its trade
routes to increase its wealth. Although his practices ultimately proved unsuccessful, his ideas were
hugely popular. Ultimately, they became overshadowed by the theory of free-market economics.

British Colonial Mercantilism

The British colonies were subject to the direct and indirect effects of mercantilist policy at home.
Here are several examples:

• Controlled production and trade: Mercantilism led to the adoption of far-reaching trade

restrictions, which stunted the growth and freedom of colonial businesses.

• The expansion of the slave trade: Trade became triangulated between the British Empire, its

colonies, and foreign markets. This fostered the development of the slave trade in many

colonies, including America. The colonies provided rum, cotton, and other products

demanded by African imperialists. In turn, slaves were returned to America or the West

Indies and traded for sugar and molasses.

• Inflation and taxation: The British government demanded that trading be conducted using

gold and silver bullion, ever seeking a positive balance of trade. The colonies often had

insufficient bullion left over to circulate in their own markets, so they issued paper

currency to replace it. Mismanagement of printed currency resulted in inflationary periods.

Additionally, since Great Britain was in a near-constant state of war, heavy taxation was

needed to prop up its army and navy. The combination of taxes and inflation caused great

colonial discontent.

Merchants and Mercantilism

By the early 16th century, European financial theorists understood the importance of the merchant
class in generating wealth. Cities and countries with goods to sell thrived in the late middle ages.

Consequently, many believed the state should allow its leading merchants to create exclusive
government-controlled monopolies and cartels. Governments used regulations, subsidies, and (if
needed) military force to protect these monopolistic corporations from domestic and foreign
competition.

Citizens could invest money in mercantilist corporations in exchange for ownership and limited
liability in their royal charters. These citizens were granted shares of the company profit. In essence,
these were the first traded corporate stocks.

The most famous and powerful mercantilist corporations were Britain's East India Company and
the Dutch East India Company. For more than 250 years, the British East India Company
maintained the exclusive, royally granted right to conduct trade between Britain, India, and China.
Its trade routes were protected by the Royal Navy.

Mercantilism vs. Capitalism

Capitalism provides several advantages over mercantilism for individuals, businesses, and nations.
With capitalism's free-trade system, individuals benefit from a greater choice of affordable goods.
On the other hand, mercantilism restricts imports and reduces the choices available to consumers.
Fewer imports mean less competition and higher prices.

Mercantilist countries engaged in warfare frequently to control resources. Nations operating under a
free-trade system prospered by engaging in mutually beneficial trade relations.

In his seminal book The Wealth of Nations, legendary economist Adam Smith argued that free trade
enabled businesses to specialize in producing the goods that they could manufacture most efficiently.
This led to higher productivity and greater economic growth.

Mercantilism Today
Today, mercantilism is deemed outdated. The disaster of World War II underscored the potential
danger of nationalistic policies. It also prodded the world toward global trading and relationships as
a way to combat them.

However, it is hard to escape mercantilism. For example, after the war, barriers to trade were still
used to protect locally entrenched industries. The United States adopted a protectionist trade policy
toward Japan and negotiated voluntary export restrictions with the Japanese government, which
limited Japanese exports to the United States.

Today, Russia and China still use a mercantilist system because it partners so well with their forms
of government. They have relied heavily on their ability to control foreign trade, their balance of
payments, and foreign reserves. They have also sought to make their exports relatively more
attractive with lower pricing.

Due to the effects of globalization, many nations and their people suffer from feeling that they've
lost wealth, control, and prestige. This has made the nationalism that is part of mercantilism more
appealing. It helped bring to power the likes of Donald Trump in the U.S. and Narendra Modi in
India.

In 2018, President Trump imposed tariffs on Chinese imports, launching a trade war that exists to
this day.

What Were the Main Beliefs of Mercantilism?

Mercantilism's original foundation included beliefs that the world had limited wealth in the form of
gold and silver; that nations had to build their stores of gold at the expense of others; that colonies
were important for supplying labor and trading partners; that armies and navies were crucial to
protecting trade practices; and that protectionism was required to guarantee trade surpluses.

Adam Smith’s Theory of Absolute Cost

Advantage

Adam Smith’s theory of absolute cost advantage in international trade was evolved as a strong reaction
of the restrictive and protectionist mercantilist views on international trade. He upheld in this theory
the necessity of free trade as the only sound guarantee for progressive expansion of trade and
increased prosperity of nations. The free trade, according to Smith, promotes international division of
labour.

Every country tends to specialize in the production of that commodity which it can produce most
cheaply. Undoubtedly, the slogans of self- reliance and protectionism have been raised from time to
time, but the self-reliance has eluded all the countries even up to the recent times. The free and
unfettered international trade can make the countries specialise in the production and exchange of
such commodities in case of which they command some absolute advantage, when compared with the
other countries.

In this context, Adam Smith writes; “Whether the advantage which one country has over another, be
natural or acquired is in this respect of no consequence. As long as one country has those advantages,
and the other wants them, it will always be more advantageous for the latter, rather to buy of the
former than to make.”

When countries specialise on the basis of absolute advantage in costs, they stand to gain through
international trade, just as a tailor does not make his own shoes and shoemaker does not stitch his
own suit and both gain by exchanging shoes and suits.

Suppose there are two countries A and B and they produce two commodities X and Y. The cost of
producing these commodities is measured in terms of labour involved in their production. If each
country has at its disposal 2 man-days and 1 man-day is devoted to the production of each of the two
commodities, the respective production in two countries can be shown through the hypothetical Table
2.1.

In country A, I man-day of labour can produce 20 units of X but 10 units of Y. In country B, on the

other hand. I man-day of labour can produce 10 units of X but 20 units of Y. It signifies that country A

has an absolute advantage in producing X while country B enjoys absolute advantage in producing

commodity Y. Country A may be willing to give up 1 unit of X for having 0.5 unit of Y. At the same

time, the country B may be willing to give up 2 units of Y to have I unit of X. If country A specialises in

the production and export of commodity X and country B specialises in the production and export of

commodity Y. both the countries stand to gain.

Adam Smith also emphasised that specialisation on the basis of absolute cost advantage would lead to

maximisation of world production. The gains from trade for the two trading countries can be shown

through Table 2.2.

Before trade, Country A produces 20 units of X and 10 units of Y. After trade, as it specialises in the
production of X commodity, the total output of 40 units of X is turned out by A and it produces no unit
of Y. Country B produces 10 units of X and 20 units of Y before trade. After trade it specialises in Y and
produces 40 units of Y and no unit of X. The gain is production of X and Y commodity each is of 10
units. The gain from trade for country A is +20 units of X and -10 units of Y so that net gain to it from
trade is +10 units of X. Similarly net gain to country B is +10 units of Y.

An interesting aspect of Smith’s analysis of trade has been his ‘Vent for Surplus’ doctrine. According to
him, the surplus of production in a country over what can be absorbed in the domestic market can be
disposed of in the foreign markets. It was basically this desire that led Mercantilists and subsequent
theorists to place much emphasis on the international trade.

The ‘Vent for Surplus’ doctrine implies that the international specialisation is not reversible and that it
is an integral part of the development process in any country. In addition, this doctrine implies that
the foreign trade results in the fullest utilisation of the idle productive capacity that is likely to exist in
the absence of trade. This implication makes a clear departure from the assumption held in the
comparative cost approach that the resources are fully employed even before trade. What trade does is
to bring about a more efficient allocation of them.

Criticisms:

Adam Smith, no doubt, provided a quite lucid explanation of the principle of absolute cost advantage
as the basis of international transactions, yet his theory has certain weaknesses.

Firstly, this theory assumes that each exporting country has an absolute cast advantage in the
production of a specific commodity. This assumption may not hold true, when a country has no
specific line of production in which it has an absolute superiority. In this context Ellsworth says
“Smith’s argument is not very convincing as it assumed without argument that international trade
required a producer of exports to have an absolute advantage, that is, an exporting country must be
able to produce with a given amount of capital and labour a larger output than any rival. But what if a
country has no line of production in which it was clearly superior.”

Most of the backward countries with inefficient labour and machinery may not be enjoying absolute
advantage in any line of activity. So the principle of absolute cost advantage cannot provide complete
and satisfactory explanation of the basis on which trade proceeds among the different countries.

Secondly, Adam Smith simply indicated the fundamental basis on which international trade rests. The
absolute cost advantage had failed to explore in any comprehensive manner the factors influencing
trade between two or more countries.

Thirdly, the ‘Vent for Surplus’ doctrine of Adam Smith is not completely satisfactory. This doctrine can
have serious adverse repercussions on the growth process of the backward countries. These countries
do not sell their surplus produce in foreign markets but are constrained to export despite domestic
shortages for the reasons of neutralising their balance of payments deficit.

A more detailed and satisfactory explanation concerning the basis of international trade has been
provided by David Ricardo and J.S. Mill.

David Ricardo’s Theory of

Comparative Cost Advantage

David Ricardo believed that the international trade is governed by the comparative cost advantage
rather than the absolute cost advantage. A country will specialise in that line of production in which it
has a greater relative or comparative advantage in costs than other countries and will depend upon
imports from abroad of all such commodities in which it has relative cost disadvantage.

Suppose India produces computers and rice at a high cost while Japan produces both the commodities
at a low cost. It does not mean that Japan will specialise in both rice and computers and India will
have nothing to export. If Japan can produce rice at a relatively lesser cost than computers, it will
decide to specialise in the production and export of computers and India, which has less comparative
cost disadvantage in the production of rice than computers will decide to specialise in the production
of rice and export it to Japan in exchange of computers.

The Ricardian comparative costs analysis is based upon the following assumptions:
(i) There is no intervention by the government in economic system.

(ii) Perfect competition exists both in the commodity and factor markets.

(iii) There are static conditions in the economy. It implies that factors supplies, techniques of
production and tastes and preferences are given and constant.

(iv) Production function is homogeneous of the first degree. It implies that output changes exactly in
the same ratio in which the factor inputs are varied. In other words, production is governed by
constant returns to scale.

(v) Labour is the only factor of production and the cost of producing a commodity is expressed in
labour units.

(vi) Labour is perfectly mobile within the country but perfectly immobile among different countries.

(vii) Transport costs are absent so that production cost, measured in terms of labour input alone,
determines the cost of producing a given commodity.

(viii) There are only two commodities to be exchanged between the two countries.

(ix) Money is non-existent and prices of different goods are measured by their real cost of production.

(x) There is full employment of resources in both the countries.

(xi) Trade between two countries takes place on the basis of barter.

This two-country, two-commodity model can be analysed through the Table 2.3.

The Table 2.3 indicates that country A has an absolute advantage in producing both the commodities
through smaller inputs of labour than in country B. In relative terms, however, country A has
comparative advantage in specialising in the production and export of commodity X while country B
will specialise in the production and export of commodity Y.

In country A, domestic exchange ratio between X and Y is 12 : 10, i.e., 1 unit of X = 12/10 or 1.20 units
of Y. Alternatively, 1 unit of Y= 10/12 or 0.83 units of X.
In country B, the domestic exchange ratio is 16 : 12, i.e., 1 unit of X = 16/12 or 1.33 units of
Y. Alternatively, 1 unit of Y = 16/12 or 0.75 unit of X.

From the above cost ratios, it follows that country A has comparative cost advantage in the production
of X and B has comparatively lesser cost disadvantage in the production of Y.

Gain from Trade:

The comparative cost principle underlines the fact that two countries will stand to gain through trade
so long as the cost ratios for two countries are not equal. On the basis of Table 2.3, country A
specialises in the production of X commodity, while country B specialises in the production of Y
commodity.

In the absence of international trade, the domestic exchange ratio between X and Y
commodities in these two countries are:

Country A: 1 unit of X = 12/10 or 1-20 units of Y

Country B: 1 unit of Y = 12/16 or 0-75 unit of X

If trade takes place and two countries agree to exchange 1 unit of X for 1 unit of Y, the gain from trade
for country A amounts to 0.20 units of Y for each unit of X. In case of country B, the gain from trade
amounts to 0.25 unit of X for each unit of Y. Thus the comparative costs principle confers gain upon
both the countries.

Heckscher-Ohlin’s Theory of
International Trade

Introduction:

The classical comparative cost theory did not satisfactorily explain why comparative costs of producing
various commodities differ as between different countries.

The new theory propounded by Heckscher and Ohlin went deeper into the underlying forces which
cause differences in comparative costs.
They explained that it is differences in factor endowments of different countries and different factor -
proportions needed for producing different commodities that account for difference in comparative
costs. This new theory is therefore-called Heckscher-Ohlin theory of international trade.

Since there is wide agreement among modern economists about the explanation of international trade
offered by Heckscher and Ohlin this theory is also called modern theory of international trade. Further,
since this theory is based on general equilibrium analysis of price determination, this is also known as
General Equilibrium Theory of International Trade.

It is worthwhile to note that, contrary to the viewpoint of classical economists, Ohlin asserts that there
does not exist any basic difference between the domestic (inter-regional) trade and international trade.
Indeed, according to him, international trade is only a special case of inter-regional trade.

Thus, Ohlin asserts that it is not the cost of transport which distinguishes international trade from
domestic trade, for transport cost is present in the domestic inter-regional trade. Trade because
currencies of different countries are related to each other through foreign exchange rates which
determine the value or purchasing power of different currencies.

Ohlin, therefore, regards different nations as mere regions separated from each other by national
frontiers, different languages and customs, etc. But these differences are not such that prevent the
occurrence of trade between nations. He, therefore, asserts that general theory of value which can be
applied to explain interregional trade can also be applied equally well to explain international trade.

According to general equilibrium theory of value, relative prices of commodious are determined by
demand for and supply of them. In the long-run equilibrium under conditions of perfect competition,
relative prices of commodities, as determined by demand and supply, are equal to average cost of
production.

The cost of production of a commodity, as is well-known, depends upon the prices paid for the factors
of production employed in the production of that commodity. Factor prices in turn determine the
incomes of the factor owners and hence the demand for goods.

Thus trade is mutual inter-dependence between prices of commodities and prices of factors, and the
exchange of goods and factors between demand for commodities and demand for factors. This is how
general equilibrium theory of value explains prices of commodities and factors between different
individuals in a region or a country.

However, according to Ohlin, the classical analysis presumes it to apply to a single market in a country
and ignores the space factor whose introduction is crucial for explanation of trade between regions.
The factors which explain the trade between different regions also explain the trade between different
nations or countries as well.

Heckscher-Ohlin Theorem:

According to Ricardo and other classical economists, international trade is based on differences in
comparative costs. It is important to note that Heckscher and Ohlin agreed with this fundamental
proposition and only elaborated this by explaining the factors which cause differences in compara tive
costs of commodities between different regions or countries. Ricardo and others who followed him
explained differences in comparative costs as arising from differences in skill and efficiency of labour
alone.

This is not a satisfactory explanation of differences in comparative cots. Ohlin pointed out more
significant factors, namely, differences in factor endowments of the nations and difference in factor
proportions of producing different commodities, which account for differences in comparative costs
and hence from the ultimate basis of inter-regional or international trade.
Thus, Heckscher-Ohlin theory does not contradict and supplant the comparative cost theory but
supplements it by offering sufficiently satisfactory explanation of what causes differences in
comparative costs.

According to Ohlin, the underlying forces behind differences in comparative costs are
twofold:

1. The different regions or countries have different factor endowments.

2. The different goods require different factor-proportions for their production.

It is a well-known fact that various countries (regions) are differently endowed with productive factors
required for production of goods. Some countries posses relatively more capital, some relatively more
labour, and some relatively more land.

The factor which is relatively abundant in a country will tend to have a lower price and the factor
which is relatively scarce will tend to have a higher price. Thus, according to Ohlin, factor endowments
and factor prices are intimately associated with each other.

Suppose K stands for the availability or supply of capital in a country, L for that of labour and PK for
price of capital and PL for the price of labour. Further, take two countries A and B; in country A capital
is relatively abundant and labour is relatively scarce. The reverse is the case in country B. Given these
factor-endowments, in country A capital will be relatively cheaper.

Critical Evaluation of Heckscher-Ohlin Theory of International Trade:

Heckscher and Ohlin theory has made invaluable contributions to the explanation of interna tional
trade. Though this theory accepts comparative costs as the basis of international trade, it makes
several improvements in the classical comparative cost theory.

First, it rescued the theory of international trade from the grip of labour theory of value and based it
on the general equilibrium theory of value according to which both demand and supply conditions
determine the prices of goods and factors.

Second, Heckscher-Ohlin theory removes the difference between international trade and inter-
regional trade, for the factors determining the two are the same. Third, a significant improvement is
the explanation offered for difference in comparative costs of commodities between trading countries.

Ricardo thought that the differences in labour efficiency alone accounted for the differences in
comparative costs. According to Heckscher and Ohlin, as seen above, the differences in factor -
endowments of the countries and also the differences in factor proportions required for producing
various commodities explain differences in comparative costs and hence from the ultimate basis of
international trade.

These reasons advanced by Heckscher and Ohlin for differences in comparative costs of commodities
in different countries are considered to be broadly true.

Fourth, as has been pointed out by Prof. Lancaster, Heckscher-Ohlin model provides a satisfactory
picture of the future of foreign trade. According to the Ricardian theory, international trade exists
because of differences in skill and efficiency of labour alone.

This implies that as there is transmission of knowledge between the countries so that they master the
techniques and skills of each other, then differences in comparative costs would cease to exist and as a
result international trade would come to an end. But this is not likely to occur despite the fact that
transmission of knowledge and techniques has greatly increased these days.

Heckscher and Ohlin explain that international trade is due to the differences in factor-endowments
(i.e. differences in supplies of all factors and not only of labour efficiency) and different factor-
proportions required for different commodities. Since the factors such as land and other natural
resources lack mobility, international trade would not cease to exist even if there is perfect
transmission of knowledge between the countries.

Despite the above merits of Heckscher-Ohlin theory, it has some shortcomings which
are briefly discussed below:

1. Leontief Paradox:

In the Heckscher-Ohlin theory it has been assumed that relative factor prices reflect the relative
supplies of factors. That is, a factor which is found in abundance in a country will have a lower price
and vice versa. This means that in the determination of factor-prices supply outweighs demand.

But if demand for factors prevails over supply, then factor prices so determined would not conform to
the supplies of factors. Thus, if in a country there is abundance of capital and scarcity of labour in
physical terms but there is relatively much greater demand for capital, then the price of capital would
be relatively higher to that of labour.

Then, under these circumstances, contrary to its factor-endowments, the country many export labour-
intensive goods and import capital-intensive goods. Perhaps it is this which lies behind the empirical
findings by Leontief that though America is a capital abundant and labour-scarce country, in the
structure of its imports capital-intensive goods are relatively greater whereas in the structure of its
exports labour- intensive goods are relatively greater. As this is contrary to the popularly held view,
this is known as Leontief Paradox.

2. Difference in Preferences or Demands for Goods:

Against Hecksher-Ohlin theorem, it has also been pointed out that differences in tastes and
preferences for goods or, to put it in other words, differences in pattern of demand also give rise to
trade between the countries. This is because under differences in demand or preferences for goods, the
commodity price-ratios would not conform to the cost-ratios based on factor endowments.

Let us take an extreme example. Suppose there are two countries A and B with same factor -
endowments. According to Heckscher-Ohlin theorem, with same factor endowments cost-ratio of
producing the two commodities and hence the commodity price ratio would be the same.

Hence there is no possibility of trade between the two countries on the basis of Heckscher -Ohlin
theorem. However, trade between the two countries is possible if the demand pattern or preferences of
the people of the two countries for wheat and rice greatly differ.

Ricardo thought that the differences in labour efficiency alone accounted for the differences in
comparative costs. According to Heckscher and Ohlin, as seen above, the differences in factor -
endowments of the countries and also the differences in factor proportions required for producing
various commodities explain differences in comparative costs and hence from the ultimate basis of
international trade.

These reasons advanced by Heckscher and Ohlin for differences in comparative costs of commodities
in different countries are considered to be broadly true.

Fourth, as has been pointed out by Prof. Lancaster, Heckscher-Ohlin model provides a satisfactory
picture of the future of foreign trade. According to the Ricardian theory, international trade exists
because of differences in skill and efficiency of labour alone.

This implies that as there is transmission of knowledge between the countries so that they master the
techniques and skills of each other, then differences in comparative costs would cease to exist and as a
result international trade would come to an end. But this is not likely to occur despite the fact that
transmission of knowledge and techniques has greatly increased these days.
Heckscher and Ohlin explain that international trade is due to the differences in factor-endowments
(i.e. differences in supplies of all factors and not only of labour efficiency) and different factor-
proportions required for different commodities. Since the factors such as land and other natural
resources lack mobility, international trade would not cease to exist even if there is perfect
transmission of knowledge between the countries.

Despite the above merits of Heckscher-Ohlin theory, it has some shortcomings which
are briefly discussed below:

1. Leontief Paradox:

In the Heckscher-Ohlin theory it has been assumed that relative factor prices reflect the relative
supplies of factors. That is, a factor which is found in abundance in a country will have a lower price
and vice versa. This means that in the determination of factor-prices supply outweighs demand.

But if demand for factors prevails over supply, then factor prices so determined would not conform to
the supplies of factors. Thus, if in a country there is abundance of capital and scarcity of labour in
physical terms but there is relatively much greater demand for capital, then the price of capital would
be relatively higher to that of labour.

Then, under these circumstances, contrary to its factor-endowments, the country many export labour-
intensive goods and import capital-intensive goods. Perhaps it is this which lies behind the empirical
findings by Leontief that though America is a capital abundant and labour-scarce country, in the
structure of its imports capital-intensive goods are relatively greater whereas in the structure of its
exports labour- intensive goods are relatively greater. As this is contrary to the popularly held view,
this is known as Leontief Paradox.

2. Difference in Preferences or Demands for Goods:

Against Hecksher-Ohlin theorem, it has also been pointed out that differences in tastes and
preferences for goods or, to put it in other words, differences in pattern of demand also give rise to
trade between the countries. This is because under differences in demand or preferences for goods, the
commodity price-ratios would not conform to the cost-ratios based on factor endowments.

Let us take an extreme example. Suppose there are two countries A and B with same factor -
endowments. According to Heckscher-Ohlin theorem, with same factor endowments cost-ratio of
producing the two commodities and hence the commodity price ratio would be the same.

Hence there is no possibility of trade between the two countries on the basis of Heckscher -Ohlin
theorem. However, trade between the two countries is possible if the demand pattern or preferences of
the people of the two countries for wheat and rice greatly differ.

Ricardo thought that the differences in labour efficiency alone accounted for the differences in
comparative costs. According to Heckscher and Ohlin, as seen above, the differences in factor -
endowments of the countries and also the differences in factor proportions required for producing
various commodities explain differences in comparative costs and hence from the ultimate basis of
international trade.

These reasons advanced by Heckscher and Ohlin for differences in comparative costs of commodities
in different countries are considered to be broadly true.

Fourth, as has been pointed out by Prof. Lancaster, Heckscher-Ohlin model provides a satisfactory
picture of the future of foreign trade. According to the Ricardian theory, international trade exists
because of differences in skill and efficiency of labour alone.

This implies that as there is transmission of knowledge between the countries so that they master the
techniques and skills of each other, then differences in comparative costs would cease to exist and as a
result international trade would come to an end. But this is not likely to occur despite the fact that
transmission of knowledge and techniques has greatly increased these days.

Heckscher and Ohlin explain that international trade is due to the differences in factor-endowments
(i.e. differences in supplies of all factors and not only of labour efficiency) and different factor-
proportions required for different commodities. Since the factors such as land and other natural
resources lack mobility, international trade would not cease to exist even if there is perfect
transmission of knowledge between the countries.

Despite the above merits of Heckscher-Ohlin theory, it has some shortcomings which
are briefly discussed below:

1. Leontief Paradox:

In the Heckscher-Ohlin theory it has been assumed that relative factor prices reflect the relative
supplies of factors. That is, a factor which is found in abundance in a country will have a lower price
and vice versa. This means that in the determination of factor-prices supply outweighs demand.

But if demand for factors prevails over supply, then factor prices so determined would not conform to
the supplies of factors. Thus, if in a country there is abundance of capital and scarcity of labour in
physical terms but there is relatively much greater demand for capital, then the price of capital would
be relatively higher to that of labour.

Then, under these circumstances, contrary to its factor-endowments, the country many export labour-
intensive goods and import capital-intensive goods. Perhaps it is this which lies behind the empirical
findings by Leontief that though America is a capital abundant and labour-scarce country, in the
structure of its imports capital-intensive goods are relatively greater whereas in the structure of its
exports labour- intensive goods are relatively greater. As this is contrary to the popularly held view,
this is known as Leontief Paradox.

2. Difference in Preferences or Demands for Goods:

Against Hecksher-Ohlin theorem, it has also been pointed out that differences in tastes and
preferences for goods or, to put it in other words, differences in pattern of demand also give rise to
trade between the countries. This is because under differences in demand or preferences for goods, the
commodity price-ratios would not conform to the cost-ratios based on factor endowments.

Let us take an extreme example. Suppose there are two countries A and B with same factor -
endowments. According to Heckscher-Ohlin theorem, with same factor endowments cost-ratio of
producing the two commodities and hence the commodity price ratio would be the same.

Hence there is no possibility of trade between the two countries on the basis of Heckscher -Ohlin
theorem. However, trade between the two countries is possible if the demand pattern or preferences of
the people of the two countries for wheat and rice greatly differ.

Ricardo thought that the differences in labour efficiency alone accounted for the differences in
comparative costs. According to Heckscher and Ohlin, as seen above, the differences in factor -
endowments of the countries and also the differences in factor proportions required for producing
various commodities explain differences in comparative costs and hence from the ultimate basis of
international trade.

These reasons advanced by Heckscher and Ohlin for differences in comparative costs of commodities
in different countries are considered to be broadly true.

Fourth, as has been pointed out by Prof. Lancaster, Heckscher-Ohlin model provides a satisfactory
picture of the future of foreign trade. According to the Ricardian theory, international trade exists
because of differences in skill and efficiency of labour alone.
This implies that as there is transmission of knowledge between the countries so that they master the
techniques and skills of each other, then differences in comparative costs would cease to exist and as a
result international trade would come to an end. But this is not likely to occur despite the fact that
transmission of knowledge and techniques has greatly increased these days.

Heckscher and Ohlin explain that international trade is due to the differences in factor-endowments
(i.e. differences in supplies of all factors and not only of labour efficiency) and different factor-
proportions required for different commodities. Since the factors such as land and other natural
resources lack mobility, international trade would not cease to exist even if there is perfect
transmission of knowledge between the countries.

Despite the above merits of Heckscher-Ohlin theory, it has some shortcomings which
are briefly discussed below:

1. Leontief Paradox:

In the Heckscher-Ohlin theory it has been assumed that relative factor prices reflect the relative
supplies of factors. That is, a factor which is found in abundance in a country will have a lower price
and vice versa. This means that in the determination of factor-prices supply outweighs demand.

But if demand for factors prevails over supply, then factor prices so determined would not conform to
the supplies of factors. Thus, if in a country there is abundance of capital and scarcity of labour in
physical terms but there is relatively much greater demand for capital, then the price of capital would
be relatively higher to that of labour.

Then, under these circumstances, contrary to its factor-endowments, the country many export labour-
intensive goods and import capital-intensive goods. Perhaps it is this which lies behind the empirical
findings by Leontief that though America is a capital abundant and labour-scarce country, in the
structure of its imports capital-intensive goods are relatively greater whereas in the structure of its
exports labour- intensive goods are relatively greater. As this is contrary to the popularly held view,
this is known as Leontief Paradox.

2. Difference in Preferences or Demands for Goods:

Against Hecksher-Ohlin theorem, it has also been pointed out that differences in tastes and
preferences for goods or, to put it in other words, differences in pattern of demand also give rise to
trade between the countries. This is because under differences in demand or preferences for goods, the
commodity price-ratios would not conform to the cost-ratios based on factor endowments.

Let us take an extreme example. Suppose there are two countries A and B with same factor -
endowments. According to Heckscher-Ohlin theorem, with same factor endowments cost-ratio of
producing the two commodities and hence the commodity price ratio would be the same.

Hence there is no possibility of trade between the two countries on the basis of Heckscher -Ohlin
theorem. However, trade between the two countries is possible if the demand pattern or preferences of
the people of the two countries for wheat and rice greatly differ.

Product Life Cycle Examples: Theory, Definition, Stages

What Is the Product Life Cycle?

The Product Life Cycle theory refers to the progression of a product through
various stages from its introduction to the market to its eventual
decline. It is a framework that helps businesses understand the
dynamics and challenges associated with different phases of a
product’s lifespan.

The PLC is divided into four stages: market introduction and

development, market growth, market maturity, and market
decline. Each international product life cycle theory stage has different
opportunities and challenges businesses must navigate to ensure
the success of their products.

Market Introduction and Development

The first stage is the market introduction and development phase.

It is where a product is introduced to the market. In this product cycle

theory stage, a company invests in market research, product

development, and creating a launch strategy. The goal is to refine
the product concept, gather feedback, and develop prototypes or
product sketches to showcase to potential investors and customers.

Market introduction and development is a lengthy process,

especially for new products, as there is a need to pioneer a
concept or idea. Businesses often face high costs and limited
revenue during this stage. However, it is a critical phase for
gathering market insights and establishing a foundation for future
growth.

Market Growth
Once a product has successfully passed the introduction stage, it
enters the market growth phase. It is when the product gains
traction and sales and revenue start to increase. During this stage,
companies focus on expanding their customer base, increasing
market share, and solidifying their brand identity.

Marketing campaigns in the product life cycle theory of the international

trade growth stage are crucial for maintaining momentum and

staying ahead of competitors. Companies invest in promotional
activities, advertising campaigns, and customer engagement
strategies. Also, product enhancements, improved customer
support, and the exploration of new distribution channels play a
crucial role in sustaining growth.

Market Maturity

After the market growth stage, a product enters the market

maturity phase. It is the longest stage in the Product Life Cycle. In
the maturity stage, sales and revenue reach their peak and the
market becomes saturated with competitors offering similar
products.

During market maturity, the focus shifts from customer

acquisition to customer retention. Companies aim to maintain
their market position by emphasizing product differentiation,
brand loyalty, and customer satisfaction. Marketing drives focus on
highlighting the unique features and benefits of the product to
attract and retain customers.

Market Decline
The final stage of the Product Life Cycle is the market decline
phase. In this stage, a product experiences a decline in sales and
revenue as customer interest wanes or shifts to newer and more
innovative alternatives. The market decline occurs due to increased
competition, outdated technology, loss of customer interest, or a
damaged brand image.

During the decline stage, businesses face the challenge of managing

the product’s decline while minimizing losses. Strategies for
managing decline include fostering nostalgia around the product,
discontinuing the product, innovating the product, or even selling
the company. Businesses need to adapt and explore new
opportunities to stay relevant in the market.

How the Product Life Cycle Works?

The Product Life Cycle theory is a dynamic process and involves the
progression of a product through its different stages.

Introduction Stage

The introduction stage is the starting point of the Product Life

Cycle. During this stage, a product is launched in the market, and
the primary focus is to create awareness and provoke interest
among consumers. Companies invest heavily in marketing and
promotional activities to attract potential customers. The goal is
to establish a strong market presence and gain a competitive edge.

Growth Stage

Once a product gains traction in the market, it enters the growth

stage. Sales and revenue start to increase rapidly during this phase.
Companies focus on expanding their customer base, increasing
market share, and solidifying their brand identity. Marketing
endeavors aim to establish the product as a market leader and
capture a larger market share.

Maturity Stage

In the maturity product cycle theory stage, sales and revenue reach their
peak but the growth rate slows down. The market becomes
saturated with competitors offering similar products. Companies
shift their focus from customer acquisition to customer retention.
Marketing efforts aim to maintain market position by emphasizing
product differentiation, brand loyalty, and customer satisfaction.

Decline Stage

The decline stage is the final phase of the Product Life Cycle. Sales
and revenue start to decline as customer interest wanes or shifts
to newer alternatives. Companies face the challenge of managing
the decline while minimizing losses. The product life cycle examples strategies
for managing decline include fostering recollections, discontinuing
the product, innovating the product, or even selling the company.

Advantages of Using the Product Life Cycle

Strategic Planning

The Product Life Cycle provides a structured framework for

strategic planning. It helps businesses anticipate and prepare for
each stage of a product’s lifespan and make the right decisions for
innovation, marketing, pricing, and resource allocation.

Market Insights
By analyzing the different stages of the Product Life Cycle,
businesses gain valuable market insights. They can identify trends,
understand customer behavior and make data-driven decisions to
stay ahead of competitors.

Resource Allocation

The Product Life Cycle assists businesses in allocating resources

effectively. It helps them determine when and where to invest
resources based on the specific needs of each stage and optimal
utilization of resources and reduces wastage.

Product Differentiation

Understanding the Product Life Cycle allows businesses to

differentiate their products from competitors. They can identify
unique selling points and develop strategies to highlight the
advantages of their products during each stage.

Competitive Advantage

By closely monitoring the Product Life Cycle, businesses can gain a

competitive advantage. They can identify gaps in the market, spot
emerging trends, and adapt their strategies accordingly to
outperform competitors.

New Product Development

The Product Life Cycle provides insights into the development of

new products. Businesses can identify opportunities to innovate
and create new offerings to meet changing customer needs and
preferences.
Marketing Strategy

The Product Life Cycle guides the development of effective

marketing strategies. It helps businesses tailor their marketing
efforts to each stage, ensuring that the right message reaches the
right audience at the right time.

Forecasting

By understanding the Product Life Cycle theory , businesses can forecast

future sales and revenue trends. It allows businesses to plan for
potential challenges, allocate resources and make financial
decisions.

Limitations of Using the Product Life Cycle

Variation Across Industries

The length and characteristics of each stage in the Product Life

Cycle vary significantly across industries. Some products may have
shorter lifespans due to rapid technological advancements, while
others may have longer lifespans due to slower market saturation.

Uncertainty and Complexity

The Product Life Cycle is subject to uncertainty and complexity.

Market dynamics, consumer preferences, and competitive
landscapes can change rapidly, making it challenging to predict
the duration and outcomes of each stage.

Lack of Flexibility

The rigidity of the Product Life Cycle framework can limit

businesses’ ability to adapt quickly to changing market conditions.
It may overlook the potential for product rejuvenation or
extension to prolong the lifespan of a product.

Limited Scope

The Product Life Cycle focuses primarily on the market dynamics

of a single product. It may not account for the broader strategic
considerations of a business or the impact of external factors such
as economic conditions or regulatory changes.

Lack of Customer Perspective

The Product Life Cycle framework may not fully capture the
evolving customers’ needs and preferences. It is important to
gather customer feedback and conduct market research to
complement the insights provided by the PLC.

Porter Diamond Model Theory

Porter Diamond is a model that emphasizes the competitive advantage of an industry or
business that makes it work better than other competitors in a region or country. Also
known as the Porter Diamond Theory of National Advantage, the model explains why
certain industries thrive in particular nations. Companies use this model to analyze the
competitive environment in foreign markets before entering them.

Porter Diamond Model discusses factors and traits of a business that make it more successful than others in a
particular region. It enables companies to identify the resources that need to be developed to enhance their
performance compared to the rest of the entities dealing in the same category of products and services.

Michael Eugene Porter, an American academician and influential thinker on management and competitiveness,
developed the Porter Diamond model. It is an economic model for businesses, especially multinational
organizations planning to expand their operations in different markets. The model lets companies identify the
key areas to focus on to capture global markets effectively.

With the help of this theory, the business players can understand the reason for certain industries being
widespread in particular nations. On this basis, they can analyze their position in the market and thereby
implement strategies to compete and excel.
The Porter Diamond theory outlines four main factors that reveal how businesses enjoy a national advantage in
the international markets. These attributes make certain nations become more competitive than others for
specific industries. For example, Germany is well known for its engineering, while Greece is famous for the
tourism services it offers on a global platform.

Porter Diamond Framework

The unique Porter Diamond framework consists of four attributes/factors. If all these four factors are favorable,
companies will innovate and stay competitive. This domestic competitiveness prepares them to excel in
international markets as well. Besides, the role of government and chance or unpredictable external events also
influence competitive advantage.

#1 – Company Structure, Rivalry, and Strategy

This aspect of the theory focuses on the competition in the native markets that businesses have to excel against.
The region in which the firms operate determines the structure and strategies to be framed to compete in the
home market.

As a result, the strategies differ from nation to nation. For example, Italy, known for its fashionable clothing, will
definitely have a different approach than Greece, which emphasizes tourism and related facilities.

In addition, rivalry plays an important role in driving every entity operating in the same sector to improve,
innovate, and perform better than each other. Therefore, the businesses have to be consistent. This makes them
trustworthy and reliable national companies around the globe in the long run.

#2 – Factor Conditions

Factor conditions include resources available to businesses that help them perform well. The availability of
resources could be influenced by the skillset, strategies, infrastructure, or nature. For example, Italy performs
well because of its ability to choose better fabrics; Greece’s tourism market is influenced by the weather, which
might keep changing.

The natural resources constitute the basic factors, while the infrastructure, skilled experts, and capital form the
advanced factors. A nation develops a real competitive advantage with the development of advanced elements.
In contrast, the contribution of basic factors to regional advantage is comparatively lower.

#3 – Demand Conditions

The demand for a particular product or service also plays an essential factor. Porter Diamond model’s third
attribute indicates how the increase in demand for an item among local customer boosts the growth of a brand
or business.

When customers want a product, businesses strive to improve the quality and live up to their expectations. As a
result, they become competent enough to acquire the number one position on the global platform.

#4 – Supporting and Related Industries

 Another factor that influences business growth is the complementary services that lend support to the
companies of national advantage. For example, the tourism services in Greece would never be the best if the
accommodation facilities and food units over there did not support the industry.

#5 – Government

The government also plays a vital role in developing and retaining the competitive advantage by offering a
conducive environment for businesses to flourish. This includes developing a robust infrastructure, ensuring fair
market practices, developing education institutions, etc.

#6 – Chance

In addition, chance or luck may also contribute to competitive advantage or disadvantage. For instance,
unpredictable events like wars, natural disasters, political situations, etc., can positively or negatively impact an
industry or nation, creating a competitive advantage or wiping it off.

Example
Let’s consider the following Porter Diamond model example:

The car manufacturing industry of Germany is one of the best examples to be cited here. The economy’s best
sector complies with all the attributes and, therefore, strives through global challenges easily. With several
competitors in the home market, car manufacturers continuously innovate and excel. As a result, the nation
manages to have the best car models.

Having no speed limits and an aspiration of citizens to have a quality and speedy life encourages the demand
for high-speed luxury cars in the nation. Besides, skilled resources like car engineers from globally-recognized
German universities give car manufacturers an edge over others. Thus, the demand conditions and factor
conditions are all met.

Next, the support from the metal industries that offer the best spare parts to the car manufacturers tends to be
the best support system for the national market. Besides, the German government’s support in the form of
better infrastructure and educational institutions creates a national competitive advantage for the car industry.

How to use Porter Diamond Model?

Porter Diamond model is used to identify the business surroundings and act accordingly to become the best. In
1990, in the book “The Competitive Advantage of Nations,” Porter discussed the role of government in
stimulating the competitive positioning of an economy on the global platform.

His model, likewise, suggested the methods through which the businesses can excel, be it by enhancing their
skilled labor or deploying advanced technology, or introducing the relevant fiscal policy.

Some of the uses of the Porter Diamond model are as follows:

• It helps businesses understand the structure and techniques of their rival companies, allowing them to
frame their strategies accordingly.
• Businesses use regional advantages to capture international markets.
• They value suppliers as they understand the importance of their support.
• Firms of national importance get to know the power of buyers in enhancing business growth.
• The model teaches market players to innovate, remain updated, and put in their best efforts to fight
the fear of being substituted.

LeX Mercatoria:

Introduction:
Lex Mercatoria, a Latin expression, implies a body of trading principles employed by

merchants throughout medieval Europe. It translates to ‘merchant law.’ Its evolution

as a custom and practice system went along through merchant courts and along

main trade routes. It emphasizes entering into contracts, alienating property,

shunning legal complexities, and deciding cases ex aequo et bono and thus functions

as the international law of commerce.

It later developed into an integrated body of law produced intentionally or

voluntarily and adjudicated and enforced voluntarily. This assuages the intensity of

the frequent friction, given the diverse backgrounds and local traditions of the

merchant. The international background rendered the state laws inapplicable at

times, and the merchant law did not always provide a leveled framework. The almost

non-existent trading and commercial activities in Europe after the end of the Roman

Empire were revitalized.[1]

The search for a third legal order arises from several jurists’ perception that neither

municipal law nor international law is sufficient or adequate for dealing with

international commercial disputes where parties from various countries are engaged.

In their opinion, the national legal system may not be receptive to a contested
party’s expectations with a different national legal context, and international law

may not be sufficient to deal with cross-border commercial transactions. The third

legal order, popularly known as the Lex Mercatoria, which is neither national nor

international law, but a combination of both attributes is, therefore, an appealing

prospect. Although the Lex Mercatoria had its presence at the beginning of human

civilization and was commonly practiced in the Middle Ages, it remained buried until

recently, when some global importance scholars began to recommend its suitability

for modem international commercial relations.

History of Lex Mercatoria

The principle of lex mercatoria is not recent. Some claim that it has its forerunner in

the Roman ius gentium, a law governing economic relations between foreigners and

Roman citizens. Others go back in time and trace the origins of the lex mercatoria in

ancient Egypt or the Greek and Phoenician sea trade of the Old Century. In either

case, in the Law of the Middle Ages, the historical origins of the lex mercatoria can

be identified. The emergence of foreign economic ties in Western Europe at the

beginning of the 11th century led to the establishment of the Law Merchant, a

cosmopolitan commercial law centered on customs and implemented to cross

border disputes by the business courts of the various European commercial

centers.[2]

This law resulted from the efforts of the medieval trade community to transcend the
outdated laws of colonial and Roman law, which could not meet the requirements of

modern foreign trade. Merchants established a superior statute, which established a

strong legal foundation for the great development of trade in the Middle Ages. For

almost 800 years, standardized codes of law have applied to traders throughout

Western Europe.

Almost all of the laws of lex mercatoria have been developed to bypass the

cumbersome rules of the common law. An example of this situation is that a person

could not offer what they did not have. In other words, a person who has no title to

products cannot offer a title. Therefore, when a person buys an item, to make sure

that they are the legitimate owner of the title, they had to ask their remote owners

for the title of that product to make sure that no one in the chain of title had

acquired it through fraud. However, according to the laws of lex mercatoria,

commercial activity “cannot be carried on if we have to inquire into the title of

anyone who comes to us with the title records.”[3]

With the rise of nationalism and the codification period of the 19th century, the ‘law

merchant’ was incorporated into the municipal laws of each country. When the

states took over International trade, the new mercantile laws were applied to

regulate international relations.

However, the growth of international trade since the Second World War has

revealed some of the shortcomings in international contracts’ conventional conduct.

These shortcomings have not been corrected by the complexities of private

international law and domestic law’s outdated existence. The dominance of

domestic law in international economic affairs has started to be challenged. Through

regular clauses, self-regulation contracts, trading practices, and access to

international commercial arbitration, traders have developed their independent

regulatory system outside of national law, labeled the modern lex mercatoria.

Sources of Lex Mercatoria

There are various contestations amongst the proponents of the lex mercatoria that

concern the sources from which it is derived and the relative significance of the

sources that are admissible. Professor Lando has listed several ‘elements’ rather than

‘sources’ of the lex mercatoria as follows:

1. public international law,

2. uniform laws,

3. the general principles of law,

4. the rules of international organizations,

5. customs and usages,

6. standard form contracts,

7. reporting of arbitral awards.

Professor Goldman’s views lex mercatoria as a principle that needs to be derived

from the customary and spontaneous principles, while the breadth of the sources

will be restricted. Dasser states that only trade usages and general principles of law

may be considered as genuine sources of the lex mercatoria.[5] Likewise, in

Professor Goode’s opinion, “only general principles and uncodified usages constitute
the lex mercatoria.”[6]

Lex Mercatoria and The Codification

of

International Trade Law

Trade lawyers have the option of choosing something similar to domestic contract

law, rather than national law, to regulate their relationship. They may do so, in part,

to protect their contract and conflicts that may emerge from the jurisdiction of

national judges. The significance of lex mercatoria as a system of governance is partly

made possible by the creeping codification of this law. Of course, the more traders

and conflict resolutions currently use this rule, the more their autonomy – from

national sources of law – is strengthened. Projects to consolidate and codify

transnational contract law have propagated over recent years. The most significant

of these are autonomous institutes of researchers and academics, which have

developed draught commercial codes of national and global scope. In the 1970s, for

example, the International Center for the Integration of Private Law started work on

what is now the UNIDROIT Standards of International Commercial Contracts, which

aspires to be a systematic code for international trade. Research is also underway to

achieve a standardized and harmonious internationalized sales regulation.[7]

Going beyond borders or concerns is the key essence of the Transnational Political

Economy, and it does so by undertaking a system of harmonization between the

three levels that compose such an economy: person, state/systemic, and structural.

Private merchants, trade coalitions, and alliances of individuals transcending national

borders (such as the Foreign Chamber of Commerce and UNIDROIT) are at the

individual stage. States and all embodiments of their authority, namely their systems

of municipal, commercial law, and private international commercial law, occupy the

structural stage.

Transnational Political Economy believes that these stages are becoming more

interconnected or harmonized, both horizontally in their own right and

vertically, as

the difference between these stages becomes unclear. Horizontal standardization

refers to a mechanism that affects actors that are limited to a particular stage. For

example, at the individual level, as the ICC enacts uniform procedures or standard

contracts for the selling of a particular product. In this way, the actors participating

in the group become more integrated into their work. Similarly, as States agree to

more codes at the level of public international commercial law, their legislation is

more harmonized.[8]

The concept of ‘vertical’ harmonization, in other words, includes the reciprocal

harmonization of the private and public spheres. One of the fascinating things

illustrated by the Transnational Political Economy is that this approach illustrates

such developments taking place at various levels at the same time. For example, the

ICC and the numerous product and professional organizations are establishing rules

of conduct, uniform codes, and model laws regulating certain elements of

international trade from the bottom up, while simultaneously, States are giving up

control over the same issues in public international commercial issues from the top

down. The Transnational Approach also seeks to integrate the process of rising

globalization and to take into consideration the complexities of the global political

economy in a multi-level context.[9]

In general, the harmonization and integration of private contract law is an

unavoidable call as a consequence of the development of international trade. With

the booming growth of foreign trade and investment, international transactions

quickly became a big part of all economic activities. Consequently, the elimination of
international transaction costs and other obstacles has become a key priority for

both governments and the private parties, which is to facilitate international sales

transactions by eliminating regulatory barriers and increasing legal certainty for

international transactions. The development of a single private international law

would offer several significant advantages in this respect.

Conclusion
On the European Continent, arbitrators are gradually applying to lex mercatoria to

diplomatic disputes. Clauses to this effect are frequently introduced in contracts

between, on the one hand, a government or a government company and, on the

other, a private enterprise. The Government does not wish to comply with the rules

of a foreign State. A private party would not wish to have a contract regulated by the

rules of a foreign country, as it could be modified to its detriment after the contract

has been concluded. Clauses relating to lex mercatoria are also included in contracts
signed between private companies.[10]

By selecting lex mercatoria, the parties expel the minutiae of the national legal

structures and escape the laws that are inappropriate for foreign contracts. They

thus avoid peculiar procedures, limited time-limits, and some of the problems that

can arise by domestic laws, which are uncommon in other countries, such as the

rules of common law on contract consideration and privilege.[11] In addition, those

involved in the proceedings – the parties, the lawyers, and the arbitrators – plead

and argue on equal ground; no one has the privilege of getting the case pleaded and

resolved by their own statute, and no one has the handicap of seeing it ruled by

international law. On the Continent and in the countries of common law, it is still a

matter of dispute whether the parties can consent to have their contract regulated

by lex mercatoria.

GATT - The General Agreement on Tariffs and Trade

The General Agreement on Tariffs and Trade (GATT) was a free trade agreement between 23

countries that eliminated tariffs and increased international trade. As the first worldwide

multilateral free trade agreement, GATT governed a significant portion of international trade

between January 1, 1948 and January 1, 1995. The agreement ended when it was replaced by the

more robust World Trade Organization (WTO).

Purpose

The purpose of GATT was to eliminate harmful trade protectionism. That had sent global trade

down 66% during the Great Depression. GATT restored economic health to the world after the

devastation of the Depression and World War II

History

GATT grew out of the Bretton Woods Agreement. The summit at Bretton Woods also created

the World Bank and the International Monetary Fund to coordinate global growth.

The 50 countries that started negotiations wanted it to be an agency within the United Nations

that would create rules, not just on trade, but also employment, commodity agreements, business

practices, foreign direct investment, and services. The ITO charter was agreed to in March 1948,

but the U.S. Congress and some other countries' legislatures refused to ratify it. In 1950, the

Truman Administration declared defeat, ending the ITO.

At the same time, 15 countries focused on negotiating a simple trade agreement. They agreed on

eliminating trade restrictions affecting $10 billion of trade or a fifth of the world’s total. A total

of 23 countries signed the GATT deal on October 30, 1947, clearing the way for it to take effect

on June 30, 1948.

GATT didn’t require the approval of Congress. That's because, technically, GATT was an

agreement under the provisions of the U.S. Reciprocal Trade Act of 1934.It was only supposed

to be temporary until the ITO replaced it.

Throughout the years, rounds of further negotiations on GATT continued. The main goal was to

further reduce tariffs. In the mid-1960s, the Kennedy round added an Anti-Dumping

Agreement.8The Tokyo round in the seventies improved other aspects of trade. The Uruguay

round lasted from 1986 to 1994 and created the World Trade Organisation.

Member Countries

The original 23 GATT members were Australia; Belgium; Brazil; Burma, (now called

Myanmar); Canada; Ceylon, now Sri Lanka; Chile; China; Cuba; Czechoslovakia, now Czech

Republic and Slovakia; France; India; Lebanon; Luxembourg; Netherlands; New Zealand;

Norway; Pakistan; Southern Rhodesia, now Zimbabwe; Syria; South Africa; the United
Kingdom and the United States. The membership increased to more than 128 countries by

1994.

Initial Round

Preparatory sessions were held simultaneously at the UNCTE regarding the GATT. After several

of these sessions, 23 nations signed the GATT on 30 October 1947 in Geneva, Switzerland. It

came into force on 1 January 1948.

Annecy Round: 1949

The second round took place in 1949 in Annecy, France. 13 countries took part in the round. The

main focus of the talks was more tariff reductions, around 5,000 in total.

Torquay Round: 1951

The third round occurred in Torquay, England in 1951. Thirty-eight countries took part in the

round. 8,700 tariff concessions were made totalling the remaining amount of tariffs to ¾ of the

tariffs which were in effect in 1948. The contemporaneous rejection by the U.S. of the Havana

Charter signified the establishment of the GATT as a governing world body.

Geneva Round: 1955–56

The fourth round returned to Geneva in 1955 and lasted until May 1956. Twenty-six countries

took part in the round. $2.5 billion in tariffs were eliminated or reduced

Dillon Round: 1960–62

The fifth round occurred once more in Geneva and lasted from 1960–1962. The talks were
named after U.S. Treasury Secretary and former Under Secretary of State, Douglas Dillon, who

first proposed the talks. Twenty-six countries took part in the round. Along with reducing over

$4.9 billion in tariffs, it also yielded discussion relating to the creation of the European

Economic Community (EEC).

Kennedy Round: 1964–67

The sixth round of GATT multilateral trade negotiations, held from 1964 to 1967. It was named

after U.S. President John F. Kennedy in recognition of his support for the reformulation of the

United States trade agenda, which resulted in the Trade Expansion Act of 1962. This Act gave

the President the widest-ever negotiating authority.

As the Dillon Round went through the laborious process of item-by-item tariff negotiations, it

became clear, long before the Round ended, that a more comprehensive approach was needed to

deal with the emerging challenges resulting from the formation of the European Economic

Community (EEC) and EFTA, as well as Europe's re-emergence as a significant international

trader more generally.

Tokyo Round: 1973–79

Reduced tariffs and established new regulations aimed at controlling the proliferation of non

tariff barriers and voluntary export restrictions. 102 countries took part in the round. Concessions

were made on $19 billion worth of trade.

Formation of Quadrilateral Group: 1981

The Quadrilateral Group was formed in 1982 by the European Union, the United States, Japan

and Canada, in order to influence the GATT.

Uruguay Round: 1986–94

The Uruguay Round began in 1986. It was the most ambitious round to date, as of 1986, hoping

to expand the competence of the GATT to important new areas such as services, capital,

intellectual property, textiles, and agriculture. 123 countries took part in the round. The Uruguay

Round was also the first set of multilateral trade negotiations in which developing countries had

played an active role.

Agriculture was essentially exempted from previous agreements as it was given special status in

the areas of import quotas and export subsidies, with only mild caveats. However, by the time of

the Uruguay round, many countries considered the exception of agriculture to be sufficiently

glaring that they refused to sign a new deal without some movement on agricultural products.

These fourteen countries came to be known as the "Cairns Group", and included mostly small

and medium-sized agricultural exporters such as Australia, Brazil, Canada, Indonesia, and New

Zealand.

The Agreement on Agriculture of the Uruguay Round continues to be the most substantial trade

liberalisation agreement in agricultural products in the history of trade negotiations. The goals of

the agreement were to improve market access for agricultural products, reduce domestic support

of agriculture in the form of price-distorting subsidies and quotas, eliminate over time export

subsidies on agricultural products and to harmonise to the extent possible sanitary and

phytosanitary measures between member countries.

Doha Round: 2001

The Doha Development Round began in 2001. The Doha Round began with a ministerial-level
meeting in Doha, Qatar in 2001. The aim was to focus on the needs of developing countries. The

major factors discussed include trade facilitation, services, rules of origin and dispute settlement.

Special and differential treatment for the developing countries were also discussed as a major

concern. Subsequent ministerial meetings took place in Cancún, Mexico (2003), and Hong Kong

(2005). Related negotiations took place in Paris, France (2005), Potsdam, Germany (2007), and

Geneva, Switzerland (2004, 2006, 2008). Progress in negotiations stalled after the breakdown of

the July 2008 negotiations

THE MOST FAVORED NATIONS PRINCIPLE

Introduction

The principle of Most Favored Nation (popularly known as the MFN treatment) by name implies

especially favourable treatment. The MFN principle is a fundamental principle of trade ensuring

non-discrimination between ‘like’ goods and services. It is a legal obligation to accord equal

treatment to all nations accorded the benefits.

The clause relates to providing the same benefit and concession to one Member, in case benefits

and concessions are provided to another Member. MFN hence calls for nondiscrimination

amongst Members inter-se; so for example, in case a country ‘A’ provides a tariff concession to

a country ‘B’ by imposing a 10% duty on import of cars, ‘A’ is obligated to charge the same rate

of 10% to the imports of cars by Country ‘C’. In this sense, a nation is bound to treat every other

nation as its favorite or most favored nation. Thus, with respect to the GATT, a Contracting

Party is expected to treat every other Contracting Party as its favorite nation.
Modes of discrimination

In order to obtain a thorough understanding of the principle of most-favored nation, it is vital to

understand the forms of discrimination. Discrimination may either be de jure or de facto.

De jure discrimination

By de jure discrimination, we mean that discrimination that is spelt out by law. Hence, when

foreign goods and services are not given the same treatment as domestic goods or services or that

which is given to other Members; despite of being similar or like, it is a case of de jure
discrimination. For example, there may be laws or regulations that have the impact of

discriminating between goods and services that are like. Also, there may be an application of

taxes in a different manner to domestic and imported goods, when in reality there is no real

difference between the two.

De facto discrimination

De facto discrimination is discrimination that is not as explicit as de jure discrimination and is

implicit in the type of measures used. For example, there may be a variable tax rate on beverages

with high alcohol content than those with low alcohol content. There being no real

discrimination apparent in such a measure, it will be regarded as de facto discrimination if, based

on the market scenario, domestic beverages have a low alcohol content and imported beverages

have a higher content. Discrimination must hence operate so as to distort the „conditions of

competition‟ between goods and services that are like. Mere existence of different rule, does not

lead us to the conclusion that like goods and services have been discriminated unless the

“conditions of competition” have been adversely impacted.

Most Favored Nation Obligations under the GATT, 1947

Article I of the GATT, 1947 that invokes the principle of most-favored nation treatment prohibits

discrimination that may be in eh form of de facto and de jure discrimination, against the

Contracting Parties inter se. It provides for non-discrimination amongst trading partners; and

applies to every governmental measure in the form of customs duties and charges, the method of

levying the same and the rules and formalities applicable in the importation and exportation of

goods.

Article 1 of the GATT additionally calls for non-discrimination amongst Members inter-se in the

importation of products that are „like‟. Article 1: 1 hence states that

“any advantage, favor, privilege or immunity granted by any Member to any product originated

in or destined for any other country shall be accorded immediately and unconditionally to the

like product originated in or destined for the territories of other Members”

The MFN principle under the GATT prohibits discrimination that is either de jure or de facto.

Hence, discrimination that is either is the form of explicit provisions of laws or regulations, or by

means of a conduct is prohibited. The Belgian Family Allowances dispute comprehensively

elucidates the scope of discrimination, and the phrase “any advantage, favor, privilege or

immunity” for the purpose of understanding the nature and scope of discrimination prohibited by

the MFN principle.

In this dispute, the measure at issue was whether Belgium had violated the MFN principle

because of levying a charge on exports only due to the fact that such countries did not have a

similar family allowance policy in place. As a result, countries like Denmark and Norway had to

pay a charge on exports only by reason of not having a similar family allowance policy as that of

Belgium. The question was whether Belgium was justified in imposing a special charge on the

condition that exporting nations should also have a policy similar to that of Belgium. In this

context, the Panel held that Belgium had Article I:1 of the GATT as a result of this measure. It
elaborated that any advantage, etc. which was granted by one Contracting Party with respect to

products originating or destined for any country must also be granted to all other countries.

Hence, the Panel stated that such classifications made for certain products must exclusively be

based on the characteristics of the products themselves; as against being based on the

characteristics of the country where they originate from.