International trade theory

Adam Smith's model

Adam Smith describes trade taking place as a result of countries having absolute advantage in production of particular goods, relative to each other.

Ricardian model

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 theory of international trade (modern development)

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.

The Ricardian model is based on the following assumptions:

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 became 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:

Applicability

In 1953, Wassily Leontief published a study in which he tested the validity of the Heckscher-Ohlin theory. 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 tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or by new interpretations.

Specific factors model

In the specific factors 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.

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.

Gravity model

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.

Ricardian theory of international trade (modern development)

The Ricardian trade theory was now constructed on many-country many-product basis in a form to include intermediate input trade for the most general case of many countries and many goods. Capital goods (comprising fixed capital) are treated as goods which is produced and input in the production.

Many countries, many goods

There were three waves of expansions and generalizations.

First phase: Major general results were obtained by McKenzie and Jones. McKenzie was more interested in the patterns of trade specialisiations (including incomplete specializations), whereas Jones was more interested in the patterns of complete specialization, in which the prices moves freely within a certain limited range. The formula he found is often cited as Jones inequality or Jones' criterion.

Second phase: Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and Samuelson This model is restricted to two country case. It is employed for example by Matsuyama and others. These theories use a special property that is applicable only for the two-country case. They normally assume fixed expenditure coefficients.

Third phase: Shiozawa 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.

Traded intermediate goods

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. This deficiency is now wiped out by the new construction of the Ricardian trade theory.

McKenzie and Jones 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." Paul Samuelson 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". It took many years until Shiozawa succeeded in removing this deficiency.

Based on an idea of Takahiro Fujimoto, 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. International intra-firm competition reflects a really new aspect of international competition in the age of so-called global competition.