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Popular Trade Theories Explaining International Trade
Friends, if we talk about what is the historical perspective of certain theories and explanations, which tells us that why, since time immemorial, international trade was happening around the world, why countries trade with each other and how it benefited them, How it benefited them to improve their economies. Why people were motivated to do international trade, in spite of the fact that international trading is a difficult proposition. Requiring long distances movement, which is difficult for humankind. Travel long distances either by route or by sea and in the present times by air. So Friends it is important to understand that what was the explanation which were given And what was the rationale, which was given for international trading.
So, if we talk about the ancient trade, it is commonly understood that the world was trading with each other, since very, very long time ago in the known history. Ancient history, it is said that two countries were a major player in international trade. Those are the countries, which represent the present regions of India and China. We talk of movement of goods through surface that were called silk routes, and later on through sea routes. So, the dominant player at that timebecause of their large size, because of their strong GDP. India and China were supposed to be the major Leaders in those times. But Friends, it is very little known that, in the ancient time, the most dominant civilization for international trade was not India and China. It was the Phoenicians, an ancient Semitic Thallasocratic civilization, which was situated on the western coastal part of the Fertile Crescent centered on the coastline of what is be known as modern Lebanon. That was a region and Friends that was the region where a lot of agriculture happened. It was a very fertile land. And in ancient trade, the major commodity of international trade was related to agriculture. So, this so called Phoenicians, they were the most dominant player in international trade on those things.
Friends, let us talk about some of the common theories of trade or the explanation of international trade, which were given from time to time by different thinkers and economists.
Friends in the modern history, one of the earliest modern theory of international trade was called theory of mercantilism. So, Friends, this theory of mercantalism was related to the thinking that the countries which will export more and import less will increase their state power. It was freinds due to this theory that, it is argued, that the era of colonialism started. And one very good example of this is the colonialism by Britishers of India. So, when East India Company came to this Indian continent, they set up their base to increase their exports to India and import only the raw materials or commodities in such a way that they benefited from this theory of mercantilism. And the power of Queen increased and because of this reason only after spending several decades of their base in India, in 1858, the British Raj was declared on India and the backing of political bigwigs of Britain was very, very clear to this theory of mercantilism.
But friends later on, Adam Smith gave another theory which was called the theory of absolute advantage. According to this theory, Adam Smith, who is regarded as the father of economics, proposed that, countries do not need to resort to theory of mercantilism. Rather they should focus on the absolute advantages which those countries enjoy. It means that they are able to produce certain things better than anybody else. And they can produce more with the similar resources. And if they do so, they will be able to export those items or goods or services to other countries. And obviously, they will benefit.
And Adam Smith also proposed that most of these countries have certain absolute advantage in something and if they will trade with each other, everybody will benefit
So, friends That was a kind of demise of the theory of mercantalism. So, the ideas changed from theory of mercantilism to theory of absolute advantage, which was proposed by Adam Smith.
Later on another economist, Ricardo proposed that even if countries have absolute advantage in several items, they need not focus on producing all those items. Rather, they should focus on producing those items in which they have a comparative advantage, which means they may be having absolute advantage in multiple items, but they will comparatively have better absolute advantage in certain items than others. So, according to this theory, it was proposed that if those countries exports and focus in the production and export of certain items only, where they have very strong competitive advantages, the advantages of international trade among all the countries will further improve. So, this theory very clearly indicated that international trade will benefit all the countries. So, it is not required that, by force a certain country create a situation where they export more and the import less.
Then Friends, another theory which is called product lifecycle theory was also proposed. Which tried to explain the reasons of international trade according to product lifecycle theory. Every product has a introduction phase, a growth phase, a maturity stage and a decline stage and there is a fixed timeframe within which these stages come. Introduction, growth maturity and decline. So, it was proposed that by introducing the same product at a later date in other countries will cause a new product life cycle. Which will have a new introduction, at a later stage. It will have a new growth, it will have new maturity and it will have new decline. So, friends what will happen is that the time period will get alongated, which means the overall length of the product lifecycle of a product will increase. So, it’s a very very strong motivation, friends, for resorting to international trade of certain goods and services.
Another theory which tried to explain the intra- industry international trade. And it is called the country similarity theory. So, friends as per the country similarity theory, it was proposed that those countries with similar level of economic development would find it comfortable to use goods and services which are produced in those countries which are having the similar level of economic development. Because if the have similar level of economic development, the needs and tastes of the customers are likely to be of similar technological level of similar nature. So, what will happen is that, the intra industry trade will increase among those countries.
Friends lateron another theory which is called a strategic advantage theory was proposed. Under this, it was proposed that very big corporations so called multi national companies, large companies which manufactures in big way, they have their major product lines. So what they do due to competition, they try to seek strategic advantages. Like first mover advantages, or by resorting to patents, copyrights and forcing the customers to buy their patented products and copyrighted products and services. So, friends, what happens is that to gather these strategic advantages and by having this patented technology information, or having the first mover advantage. these companies find it very, very comfortable to make profits by expanding to overseas markets. Because those patents, those copyrights, and the fact that they had the first mover advantages will apply in other countries also. So companies would like to maximize their profits of the strategic advantages in the industry. So this was another theory, which was proposed.
Then freinds, there was another theory which was called pull and push forces theory. What is the rationale of this theory is that it says that due to certain internal factors, country factors and international factors, there will be some pull or push forces, which will force or enable companies to expand into international markets. So, friends to give you an example, if a certain company has a very comfortable internal environment and specific capabilities, talents and resources, they will over the time look for international expansion using those specific enablers, internal enablers, certain capabilities, certain competencies, which the company enjoys, which others cannot do. So, this kind of specific advantages which this company enjoys will force the company to expand into international market. Similarly friends due to country factors like small size of the market or very strong domestic competition or unfavorable government policies, companies will be forced to seek and explore the markets in other countries which are large, which are located better, which has got strong consumer demand. Where the regulatory and operational environment is very favorable. So, friends, these countries factors can push several companies to either exit from those countries or limit their operation in those countries. And, then seek international markets. So, to give you an example, friends in this push and pull forces theory, if you look at country like Switzerland, which, which is small country and which, which is famous for products like watches, chocolates and many financial services. So, friends, Switzerland as a country is a very small country and it has got very limited captive market. So, the business operations in Switzerland cannot enjoy economies of scale. Because of the small size of customer base. So, the companies in Switzerland, they always look for international markets and so, the most successful companies in Switzerland, they actually depend on revenue more from outside Switzerland.
Then later, friends another theory, which is called Porter’s diamond theory was proposed. According to this theory, there are multiple factors which exist in a particular industry domain, in particular country or region, which enables certain industries and companies to derive strategic and competitive advantages vis a vis others and vis a vis other countries. This strategic and competitive advantage is derived from multiple factors. Which enable these companies to export their goods in international market.