International Trade and Comparative Advantage Because Trade Term Paper

  • Length: 12 pages
  • Subject: Economics
  • Type: Term Paper
  • Paper: #92569101

Excerpt from Term Paper :

International Trade and Comparative Advantage

Because trade between nations is as ancient as mankind itself, there have been a number of theories advanced over the years to help account for why some countries seem to benefit more than others in the process. To this end, this paper provides an overview of trade theories according to Adam Smith and Ricardo to determine how free trade has adversely affected developing countries in general and Egypt and the Middle East in particular. An examination of different trade policies in developing countries and how these policies assisted some countries but not others is followed by a summary of the research in the conclusion.

Background and Overview of Trade Theories. Early on, David Ricardo examined the laws that seemed to control the distribution of everything that could be produced by the "three classes of the community" (e.g., the landlords, the workers, and the owners of capital) (Spengler 1). As part of his theory of distribution, Ricardo maintained that profits tended to shift inversely with wages, which increase or decrease according to the cost of necessities. Ricardo also suggested that rent tends to increase as population increases because of the higher costs associated with the agricultural requirements of a larger population (Spengler 2). In this regard, Ricardo believed that unemployment was not as much of a threat to a nation's economy uncontrolled population growth, a trend that could constrain wages to the subsistence level, thereby restricting both profits and the creation of new capital through the extension of the margin of cultivation; further, he also believed that trade between nations was affected by the relative costs of production and by differences in internal price structures that could maximize the comparative advantages of the nations involved (Spengler 3). For example, Ricardo maintained that the real wage would tend to the "natural price of labor," in other words, the wages that are required to allow labor to reproduce itself; the concept of reproduction included social as well as subsistence considerations. In the Principles of Political Economy, Ricardo makes the point that:

It is not to be understood that the natural price of labor, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends upon the habits and customs of the people. Many of the conveniences now enjoyed in an English laborer's cottage, would have been thought luxuries at an earlier period of our history. (1951, pp. 96-7)

In Jarsulic's analysis of Ricardo's the example is made that an economy of an agricultural-based capitalist country that produces, for instance, only corn by using land, labor and seed corn in the process of production can achieve successful yields if everything in the marketplace is just right: "If there is plenty of land of uniform quality," Jarsulic says, "those who possess a sufficient stock of corn to pay the wages of workers through the agricultural production cycle will be able to hire workers and organize production in the way they wish" (12). This type of simple economy, though, also requires labor for the production of corn; because it has been assumed that corn must be provided to a country's workers during its production, some of the output must be subtracted from this physical surplus when determining the amount of economic surplus that is actually going to the capitalist farmers who advance these wages (Jarsulic 12). Any surplus represents the profit for these farmers, which is the very reason they were willing to pay wages from the outset; therefore, Jarsulic points out that if the total amount required for wages is too much, there will be no profit and no reason for those with stocks of corn, the only 'capital' in this economy, to engage workers. "Both the labor requirement and the real wage," he says, "are crucial for determining the division of surplus and the level of profits" (13).

In his work, The Wealth of Nations, Adam Smith stated that the first goal of any political economy was "to provide a plentiful revenue or subsistence for the people, or more properly to enable them to provide such a revenue or subsistence for themselves" (449). In the market economy described by Smith as a "subsistence for the people" would depend on their wages or what he called the natural price of labor. "The natural wage of labor meant to Smith, as the just wage had to medieval thinkers, that society should be concerned when labor markets did not provide a subsistence that was 'plentiful.' Smith's study of wages was a significant advance over his predecessors, who emphasized prices" (Stabile 1997:293).

Today, the structure of international trade is considered to have both behavioral and institutional attributes; for example, the extent of openness to international commerce from one nation's perspective can be described both by the flow of goods and by the policies that are followed by states with regard to trade barriers and international payments (Frieden & Lake 2000:24). "Openness," they advise, "is associated with those historical periods in which tariffs were substantially lowered: the third quarter of the nineteenth century and the period since the Second World War" (Frieden & Lake 24). These various economic and political considerations are discussed further below as they apply to the economies of Middle Eastern countries in general and Egypt in particular.

Analysis of Impact of Free Trade on Developing Countries. According to Frieden and Lake, the concentration of trade within regions comprised of states at different levels of development represents an indicator of the openness of the international political economy. "The degree of such regional encapsulation is determined not so much by comparative advantage (because relative factor endowments would allow almost any backward area to trade with almost any developed one)," they say, "but by political choices or dictates" (24). Countries that have larger economies will likely try to protect themselves from the exigencies of a global marketplace by exploiting their interests through regional trading blocs; in reality, though, the increased openness in the global marketplace has meant primarily increased trade among the leading industrial states only (Frieden & Lake 25). When international trade is less open, the developing nations of the world have fewer opportunities to engage with the larger industrial states, thereby constraining their ability to effectively compete. "A description of the international trading system involves, then, an exercise that is comparative rather than absolute" (Frieden & Lake 25). Notwithstanding the emergence of regional trading blocs among the leading nations of the world, many emerging countries of the Middle East have been excluded from these economic partnerships.

In their essay, "Dividends of Fear: America's $94 Billion Arab Market Export Loss," the editors of Washington Report on Middle East Affairs point out that the share of world merchandise exports to the Arab Middle East from the United States decreased from 18% in 1997 to just 13% in 2001. This decline took place at a time when there was strong import demand that had been averaging one percent per year together with high demand for value-added capital goods among Arab economies ("Dividends of Fear" IM1). "The hardest hit U.S. export sectors include civilian aircraft, agriculture, heavy transportation," they report, "as well as telecommunications and industrial equipment. On the demand side, the broad U.S. export downturn is driven by growing Arab boycotts against U.S. consumer and industrial goods" ("Dividends of Fear" IM1). These declines in American exports occurred largely as a response to the perceived loss of U.S. regional foreign policy legitimacy from the perspective of Arab buyers:

On the supply side, the increasing restrictions on Arab business travel to the United States, and surging U.S. fear, xenophobia and legal campaigns leveled against Arab business are positioned to accelerate the toll on future trade. The IRMEP estimates that America has already lost U.S. $31 billion in exports between 1998 and 2002. If the trend continues, the U.S. stands to lose an additional U.S. $63 billion through 2007 for a ten-year export loss of U.S. $94 billion. ("Dividends of Fear" IM2).

The Middle Eastern nations are at a crossroads both in terms of their political as well as their economic futures. To the extent that the economic theory of Smith's "invisible hand" at least play out in the real world will be the extent to which these emerging nations become part of the rapidly growing globalized marketplace; however, there remains much to be done in many of these countries in terms of how their policymakers decide to approach their strategic economic positioning as well as come to terms with the growing political strife that is increasingly characterizing this region of the world.

The World Bank provides a Knowledge Economy Index (KEI) assessment of selected countries of the world; the KEI is the average of the performance scores of a country or region in all four KE pillars: 1) Economic Incentive Regime, 2) Education, 3) Innovation, and 4) Information Communications & Technology); each pillar score is the average…

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