Evolution of international trade from Ricardian to modern dynamic models

¶ … Evolution of International Trade From Static to Dynamic Theories

Evolution of International Trade

Generally, the principles governing the gains from trade can apply in both foreign and domestic trade. Although there is a tendency by states to view the two elements as different, economists on the other hand, suggest that the consequences of international trade were an extension of the laws governing domestic trade. Some of these principles were established very early, but a number of economists, for instance, John Stuart satisfactorily showed that it was possible to use similar principles to explain international and domestic trade. Therefore, economists are now confident that questions pertaining trade are similar, for instance, what is the advantage of trade between two parties? Between regions or countries? If individuals were self-sufficient, and can produce food, cloth or shelter, the living standards would be very low (Appleyard, Field and Cobb, 2005).

On the other hand, if people do not have such capacities to produce food, or access some basic items, this would call for trade between the individuals. Therefore, trade will let people to be in a position of specializing in things they can produce, but buy from other people the things that they cannot produce. Owing to this, it is apparent that trade and specialization have a substantial relationship. This principle provides the basis of all other forms of trade among countries, locals and regions. Specialization is the case that applies in international trade, where a given country has the capacity to produce particular things, whereas others cannot. In order to enjoy the things produced by a certain countries, the two or parties involved engage in trade. Although this is the case before the emergence of modern economies, economists strongly believed that trade was beneficial when it resulted to an export surplus (Smithies, 1952).

Models of International Trade

Ricardian Model

The Ricardian approach suggests that specialization has the capacity to maximize the national income of countries involved in international trade; however, it does not explain how they will find the equilibrium prices when they engage in trade. Nevertheless, the theory assumes that if consumer countries engaging in trade have different tastes, it is possible that they will not take part in trade (Choi, 2002). For instance, if the consumers in the respective countries like their local beers, there is no need to take part in international trade of beers. Therefore, the approach assumes that the consumers have similar tastes globally; it is possible that trade may not occur if the transport costs are high (Bittante, 2013). Globally, the transportation costs, especially when they are high can serve as barriers to international trade (Appleyard, Field and Cobb, 2005).

In addition, the approach assumes zero transport costs, and considered trade based on comparative advantages (Appleyard, Field and Cobb, 2005). Although this theory offers substantial information in relation to trade, some of the assumptions provided have been proven wrong by empirical evidence. For instance, it is apparent that the principles of trade are similar, both locally and internationally (Choi, 2002). This is one area where the approach refutes it suggests that what was true for the local market was not true for the international setting. It further suggests that in international trade, firms that have a comparative advantage do not necessarily have the advantage. In addition, in an attempt to justify this, the approach postulates that there are different set of laws governing the international trade, whereas it is apparent, that trade is central to similar principles.

The Modern Trade Theory

Although there were existing, models/theories that attempted to explain the structure of the international trade, substantial literature suggests that economists felt that they did not offer an extensive explanation on the same. These traditional theories failed to provide an explanation concerning the structure of international trade. Empirical studies, which offered support for the traditional theories, provided limited support for the theories. Moreover, the information about the international trade contained substantial empirical irregularities, which led to evolution to modern theories (Appleyard and Field, 2005). Traditionally, the trade theories evolved as separate subfields of economics. In the current literature, the theories have converged and combined through new theoretical insights that emphasize that similar forces determine specialization across countries for a given global factors of production.

Countries engaged in trade because of some differences in some respect either in terms of technology, or in the context of advantages. Although the traditional theories offered substantial significant information about the trade patterns in the past, a large percentage of modern economists who observe that comparative advantage are less pertinent in the contemporary world. In the current world (Feenstra, 2003), trade takes place between states that share similar technologies, similar goods, and similar factor proportions. Attempting to use the traditional perspective in the current trade scenario, for instance, a country would have comparative advantage when producing a specific type of good or service, seems farfetched as an explanation.

International Factor Movements

Notably, the principles, which form the basis of the international factor movements, have some similarities with principles found in trade, especially when applied in economic reasoning. The difference comes in the political context (Wafo, 1995) because the international movements tend to raise political complications when compared to international trade (Blackhurst and Otten, 1996; Lattore, 2008). Therefore, the factor movements are subject to restrictive precautions, for instance, there are immigration restrictions throughout the globe. FDI is a type of global capital flow, mainly because it can influence the state's stock of productive resources and competitive state in the market. FDI represents capital transfer, which is risk bearing because it involves the transfer of managerial proficiency between the countries (Appleyard and Field, 2005).

Initially, FDI was a model, for instance, the production factor, which moved across countries, and it aimed to respond to the variations in the expected returns on capital. In this context, it was predicted that FDI would move from countries with ample capital, to countries with inadequate capital (MacDougall, 1960; Krugman, 1979). Corporations that establish foreign operations are typical examples of the FDI. FDI is industry-specific investment, but its economical significance traits emerge not so much from transferring capital from one country to the other. In comparison to organizations that do not have foreign operations, multinationals experience higher production. Prior studies, which utilize total factor productivity and labor productivity offer empirical evidence on the status (Lipsey and Sjoholm, 2004).

This is because multinationals have immense capabilities and ownership advantages. In addition, multinationals are larger when compared to exporting farms, which in turn are larger compared to firms that lack foreign operations (Greenaway and Kneller, 2007). Although it is not easy to establish whether multinationals can produce trade deficits in the host economy, FDI inflows have the capacity to reduce or increase imports of the host economy (Swenson, 2004). Most importantly, the connection between FDI and trade has a relation to the predominance of vertical or horizontal multinationals. In the case of vertical multinationals, FDI and trade are complementary, whereas in the case of vertical multinationals FDI and trade are substitutes (Blonigen, 2001).

The most studied effects of FDI are that of the positive or negative externalities that emerge due to the presence of multinationals. Arrival of new products is a typical example of an externality that foreign affiliates produce, which is beneficial to consumers. Nevertheless, FDI inflows have the capacity to raise welfare by raising the varieties for potential consumers (Rutherford and Tarr 2008). In the case of negative externalities, some scholars found evidence of the effects of such externalities on the firm's productivity. In the case, FDI decreases the total output, which makes their production less efficient points on their declining average cost curve, hence, decreasing their overall productivity (Head and Ries 2001; Aitken and Harrison 1999).

Conclusion

Trade, as seen from prior literature, was a method used by countries to access what they did not have capacity to produce. Therefore, countries began specializing on what they could produce substantially, and trade helped the countries enjoy what they could not produce. Notably, in both domestic and international trade, similar principles apply; however, states tend to view the two as different. International trade was a complex phenomenon and in an attempt to explain it, there were traditional theories such as Ricardian, and H-O models, which offered some important insights concerning international trade. In comparison, the H-O model, in a way provided a realistic framework because it utilized a second factor of production, capital.

However, the two traditional theories failed to provide a comprehensive explanation concerning international trade, which saw to the emergence of modern theories. This is because economists argue that the international factor movements utilize similar principles used by international trade; however, the principles differ in the political context. FDI, which was a model, initially, had the capacity to influence the country's stock of productive resources. For instance, in the vertical multinationals, the FDI and trade serves as a complementary while in horizontal multinationals FDI and trade serve as substitutes.