International Business

Week 3 – International Trade

Lecturer:
Fernando Ramírez de Verger, PhD, MBA
fernando.ramirezdeverger@uwl.ac.uk
  Definition:

Factor mobility refers to the ability of factors of production

(capital, technology and people) to move between different uses or

What is Factor
locations within an economy.

 Types of factor mobility:

Mobility 1. Labour Mobility:

• Geographical Mobility: Ability of workers to move between

different regions or countries in search of employment
opportunities.

• Occupational Mobility: Flexibility of workers to switch

between different types of jobs or industries.

2. Capital Mobility:

• Financial Capital Mobility: Movement of financial resources,

such as investments and capital, across borders. In a
globalized economy, capital can flow between countries
seeking the most favourable investment opportunities.

• Physical Capital Mobility: Movement of physical assets, like

machinery and equipment, across locations. Industries may
relocate production facilities to areas with lower production
costs or better access to resources.

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 Understanding factor mobility is crucial for policymakers,
businesses, and individuals to navigate the challenges and
opportunities presented by a dynamic and interconnected global

Implications of economy.

Factor Mobility • Efficiency: For example, if Labour is free to move to areas where
it is most needed, this can help reduce unemployment and boost
economic productivity.

• Equity: Factor mobility can also impact income distribution and

social equity. For instance, if Labour mobility is restricted, some
regions or groups may face higher unemployment rates or lower
wages.

• Globalization: The mobility of capital and Labour across borders

is a defining feature. It allows businesses to seek the most cost-
effective production locations and enables workers to pursue job
opportunities globally.

• Policy Considerations: Governments often implement policies to

either encourage or restrict factor mobility, depending on their
economic objectives. For instance, some countries may implement
immigration policies to attract skilled workers, while others may
impose trade barriers to protect domestic industries.

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 Understanding of how government trade policies might affect
business competitiveness.

 Fundamental questions in International Trade

Trade Theories 1. Why does international trade take place?

and business 2. What determines which country should export a particular

good and which country should import it?

3. Who gains from such trades?

 Why talk about trade theories?

“International trade theories have long 1. Benefits of international trade.

held that …
2. Theories show why countries should trade for
some trade is better than no trade, and products/services even when they can produce them
more trade is better than less trade, and
domestically.
free trade is better than restricted
trade…” 3. Talks about patterns of international trade.

Free trade is a situation where a 4. Theories show why countries specialize the way they do.
government does not influence
international trade through quotas and 5. Talks about the role of intervention.
tariffs
6. Theories help articulate the role of government policy (tariffs,
quotas, etc.)

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 Traditional theories Modern theories

Overview of •
•
•
Mercantilism theory - IT
Absolute advantage theory - FT
Comparative advantage theory - FT
•
•
Heckscher-Ohlin model - FT
Product life cycle – IT&FT

Trade Theory
• New trade theory - FT
• Factor endowment - FT
• Porter’s diamond theory – IT&FT
• Leontief paradox

Some nations take a more laissez-faire approach, one that allows the
market to determine trading relations.

Free-trade theories take a complete laissez-faire approach because

they prescribe that governments should not intervene directly to affect
trade.

At the other extreme are the Interventionists theories like

mercantilism and neomercantilism, which prescribe a government
intervention.

Whether taking a free-trade or interventionist approach, countries rely

on trade theories to guide policy development.

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Interventionist Theories
 What is Mercantilism?
Economic theory that emphasizes self-sufficiency through a
favourable balance of trade. Mercantilist policies focus on the
Mercantilism accumulation of wealth and resources while maintaining a positive
trade balance with other countries.
theory  Mercantilism views trade as a zero-sum game: one in which a gain
by one country results in a loss by another. A nation can only grow
rich at the expense of other nations

Thomas Mun, 1664  Emerged in 16th century England and is considered to be

the oldest theory of International Trade.

 According to this theory, a country’s wealth could be determined

by the amount of its gold and silver stock.

 It is in a country’s best interest to maintain a trade surplus

exporting more than importing.

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 The beginnings:

 This theory flourished during the 17th and the 18th century as

Mercantilism imperialism was being promoted by colonial empires.

theory  The countries used raw materials to manufacture goods and sell
them, thereby promoting exports.

Disadvantages:

 Import restrictions were imposed by countries that ultimately led

to higher prices and severely affected the consumers (Adam
Smith). The biggest promoters of this theory were British, Dutch
and Spanish Empires.

 Mercantilism was one way traffic. It focus on export but not

import, it is not easy to be self-sufficient. Many countries of
Europe fails to be self-sufficient which increased their miseries.

Even today this theory is being followed to some extent by export

economies like Germany, Japan, and Singapore etc. Some have
dubbed the policy of these countries to be a kind of neo-
mercantilism.

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Free-Trade Theories
 Advantages
Absolute  Natural Advantage: A country would produce those goods that are

Advantage naturally favoring its climatic conditions. The type of goods

produced would also depend upon the availability of natural

theory
resources.

Criticisms of this theory

 Assumption of Full Employment: The absolute advantage
Adam Smith, 1776 theory assumes full employment of resources in both countries.
Unemployment and underemployment can complicate the
application of this theory.

 Ignores Opportunity Cost: The absolute advantage theory does

not consider the concept of opportunity cost. It focuses solely on
comparing absolute productivity without considering the trade-
offs involved.

 Limited Applicability: This theory is more applicable to

situations where one country is uniformly more efficient than
another in the production of all goods. In the real world, such
situations are rare.

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 PRODUCTIVITY
Absolute Advantage theory Adam Smith, 1776

 This theory believed that a nation should specialize in producing those goods that it can produce at a cheaper cost
than that of other nations. These goods should be exchanged with other goods that are being cheaply produced by the
other nations.

 A country has an absolute advantage if it can produce more of that good using the same amount of resources or
produce the same amount using fewer resources compared to another country. Absolute advantage is comparison of
productivity between two countries.

 Countries should specialize in the production of goods for which they have an absolute advantage.

PRODUCTION WITHOUT GAIN IN PRODUCTION PRODUCTION WITH

SPECIALIZATION SPECIALIZATION

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 Advantages

Comparative  This theory also has the potential to incorporate costs other
than labour.

Advantage  It considers the ‘Opportunity Cost’.

theory Criticisms of this theory

 This theory like Absolute Advantage again assumes existence
of free trade between the countries. It fails to consider factors
David Ricardo, 1817 like quantitative restrictions, public policy, protectionist measures,
export subsidies etc.

 The comparative advantage theory assumes constant opportunity

costs, meaning that the opportunity cost of producing one good
remains constant as more of it is produced. Opportunity costs can
change with production levels.

 This theory assumed that only bilateral trade could take place
between the nations and only in two commodities that are to be
exchanged.

 This theory assumes that the internal economies of countries

are competitive. However, this is not true. Most of the countries
have industries that are monopolistic in nature.

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Comparative Advantage theory
 As per this theory, Comparative Advantage exists when a country can produce a commodity more efficiently than it does other
commodities. This theory focuses on the relative productivity difference, whereas Absolute Advantage theory focused only
on absolute productivity.

David Ricardo, 1817

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Comparative
The table below shows the production possibilities of two countries,
Country A and Country B, of two goods, smartphones and apples,
given a fixed amount of resources.

Advantage Apples Smartphones

theory. Example Country A

Country B
39
48
13
24

a. Which country has the absolute advantage in smartphones,

and which has the absolute advantage in apples?

b. Calculate Country A’s opportunity cost of smartphones in

terms of apples

c. If the two countries were to specialize and trade with one

another, which country would import smartphones?

d. Assume the countries decide to specialize and trade and

settled on a trading price of 2.5 smartphones per apple.
Explain why the country that specializes in apples would
experience gains from trade.

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 a. Country B has an absolute advantage in smartphones because
it can produce 48 smartphones compared to just 39 in Country A.
Country B also has an absolute advantage in apples, since it can

Comparative
produce 24 apples compared to just 13 in Country A.

b. Country A can produce 39 smartphones or 13 apples. To determine

Advantage the opportunity cost we can divide the number of apples it can
produce by the number of smartphones it could have produced

theory. Example with the same resources:

39 smartphone = 13 apples; 1 Smartphone = 13/39 apples.

For each smartphone Country A produces it gives up

just 1/3 of an apple, so the opportunity cost of 1 smartphone is
0.33 apples, while Country B produce 2 smartphones per 1
apple, so an opportunity cost of 0.5 apples.

c. Country A can produce smartphones at a lower opportunity cost

than Country B (1/3 apple per smartphone compared to Country
B’s 1/2 apple per smartphone). Therefore, Country A will
specialize in and export smartphones and Country B will
import smartphones.

d. Country B, which has a comparative advantage in apples

(2 smartphones per apple compared to Country A 3 smartphones
per apple) will gain from trade because by exchanging apples with
Country A, Country B will receive 2.5 smartphones for every apple
it give up instead of just 2 smartphones, which it would get if it
tried to produce smartphones domestically.
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Other theories
 Factor Endowment Theory: This theory is closely related to the Heckscher-Ohlin model and is generally associated with
free trade. It emphasizes that countries should specialize in producing goods that use their abundant factors of
production to achieve efficiency.
 Heckscher-Ohlin Theory: This theory is generally associated with free trade and can be considered part of the Endowment
theories.
 Leontief Paradox: The Leontief Paradox is more of an empirical observation rather than a specific trade theory and
considered simply a challenge to the Heckscher-Ohlin Theory. It suggested that the United States, which was considered a
capital-abundant country, was exporting more labour-intensive goods than it was importing.
 Product Life Cycle Theory: This theory, proposed by Raymond Vernon, is more descriptive than prescriptive. Describes the
evolution of a product over time, suggesting that as a product matures, production may shift to lower-cost countries. It can be
both interventionist and free-trade-oriented, depending on the policy implications.. It is not explicitly interventionist or free-
trade-oriented.
 New Trade Theory: associated with economists like Paul Krugman, focuses on economies of scale and product
differentiation. It doesn't necessarily advocate for strict interventionism but recognizes the role of economies of scale in trade,
which may involve government policies.
 Porter's Diamond Theory: It is more about the competitiveness of nations rather than a strict trade theory. It highlights
factors like factor conditions, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry. It
doesn't neatly fit into the categories of interventionist or free trade, as it focuses on the determinants of national
competitiveness.

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The relationship between trade and FM
Factor movement is an alternative to trade that may a more efficient use of resources. Let’s see how free trade coupled with
freedom of factor mobility can result in the most efficient resource allocation.
 Substitution Pressures exist for the most abundant factors to move to countries with greater scarcity, where they can
command a better return. In countries where labor is more abundant than capital, laborers tend to go to countries that have full
employment and higher wages. They receive higher wages not only because of the greater scarcity, but also because more
capital-rich countries have invested in machinery and infrastructure that make the imported laborers more productive
than in their home countries.
 Of course, as we discussed in the section on factor endowment theory, the ratio of land (an immobile factor) to people also
influences the movement of labor.
 However, as is true of trade, there are restrictions on factor movements that make them only partially mobile internationally—
such as both U.S. immigration restrictions and Mexican foreign capital ownership restrictions in the petroleum industry.

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The relationship US vs Mexico Example
between trade and  The United States and Mexico have equally productive land available at

FM the same cost for growing tomatoes.

 The cost of transporting tomatoes between the United States and Mexico
is $0.75 per bushel.

 The only differences in price between the two countries are due to
variations in labour and capital cost. In the United States the labour rate
is $1.25 per bushel; in Mexico it is $0.25 per bushel. The capital needed to
buy seeds, fertilizers, and equipment costs the equivalent of $0.30 per
bushel in the United States and $0.50 per bushel in Mexico.

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The relationship
between trade and
FM

A) Neither tomatoes nor production

factors can move between the two
countries. No trade no mobility

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The relationship
between trade and
FM

B) No trade but factor mobility is

allowed

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The relationship
between trade and
FM

C) Trade but NO factor mobility

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The relationship
between trade and
FM

D) Both allowed

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