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Globalization Theory Essay

1715 words - 7 pages

Theories of International Trade & the Multinational Enterprise

Theories of International Trade & the Multinational Enterprise
International trade is the exchange of goods and services across borders. Trade provides people with greater selection of goods and services to choose from. The importance of international trade to a nation economic welfare and development suggest that economies need to export goods and services in order to generate revenue to finance imported goods and services which cannot be produce indigenously (Coutts and Godley, 1992: McCombie and Thirlwall, 1992). Most theories of international trade such as comparative advantage theory, product life cycle ...view middle of the document...

Theory of comparative advantage was developed by David Ricardo (1817) means that the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. If country A can produce one goods at lower opportunity cost than country B whereas country B has a lower opportunity cost in producing another goods, both countries can trade relatively cheaper goods. Paul Samuelson gives the following example by using Ricardo's classic example dealing with trade between England and Portugal (Table 1).

Unit Labour Cost
(Hour/Unit) | Cloth | Wine |
Britain | 100 | 110 |
Portugal | 90 | 80 |
Example given by Paul Krugman using Ricardo's classic example. Source: A Globalization Puzzle
"In spite of the fact that the Portuguese could produce both cloth and wine with less amount of labour, Ricardo suggested that theoretically both countries benefit from trade with each other." In the absence of transportation costs, it is efficient for Britain to produce cloth and for Portugal to produce wine as, assuming that these trade at equal price (1 unit of cloth for 1 unit of wine). Britain can obtain wine at a cost of 100 labour units by producing cloth and trading, rather than 110 units by producing the wine itself. Whereas, Portugal can obtain cloth at a cost of 80 units by trade rather than 90 units by production.
The Theory of Absolute Advantage and the Theory of Comparative Advantage rest on very strong assumptions, as follows:
a) Two countries, two commodities - assumed in both theories.
b) Zero Transportation Costs - both theories presume that transportation costs between and within countries are zero.
c) Full employment - Both theories assume full employment in each country.
According to factor endowment theory, countries will tend to generate and export goods and services that harness large amounts of abundant production factors that they possess, while they will import goods and services that require large amounts of production factors which may be relatively scarce (Hecksher and Ohlin, 1993). The Heckscher–Ohlin theorem states that a country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively. In the two-factor case, it states: "A capital-abundant country will export the capital-intensive good, while the labour-abundant country will export the labour-intensive good." The relative abundance in capital will cause the capital-abundant country to produce the capital-intensive good cheaper than the labour-abundant country and vice versa. Relative endowments of the factors of production (land, labour, and capital) determine a country's comparative advantage.
The product life-cycle theory is an economic theory that was developed by Raymond Vernon (1966) to explain the observed pattern of international trade of a new product. Product life cycle theory divides the marketing of a product into four stages: introduction, growth,...

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