Unlike in the past, nations can now share ideas, products and culture among other things through globalization. Among these aspects of globalization, trade is vital as it leads to such things as increased productivity and efficiency due to specialization. In addition, it enables nations to feed and clothe their citizens since without it, life would be difficult. For example, petroleum, which is only produced some specific countries would be totally unavailable to other nations in the absence of international trade. Because of its relevance, many scholars and theorists have concerned themselves with the study of international trade in order to understand why it takes place, how this trade can be enhanced and how nations can perform better than others in the process. Some of the theories of international trade developed for the named purposes are the classical theories, which are inclusive of Mercantilism theory and the New Trade theory among others. Other groups of theories include the contemporary theories, which include Comparative Advantage of Nations and the National industrial theories among others. One of the characteristics of these international trade theories is that they were not developed in a single period. Instead, international theories of trade have evolved in time to comprise such theories as the modern trade theories, which somehow different with the past theories. The evolution of these theories, as it seems is an ongoing process, which can take any direction in the future in order to explain the ever changing nature of international trade. In order to explain this, this paper will discuss the evolution of trade theory in order to understand the motivations behind international trade and how this can be enhanced in order to benefits nations and their citizens who are the end beneficiaries.
The earliest trade theory according to scholars, dates back in the 16th century when gold was the major product of trade. The earliest theory to be documented is Mercantilism theory, which was founded by such people as Thomas Mun and Antonio Serra. This theory views prosperity as stemming from a positive balance of trade where imports are minimized and exports maximized. Among the important strategies emphasized in this theory was manufacturing and state intervention since it would help in enhancing domestic production. Production, in this case was seen as the only way towards wealth formation, which is the reason why it was emphasized. Although avoiding imports and maximizing exports was seen as one of the ways of increasing a country’s earning, the method did not eventually work. Some of the nations such as the United Nations, which tried the policy after the First World War ended up failing terribly.
Absolute Advantage Principle
The drawbacks of Mercantilism were catered for by the subsequent Absolute Advantage Principle, which emphasized on free trade instead of restrictions of imports and exports. Free trade according to Adam Smith could lead to division of labor, which could in turn help in lowering of labor costs. Smith saw much rationality in obtaining goods at lower prices from imports instead of producing the same goods at higher prices in domestic production. Eventually, it would be possible for countries to export goods that they were good at producing and import goods that other countries produced and supplied at lower costs. According to Smith, there would be absolute advantage if countries produced goods in areas where the country was good at producing because of such things as good climate and good soil. Smith viewed as his theory as being advantageous regardless whether nations used natural or acquired advantage. In his arguments, more advantage would be gained as long as one nation had some advantage in the production of some goods and another was in need of these advantages. Just like Mercantilism had its drawbacks, the Absolute Advantage Principle also had its drawbacks since there was no differentiation of domestic trade with international trade when dealing with domestic and international resource mobility. The theory also lacked an adjustment mechanism whereby real costs would be translated into monetary costs.
Comparative Advantage Principle
The theory, which is introduced by Ricardo is based on the idea of free trade among nations and that all of these nations despite their levels of development can trade freely and benefit from this trade than in times of restricted trade. Benefits derived from this trade also include increased economic efficiency, higher income and higher national consumption. Unlike the previous theories that had many drawbacks, this theory received approvals first because of its emphasis on free trade. Sen argues that the theory’s approval compared to the other theory of Absolute Advantage received more approval and was not only considered sufficient, but was also seen as necessary since it would lead to mutual trade gains between nations. The theory also allowed for complete specialization of nations in areas where they had more advantage when it came to labor hours needed in a unit of output.
Factors Proportion Theory
The theory, which also assumes the name of factor endowment theory views nations as being different endowment proportions. The theory is also referred to as the Heckscher-Ohlin model and views factors of production in countries as differing in terms of quantity and type. Advantages of using this theory in international trade is that discrepancies between nations can remove or deal with their discrepancies when it comes to factor endowment through export of commodities that abundantly use the factors of production. The strategies also see nations as being capable of specializing in those industries that help them in in efficient utilization of their national resources. In case of imports, nations can import resources that would help them in using factors that are scarce in their nations thus helping them in relieving the scarcity of these resources. In such cases, factor prices would be equalized especially between countries having the same technology. Compared with the other theories especially the theory of Comparative Advantage, this theory has evolved since it takes into consideration the difference in technologies between nations during trade. Costs of production in this theory are also viewed as endogenous since they are different even when same technology is used in production of same goods.
When emphasizing on the importance of theory, Zhang argues that it is a breakthrough mostly because it relates comparative advantage with a country’s production factors such as capital and labor. Zhen also explains that theory is not sophisticated especially when being explored using modern geometrical analysis. Unlike Ricardian theory, this theory can simply help in understanding the relationships that exists between factor prices and commodity prices. It can also help in understanding the relationship between factor rewards and factor supply. Zheng thus sees this theory as a refinement of the Ricardian theory despite the fact that it has not supplement the Ricardian model. The theory, according to Zheng is logical when it comes to the neoclassical methodology promises.
International Product Cycle Theory
The theory was developed Raymond Vernon after an observation of how advanced countries are the source of innovation. He also observed of the process of technologies and product development, which started from introduction followed by introduction and growth. The initial stage, according to this theorist is advantageous to the producing country since it enjoys the monopoly, which apparently is only for a short time. This power weakens as foreign investors enters the same line of production leading to such things as mass production.
Contemporary Theories of International Trade
Unlike classical theories of international trade that mostly focus in increased production, the modern theories focus more on the competitive advantage of nations.
The Competitive Advantage of Nations
Theorized by Michael Porter, the theory viewed a nation’s competitive advantages as stemming from the nation’s firms. Porter argued that just as nations benefit from firms, so does firms since the competitive advantage derived helped in the firm development. The theory also considered individual firm competition where unique firm characteristics are seen as one of the sources of a competitive advantage. The theory views firms as having the ability to increase their competitive advantage through innovation and development of new products. Innovation is actually seen as the one way of increasing a firm’s competitive advantage.
Michael Porter’s Diamond Model
Also developed my Michael Porter, this theory views firm strategy, factor conditions, supporting industries and demand conditions as sources of a nation’s competitive advantage. Firm strategy, which also include structure and rivalry and firm structure are seen as sources of competitive advantage with competition at the national level being important in increasing and maintaining competition. The pressure obtained from this competition, according to Porter forces firms to innovate and improve their operations. Competition also helps firms in sourcing technical and skilled leadership and also emphasizing on the quality of goods and products.
In terms of factor conditions, Porters viewed nations as having abundant of some of the factor conditions, which helps the nation in assuming a certain position in the international competition. Some of the factor conditions that can help a firm or a nation in having some added advantage include natural resources, labor and technology among others. Demand conditions, on the other hand helps firms in attaining competitive advantage by pressuring firms in engaging in faster innovations and better production. Related industries, which is the last factor as outlines by Porter views the presence of such things as suppliers and firms related to specific industries as being useful in enhancing production and innovation. Chance events and governments are also explained as driving firms’ competitive advantage.
National Industrial Policy
This theory rests on the assumption that natural resources are not the only source of competitive advantage since new advantages can be created to improve a nation’s competitive advantage. This is a development from the earlier contemporary arguments, which viewed competitive advantages as emanating from a nation’s natural resources. Policies that encourage development can be used by firms in developing factor endowments. One of the best examples given by most scholars in its ability to develop factor endowments is Dubai, which despite is location is able to develop industries in different areas in order to increase its competitive advantage. The theory stressed on such things as Monetary and Fiscal Policies, tax incentives, education and infrastructure in increasing a nation’s ability to develop competitive advantage.
Apart from Contemporary theories, the other group of International Trade Theories is the theories of firm internationalization, which explains why firms internationalize and how they do this.
Internationalization Process of the Firm
This theory seeks to understand the process of firm internationalization, which is viewed as a gradual process that takes a long time. Exporting is seen as one of the major processes, which may be slowed down by the lack of knowledge of the international market. Domestic focus is seen as the first process, followed by the pre-export stage and the mental involvement stage. Eventually, the nation moves to active involvement, which helps it to enter into the last committed involvement stage. This proceeds to a point where international business is viewed as an important factor in the making of profits whereby many foreign markets are targeted for this reason.
Early Internalization and Internalization Entrepreneurship
Just as other theories advances from the previous theories, this theory is an advanced theory from the previous theory of internalization process. The theory looks at gradual internalization, which is not only the process of large multinational organizations that has the necessary resources, but is also a result of ability to venture abroad because of reduced costs. This is why firms venture into international levels soon after they start.
Other groups of international trade theories focus on the total assets owned by multinational enterprises.
Monopolistic Advantage Theory
This theory is based on the notion that some MNE have some advantage over others because of large scale production of goods, which is the economies of scale. This is mostly possessed by some international firms leading to an advantage over other firms, which governments should control. The theory was an advancement of the foreign investment theory as it includes imperfect competition into its explanations.
This theory focuses on firm’s internationalization and how firms can use their internal organizational design to expand or to interact with the outside environment. Institutional approach, which is emphasized in this theory helps in effective and efficient operations of MNEs. This is advancement from the previous theories since it included the internal structure into the explanations of internationalization.
Dunning’s Electric Paradigm Theory
This theory, which was recently developed and holds that the most important thing in international trade as the organizational structure especially because costs in a free market can be more than the internal costs. Other techniques such as trademark, entrepreneurship skills are also viewed as important when it comes to FDI. Location and internalization advantages of a firm also increase its advantage since they help firms in competing more.
In conclusion, globalization increased nations’ ability to trade with one another. This also increased the need for scholars to explain how this trade can be enhanced using international trade theories. The earliest of these theories can be traced in the 16th century with Mercantilism Theory being on the list of the oldest theory of international trade. Since then, other theorists have tried to explain about the reason why nations trade and how this trade is conducted. Advanced theories have been developed with subsequent theories being an improvement of the past theories. Mercantilism Theory, for example was succeeded by the Absolute Advantage Principle, which dealt with the shortcomings of Mercantilism as it restricted imports. This second theory was then replaced by the Comparative Advantage Principle, which though emphasizing on free trade like the previous theory viewed mutual gain as being important in this case. The analysis of subsequent trade theories reveals the same trend as more advanced ideas were developed in order to explain the need for international trade. Through this analysis, it is clear that there is no theory that is sufficient enough to explain the whole phenomenon of international trade. Instead, increased trade and increased globalization leads to developments of new theories to explain how nations can increase trade and how they can benefit from this trade. Therefore, the evolution of international trade theory can be considered as an ongoing process with more theories still expected.