Question

Chapter 5. Discussion Questions

PART I.

Select two of the following classical trade theories, and explain them in your own words. Use examples as necessary:

The Mercantilist View

Absolute Advantage Principle

Comparative Advantage Principle

Factor Proportions Theory

International Product Life Cycle Theory

New Trade Theory

What is National Competitive Advantage?

What is Porter’s Diamond model?

What is National Industrial Policy?

What is the Internationalization Process Model?

What are Born Globals?

What is the monopolistic theory?

What is the internalization theory?

What is Dunning’s Eclectic Paradigm?

Give examples of the non-FDI based explanation of internationalization?

Answer 1

The Mercantilist view:

Mercantilism is one of the trade theories, which was dominant in Europe during 16^th to 18^th century. Adam Smith, who is regarded as the father of Modern Economics, and the critic of mercantilism, coined the term “mercantile system” in order to define the system of economy, where the country tries to restrict the imports and tries to encourage more and more exports for increasing their wealth. Let me explain this concept in detail.

In mercantilism, the states (government) tries to restrict imports by imposing more and more tariffs and customs duties and tries to encourage exports by giving subsidies to industries, which are export oriented. In this way the economies tried to accumulate more and more gold and silver. In those days, that is during 16^th century, people believed that accumulation of gold and silver was the best way to raise the wealth and growth of an economy. The primary objective of mercantilist economy was to make the economy rich and strong by accumulating more and more of precious metals like gold and silver. They tried to achieve this objective through encouraging more and more exports. This concept of mercantilism was popular in different names in different countries in Europe. For example, in France, “Colbertism” was the name for mercantilism, which got its name from the name of the king Louie XIV’s finance minister, Colbert. Mercantilism was called as “Cameralism” in Austria and Germany. It was known as “Bullionsism” also, because it was involved with gold and silver.

There was lot of criticism on mercantilism. The main points are: It is regarded a zero sum game. Because one country gets benefitted at the cost of others. This model cannot be applied at global level. This model of trade encourages selfishness among countries as well as people. If mercantilism continues, the countries may make tit for tat policies.

Example of mercantilism:

During the British rule, England restricted India from buying goods from domestic industries and Indians were forced to buy goods from England, which were exported by England. Even salt was exported from England to India. One more example is that, in 17^th century, England made a rule that foreign vessels were not supposed to involve in coastal trade in England.

Absolute Advantage Principle:

Absolute advantage principle is theory of international trade, which was given by Adam Smith, states that, the countries with absolute advantage in producing certain goods and services must continue to produce those goods and services, because they are more efficient in that and they can specialize in that. Here, absolute advantage means the ability of an entity or an economy to produce certain goods and services at much lower cost than the production cost incurred by other countries or entities. That means the countries with absolute advantage can produce more number of goods and services than other countries with same amount of inputs.

For example, India can produce one lakh tons of rice in a year, with given amount of inputs. At the same time, UK produces only fifty thousand tons of rice in year, with same amount of inputs. Here, India has absolute advantage in producing rice that is India is giving more output with same amount of inputs. Another example, UK can produce one thousand tractors per year, and India can produce only five hundred tractors per year. In this case, UK has absolute advantage in producing tractors. So, if both the countries export the goods in which they have absolute advantage, both of the countries gain from that trade and that would be a positive sum game.

The main criticism on absolute advantage theory is that it can be applied only to the bilateral trade, and difficult to apply for multilateral trade. The assumption of free trade in case of absolute advantage theory is not possible in the real world. Ricardo criticized the concept of absolute advantage theory and he came up with new theory called comparative advantage theory, which mainly focuses on the opportunity cost of agents’ decisions on production.