ECS3702 - INTERNATIONAL TRADE
1 INTRODUCTION 4.5.4 Empirical Relevance.
1.1 Introduction 4.6 Empirical Tests of the Heckscher-Ohlin Model.
1.2 The globalization of the world economy 4.6.1 The Leontief Paradox.
1.3 International trade and the nation’s standard of living 4.6.2 Explanations of the Leontief paradox and Other Empirical Tests of the
1.4 South Africa in world trade H-O Model
1.5 International economic theories and policies 4.6.3 Factor Intensity Reversal
1.6 Current international economic problems and challenges 4.7 Criticisms of the factor proportions theory
4.8 Alternative theories of trade
2 WHY NATIONS TRADE: THE CLASSICAL THEORY 4.8.1 International Trade and Economies of scale
2.1 Introduction 4.8.2 International Trade and Imperfect Competition
2.2 Mercantilists’ views on trade 4.8.3 Trade based on dynamic technological differences
2.3 Classical theorists 4.8.31 The Technological Gap Model
2.3.1 Trade based on absolute advantage (Adam Smith) 4.8.3.2 The Product Cycle Model
2.3.2 Illustration of Absolute Advantage.
2.3.3 Ricardian theory of comparative advantage (David Ricardo) 5 TARIFF AND NONTARIFF BARRIERS TO TRADE
2.3.4 Equal advantage. 5.1 Introduction
2.4 Gains from Trade 5.2 Tariffs
2.5 Comparative advantage and opportunity costs. 5.2.1 Specific and ad valorem tariffs
2.5.1 Comparative Advantage and the Labour Theory of Value 5.2.2 Partial Equilibrium Analysis of a Tariff.
2.5.2 The Opportunity Cost Theory. 5.3 The Optimum Tariff
2.5.3 The Production Possibility Frontier under Constant Costs 5.4 The rate of Effective Protection
2.5.4 Opportunity Costs and Relative Commodity Prices 5.5 Nontariff barriers to trade
2.6 The basis for and the gains from trade under constant costs. 5.5.1 Import quotas
2.6.1 An illustration of the Gains from Trade. 5.5.2 Other Nontariff Barriers
2.7 Empirical tests of the Ricardian model. 5.6 Arguments for protection.
2.8 Criticisms of the classical theory
6 TRADE LIBERALISATION AND ECONOMIC INTEGRATION
3 THE STANDARD THEORY OF INTERNATIONAL TRADE 6.1 International and regional approaches to free trade
3.1 Introduction 6.2 The international approach and the WTO
3.2 The production frontier with increasing costs 6.3 The regional approach
3.3 Community indifference curves
3.4 Equilibrium in isolation 7 DIRECT FOREIGN INVESTMENT AND MULTI-NATIONAL CORPORATIONS
3.5 The basis for and the gains from trade with increasing costs 7.1 Mobility of the factors of production
3.5.1 Illustrations of the basis for and the gains from trade with increasing 7.2 Motives for international capital flows
costs 7.3 Welfare effects of international capital flows
3.5.2 The gains from exchange and from specialization 7.3.1 Effects on the Investing and host countries
7.3.2 Other Effects on the Investing and host countries
4 THE BASIS OF TRADE: THE FACTOR PROPORTIONS THEORY 7.4 Multinational corporations
4.1 Introduction 7.4.1 Reasons for the existence of Multinational Corporations
4.2 Assumptions of the theory 7.4.2 Problems created by Multinational Corporations in the Home and
4.2.1 Basic assumptions host Countries.
4.2.2 Meaning of the assumptions
4.3 Factor intensity, factor abundance, and the shape of the production
frontier
4.3.1 Concept of factor intensity.
4.3.2 Concept of Factor Abundance.
4.3.3 Factor Abundance and the Production Frontier
4.4 Factor endowments and the factor proportions theory
4.4.1 The Heckscher-Ohlin Theorem
4.4.2 Illustration of the Heckscher-Ohlin Theory.
4.5 Factor - price equalization and income distribution.
4.5.1 The Factor price Equalisation Theorem.
4.5.2 Effect of trade on the Distribution of Income: The Stolper-Samuelson
Theorem.
4.5.3 The Specific-Factors Model.
H.Crassas – 2015 – ECS3702 - International Trade Page 1
,ECS3702 - INTERNATIONAL TRADE
STUDY UNIT 1 – INTRODUCTION
1.1 INTRODUCTION
International economics concerns the exchange of goods, services, factors of production and capital across national
boundaries. We focuses on the flows of goods, services, labour and direct foreign investment between countries. The module
in international finance examines the exchange of financial assets and liabilities and the monetary aspects of international
economics.
In both international and domestic trade, voluntary exchanges of goods and services increase the economic welfare of the
parties concerned, whether they be individuals, companies or countries. The fundamental proposition of all trade is that
voluntary trade is mutually beneficial. There are a number of important differences between domestic and international trade.
• Goods in different sovereign countries are priced in different national currencies. Thus the exchange of goods and
services between countries also requires the exchange of different national currencies.
• Governments can impose a wide range of commercial policies on imports and exports of goods and services which are
absent from domestic trade.
1.2 THE GLOBALIZATION OF THE WORLD ECONOMY
Globalization in 1870-1914 resulted from the Industrial Revolution in Europe and the opening up of new, resource-rich, but
sparsely populated lands in North America (the United States and Canada), South America (Argentina. Chile, and Uruguay),
Australia and New Zealand, and South Africa. These lands received millions of immigrants and vast amounts of foreign
investments, principally from England, to open up new lands to food and raw material production. This period of modern
globalization came to an end with the breakout of World War 1 in 1914.
The second period of rapid globalization started with the end of World War II in 1945 and extended to about 1980. It was
characterized by the rapid increase of international trade as a result of the dismantling of the heavy trade protection that had
been put in place during the Great Depression that started in the United States in 1929 and during World War II.
As all revolutions, however, today's globalization brings many benefits and advantages but also has some disadvantages;
• Although labor migration generally leads to the more efficient utilization of labor, it also leads to job losses and lower
wages for less-skilled labor in advanced nations and harms ("brain drain") the nations of emigration.
• Financial globalization and unrestricted capital flows lead to the more efficient use of capital throughout the world, as
well as provide opportunities for higher returns and risk diversification for individuals and corporations. But they also
seem to lead to periodic international financial crises.
• Finally, are we running out of resources such as petroleum, other minerals, water? Is the world headed for a climate
disaster?
Globalization is being blamed for world poverty and child labor in poor countries, job losses and lower wages in rich countries,
as well as environmental pollution and climate change throughout the world. Globalization has many social, political, legal, and
ethical aspects, and so economists need to work closely with other social and physical scientists, as well as with the entire civil
society, to give globalization a more human face. Globalization is important because it increases efficiency in the production of
material things; it is inevitable because we cannot hide or run away from it.
1.3 INTERNATIONAL TRADE AND THE NATION’S STANDARD OF LIVING
A rough measure of the economic relationship among nations, or their interdependence, is given by the ratio of their imports
and exports of goods and services to their gross domestic product (GDP). The GDP refers to the total value of all goods and
services produced in the nation in a year.
The United States relies to a relatively small extent on international trade. First of all, there are many commodities—coffee,
bananas, cocoa, tea, scotch, cognac—that the country does not produce at all and it has no deposits of such minerals as tin,
tungsten, and chromium, which are important to certain industrial processes, and it has only dwindling reserves of petroleum,
copper, and many other minerals.
H.Crassas – 2015 – ECS3702 - International Trade Page 2
,Much more important quantitatively for the nation's standard of living are the many products that are produced domestically
but at a higher cost than abroad. We will see later that these account for most of the benefits or gains from trade.
In general, the economic interdependence among nations has been increasing over the years, as measured by the more rapid
growth of world trade than world production but there are many other crucial ways in which nations are interdependent, so
that economic events and policies in one nation significantly affect other nations (and vice versa). For example, if the United
States stimulates its economy, increasing demand for goods and services, which stimulate the economies of other nations that
export those commodities.
Finally, trade negotiations that reduce trade barriers across nations may lead to an increase in the exports of high-technology
goods and thus to an increase in employment and wages in those industries in the United States, but also to an increase in
imports of shoes and textiles, thereby reducing employment and wages in those sectors.
1.4 SOUTH AFRICA IN WORLD TRADE
South Africa, with an index of openness exceeding 20 percent, is a relatively open economy. However, the index declined
between 1985 and 1994. The index measures exports as a percentage of GDP. During the 1980s, South Africa suffered severe
international sanctions. Trade sanctions did not, however, affect the volume of exports significantly as South Africa remained
the most important and reliable supplier of precious and base metals and minerals.
Of far greater concern were financial sanctions. South Africa experienced large-scale capital flight and relatively low economic
growth over this period. To finance the outflow of capital, the country was compelled to reduce imports by imposing restrictive
monetary and fiscal policies, which led to slow growth. Exports in 1985 were thus high relative to GDP, which was reflected in a
high index of openness. By 1994, while exports continued to grow, the economy grew even more rapidly as financial sanctions
were removed and foreign capital flowed into the country. Above-average growth in South African exports coupled with
sluggish GDP growth pushed the index significantly higher, to about 27 percent in 2001.
The gravity model postulates that the bilateral trade between two countries is proportional, or positively related, to the
product of the two countries’ GDPs and to be smaller the greater the distance between the two countries. That is, the larger
and the closer the two countries are, the larger the volume of trade between them is expected to be.
The United Kingdom, Japan, the United States and Germany have been South Africa's main trading partners for some time,
although not always in that order. More recently, South Africa has increased its imports from China. South Africa got more than
40 percent of its imports from these five countries and sent more than 40 percent of its exports to them. As regards trading
blocs, South Africa sent more than 34 percent of its exports to the European Union.
Since the mid-1980s, the US has diminished while the EU has increased in importance as regards trade with South Africa.
Another important trend that has emerged recently is that South Africa is increasingly becoming the port of entry into Africa,
with significant amounts of imports being re-exported to other parts of Africa.
South Africa remains partly dependent on primary sector commodities for its exports, but the contribution by manufactured
and semi-processed goods has grown significantly. Unlike many developing countries which depend on the exports of a few
primary products, South Africa can be classed as a semi-industrialised country and the contribution of the industrial sector to
exports is increasing steadily, motor vehicle exports contributed about 5 percent to South Africa's exports in 2006. Machinery
and equipment are, as is to be expected for a developing economy, the most important of South Africa's imports. South Africa
also imports the bulk of its oil needs, despite having a significant oil from coal capability in Sasol.
South African imports and exports as percentages of GDP for the period 1960 to 2007 show no significant trend for both
exports and imports over the entire period. In the post 1994 period, however, an upward trend in both variables is evident.
Generally, the share of exports and imports in GDP has averaged 25 percent over the period.
H.Crassas – 2015 – ECS3702 - International Trade Page 3
, 1.5 INTERNATIONAL ECONOMIC THEORIES AND POLICIES
The purpose of economic theory in general is to predict and explain. That is. economic theory abstracts from the details
surrounding an economic event in order to isolate the few variables and relationships deemed most important in predicting
and explaining the event.
Along these lines, international economic theory usually assumes
• A two-nation, two-commodity, and two-factor world.
• No trade restrictions to begin with
• Perfect mobility of factors within the nations but no international mobility
• Perfect competition in all commodity and factor markets
• No transportation costs.
Starting with the simplifying assumptions, international economic theory examines the
• Basis for and the gains from trade
• The reasons for and the effects of trade restrictions
• Policies directed at regulating the flows of international payments and receipts
• The effects of these policies on a nation's welfare and on the welfare of other nations
• The effectiveness of macroeconomic policies under different types of international monetary systems.
The Subject Matter of International Economics
This economic and financial interdependence of nations is affected by, and in turn influences, the political, social, cultural, and
military relations among nations.
Specifically, international economics deals with international trade theory, international trade policy, the balance of payments
and foreign exchange markets, and open-economy macroeconomics.
• International trade theory analyzes the basis and the gains from trade.
• International trade policy examines the reasons for and the effects of trade restrictions.
• The balance of payments measures a nation's total receipts from and the total payments to the rest of the world,
• Foreign exchange markets are the institutional framework for the exchange of one national currency for others.
• Open-economy macroeconomics deals with the mechanisms of adjustment in balance-of-payments disequilibria
(deficits and surpluses). It analyzes the relationship between the internal and the external sectors and how they are
interrelated or interdependent with the rest of the world economy under different international monetary systems.
International trade theory and policies are the microeconomic aspects of international economics because they deal with
individual nations treated as single units and with the (relative) price of individual commodities.
On the other hand, since the balance of payments deals with total receipts and payments, as well as with adjustment and other
economic policies that affect the level of national income and the general price level of the nation, these are often referred to
as open-economy macroeconomics or international finance.
1.6 CURRENT INTERNATIONAL ECONOMIC PROBLEMS AND CHALLENGES
Economic problems and challenges being faced by the world economy. These include:
1. The deep financial and economic crisis
2. Trade protectionism in advanced countries
3. Excessive fluctuations and misalignment in exchange rates and financial crises
4. Structural imbalances in the USA, slow growth in Europe and Japan, and insufficient restructuring in transition
economies
5. Deep poverty in many developing countries
6. Resource scarcity, environmental degradation, climate change, and unsustainable development.
H.Crassas – 2015 – ECS3702 - International Trade Page 4
