Trade Economics (brief discussion)

Ricardian theory illustrates that countries without an absolute advantage can still gain through international trade based upon having a comparative advantage as long as the relative prices for goods or services are different between the two countries. In other words, even though a country is not the most efficient producer of any product or service, they can still gain by trading with another country that is more efficient, as the other country is invariable more efficient in producing one specific good or service than another. That country would gain its best comparative advantage through complete specialization, or by focusing its resources on the production of the good or service in which they are the most efficient at producing. A country can gain developmentally through trading with a country for a product that they themselves are more efficient in producing, as long as they devote their resources towards producing their single most efficient product. Additionally, the Ricardian theory illustrates that a country that is incapable of meeting global demand for their product stands to gain substantial advantages from trading their product internationally and can maximize their development. The Ricardian model demonstrates that both countries gain, however only the concentration of labor resources as they are applied to production capabilities are considered through this model. Therefore utilizing the Ricardian model, opportunity costs exist as a simple scale and only when substituting the production of one product directly for another.

Regarding international trade patterns, the Heckscher-Ohlin Theory, or H-O Theory, builds upon the Ricardian Theory of economics, but is substantially different in that it includes not only labor as a resource but also capital, where capital is a production resource, as well. The H-O theory illustrates that labor is not the only resource to consider when comparing productivity between trading partners, the H-O model introduces capital as an additional variable. Using this additional variable means that opportunity costs between products exist in an increasing arc rather than a simple scale, and that there is a optimal point of opportunity cost when considering the production of two different products. While some countries may have significant advantages in labor, other countries have significant advantages in capital, and these two resources can be traded to gain comparative advantages for those countries.

H-O models theorize commodities are traded with different relative factor endowments, where a country decides what to produce based upon a combination of which resources are most abundant and economical in terms of capital and labor. Appleyard, Field, and Cobb, describe this abundance in terms of “physical definition” as compared with “price definition”, where the “physical definition” of a country is its ratio of capital to labor where countries are either capital-abundant or a labor-abundant, and the “price definition” of a country considers the prices of capital and labor, (p. 128). Capital-abundant countries, where capital is economical, therefore naturally choose to produce those goods or services that are capital intensive to produce, while labor-abundant countries choose to produce those goods or services that are labor intensive, when labor is economical, as each country utilizes these resources efficiently and can produce more goods.
Additionally the H-O theory is elaborated by the Stolper-Samuelson theorem which considers the effects within countries, as countries continue producing and trading their abundant resources. In short, as countries continue to produce and export their goods utilizing their abundant resources, that industry realizes increased profitability, (Appleyard et al, p. 139). Consumers within these countries also benefit through their ability to purchase goods that utilize the scarcer resources for a more economical price from the countries trading partner. As time goes on, the price of the abundant commodity increases, as does the income for the producer. Producers of goods that utilize a country’s scarcer resources are necessarily disadvantaged as their incomes inevitably drop as their consumer pricing cannot effectively compete against imports of the same product from a country with abundant resources for producing this product. Due to diminished income realization producers that utilize scarce resources favor increased trade restrictions, such as tariffs or quotas, while producers that utilize abundant resources favor increased globalization.

While the H-O theory accounts for both capital and labor, it is flawed in interpreting trade between countries with abundant resources in that it does not observe all phenomena associated with international trade. This flaw is noted when observing the Leontief Paradox, where countries with high capital to labor ratios generally export product with high labor to capital ratios and import products with high capital to labor ratios. While the Leontief paradox weakens the impact of H-O theory, there are several explanations as to why this occurs. Some of these include that H-O theory doesn’t distinguish between a countries preferences for capital intensive or labor intensive goods, that different countries can produce the same product utilizing varying degrees of either capital or labor, a countries trade restrictions, differences between skilled and unskilled labor, and finally that it doesn’t consider a countries natural resources, (Appleyard et al, p. 155-160).

Finally, neither the Ricardian theory nor the H-O theory deals specifically with the individual preferences, or product differentiation, of consumers within a country. One such theory that accounts for this is the Linder theory. The Linder theory asserts that consumers in capital intensive production countries tend to prefer goods from other capital intensive countries. Additionally, Linder’s theory maintains that consumers in labor intensive countries are more likely to buy products from other labor intensive countries, and that this phenomena exists often because these countries are likely to be trading partners due to reasons beyond consumer preferences including in some part geographical location. A final observation is that due to individual consumer preferences regarding perceived value, trade tends to be bidirectional regarding goods between these countries, even if the products or services are similar, regardless of which country has the competitive advantage.



Q&A: Describe a specific tariff, an ad valorem tariff, and a compound tariff. What are the advantages and disadvantages of each?

A specific tariff is a fixed tax based upon a measurable unit of a product such as quantity or weight, thus for every predetermined unit imported the tax is incrementally increased, while an ad valorem tariff is a tax based upon the perceived value of the import at the time of trade and can be adjusted temporally according to the value of the product. There are inherent problems dealing with both a specific tariffs and ad valorem tariffs, in that the former does not account for inflation and therefore the increase in the value of the import, and the latter relies upon the perceived value of the product by both the importer and the exporter. A compound tariff is an import duty that combines features of a specific tariff and that of an ad valorem tariff. While a compound tariff can potentially combine the best features of a specific tariff and an ad valorem tariff and be considered fairer than either, it can also combine the worst feature of both and can in fact be utilized in a protectionist manner.


References:

Appleyard, D., Field, A., & Cobb, S. (2010). International economics (7th ed.). New York: McGraw-Hill Irwin.