Trade theories and economic development

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of our own industry.

Adam Smith

CHAPTER OUTLINE

■ Basis for international trade

0 Production possibility curve

0 Principle of absolute advantage

0 Principle of comparative/relative advantage

■ Exchange ratios, trade, and gain

■ Factor endowment theory

■ The competitive advantage of nations

■ A critical evaluation of trade theories

0 The validity of trade theories

0 Limitations and suggested refinements

■ Economic cooperation

0 Levels of economic integration

0 Economic and marketing implications

■ Conclusion

■ Case 2.1 The United States of America vs. the United States of Europe

PURPOSE OF CHAPTER

The case of Botswana illustrates the necessity of trading. Botswana must import in order to survive, and it must export in order to earn funds to meet its import needs. Botswana’s import and export needs are readily apparent; not so obvious is the need for other countries to do the same. There must be a logical explanation for well-endowed countries to continue to trade with other nations.

This chapter explains the rationale for international trade and examines the principles of absolute advan- tage and relative advantage. These principles describe what and how nations can make gains from each other. The validity of these principles is discussed, as well as concepts that are refinements of these princi- ples. The chapter also includes a discussion of factor endowment and competitive advantage. Finally, it

concludes with a discussion of regional integration and its impact on international trade.

Marketing illustration botswana: the world’s fastest-growing economy

In 1966, Botswana had only three-and-a-half miles of paved roads, and three high schools in a country of

550,000 people. Water was quite scarce and precious, leading the nation to name its currency pula, meaning rain. At the time, Botswana’s per capita income was

$80 a year.

Fast forward it to the new millennium. Botswana, one of Africa’s few enclaves of prosperity, is now a model for the rest of Africa or even the world. Its per capita income has rocketed to $6600. While the other African currencies are weak, the pula is strong – being backed by one of the world’s highest per capita reserves ($6.2 billion).

How did Botswana do it? As a land-locked nation in southern Africa that is two-thirds desert, Botswana is a trader by necessity, but, as the world’s fastest growing economy, Botswana is a trader by design. Instead of being tempted by its vast diamond wealth

that could easily lead to short-term solutions, the

peaceful and democratic Botswana has adhered to free-market principles. Taxes are kept low. There is no nationalization of any businesses, and property rights are respected.

According to the World Bank’s World Develop- ment Indicators (which reports on the world’s eco- nomic and social health), the fastest growing economy over the past three decades is not in East Asia but in Africa. Since 1966, Botswana has outperformed all the others. Based on the average annual percentage growth of the GDP per capita, Botswana grew by

9.2 Percent. South Korea is the second fastest per- former, growing at 7.3 percent. China came in third at 6.7 percent.

Sources: “World’s Fastest Growing Economy Recorded in Africa, “ Bangkok Post, April 18, 1998; and “Lessons from the Fastest-Growing Nation: Botswana?” Business Week, August 26, 2002, 116ff.

Basis for international trade

Whenever a buyer and a seller come together, each expects to gain something from the other. The same expectation applies to nations that trade with each other. It is virtually impossible for a country to be

completely self-sufficient without incurring undue costs.Therefore, trade becomes a necessary activity, though, in some cases, trade does not always work to the advantage of the nations involved. Virtually all governments feel political pressure when they experience trade deficits. Too much emphasis is

often placed on the negative effects of trade, even though it is questionable whether such perceived disadvantages are real or imaginary. The benefits of trade, in contrast, are not often stressed, nor are they well communicated to workers and consumers.

Why do nations trade? A nation trades because it expects to gain something from its trading partner. One may ask whether trade is like a zero-sum game, in the sense that one must lose so that another will gain.The answer is no, because, though one does not mind gaining benefits at someone else’s expense, no one wants to engage in a transaction that includes a high risk of loss. For trade to take place, both nations must anticipate gain from it. In other words, trade is a positive-sum game. Trade is about “mutual gain.”

In order to explain how gain is derived from trade, it is necessary to examine a country’s pro- duction possibility curve. How absolute and relative advantages affect trade options is based on the trading partners’ production possibility curves.