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Theories of International Trade,
Tariff and Non-tariff barriers and
Trade Blocks
International Business Management




                          Mrs. Charu Rastogi Asst. Prof.
Agenda
 Theories of International Trade
 Tariff & Non-tariff Barriers
 Trade Blocks




                       Mrs. Charu Rastogi Asst. Prof.
Adam Smith
Ricardo
Ohlin & Heckscher

THEORIES OF
INTERNATIONAL TRADE




                    Mrs. Charu Rastogi Asst. Prof.
Evolution of Trade Theories
 Mercantilism
 Absolute advantage (Classical)
 Comparative advantage
 Factor Proportions Trade
 International Product Cycle
 New Trade Theory
 National competitive advantage




                             Mrs. Charu Rastogi Asst. Prof.
Mercantilism: mid-16th century

   Theory assumes that a nation‟s wealth
    depends on accumulated treasure
    ◦ Gold and silver are the currency of trade
 Therefore, this theory holds that nations
  should accumulate financial wealth, in the
  form of gold or silver by encouraging
  exports and discouraging imports
 Theory says you should have a trade
  surplus.
    ◦ Maximize export through subsidies.
    ◦ Minimize imports through tariffs and quotas
   Flaw: restrictions, impaired growth
                                Mrs. Charu Rastogi Asst. Prof.
Assumptions of Absolute Advantage
and Comparative Advantage
Theories 2 commodity model
 2 countries,
   Labor as the only input
   Single currency assumed thereby eliminating
    effects of exchange rate changes
   Homogeneous factors of production – All
    labor units are of same type. They can be
    freely moved from production of cloth to
    production of bread and vice versa. i.e. No
    specialized labor.
   Units of production are divisible in compact
    units.
   All factors of production are fully employed.
   No government restrictions on freeAsst. Prof.
                               Mrs. Charu Rastogi trade
Theory of absolute advantage
   Adam Smith: Wealth of Nations (1776) argued:
    ◦ A country should produce only goods where it is most
      efficient, and trade for those goods where it is not efficient
    ◦ Export those goods and services for which a country is
      more productive than other countries
    ◦ Import those goods and services for which other countries
      are more productive than it is
   Trade between countries is, therefore, beneficial
   Assumes there is an absolute balance among
    nations




                                        Mrs. Charu Rastogi Asst. Prof.
Theory of absolute advantage
   … destroys the mercantilist idea since there are
    gains to be had by both countries party to an
    exchange
   … questions the objective of national governments
    to acquire wealth through restrictive trade policies
   … measures a nation‟s wealth by the living
    standards of its people




                                 Mrs. Charu Rastogi Asst. Prof.
Theory of absolute advantage
      PPF – Production Possibility
      Frontier




                 Ghan
                 a




                           South
                           Korea




                              Mrs. Charu Rastogi Asst. Prof.
Absolute Advantages and Gains
from Trade




Assume total amount of resources at 200. In the absence of trade resource is used
                                                     Mrs. Charu Rastogi Asst. Prof.
equally for both products; 100 for cocoa and 100 for Ghana
Mrs. Charu Rastogi Asst. Prof.
Mrs. Charu Rastogi Asst. Prof.
Mrs. Charu Rastogi Asst. Prof.
Criticism of Absolute Cost
Advantage Theory
 Most of the criticisms from absolute
  advantage theory would arise because of the
  unrealistic nature of its assumptions.
 However, an important incompleteness in the
  theory was the fact that it addressed only a
  situation wherein one country enjoyed an
  absolute advantage in production of a
  commodity over another country. It was
  pointed out that such situations are rare.
 Quite often the advantage is not an absolute
  advantage but a comparative one as would
  be clear from the Ricardian Theory of
  Comparative Cost Advantage.

                           Mrs. Charu Rastogi Asst. Prof.
Theory of comparative
               advantage
   David Ricardo: Principles of Political Economy
    (1817)
    ◦ Extends free trade argument
    ◦ Efficiency of resource utilization leads to more
      productivity
    ◦ Should import even if country is more efficient in
      the product‟s production than country from which
      it is buying.
   Produce and export those goods and services for
    which it is relatively more productive than other
    countries
   Import those goods and services for which other
    countries are relatively more productive than it is
   Makes better use of resourcesrs. Charu Rastogi Asst. Prof.
                                   M
Theory of comparative
advantage
       PPF – Production Possibility
       Frontier



                        Ghan
                        a




                                            South
                                            Korea




                               Mrs. Charu Rastogi Asst. Prof.
Comparative Advantage and Gains
               from Trade

100-100
for both
products


SK:100-
100
Ghana:
150 for
Cocoa
and 50 for
Rice




             Assume total amount of resources at 200. In the absenceMrs. Charu Rastogi Asst. Prof.equally for
                                                                    of trade resource is used
             both products; 100 for cocoa and 100 for Ghana
Limitation of Comparative
Advantage Theory
 Driven only by maximization of production and
  consumption
 Only 2 countries engaged in production and
  consumption of just 2 goods?
 What about the transportation costs?
 Only resource – labour (that too, non-transferable)
 No consideration for „learning theory‟




                               Mrs. Charu Rastogi Asst. Prof.
Mrs. Charu Rastogi Asst. Prof.
Comparative advantage:
Bollywood




                 Mrs. Charu Rastogi Asst. Prof.
Mrs. Charu Rastogi Asst. Prof.
Mrs. Charu Rastogi Asst. Prof.
Factor proportions theory
   Heckscher (1919) - Olin (1933) Theory
   Export goods that intensively use factor
    endowments which are locally abundant
    ◦ Corollary: import goods made from locally scarce
      factors
       Note: Factor endowments can be impacted by
       government policy - minimum wage
   Patterns of trade are determined by differences in
    factor endowments - not productivity
   Remember, focus on relative advantage, not
    absolute advantage




                                   Mrs. Charu Rastogi Asst. Prof.
Factor proportions theory
   … trade theory holding that countries produce and
    export those goods that require resources (factors)
    that are abundant (and thus cheapest) and import
    those goods that require resources that are in short
    supply
   Example:
    ◦ Australia – lot of land and a small population (relative to its
      size)
    ◦ So what should it export and import?




                                         Mrs. Charu Rastogi Asst. Prof.
Factor Proportions Trade Theory:
Considers Two Factors of Production


          Labor




          Capital



                     Mrs. Charu Rastogi Asst. Prof.
Factor Proportions Trade Theory

    A country that is relatively labor abundant should
    specialize in the production and export of that
    product which is relatively labor intensive
   A country that is relatively capital abundant should
    specialize in the production and export of that
    product which is relatively capital intensive
   A country will have a comparative advantage in
    producing products that intensively use resources
    (factors of production) it has in abundance
    ◦ China: labor
    ◦ Saudi Arabia: oil
    ◦ Argentina: wheat


                                  Mrs. Charu Rastogi Asst. Prof.
Tariff and Non-Tariff Barriers, Trade Blocks

TRADE BARRIERS




                            Mrs. Charu Rastogi Asst. Prof.
Trade Barriers
 Countries use protectionist measures to shield a
  country‟s markets from intrusion by foreign competition
  and imports
 Protectionism is implemented through the imposition of
  trade barriers, which include tariff barriers and non-tariff
  barriers
 Reasons for protectionism:
    ◦   Maintain employment and reduce unemployment
    ◦   Increase of business size
    ◦   Retaliation and bargaining
    ◦   Protection of the home market
    ◦   Need to keep money at home
    ◦   Encouragement of capital accumulation
    ◦   Maintenance of the standard of living and real wages
    ◦   Conservation of natural resources
    ◦   Protection of an infant industry
    ◦   Industrialization of a low-wage nation
    ◦   National defense
                                         Mrs. Charu Rastogi Asst. Prof.
Tariff
   Tariff in international trade refers to the duties or
    taxes imposed on the import traded goods when
    they cross the national borders.
   Different rate of duty for different goods
   Customs Tariff Structure for 2012-13:
    http://www.cbec.gov.in/customs/cst2012-
    13/cst1213-idx.htm
   Example: There is a 100% duty on importing
    private cars/vehicles




                                   Mrs. Charu Rastogi Asst. Prof.
Non-Tariff Barriers
A form of restrictive trade where barriers to trade are set
    up and take a form other than a tariff. Forms of NTBs
 Specific Limitations on Trade:
  ◦       Quotas
           sets a physical limit on the quantity of a good that can be imported into a
            country in a given period of time
           Example: Russia has quotas on the number of tons of beef (315,000) and
            chicken (1.05 million) that can be imported each year. If the quotas are
            reached, the state then charges an additional 60-80% tax.
  ◦       Import Licensing requirements
           Each license specifies the volume of imports allowed, and the total volume
            allowed should not exceed the quota. Licenses can be sold to importing
            companies at a competitive price, or simply a fee.
  ◦       Proportion restrictions of foreign to domestic goods (local
          content requirements)
  ◦       Minimum import price limits
  ◦       Embargoes
           An embargo is the partial or complete prohibition of commerce and trade
            with a particular country, in order to isolate it.


                                                   Mrs. Charu Rastogi Asst. Prof.
Non-Tariff Barriers
       Customs and Administrative Entry Procedures:
    ◦      Valuation systems
    ◦      Antidumping practices
    ◦      Tariff classifications
        ◦ a classification assigned by government officials that affects the size of a
          tariff and the imposition of import quotas.
        ◦ Example: The U.S. Customs Service only charges an 8.5% tariff on
          imported leather or “non rubber” shoes, while it charges anywhere from
          20-67% for imported rubber shoes like athletic footwear or waterproof
          shoes
    ◦      Documentation requirements
    ◦      Fees
       Standards:
    ◦      Standard disparities
    ◦      Intergovernmental acceptances of testing methods and
           standards
    ◦      Packaging, labeling, and marking

                                                    Mrs. Charu Rastogi Asst. Prof.
Non-Tariff Barriers
       Government Participation in Trade:
    ◦       Government procurement policies
    ◦       Export subsidies
    ◦       Countervailing duties
             A duty placed on imported goods that are being subsidized by the
              importing government
    ◦       Domestic assistance programs
       Charges on imports:
    ◦       Prior import deposit subsidies
    ◦       Administrative fees
    ◦       Special supplementary duties
    ◦       Import credit discriminations
    ◦       Variable levies
    ◦       Border taxes
       Others:
    ◦       Voluntary export restraints
    ◦       Orderly marketing agreements

                                                    Mrs. Charu Rastogi Asst. Prof.
Trade Blocks
 A trade block is a type of intergovernmental
  agreement, often part of a regional
  intergovernmental organization, where regional
  barriers to trade, (tariffs and non-tariff barriers) are
  reduced or eliminated among the participating
  states
 Criteria for formation of Regional Trade Blocks –
    ◦ Neighboring countries
    ◦ Similar resource endowments and production structures – and
      hence possibility of cartelization in International market for buying
      / selling
                                    OR
    ◦ High degree of mutual dependence – hence large gains through
      mutual free trade
    ◦ Political will                        Mrs. Charu Rastogi Asst. Prof.
Major Trade Blocks
   European Union (EU)
   North American Free Trade Agreement (NAFTA)
   Singapore American Free Trade Agreement
    (SAFTA)
   Organization of Petroleum Exporting Countries
    (OPEC)
   Association of South East Asian Nations (ASEAN)
   South Asian Association of Regional Co-operation
    (SAARC)




                               Mrs. Charu Rastogi Asst. Prof.
Levels of integration
                    • Special Tariffs
Trade Concessions   • Relaxation in NTBs
                    • Only for select commodities and services


                    • Complete removal of restrictions on movement of
 Free Trade Area      goods
                    • Quite often leading to Customs Union


                    • Adoption of common standards – environment,
 Common Market        labor, etc.
                    • Common external trade policy


                    • Common Economic Policy
 Economic Union     • Common Currency and Monetary Policy
                    • Free movement of factors


                    • Common Governing Body
  Political Union   • Common Laws



                                      Mrs. Charu Rastogi Asst. Prof.
Possible Questions
   Theories of International Trade
   Explain Adam Smith‟s theory of absolute
    advantage. How does Ricardo‟s theory of
    comparative advantage differ from theory of
    absolute advantage ?
   Explain the concept of trade barriers. What are
    different types of tariff and nontariff barriers?
   Explain the term Globalisation. Discuss various
    stages in Globalisation.
   What are the barriers to international trade ? List
    and explain all the types of barriers to international
    trade.
                                   Mrs. Charu Rastogi Asst. Prof.
Mrs. Charu Rastogi Asst. Prof.

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2. Theories of International Trade, Tariff and Non-tariff barriers and Trade Blocks

  • 1. Theories of International Trade, Tariff and Non-tariff barriers and Trade Blocks International Business Management Mrs. Charu Rastogi Asst. Prof.
  • 2. Agenda  Theories of International Trade  Tariff & Non-tariff Barriers  Trade Blocks Mrs. Charu Rastogi Asst. Prof.
  • 3. Adam Smith Ricardo Ohlin & Heckscher THEORIES OF INTERNATIONAL TRADE Mrs. Charu Rastogi Asst. Prof.
  • 4. Evolution of Trade Theories  Mercantilism  Absolute advantage (Classical)  Comparative advantage  Factor Proportions Trade  International Product Cycle  New Trade Theory  National competitive advantage Mrs. Charu Rastogi Asst. Prof.
  • 5. Mercantilism: mid-16th century  Theory assumes that a nation‟s wealth depends on accumulated treasure ◦ Gold and silver are the currency of trade  Therefore, this theory holds that nations should accumulate financial wealth, in the form of gold or silver by encouraging exports and discouraging imports  Theory says you should have a trade surplus. ◦ Maximize export through subsidies. ◦ Minimize imports through tariffs and quotas  Flaw: restrictions, impaired growth Mrs. Charu Rastogi Asst. Prof.
  • 6. Assumptions of Absolute Advantage and Comparative Advantage Theories 2 commodity model  2 countries,  Labor as the only input  Single currency assumed thereby eliminating effects of exchange rate changes  Homogeneous factors of production – All labor units are of same type. They can be freely moved from production of cloth to production of bread and vice versa. i.e. No specialized labor.  Units of production are divisible in compact units.  All factors of production are fully employed.  No government restrictions on freeAsst. Prof. Mrs. Charu Rastogi trade
  • 7. Theory of absolute advantage  Adam Smith: Wealth of Nations (1776) argued: ◦ A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient ◦ Export those goods and services for which a country is more productive than other countries ◦ Import those goods and services for which other countries are more productive than it is  Trade between countries is, therefore, beneficial  Assumes there is an absolute balance among nations Mrs. Charu Rastogi Asst. Prof.
  • 8. Theory of absolute advantage  … destroys the mercantilist idea since there are gains to be had by both countries party to an exchange  … questions the objective of national governments to acquire wealth through restrictive trade policies  … measures a nation‟s wealth by the living standards of its people Mrs. Charu Rastogi Asst. Prof.
  • 9. Theory of absolute advantage PPF – Production Possibility Frontier Ghan a South Korea Mrs. Charu Rastogi Asst. Prof.
  • 10. Absolute Advantages and Gains from Trade Assume total amount of resources at 200. In the absence of trade resource is used Mrs. Charu Rastogi Asst. Prof. equally for both products; 100 for cocoa and 100 for Ghana
  • 11. Mrs. Charu Rastogi Asst. Prof.
  • 12. Mrs. Charu Rastogi Asst. Prof.
  • 13. Mrs. Charu Rastogi Asst. Prof.
  • 14. Criticism of Absolute Cost Advantage Theory  Most of the criticisms from absolute advantage theory would arise because of the unrealistic nature of its assumptions.  However, an important incompleteness in the theory was the fact that it addressed only a situation wherein one country enjoyed an absolute advantage in production of a commodity over another country. It was pointed out that such situations are rare.  Quite often the advantage is not an absolute advantage but a comparative one as would be clear from the Ricardian Theory of Comparative Cost Advantage. Mrs. Charu Rastogi Asst. Prof.
  • 15. Theory of comparative advantage  David Ricardo: Principles of Political Economy (1817) ◦ Extends free trade argument ◦ Efficiency of resource utilization leads to more productivity ◦ Should import even if country is more efficient in the product‟s production than country from which it is buying.  Produce and export those goods and services for which it is relatively more productive than other countries  Import those goods and services for which other countries are relatively more productive than it is  Makes better use of resourcesrs. Charu Rastogi Asst. Prof. M
  • 16. Theory of comparative advantage PPF – Production Possibility Frontier Ghan a South Korea Mrs. Charu Rastogi Asst. Prof.
  • 17. Comparative Advantage and Gains from Trade 100-100 for both products SK:100- 100 Ghana: 150 for Cocoa and 50 for Rice Assume total amount of resources at 200. In the absenceMrs. Charu Rastogi Asst. Prof.equally for of trade resource is used both products; 100 for cocoa and 100 for Ghana
  • 18. Limitation of Comparative Advantage Theory  Driven only by maximization of production and consumption  Only 2 countries engaged in production and consumption of just 2 goods?  What about the transportation costs?  Only resource – labour (that too, non-transferable)  No consideration for „learning theory‟ Mrs. Charu Rastogi Asst. Prof.
  • 19. Mrs. Charu Rastogi Asst. Prof.
  • 20. Comparative advantage: Bollywood Mrs. Charu Rastogi Asst. Prof.
  • 21. Mrs. Charu Rastogi Asst. Prof.
  • 22. Mrs. Charu Rastogi Asst. Prof.
  • 23. Factor proportions theory  Heckscher (1919) - Olin (1933) Theory  Export goods that intensively use factor endowments which are locally abundant ◦ Corollary: import goods made from locally scarce factors  Note: Factor endowments can be impacted by government policy - minimum wage  Patterns of trade are determined by differences in factor endowments - not productivity  Remember, focus on relative advantage, not absolute advantage Mrs. Charu Rastogi Asst. Prof.
  • 24. Factor proportions theory  … trade theory holding that countries produce and export those goods that require resources (factors) that are abundant (and thus cheapest) and import those goods that require resources that are in short supply  Example: ◦ Australia – lot of land and a small population (relative to its size) ◦ So what should it export and import? Mrs. Charu Rastogi Asst. Prof.
  • 25. Factor Proportions Trade Theory: Considers Two Factors of Production  Labor  Capital Mrs. Charu Rastogi Asst. Prof.
  • 26. Factor Proportions Trade Theory  A country that is relatively labor abundant should specialize in the production and export of that product which is relatively labor intensive  A country that is relatively capital abundant should specialize in the production and export of that product which is relatively capital intensive  A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance ◦ China: labor ◦ Saudi Arabia: oil ◦ Argentina: wheat Mrs. Charu Rastogi Asst. Prof.
  • 27. Tariff and Non-Tariff Barriers, Trade Blocks TRADE BARRIERS Mrs. Charu Rastogi Asst. Prof.
  • 28. Trade Barriers  Countries use protectionist measures to shield a country‟s markets from intrusion by foreign competition and imports  Protectionism is implemented through the imposition of trade barriers, which include tariff barriers and non-tariff barriers  Reasons for protectionism: ◦ Maintain employment and reduce unemployment ◦ Increase of business size ◦ Retaliation and bargaining ◦ Protection of the home market ◦ Need to keep money at home ◦ Encouragement of capital accumulation ◦ Maintenance of the standard of living and real wages ◦ Conservation of natural resources ◦ Protection of an infant industry ◦ Industrialization of a low-wage nation ◦ National defense Mrs. Charu Rastogi Asst. Prof.
  • 29. Tariff  Tariff in international trade refers to the duties or taxes imposed on the import traded goods when they cross the national borders.  Different rate of duty for different goods  Customs Tariff Structure for 2012-13: http://www.cbec.gov.in/customs/cst2012- 13/cst1213-idx.htm  Example: There is a 100% duty on importing private cars/vehicles Mrs. Charu Rastogi Asst. Prof.
  • 30. Non-Tariff Barriers A form of restrictive trade where barriers to trade are set up and take a form other than a tariff. Forms of NTBs  Specific Limitations on Trade: ◦ Quotas  sets a physical limit on the quantity of a good that can be imported into a country in a given period of time  Example: Russia has quotas on the number of tons of beef (315,000) and chicken (1.05 million) that can be imported each year. If the quotas are reached, the state then charges an additional 60-80% tax. ◦ Import Licensing requirements  Each license specifies the volume of imports allowed, and the total volume allowed should not exceed the quota. Licenses can be sold to importing companies at a competitive price, or simply a fee. ◦ Proportion restrictions of foreign to domestic goods (local content requirements) ◦ Minimum import price limits ◦ Embargoes  An embargo is the partial or complete prohibition of commerce and trade with a particular country, in order to isolate it. Mrs. Charu Rastogi Asst. Prof.
  • 31. Non-Tariff Barriers  Customs and Administrative Entry Procedures: ◦ Valuation systems ◦ Antidumping practices ◦ Tariff classifications ◦ a classification assigned by government officials that affects the size of a tariff and the imposition of import quotas. ◦ Example: The U.S. Customs Service only charges an 8.5% tariff on imported leather or “non rubber” shoes, while it charges anywhere from 20-67% for imported rubber shoes like athletic footwear or waterproof shoes ◦ Documentation requirements ◦ Fees  Standards: ◦ Standard disparities ◦ Intergovernmental acceptances of testing methods and standards ◦ Packaging, labeling, and marking Mrs. Charu Rastogi Asst. Prof.
  • 32. Non-Tariff Barriers  Government Participation in Trade: ◦ Government procurement policies ◦ Export subsidies ◦ Countervailing duties  A duty placed on imported goods that are being subsidized by the importing government ◦ Domestic assistance programs  Charges on imports: ◦ Prior import deposit subsidies ◦ Administrative fees ◦ Special supplementary duties ◦ Import credit discriminations ◦ Variable levies ◦ Border taxes  Others: ◦ Voluntary export restraints ◦ Orderly marketing agreements Mrs. Charu Rastogi Asst. Prof.
  • 33. Trade Blocks  A trade block is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminated among the participating states  Criteria for formation of Regional Trade Blocks – ◦ Neighboring countries ◦ Similar resource endowments and production structures – and hence possibility of cartelization in International market for buying / selling OR ◦ High degree of mutual dependence – hence large gains through mutual free trade ◦ Political will Mrs. Charu Rastogi Asst. Prof.
  • 34. Major Trade Blocks  European Union (EU)  North American Free Trade Agreement (NAFTA)  Singapore American Free Trade Agreement (SAFTA)  Organization of Petroleum Exporting Countries (OPEC)  Association of South East Asian Nations (ASEAN)  South Asian Association of Regional Co-operation (SAARC) Mrs. Charu Rastogi Asst. Prof.
  • 35. Levels of integration • Special Tariffs Trade Concessions • Relaxation in NTBs • Only for select commodities and services • Complete removal of restrictions on movement of Free Trade Area goods • Quite often leading to Customs Union • Adoption of common standards – environment, Common Market labor, etc. • Common external trade policy • Common Economic Policy Economic Union • Common Currency and Monetary Policy • Free movement of factors • Common Governing Body Political Union • Common Laws Mrs. Charu Rastogi Asst. Prof.
  • 36. Possible Questions  Theories of International Trade  Explain Adam Smith‟s theory of absolute advantage. How does Ricardo‟s theory of comparative advantage differ from theory of absolute advantage ?  Explain the concept of trade barriers. What are different types of tariff and nontariff barriers?  Explain the term Globalisation. Discuss various stages in Globalisation.  What are the barriers to international trade ? List and explain all the types of barriers to international trade. Mrs. Charu Rastogi Asst. Prof.
  • 37. Mrs. Charu Rastogi Asst. Prof.