International trade

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Global Competitiveness Index (2008-2009): competitiveness is an important determinant for the well-being of states in an international trade environment.

International trade uses a variety of currencies, the most important of which are held as foreign reserves by governments and central banks. Here the percentage of global cummulative reserves held for each currency between 1995 and 2005 are shown: the US dollar is the most sought-after currency, with the Euro in strong demand as well. International trade is exchange of capital, goods, and services across international borders or territories.[1] In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders. International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is

across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture. Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in goods and services can serve as a substitute for trade in factors of production. Instead of importing a factor of production, a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor. International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.

Ancient silk road trade routes across Eurasia.

Contents
[hide]

1 Models o 1.1 Ricardian model o 1.2 Heckscher-Ohlin model 1.2.1 Reality and Applicability of the Heckscher-Ohlin Model o 1.3 Specific factors model o 1.4 New Trade Theory o 1.5 Gravity model o 1.6 Ricardian theory of international trade (modern development) 1.6.1 Contemporary theories

1.6.2 Neo-Ricardian trade theory 1.6.3 Traded intermediate goods 1.6.4 Ricardo-Sraffa trade theory 2 Top trading nations 3 Top traded commodities (exports) 4 Regulation of international trade 5 Risk in international trade 6 Gallery 7 See also 8 Notes 9 References 10 External links o 10.1 Data 10.1.1 Official statistics 10.1.2 Other data sources
o

10.2 Other external links

[edit] Models
Several different models have been proposed to predict patterns of trade and to analyze the effects of trade policies such as tariffs.

[edit] Ricardian model

Further information: Ricardian economics

The Panama Canal is important for international sea trade between the Atlantic Ocean and the Pacific Ocean. The Ricardian model focuses on comparative advantage, perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods.

Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The main merit of Ricardian model is that it assumes technology differences between countries.[citation needed] Technology gap is easily included in the Ricardian and Ricardo-Sraffa model (See the Ricardian theory (modern development)). The Ricardian model makes the following assumptions: 1. Labor is the only primary input to production (labor is considered to be the ultimate source of value). 2. Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to scale, and simple technology.) 3. Limited amount of labor in the economy 4. Labor is perfectly mobile among sectors but not internationally. 5. Perfect competition (price-takers). The Ricardian model measures in the short-run, therefore technology differs internationally. This supports the fact that countries follow their comparative advantage and allows for specialization. For the modern development of Ricardian model, see the subsection below: Ricardian theory of international trade.

[edit] Heckscher-Ohlin model

Main article: Heckscher-Ohlin model In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the HeckscherOhlin theory. The Heckscher-Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since those theories focus on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialize production and export using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier theories stated, the goods it produces most efficiently. The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory. The theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. Empirical problems with the H-O model, known as the Leontief paradox, were exposed in empirical tests by Wassily Leontief who found that the United States tended to export labor intensive goods despite having a capital abundance.

The H-O model makes the following core assumptions: 1. Labor and capital flow freely between sectors 2. The production of shoes is labor intensive and the production of computers is capital intensive 3. The amount of labor and capital in two countries differ (difference in endowments) 4. Free trade 5. Technology is the same across countries (long-term) 6. Tastes are the same. The problem with the H-O theory is that it excludes the trade of capital goods (including materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to each country. In a modern economy, capital goods are traded internationally. Gains from trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001). [edit] Reality and Applicability of the Heckscher-Ohlin Model The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists, because it makes fewer simplifying assumptions.[citation needed] In 1953, Wassily Leontief published a study, where he tested the validity of the Heckscher-Ohlin theory.[2] The study showed that the U.S was more abundant in capital compared to other countries, therefore the U.S would export capitalintensive goods and import labour-intensive goods. Leontief found out that the U.S's export was less capital intensive than import. After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or either by new interpretations. Leamer[3] emphasized that Leontief did not interpret HO theory properly and claimed that with a right interpretation paradox did not occur. Brecher and Choudri[4] found that, if Leamer was right, the American workers consumption per head should be lower than the workers world average consumption. Many other trials followed but most of them failed.[5][6] Many famous textbook writers, including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model.[7][8] After examining the long history of empirical research, Bowen, Hollander and Viane concluded: "Recent tests of the factor abundance theory [H-O theory and its developed form into many-commodity and many-factor case] that directly examine the H-O-V equations also indicate the rejection of the theory."[8]:321 Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems. The assumptions of HO are less realistic with respect to N-S than N-N (or S-S) trade. Income differences between North and South is the one that third world cares most. The factor price equalization [a consequence of HO theory] has not shown much sign of realization. HO model assumes identical production functions between countries. This is highly unrealistic. Technological gap between developed and developing countries is the main concern of the poor countries.[9]

[edit] Specific factors model

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In this model, labor mobility between industries is possible while capital is immobile between industries in the short-run. Thus, this model can be interpreted as a 'short run' version of the Heckscher-Ohlin model. The specific factors name refers to the given that in the short-run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms; in other terms, the international trade is the biggest network on the earth. Additionally, owners of opposing specific factors of production (i.e. labor and capital) are likely to have opposing agendas when lobbying for controls over immigration of labor. Conversely, both owners of capital and labor profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade.

[edit] New Trade Theory

Main article: New Trade Theory New Trade Theory tries to explain empirical elements of trade that comparative advantage-based models above have difficulty with. These include the fact that most trade is between countries with similar factor endowment and productivity levels, and the large amount of multinational production (i.e. foreign direct investment) which exists. New Trade theories are often based on assumptions like monopolistic competition and increasing returns to scale. One result of these theories is the home-market effect, which asserts that, if an industry tends to cluster in one location because of returns to scale and if that industry has high transportation costs, the industry will be located in the country with most of its demand to minimize.

[edit] Gravity model

Main article: Gravity model of trade The Gravity model of trade presents a more empirical analysis of trading patterns rather than the more theoretical models discussed above. The gravity model, in its basic form, predicts trade based on the distance between countries and the interaction of the countries' economic sizes. The model mimics the Newtonian law of gravity which also considers distance and physical size between two objects. The model has been proven to be empirically strong through econometric analysis. Other factors such as income level, diplomatic relationships between countries.

[edit] Ricardian theory of international trade (modern development)

The Ricardian theory of comparative advantage became a basic constituent of neoclassical trade theory. Any undergraduate course in trade theory includes expansions of Ricardo's example of four numbers in for form of a two commodity, two country model. This model was expanded to many-country and many-commodity cases. Major general results were obtained by the beginning of 1960's by McKenzie[10] and Jones,[11] including his famous formula. It is a theorem about the possible trade pattern for N-country N-commoditty cases. Let aij be the labor input coefficent for a country i and for the industry j (or for the production of good j). If a trade pattern i country specialises in i industry, then the product a11 a22 ... aNN is strictly smaller than any permutation products of the form a1(1) a2(2) ... aN(N) for any perumutation except the identity permuation which transforms i onto i. [edit] Contemporary theories Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and Samuelson[12] This formulation is employed for example by Matsuyama [13] and others. These theories uses the special property which is applicable only for the two country case. [edit] Neo-Ricardian trade theory Inspired by Piero Sraffa, a new strand of trade theory emerged and was named neo-Ricardian trade theory. The main contributors include Ian Steedman (1941-) and Stanley Metcalfe (1946-). They have criticized neoclassical international trade theory, namely the Heckscher-Ohlin model on the basis that the notion of capital as primary factor has no method of measuring it before the determination of profit rate (thus trapped in a logical vicious circle).[14] This was a second round of the Cambridge capital controversy, this time in the field of international trade.[15] The merit of neo-Ricardian trade theory is that input goods are explicitly included to the analytical framework. This is in accordance with Sraffa's idea that any commodity is a product made by means of commodities. The limit of their theory is that the analysis is limited to small country cases. [edit] Traded intermediate goods Ricardian trade theory ordinarily assumes that the labor is the unique input. This is a great deficiency as trade theory, for the intermediate goods occupy the major part of the world international trade. Yeats[16] found that 30% of world trade in manufacturing is intermediate inputs. Bardhan and Jafee[17] found that intermediate inputs occupy 37 to 38% in the imports to the US for years 1992 and 1997, whereas the percentage of intrafirm trade grew from 43% in 1992 to 52% in 1997.

McKenzie[18] and Jones[19] emphasized the necessity to expand the Ricardian theory to the cases of traded inputs. In a famous comment McKenzie (1954, p. 179) pointed that "A moment's consideration will convince one that Lancashire would be unlikely to produce cotton cloth if the cotton had to be grown in England."[20] Paul Samuelson[21] coined a term Sraffa bonus to name the gains from trade of inputs. [edit] Ricardo-Sraffa trade theory John Chipman observed in his survey that McKenzie stumbled upon the questions of intermediate products and discovered that "introduction of trade in intermediate product necessitates a fundamental alteration in classical analysis."[22] It took many years until recently Y. Shiozawa[23] succeeded to remove this deficiency. The Ricardian trade theory was now constructed in a form to include intermediate input trade for the most general case of many countries and many goods. This new theory is called Ricardo-Sraffa trade theory. It is emphasized that the Ricardian trade theory now provides a general theory which includes trade of intermediates such as fuel, machine tools, machinery parts and processed materials. The traded intermediate goods are then used as inputs of productions in the importing country. Capital goods are nothing other than inputs to the productions. Thus, in the Ricardo-Sraffa trade theory, capital goods moves freely from country to country. Labor is the unique factor of production that remains immobile in the country of its origin. In a blog post of April 28, 2007, Gregory Mankiw compared Ricardian theory and HeckscherOhlin theory and stood by the Ricardian side.[24] Mankiw argued that Ricardian theory is more realistic than the Heckscher-Ohlin theory as the latter assumes that capital does not move from country to country. Mankiw's argument contains a logical slip, for the traditional Ricardian trade theory does not admit any inputs. Shiozawa's result saves Mankiw from his slip.[25] The neoclassical Heckscher-Ohlin-Samuelson theory only assumes production factors and finished goods. It contains no concept of intermediate goods. Therefore, it is the Ricardo-Sraffa trade theory that provides theoretical bases for the topics such as outsourcing, fragmentation and intrafirm trade.

[edit] Top trading nations

Main articles: List of countries by exports and List of countries by imports Rank 1 2 3 4 5 6 Country European Union (Extra-EU27) United States People's Republic of China Germany Japan France United Kingdom Exports + Imports $3,764,000,000,000 $3,173,000,000,000 $2,813,000,000,000 $2,457,000,000,000 $1,402,000,000,000 $1,086,400,000,000 $952,100,000,000 Date of information 2010 [26] 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est.

7 8 9 10 11 12 13 14 15 16 17 18 19 20

Italy South Korea Netherlands Canada Hong Kong Singapore Russia Mexico India Spain Belgium Taiwan (Republic of China) Switzerland Australia Brazil

$918,100,000,000 $884,200,000,000 $859,700,000,000 $813,200,000,000 $795,600,000,000 $666,800,000,000 $614,000,000,000 $609,000,000,000 $596,000,000,000 $592,900,000,000 $560,900,000,000 $524,800,000,000 $453,000,000,000 $411,100,000,000 $387,400,000,000

2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est. 2010 est.

Source : Exports. Imports. The World Factbook.

[edit] Top traded commodities (exports)

Rank 1 2 3 4 5 6 7 8 9 10 Commodity Mineral fuels, oils, distillation products, etc Electrical, electronic equipment Machinery, nuclear reactors, boilers, etc Vehicles other than railway, tramway Pharmaceutical products Optical, photo, technical, medical, etc apparatus Plastics and articles there of Pearls, precious stones, metals, coins, etc Organic chemicals Iron and steel Value in US$('000) $1,658,851,456 $1,605,700,864 $1,520,199,680 $841,412,992 $416,039,840 $396,337,696 $386,628,064 $320,174,080 $310,106,432 $273,024,416 Date of information 2009 2009 2009 2009 2009 2009 2009 2009 2009 2009

Source: International Trade Centre [27]

[edit] Regulation of international trade

Current members of the World Trade Organisation. Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in mercantilism most nations had high tariffs and many restrictions on international trade. In the 19th century, especially in the United Kingdom, a belief in free trade became paramount.[citation needed] This belief became the dominant thinking among western nations since then. In the years since the Second World War, controversial multilateral treaties like the General Agreement on Tariffs and Trade (GATT) and World Trade Organization have attempted to promote free trade while creating a globally regulated trade structure. These trade agreements have often resulted in discontent and protest with claims of unfair trade that is not beneficial to developing countries. Free trade is usually most strongly supported by the most economically powerful nations, though they often engage in selective protectionism for those industries which are strategically important such as the protective tariffs applied to agriculture by the United States and Europe.[citation needed] The Netherlands and the United Kingdom were both strong advocates of free trade when they were economically dominant, today the United States, the United Kingdom, Australia and Japan are its greatest proponents. However, many other countries (such as India, China and Russia) are increasingly becoming advocates of free trade as they become more economically powerful themselves. As tariff levels fall there is also an increasing willingness to negotiate non tariff measures, including foreign direct investment, procurement and trade facilitation.[citation needed] The latter looks at the transaction cost associated with meeting trade and customs procedures. Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors often support protectionism.[citation needed]This has changed somewhat in recent years, however. In fact, agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible for particular rules in the major international trade treaties which allow for more protectionist measures in agriculture than for most other goods and services. During recessions there is often strong domestic pressure to increase tariffs to protect domestic industries. This occurred around the world during the Great Depression. Many economists have attempted to portray tariffs as the underlining reason behind the collapse in world trade that many believe seriously deepened the depression. The regulation of international trade is done through the World Trade Organization at the global level, and through several other regional arrangements such as MERCOSUR in South America, the North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico,

and the European Union between 27 independent states. The 2005 Buenos Aires talks on the planned establishment of the Free Trade Area of the Americas (FTAA) failed largely because of opposition from the populations of Latin American nations. Similar agreements such as the Multilateral Agreement on Investment (MAI) have also failed in recent years.

[edit] Risk in international trade

Companies doing business across international borders face many of the same risks as would normally be evident in strictly domestic transactions. For example,

Buyer insolvency (purchaser cannot pay); Non-acceptance (buyer rejects goods as different from the agreed upon specifications); Credit risk (allowing the buyer to take possession of goods prior to payment); Regulatory risk (e.g., a change in rules that prevents the transaction); Intervention (governmental action to prevent a transaction being completed); Political risk (change in leadership interfering with transactions or prices); and War and other uncontrollable events.
Kiminori Matsuyama, A General Theory of Competitive Trade Page 2 of 45

Why Study International Economics? It is misleading to analyze the World Economy as a mere collection of the national economies, as if each of these national economies were an isolated, autonomous closed economy (which is what most nave crosscountry comparative studies assume). There are enough flows of trade, capital, and technologies between national economies. However, the integration of these national economies is far from complete, so that it would also be misleading to treat the World Economy as if it were a single closed economy. To me, the ultimate goal of international economics is to understand the working of the

World Economy, while explicitly recognizing that the World Economy consists of many semi-autonomous sub-systems (nations as well as regions) that are affecting each other. Obviously, this is a very challenging problem, so we need to make some special assumptions as a first step.

Attempts to analyze the reasons for a nation's competitive advantage in a particular industry Increasingly, corporate strategies have to be seen in a global context. Even if an organization does not plan to import or to export directly, management has to look at an international business environment, in which actions of competitors, buyers, sellers, new entrants of providers of substitutes may influence the domestic market. Information technology is reinforcing this trend. Michael Porter introduced a model that allows analyzing why some nations are more competitive than others are, and why some industries within nations are more competitive than others are, in his book The Competitive Advantage of Nations. This model of determining factors of national advantage has become known as Porters Diamond. It suggests that the national home base of an organization plays an important role in shaping the extent to which it is likely to achieve advantage on a global scale. This home base provides basic factors, which support or hinder organizations from building advantages in global competition. Porter distinguishes four determinants: Factor Conditions The situation in a country regarding production factors, like skilled labor, infrastructure, etc., which are relevant for competition in particular industries. These factors can be grouped into human resources (qualification level, cost of labor, commitment etc.), material resources (natural resources, vegetation, space etc.), knowledge resources, capital resources, and infrastructure. They also include factors like quality of research on universities, deregulation of labor markets, or liquidity of national stock markets. These national factors often provide initial advantages, which are subsequently built upon. Each country has its own particular set of factor conditions; hence, in each country will develop those industries for which the particular set of factor conditions is optimal. This explains the existence of so-called low-cost-countries (low costs of labor), agricultural countries (large countries with fertile soil), or the start-up culture in the United States (well developed venture capital market). Porter points out that these factors are not necessarily nature-made or inherited. They may develop and change. Political initiatives, technological progress or socio-cultural changes, for instance,

may shape national factor conditions. A good example is the discussion on the ethics of genetic engineering and cloning that will influence knowledge capital in this field in North America and Europe. Home Demand Conditions Describes the state of home demand for products and services produced in a country. Home demand conditions influence the shaping of particular factor conditions. They have impact on the pace and direction of innovation and product development. According to Porter, home demand is determined by three major characteristics: their mixture (the mix of customers needs and wants), their scope and growth rate, and the mechanisms that transmit domestic preferences to foreign markets. Porter states that a country can achieve national advantages in an industry or market segment, if home demand provides clearer and earlier signals of demand trends to domestic suppliers than to foreign competitors. Normally, home markets have a much higher influence on an organization's ability to recognize customers' needs than foreign markets do. Related and Supporting Industries The existence or non-existence of internationally competitive supplying industries and supporting industries. One internationally successful industry may lead to advantages in other related or supporting industries. Competitive supplying industries will reinforce innovation and internationalization in industries at later stages in the value system. Besides suppliers, related industries are of importance. These are industries that can use and coordinate particular activities in the value chain together, or that are concerned with complementary products (e.g. hardware and software). A typical example is the shoe and leather industry in Italy. Italy is not only successful with shoes and leather, but with related products and services such as leather working machinery, design, etc. Firm Strategy, Structure, and Rivalry The conditions in a country that determine how companies are established, are organized and are managed, and that determine the characteristics of domestic competition Here, cultural aspects play an important role. In different nations, factors like management structures, working morale, or interactions between companies are shaped differently. This will provide advantages and disadvantages for particular industries. Typical corporate objectives in relation to patterns of commitment among workforce are of special importance. They are heavily influenced by structures of ownership and control. Family-business based industries that are dominated by owner-managers will behave differently than publicly quoted companies. Porter argues that domestic rivalry and the search for competitive advantage within a nation can help provide organizations with bases for achieving such advantage on a more global scale. Porters Diamond has been used in various ways. Organizations may use the model to identify the extent to which they can build on home-based advantages to create competitive advantage in relation to others on a global front. On national level, governments can (and should) consider the policies that they should follow to establish national advantages, which enable industries in their country to develop a strong competitive position globally. According to Porter, governments can foster such advantages by ensuring high expectations of product performance, safety or environmental standards, or encouraging vertical co-operation between suppliers and buyers on a domestic level etc.

Read more: http://wiki.answers.com/Q/What_is_National_Competitive_Advantage_Theory_of_International_ Trade#ixzz1MmIu4cr8 Attempts to analyze the reasons for a nation's competitive advantage in a particular industry Increasingly, corporate strategies have to be seen in a global context. Even if an organization does not plan to import or to export directly, management has to look at an international business environment, in which actions of competitors, buyers, sellers, new entrants of providers of substitutes may influence the domestic market. Information technology is reinforcing this trend. Michael Porter introduced a model that allows analyzing why some nations are more competitive than others are, and why some industries within nations are more competitive than others are, in his book The Competitive Advantage of Nations. This model of determining factors of national advantage has become known as Porters Diamond. It suggests that the national home base of an organization plays an important role in shaping the extent to which it is likely to achieve advantage on a global scale. This home base provides basic factors, which support or hinder organizations from building advantages in global competition. Porter distinguishes four determinants: Factor Conditions The situation in a country regarding production factors, like skilled labor, infrastructure, etc., which are relevant for competition in particular industries. These factors can be grouped into human resources (qualification level, cost of labor, commitment etc.), material resources (natural resources, vegetation, space etc.), knowledge resources, capital resources, and infrastructure. They also include factors like quality of research on universities, deregulation of labor markets, or liquidity of national stock markets. These national factors often provide initial advantages, which are subsequently built upon. Each country has its own particular set of factor conditions; hence, in each country will develop those industries for which the particular set of factor conditions is optimal. This explains the existence of so-called low-cost-countries (low costs of labor), agricultural countries (large countries with fertile soil), or the start-up culture in the United States (well developed venture capital market). Porter points out that these factors are not necessarily nature-made or inherited. They may develop and change. Political initiatives, technological progress or socio-cultural changes, for instance, may shape national factor conditions. A good example is the discussion on the ethics of genetic engineering and cloning that will influence knowledge capital in this field in North America and Europe. Home Demand Conditions Describes the state of home demand for products and services produced in a country. Home demand conditions influence the shaping of particular factor conditions. They have impact on the pace and direction of innovation and product development. According to Porter, home demand is determined by three major characteristics: their mixture (the mix of customers needs and wants), their scope and growth rate, and the mechanisms that transmit domestic preferences to foreign markets. Porter states that a country can achieve national advantages in an industry or market segment, if home demand provides clearer and earlier signals of demand trends to domestic suppliers than to

foreign competitors. Normally, home markets have a much higher influence on an organization's ability to recognize customers' needs than foreign markets do. Related and Supporting Industries The existence or non-existence of internationally competitive supplying industries and supporting industries. One internationally successful industry may lead to advantages in other related or supporting industries. Competitive supplying industries will reinforce innovation and internationalization in industries at later stages in the value system. Besides suppliers, related industries are of importance. These are industries that can use and coordinate particular activities in the value chain together, or that are concerned with complementary products (e.g. hardware and software). A typical example is the shoe and leather industry in Italy. Italy is not only successful with shoes and leather, but with related products and services such as leather working machinery, design, etc. Firm Strategy, Structure, and Rivalry The conditions in a country that determine how companies are established, are organized and are managed, and that determine the characteristics of domestic competition Here, cultural aspects play an important role. In different nations, factors like management structures, working morale, or interactions between companies are shaped differently. This will provide advantages and disadvantages for particular industries. Typical corporate objectives in relation to patterns of commitment among workforce are of special importance. They are heavily influenced by structures of ownership and control. Family-business based industries that are dominated by owner-managers will behave differently than publicly quoted companies. Porter argues that domestic rivalry and the search for competitive advantage within a nation can help provide organizations with bases for achieving such advantage on a more global scale. Porters Diamond has been used in various ways. Organizations may use the model to identify the extent to which they can build on home-based advantages to create competitive advantage in relation to others on a global front. On national level, governments can (and should) consider the policies that they should follow to establish national advantages, which enable industries in their country to develop a strong competitive position globally. According to Porter, governments can foster such advantages by ensuring high expectations of product performance, safety or environmental standards, or encouraging vertical co-operation between suppliers and buyers on a domestic level etc.

Read more: http://wiki.answers.com/Q/What_is_National_Competitive_Advantage_Theory_of_International_ Trade#ixzz1MmIu4cr8

Comparative advantage
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In economics, the law of comparative advantage says that two countries (or other kinds of parties, such as individuals or firms) can both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods. Even if one country is more efficient in the production of all goods (absolute advantage), it can still gain by trading with a less-efficient country, as long as they have different relative efficiencies.[1][2][3] For example, if, using machinery, a worker in one country can produce both shoes and shirts at 2 per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in an hour, each country can gain from trade because their internal trade-offs between shoes and shirts are different. The less-efficient country has a comparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more-efficient country for shoes. Without trade, its cost per shoe was 2 shirts; by trading, its cost per shoe can reduce to as low as 1 shirt depending on how much trade occurs (since the more-efficient country has a 1:1 trade-off). The more-efficient country has a comparative advantage in shoes, so it can gain in efficiency by moving some workers from shirt-production to shoe-production and trading some shoes for shirts. Without trade, its cost to make a shirt was 1 shoe; by trading, its cost per shirt can go as low as 1/2 shoe depending on how much trade occurs. The net benefits to each country are called the gains from trade.

Contents
[hide]

1 Origins of the theory 2 Examples o 2.1 Example 1 o 2.2 Example 2 o 2.3 Example 3 3 Effect of trade costs 4 Effects on the economy 5 Considerations o 5.1 Development economics o 5.2 Free mobility of capital in a globalized world 6 See also 7 Notes 8 References 9 External links

Origins of the theory

Comparative advantage was first described by Robert Torrens in 1815 in an essay on the Corn Laws. He concluded it was to England's advantage to trade with Portugal in return for grain, even though it might be possible to produce that grain more cheaply in England than Portugal.

However, the concept is usually attributed to David Ricardo who explained it in his 1817 book On the Principles of Political Economy and Taxation in an example involving England and Portugal.[4] In Portugal it is possible to produce both wine and cloth with less labor than it would take to produce the same quantities in England. However the relative costs of producing those two goods are different in the two countries. In England it is very hard to produce wine, and only moderately difficult to produce cloth. In Portugal both are easy to produce. Therefore while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. Conversely England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at a lower price, closer to the cost of cloth. The conclusion drawn is that each country can gain by specializing in the good where it has comparative advantage, and trading that good for the other.

Examples
The following hypothetical examples explain the reasoning behind the theory. In Example 2 all assumptions are italicized for easy reference, and some are explained at the end of the example.

Example 1
Two men live alone on an isolated island. To survive they must undertake a few basic economic activities like water carrying, fishing, cooking and shelter construction and maintenance. The first man is young, strong, and educated. He is also faster, better, and more productive at everything. He has an absolute advantage in all activities. The second man is old, weak, and uneducated. He has an absolute disadvantage in all economic activities. In some activities the difference between the two is great; in others it is small. Despite the fact that the younger man has absolute advantage in all activities, it is not in the interest of either of them to work in isolation since they both can benefit from specialization and exchange. If the two men divide the work according to comparative advantage then the young man will specialize in tasks at which he is most productive, while the older man will concentrate on tasks where his productivity is only a little less than that of the young man. Such an arrangement will increase total production for a given amount of labor supplied by both men and it will benefit both of them.

Example 2
Suppose there are two countries of equal size, Northland and Southland, that both produce and consume two goods, food and clothes. The productive capacities and efficiencies of the countries are such that if both countries devoted all their resources to food production, output would be as follows:

Northland: 100 tonnes Southland: 400 tonnes

If all the resources of the countries were allocated to the production of clothes, output would be:

Northland: 100 tonnes Southland: 200 tonnes

Assuming each has constant opportunity costs of production between the two products and both economies have full employment at all times. All factors of production are mobile within the countries between clothes and food industries, but are immobile between the countries. The price mechanism must be working to provide perfect competition. Southland has an absolute advantage over Northland in the production of food and clothes. There seems to be no mutual benefit in trade between the economies, as Southland is more efficient at producing both products. The opportunity costs shows otherwise. Northland's opportunity cost of producing one tonne of food is one tonne of clothes and vice versa. Southland's opportunity cost of one tonne of food is 0.5 tonne of clothes, and its opportunity cost of one tonne of clothes is 2 tonnes of food. Southland has a comparative advantage in food production, because of its lower opportunity cost of production with respect to Northland, while Northland has a comparative advantage in clothes production, because of its lower opportunity cost of production with respect to Southland. To show these different opportunity costs lead to mutual benefit if the countries specialize production and trade, consider the countries produce and consume only domestically. The volumes are: Production and consumption before trade Country Food Clothes Northland 50 50 Southland 200 100 TOTAL 250 150 This example includes no formulation of the preferences of consumers in the two economies which would allow the determination of the international exchange rate of clothes and food. Given the production capabilities of each country, in order for trade to be worthwhile Northland requires a price of at least one tonne of food in exchange for one tonne of clothes; and Southland requires at least one tonne of clothes for two tonnes of food. The exchange price will be somewhere between the two. The remainder of the example works with an international trading price of one tonne of food for 2/3 tonne of clothes. If both specialize in the goods in which they have comparative advantage, their outputs will be: Production after trade Country Food Clothes Northland 0 100 Southland 300 50 TOTAL 300 150

World production of food increased. clothes production remained the same. Using the exchange rate of one tonne of food for 2/3 tonne of clothes, Northland and Southland are able to trade to yield the following level of consumption: Consumption after trade Country Food Clothes Northland 75 50 Southland 225 100 World total 300 150 Northland traded 50 tonnes of clothes for 75 tonnes of food. Both benefited, and now consume at points outside their production possibility frontiers. Assumptions in Example 2:

Two countries, two goods - the theory is no different for larger numbers of countries and goods, but the principles are clearer and the argument easier to follow in this simpler case. Equal size economies - again, this is a simplification to produce a clearer example. Full employment - if one or other of the economies has less than full employment of factors of production, then this excess capacity must usually be used up before the comparative advantage reasoning can be applied. Constant opportunity costs - a more realistic treatment of opportunity costs the reasoning is broadly the same, but specialization of production can only be taken to the point at which the opportunity costs in the two countries become equal. This does not invalidate the principles of comparative advantage, but it does limit the magnitude of the benefit. Perfect mobility of factors of production within countries - this is necessary to allow production to be switched without cost. In real economies this cost will be incurred: capital will be tied up in plant (sewing machines are not sowing machines) and labour will need to be retrained and relocated. This is why it is sometimes argued that 'nascent industries' should be protected from fully liberalised international trade during the period in which a high cost of entry into the market (capital equipment, training) is being paid for. Immobility of factors of production between countries - why are there different rates of productivity? The modern version of comparative advantage (developed in the early twentieth century by the Swedish economists Eli Heckscher and Bertil Ohlin) attributes these differences to differences in nations' factor endowments. A nation will have comparative advantage in producing the good that uses intensively the factor it produces abundantly. For example: suppose the US has a relative abundance of capital and India has a relative abundance of labor. Suppose further that cars are capital intensive to produce, while cloth is labor intensive. Then the US will have a comparative advantage in making cars, and India will have a comparative advantage in making cloth. If there is international factor mobility this can change nations' relative factor abundance. The principle of comparative advantage still applies, but who has the advantage in what can change. Negligible transport cost - Cost is not a cause of concern when countries decided to trade. It is ignored and not factored in. Before specialization, half of each country's available resources are used to produce each good.

Perfect competition - this is a standard assumption that allows perfectly efficient allocation of productive resources in an idealized free market.

Example 3
The economist Paul Samuelson provided another well known example in his Economics. Suppose that in a particular city the best lawyer happens also to be the best secretary, that is he would be the most productive lawyer and he would also be the best secretary in town. However, if this lawyer focused on the task of being a lawyer and, instead of pursuing both occupations at once, employed a secretary, both the output of the lawyer and the secretary would increase, as it is more difficult to be a lawyer than a secretary.

Effect of trade costs

Trade costs, particularly transportation, reduce and may eliminate the benefits from trade, including comparative advantage. Paul Krugman gives the following example.[5] Using Ricardo's classic example: Unit labor costs Cloth Wine Britain 100 110 Portugal 90 80 In the absence of transportation costs, it is efficient for Britain to produce cloth, and Portugal to produce wine, as, assuming that these trade at equal price (1 unit of cloth for 1 unit of wine) Britain can then obtain wine at a cost of 100 labor units by producing cloth and trading, rather than 110 units by producing the wine itself, and Portugal can obtain cloth at a cost of 80 units by trade rather than 90 by production. However, in the presence of trade costs of 15 units of labor to import a good (alternatively a mix of export labor costs and import labor costs, such as 5 units to export and 10 units to import), it then costs Britain 115 units of labor to obtain wine by trade 100 units for producing the cloth, 15 units for importing the wine, which is more expensive than producing the wine locally, and likewise for Portugal. Thus, if trade costs exceed the production advantage, it is not advantageous to trade. Krugman proceeds to argue more speculatively that changes in the cost of trade (particularly transportation) relative to the cost of production may be a factor in changes in global patterns of trade: if trade costs decrease, such as on the advent of steam-powered shipping, trade should be expected to increase, as more comparative advantages in production can be realized. Conversely, if trade costs increase, or if production costs decrease faster than trade costs (such as via electrification of factories), then trade should be expected to decrease, as trade costs become a more significant barrier.

Effects on the economy

Conditions that maximize comparative advantage do not automatically resolve trade deficits. In fact, many real world examples where comparative advantage is attainable may require a trade deficit. For example, the amount of goods produced can be maximized, yet it may involve a net transfer of wealth from one country to the other, often because economic agents have widely different rates of saving. As the markets change over time, the ratio of goods produced by one country versus another variously changes while maintaining the benefits of comparative advantage. This can cause national currencies to accumulate into bank deposits in foreign countries where a separate currency is used. Macroeconomic monetary policy is often adapted to address the depletion of a nation's currency from domestic hands by the issuance of more money, leading to a wide range of historical successes and failures.

Considerations
Development economics
The theory of comparative advantage, and the corollary that nations should specialize, is criticized on pragmatic grounds within the import substitution industrialization theory of development economics, on empirical grounds by the SingerPrebisch thesis which states that terms of trade between primary producers and manufactured goods deteriorate over time, and on theoretical grounds of infant industry and Keynesian economics. In older economic terms, comparative advantage has been opposed by mercantilism and economic nationalism. These argue instead that while a country may initially be comparatively disadvantaged in a given industry (such as Japanese cars in the 1950s), countries should shelter and invest in industries until they become globally competitive. Further, they argue that comparative advantage, as stated, is a static theory it does not account for the possibility of advantage changing through investment or economic development, and thus does not provide guidance for long-term economic development. Much has been written since Ricardo as commerce has evolved and cross-border trade has become more complicated. Today trade policy tends to focus more on "competitive advantage" as opposed to "comparative advantage". One of the most indepth research undertakings on "competitive advantage" was conducted in the 1980s as part of the Reagan administration's Project Socrates to establish the foundation for a technology-based competitive strategy development system that could be used for guiding international trade policy.

Free mobility of capital in a globalized world

Ricardo explicitly bases his argument on an assumed immobility of capital: " ... if capital freely flowed towards those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labour price of commodities, than the additional quantity of labour required to convey them to the various markets where they were to be sold."[6]

He explains why, from his point of view, (anno 1817) this is a reasonable assumption: "Experience, however, shows, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and entrust himself with all his habits fixed, to a strange government and new laws, checks the emigration of capital."[6] Some scholars, notably Herman Daly, an American ecological economist and professor at the School of Public Policy of the University of Maryland, have voiced concern over the applicability of Ricardo's theory of comparative advantage in light of a perceived increase in the mobility of capital: "International trade (governed by comparative advantage) becomes, with the introduction of free capital mobility, interregional trade (governed by Absolute advantage)."[7] Adam Smith developed the principle of absolute advantage. The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile.[8][9] Limitations to the theory may exist if there is a single kind of utility. Yet the human need for food and shelter already indicates that multiple utilities are present in human desire. The moment the model expands from one good to multiple goods, the absolute may turn to a comparative advantage. The opportunity cost of a forgone tax base may outweigh perceived gains, especially where the presence of artificial currency pegs and manipulations distort trade.[10] Global labor arbitrage, where one country exploits the cheap labor of another, would be a case of absolute advantage that is not mutually beneficial.[11][12][13] Economist Ha-Joon Chang criticized the comparative advantage principle, contending that it may have helped developed countries maintain relatively advanced technology and industry compared to developing countries. In his book Kicking Away the Ladder, Chang argued that all major developed countries, including the United States and United Kingdom, used interventionist, protectionist economic policies in order to get rich and then tried to forbid other countries from doing the same. For example, according to the comparative advantage principle, developing countries with a comparative advantage in agriculture should continue to specialize in agriculture and import high-technology widgits from developed countries with a comparative advantage in high technology. In the long run, developing countries would lag behind developed countries, and polarization of wealth would set in. Chang asserts that premature free trade has been one of the fundamental obstacles to the alleviation of poverty in the developing world. Recently, Asian countries such as South Korea, Japan and China have utilized protectionist economic policies in their economic develo

Competitive

advantage
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Competitive advantage is defined as the strategic advantage one business entity has over its rival entities within its competitive industry. Achieving competitive advantage strengthens and positions a business better within the business environment. During the Reagan Administration a team of experts led by Michael Sekora was brought together to 1) determine why US industries were losing their ability to compete in the world marketplace and 2) develop a solution to restore US industry's ability to compete. As a result, Project Socrates was initiated. The Socrates team launched one of the most in-depth research undertakings ever conducted in the US intelligence community, producing ten key findings that became the basis for the "Socrates technology-based competitive strategy" system, and support tools for developing and executing competitive strategies. The Socrates system was successfully deployed and considered instrumental in the economic recovery of the 1980s. Early in the George H. W. Bush presidency, the program was de-funded by George Bush for political reasons. After leaving the government shortly after Socrates was defunded, Michael Sekora continued refining the system and applying it to individual companies. Recently, legislation has been introduced to revive the Socrates system as a solution to the US current economic downturn. [1][2][3]

Contents
[hide]

1 Resource-based view perspective 2 See also 3 References 4 Further reading 5 External links

[edit] Resource-based view perspective

Competitive advantage is a theory that seeks to address some of the criticisms of comparative advantage. Michael Porter proposed the theory in 1985. Competitive advantage theory suggests that states and businesses should pursue policies that create high-quality goods to sell at high

prices in the market. Porter emphasizes productivity growth as the focus of national strategies. Competitive advantage rests on the notion that cheap labor is ubiquitous and natural resources are not necessary for a good economy. The other theory, comparative advantage, can lead countries to specialize in exporting primary goods and raw materials that trap countries in low-wage economies due to terms of trade. Competitive advantage attempts to correct for this issue by stressing maximizing scale economies in goodsservices that garner premium prices (Stutz and Warf 2009). Competitive advantage occurs when an organization acquires or develops an attribute or combination of attributes that allows it to outperform its competitors. These attributes can include access to natural resources, such as high grade ores or inexpensive power, or access to highly trained and skilled personnel human resources. New technologies such as robotics and information technology either to be included as a part of the product, or to assist making it. Information technology has become such a prominent part of the modern business world that it can also contribute to competitive advantage by outperforming competitors with regard to internet presence. From the very beginning, i.e. Adam Smith's Wealth of Nations, the central problem of information transmittal, leading to the rise of middle-men in the marketplace, has been a significant impediment in gaining competitive advantage. By using the internet as the middle-man, the purveyor of information to the final consumer, businesses can gain a competitive advantage through creation of an effective website, which in the past required extensive effort finding the right middle-man and cultivating the relationship. The term competitive advantage is the ability gained through attributes and resources to perform at a higher level than others in the same industry or market (Christensen and Fahey 1984, Kay 1994, Porter 1980 cited by Chacarbaghi and Lynch 1999, p. 45). The study of such advantage has attracted profound research interest due to contemporary issues regarding superior performance levels of firms in the present competitive market conditions. A firm is said to have a competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential player (Barney 1991 cited by Clulow et al.2003, p. 221). Successfully implemented strategies will lift a firm to superior performance by facilitating the firm with competitive advantage to outperform current or potential players (Passemard and Calantone 2000, p. 18). To gain competitive advantage a business strategy of a firm manipulates the various resources over which it has direct control and these resources have the ability to generate competitive advantage (Reed and Fillippi 1990 cited by Rijamampianina 2003, p. 362). Superior performance outcomes and superiority in production resources reflects competitive advantage (Day and Wesley 1988 cited by Lau 2002, p. 125). Above writings signify competitive advantage as the ability to stay ahead of present or potential competition, thus superior performance reached through competitive advantage will ensure market leadership. Also it provides the understanding that resources held by a firm and the business strategy will have a profound impact on generating competitive advantage. Powell (2001, p. 132) views business strategy as the tool that manipulates the resources and create competitive advantage, hence, viable business strategy may not be adequate unless it possess control over unique resources that has the ability to create such a unique advantage. Summarizing the view points, competitive advantage is a key determinant of superior performance and it will ensure survival and prominent placing in the market. Superior performance being the ultimate desired

goal of a firm, competitive advantage becomes the foundation highlighting the significant importance to develop sam[14]

Competitive Advantage
What Does Competitive Advantage Mean? An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers than its competition. There can be many types of competitive advantages including the firm's cost structure, product offerings, distribution network and customer support.

Investopedia explains Competitive Advantage Competitive advantages give a company an edge over its rivals and an ability to generate greater value for the firm and its shareholders. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage. There are two main types of competitive advantages: comparative advantage and differential advantage. Comparative advantage, or cost advantage, is a firm's ability to produce a good or service at a lower cost than its competitors, which gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales. A differential advantage is created when a firm's products or services differ from its competitors and are seen as better than a competitor's products by customers.