Table Of Contents

Increased Efficiency of Trading Globally.................................................4

Globalization and International Trade:..................................................... 5

1. The Flows of Globalization................................................................................... 5
2. Trade Facilitation................................................................................................. 7
Distribution-based.......................................................................................... 7
Regulation-based........................................................................................... 7
Transaction-based.......................................................................................... 7
Integration processes..................................................................................... 7
Standardization.............................................................................................. 8
Production systems........................................................................................ 8
Transport efficiency........................................................................................ 8
Transactional efficiency..................................................................................8

Adam Smith Model...................................................................................9

Ricardian model......................................................................................11

Heckscher-Ohlin model.......................................................................... 11

Regulation of international trade............................................................ 18

Risk in international trade.......................................................................19

Absolute advantage.................................................................................19
Origin of the theory............................................................................................... 19
Examples................................................................................................................. 20
Example 1........................................................................................................ 20
Example 2........................................................................................................ 20
Example 3........................................................................................................ 21

Comparative advantage...........................................................................21

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 Origins of the theory.................................................................................................. 22
Effect of trade costs................................................................................................... 22
Effects on the economy............................................................................................... 23
Considerations................................................................................................... 24
Development economics........................................................................................... 24
Free mobility of capital in a globalized world...............................................................24

Balance of trade...................................................................................... 26
Definition............................................................................................................... 27
Views on economic impact.................................................................................... 28
Conditions where trade imbalances may be problematic...................................28
Conditions where trade imbalances may not be problematic............................29
Adam Smith on trade deficits............................................................................. 30
Frdric Bastiat on the fallacy of trade deficits..................................................30
John Maynard Keynes on the balance of trade...................................................31
Milton Friedman on trade deficits.......................................................................32
Warren Buffett on trade deficits.........................................................................33
Physical balance of trade...................................................................................... 33

Free trade................................................................................................ 34
Features of free trade............................................................................................ 34
Current status....................................................................................................... 35

Protectionism.......................................................................................... 35
Arguments for protectionism................................................................................. 36
Comparative advantage has lost its legitimacy.................................................36
Domestic tax policies can favor foreign goods...................................................36
Infant industry argument................................................................................... 37
Unrestricted trade undercuts domestic policies for social good.........................37
Arguments against protectionism.........................................................................37
Current world trends............................................................................................. 38
Protectionism after the 2008 financial crisis....................................................................39

International trade law............................................................................ 39

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 Overview............................................................................................................... 39
World Trade Organization...................................................................................... 40
Trade in goods....................................................................................................... 40
Trade and Intellectual Property.............................................................................. 41
Dispute settlement................................................................................................ 41

Trade bloc............................................................................................... 41
Description............................................................................................................ 42

Free Trade Vs. Protectionism..................................................................42

What Is International Trade?

International trade is the exchange of goods and services between countries. This type of trade
gives rise to a world economy, in which prices, or supply and demand, affect and are affected by
global events. Political change in Asia, for example, could result in an increase in the cost of
labor, thereby increasing the manufacturing costs for an American sneaker company based in
Malaysia, which would then result in an increase in the price that you have to pay to buy the
tennis shoes at your local mall. A decrease in the cost of labor, on the other hand, would result in
you have to pay very less for your new pair of shoes that you want to buy

Trading globally gives consumers and countries the opportunity to be exposed to goods and
services not available in their own countries. Almost every kind of product can be found on the
international market: food, clothes, spare parts, oil, jewelry, wine, stocks, currencies and water.
Services are also traded: tourism, banking, consulting and transportation. A product that is sold to
the global market is an export, and a product that is bought from the global market is an import.
Imports and exports are accounted for in a country's current account in the balance of payments.

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 cumulative 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 the exchange of capital, goods, and services across international borders or
territories. In most countries, such trade 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.

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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 labor 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. 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 that factor of production and thus embody it. An example is the import of labor-intensive
goods by the United States from China. Instead of importing Chinese labor, the United States
imports goods that were produced with Chinese labor. One report in 2010 suggested that
international trade was increased when a country hosted a network of immigrants, but the trade
effect was weakened when the immigrants became assimilated into their new country.

International trade is also a branch of economics, which, together with international finance,
forms the larger branch of international economics.

ADVANTAGES OF INTERNATIONAL TRADE

International trade allows countries to exchange good and services with the use of money as a
medium of exchange. Several advantages can be identified with reference to international trade.
However international trade does have its limitations as well. Discussed below are both
advantages and disadvantages of international trade.

Advantages
Greater variety of goods available for consumption international trade brings in different
varieties of a particular product from different destinations. This gives consumers a wider array
of choices which will not only improve their quality of life but as a whole it will help the country
grow.

Efficient allocation and better utilization of resources since countries tend to produce goods in
which they have a comparative advantage. When countries produce through comparative
advantage, wasteful duplication of resources is prevented. It helps save the environment from

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harmful gases being leaked into the atmosphere and also provides countries with a better
marketing power.

Promotes efficiency in production as countries will try to adopt better methods of production to
keep costs down in order to remain competitive. Countries that can produce a product at the
lowest possible cost will be able to gain a larger share in the market. Therefore an incentive to
produce efficiently arises. This will help standards of the product to increase and consumers will
have a good quality product to consume.

More employment could be generated as the market for the countries goods widens through
trade. International trade helps generate more employment through the establishment of newer
industries to cater to the demands of various countries. This will help countries bring down their
unemployment rates.

ADVANTAGES OF INTERNATIONAL TRADE

Various advantages are named for the countries entering into trade relations on an international
scale such as:

A country may import things which it cannot produce

International trade enables a country to consume things which either cannot be produced within
its borders or production may cost very high. Therefore it becomes cost cheaper to import from
other countries through foreign trade.

Maximum utilization of resources

International trade helps a country to utilize its resources to the maximum limit. If a country
does not takes up imports and exports then its resources remain unexploited. Thus it helps to
eliminate the wastage of resources.

Benefit to consumer
Imports and exports of different countries provide opportunities to the consumer to buy and
consume those goods which cannot be produced in their own country. They therefore get
diversity in choices.

Reduces trade fluctuations

By making the size of the market large with large supplies and extensive demand international
trade reduces trade fluctuations. The prices of goods tend to remain more stable.

Utilization of Surplus produce

International trade enables different countries to sell their surplus products to other countries and
earn foreign exchange.

Fosters International trade-International trade fosters peace, goodwill and mutual

understanding among nations. Economic interdependence of countries often leads to close
cultural relationship and thus avoid war between them.

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DISADVANTAGES OF INTERNATIONAL TRADE
International trade does not always amount to blessings. It has certain drawbacks also such as:

Import of harmful goods

Foreign trade may lead to import of harmful goods like cigarettes, drugs etc. Which may run the
health of the residents of the country? E.g. the people of China suffered greatly through opium
imports.

It may exhaust resources

International trade leads to intensive cultivation of land. Thus it has the operations of law of
diminishing returns in agricultural countries. It also makes a nation poor by giving too much
burden over the resources.

Over Specialization
Over Specialization may be disastrous for a country. A substitute may appear and ruin the
economic lives of millions.

Danger of Starvation
A country might depend for her food mainly on foreign countries. In times of war there is a
serious danger of starvation for such countries.

One country may gain at the expensive of another

One of the serious drawbacks of foreign trade is that one country may gain at the expense of
other due to certain accidental advantages. The Industrial revolution is great Britain ruined
Indian handicrafts during the nineteenth century.

It may lead to war

Foreign trade may lead to war different countries compete with each other in finding out new
markets and sources of raw material for their industries and frequently come into clash. This was
one of the causes of first and Second World War.

Foreign Trade & Economic Growth:

The issues of international trade and economic growth have gained substantial importance with
the introduction of trade liberalization policies in the developing nations across the world.
International trade and its impact on economic growth crucially depend on globalization. As far
as the impact of international trade on economic growth is concerned, the economists and policy
makers of the developed into and developing economies are divided two separate groups.

Increased Efficiency of Trading Globally

Global trade allows wealthy countries to use their resources - whether labor, technology

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or capital - more efficiently. Because countries are endowed with different assets and natural
resources (land, labor, capital and technology), some countries may produce the same good more
efficiently and therefore sell it more cheaply than other countries. If a country cannot efficiently
produce an item, it can obtain the item by trading with another country that can. This is known
as specialization in the field of the international trade between the two countries

Let's take a simple example. Country A and Country B both produce cotton sweaters and wine.
Country A produces 10 sweaters and six bottles of wine a year while Country B produces six
sweaters and 10 bottles of wine a year. Both can produce a total of 16 units. Country A, however,
takes three hours to produce the 10 sweaters and two hours to produce the six bottles of wine
(total of five hours). Country B, on the other hand, takes one hour to produce 10 sweaters and
three hours to produce six bottles of wine (total of four hours).

But these two countries realize that they could produce more by focusing on those products with
which they have a comparative advantage. Country A then begins to produce only wine and
Country B produces only cotton sweaters. Each country can now create a specialized output of
20 units per year and trade equal proportions of both products

We can see then that for both countries, the opportunity cost of producing both products is
greater than the cost of specializing. More specifically, for each country, the opportunity cost of
producing 16 units of both sweaters and wine is 20 units of both products (after trading).
Specialization reduces their opportunity cost and therefore maximizes their efficiency in
acquiring the goods they need. With the greater supply, the price of each product would decrease,
thus giving an advantage to the end consumer as well.

Note that, in the example above, Country B could produce both wine and cotton more efficiently
than Country A (less time). This is called an absolute advantage, and Country B may have it
because of a higher level of technology. However, according to the international trade theory,
even if a country has an absolute advantage over another, it can still benefit from specialization.

Other Possible Benefits of Trading Globally

International trade not only results in increased efficiency but also allows countries to participate
in a global economy, encouraging the opportunity of foreign direct investment (FDI), which is
the amount of money that individuals invest into foreign companies and other assets. In theory,
economies can therefore grow more efficiently and can more easily become competitive
participants

For the receiving government, FDI is a means by which foreign currency and expertise can enter
the country. These raise employment levels, and, theoretically, lead to a growth in the gross
domestic product. For the investor, FDI offers company expansion and growth, which means
higher revenues.

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Globalization and International Trade:

1. The Flows of Globalization

"Courtesy of ongoing trade liberalization, in conjunction with sharply declining communication
and transportation costs, there has been a sharp increase in the tradable goods portion of world
output over the past 15 years. At the same time, a veritable explosion in e-based connectivity
since 1995, together with the emergence of an entirely new global IT outsourcing industry, has
led to the networking of service providers around the world. As a result, rapidly expanding trade
in both goods and services has become an increasingly powerful engine in driving the global
growth dynamic." Stephen Roach, Morgan Stanley, July 18, 2005.

In a global economy, no nation is self-sufficient. Each is involved at different levels in trade to

sell what it produces, to acquire what it lacks and also to produce more efficiently in some
economic sectors than its trade partners. As supported by conventional economic theory, trade
promotes economic efficiency by providing a wider variety of goods, often at lower costs,
notably because of specialization, economies of scale and the related comparative advantages.
International trade is also subject to much contention since it can at time be a disruptive
economic and social force as it changes the conditions wealth is distributed within a national
economy, particularly due to changes in prices and wages.

The globalization of production is concomitant to the globalization of trade as one cannot

function without the other. Even if international trade has taken place centuries before the
modern era, as ancient trade routes such as the Silk Road can testify, trade occurred at an ever
increasing scale over the last 600 years to play an even more active part in the economic life of
nations and regions. This process has been facilitated by significant technical changes in the
transport sector. The scale, volume and efficiency of international trade have all continued to
increase since the 1970s. As such, space / time convergence was an ongoing process that implied
a wider market coverage could be accessed with a lower amount of time. It has become
increasingly possible to trade between parts of the world that previously had limited access to
international transportation systems. Further, the division and the fragmentation of production
that went along with these processes also expanded trade. Trade thus contributes to lower
manufacturing costs.

Without international trade, few nations could maintain an adequate standard of living. With only
domestic resources being available, each country could only produce a limited number of
products and shortages would be prevalent. Global trade allows for an enormous variety of
resources from Persian Gulf oil, Brazilian coffee to Chinese labor to be made more widely
accessible. It also facilitates the distribution of many different manufactured goods that are
produced in different parts of the world to what can be labeled as the global market. Wealth
becomes increasingly derived through the regional specialization of economic activities. This

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way, production costs are lowered, productivity rises and surpluses are generated, which can be
transferred or traded for commodities that would be too expensive to produce domestically or
would simply not be available. As a result, international trade decreases the overall costs of
production worldwide. Consumers can buy more goods from the wages they earn, and standards
of living should, in theory, increase.

International trade consequently demonstrates the extent of globalization with increased spatial
interdependencies between elements of the global economy and their level of integration. These
interdependencies imply numerous relationships where flows of capital, goods, raw materials
and services are established between regions of the world.

As of the beginning of the 21st century, the flows of globalization have been shaped by four
salient trends:

An ongoing growth of international trade, both in absolute terms and in relation to global
national income. From 1970 to 2010 the value of exports has grown by a factor of 48
times if measured in current dollars, while GDP increased 22 times and population
increased 1.8 times.

A substantial level of containerization, often complete, of commercial flows.

Containerization tends to grow at a rate faster than trade and GDP growth.

A higher relative growth of trade in Pacific Asia as many economies developed an export-
oriented development strategy that has been associated with imbalances in commercial
relations.

The growing role of multinational corporations as vectors for international trade,

particularly in terms of the share of international trade taking place within corporations.

2. Trade Facilitation
The volume of exchanged goods and services between nations is taking a growing share of the
generation of wealth, mainly by offering economic growth opportunities in new regions and by
reducing the costs of a wide array of manufacturing goods. By 2007, international trade
surpassed for the first time 50% of global GDP, a twofold increase in its share since 1950.
The facilitation of trade involves how the procedures regulating the international movements of
goods can be improved. It depends on the reduction of the general costs of trade, which considers
transaction, tariff, transport and time costs, often labeled as the "Four Ts" of international trade.
United nations estimates have underlined that for developing countries a 10% reduction in
transportation cost could be accompanied with a growth of about 20% in international and
domestic trade. Thus, the ability to compete in a global economy is dependent on the transport
system as well as a trade facilitation framework with activities including:

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 Distribution-based. A multimodal and intermodal freight transport system composed
of modes, infrastructures and terminals that spans across the globe. It insures a physical
capacity to support trade and its underlying supply chains.

Regulation-based. Customs procedures, tariffs, regulations and handling of

documentation. They insure that trade flows abide to the rules and regulations of the
jurisdictions they cross. Cross-border clearance, particularly in developing countries, can
be a notable trade impediment with border delays, bottlenecks and long customer
clearance times.

Transaction-based. Banking, finance, legal and insurance activities where accounts

can be settled and risk mitigated. They insure that the sellers of goods and services are
receiving an agreed upon compensation and that the purchasers have a legal recourse if
the outcome of the transaction is judged unsatisfactory or is insured if a partial or full loss
incurs.

The quality, cost, and efficiency of these services influence the trading environment as well as
the overall costs linked with the international trade of goods. Many factors have been conductive
to trade facilitation in recent decades, including integration processes, standardization,
production systems, transport efficiency and transactional efficiency:

Integration processes, such as the emergence of economic blocks and the decrease
of tariffs at a global scale through agreements, promoted trade as regulatory
regimes were harmonized. One straightforward measure of integration relates to custom
delays, which can be a significant trade impediment since it adds uncertainty in supply
chain management. The higher the level of economic integration, the more likely the
concerned elements are to trade. International trade has consequently been facilitated by a
set of factors linked with growing levels of economic integration, the outcome of
processes such as the European Union or the North American Free Trade Agreement. The
transactional capacity is consequently facilitated with the development of transportation
networks and the adjustment of trade flows that follows increased integration. Integration
processes have also taken place at the local scale with the creation of free trade
zones where an area is given a different governance structure in order to promote trade,
particularly export oriented activities. In this case, the integration process is not uniform
as only a portion of a territory is involved. China is a salient example of the far-reaching
impacts of the setting of special economic zones operating under a different regulatory
regime.

Standardization concerns the setting of a common and ubiquitous frame of reference

over information and physical flows. Standards facilitate trade since those abiding by
them benefit from reliable, interoperable and compatible goods and services which often
results in lower production, distribution and maintenance costs. Measurement units were
among the first globally accepted standards (metric system) and the development of
information technologies eventually led to common operating and telecommunication
systems. It is however the container that is considered to be the most

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 significant international standard for trade facilitation. By offering a load unit that can be
handled by any mode and terminal with the proper equipment, access to international
trade is improved.

Production systems are more flexible and embedded (see concept 3). It is
effectively productive to maintain a network of geographically diversified inputs, which
favors exchanges of commodities, parts and services. Information technologies have
played a role by facilitating transactions and the management of complex business
operations. Foreign direct investments are commonly linked with the globalization of
production as corporations invest abroad in search of lower production costs and new
markets. China is a leading example of such a process, which went on par with a growing
availability of goods and services that can be traded on the global market.

Transport efficiency has increased significantly because of innovations and

improvements in the modes and infrastructures in terms of their capacity and throughput.
Ports are particularly important in such a context since they are gateways to international
trade through maritime shipping networks. As a result, the transferability of commodities,
parts and finished goods has improved. Decreasing transport costs does more than
increasing trade; it can also help change the location of economic activities. Yet,
transborder transportation issues remain to be better addressed in terms of capacity,
efficiency and security.

Transactional efficiency. The financial sector also played a significant role in

integrating global trade, namely by providing investment capital and credit for
international commercial transactions. For instance, a letter of credit may be issued based
upon an export contract. An exporter can thus receive a payment guarantee from a bank
until its customer finalizes the transaction upon delivery. This is particularly important
since the delivery of international trade transactions can take several weeks due to the
long distances involved. During the transfer, it is also common that the cargo is insured in
the event of damage, theft or delays, a function supported by insurance companies. Also,
global financial systems permit to convert currencies according to exchange rates that are
commonly set by market forces, while some currencies, such as the Chinese Yuan, are set
by policy. Monetary policy can thus be a tool, albeit contentious, used to influence trade.

Adam Smith Model

Adam Smith displays trade taking place on the basis of countries exercising absolute cost
advantage over one another.

One of the major aims of Smith's Wealth of Nations was to demonstrate the falsity of the rather
extensive set of ideas now called mercantilismabout 25 percent of his book is devoted to an
examination of mercantilist doctrine and practice. Some mercantilists argued that government
regulation of foreign trade was necessary in order for a country to have a so-called favorable
balance of tradeexports greater than importsand, therefore, an increase in the quantity of
bullion, as other countries paid in precious metals for the home country's excess of exports over

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imports. Interestingly, we still use the term "favorable balance of trade" to describe a situation in
which a country gives others more goods than it gets in exchange, the difference being settled
through payments of gold or IOUs. A favorable balance of trade, however, is favorable only if
one incorrectly believes that the wealth of a nation depends upon its holdings of precious metals.

Smith, on the contrary, argued for unregulated foreign trade, reasoning that if England can
produce a good, e.g., wool, at lower costs than France, and if France can produce another good,
e.g., wine, at lower costs than England, then it is beneficial to both parties to exchange these
goods, with each trading the good it produces at lower costs for the good it produces at higher
costs. In the language of economics, this became known as the absolute advantage argument for
foreign trade. This argument, moreover, is not limited to international trade. It applies to trade a
country

Embedded in Smith's analysis of how markets develop dynamically over time, one finds another
argument for free international trade. Although Smith never fully developed this argument, later
economists were able to infer it from the Wealth of Nations. We have already seen that Smith
held that a key determinant of the wealth of nations was the productivity of labor and that labor
productivity depended primarily upon the division of labor. As labor becomes more divided and
specialized, he pointed out, its productivity increases dramatically. Smith held that differences in
individual abilities, and hence productivity, were largely the effects of the division of labor, not
its cause. At birth, Smith asserted, we are all similarly talented; it is only after we begin to
specialize in various activities that we become more proficient relative to others who do not so
specialize. We learn by doing, becoming progressively able to produce our goods more cheaply

In the language of modern economics, there are increasing returns (decreasing costs) as labor
becomes more and more specialized. Part of Smith's argument for the advantages of foreign trade
was broadly based on this dynamic notion of increasing returns. He realized that if two
individuals are equally talented at birth and their talents remain unchanged, it follows that there
are no advantages to either of them if they specialize and trade their goods. (The nationality of
the individuals makes no difference to these argumentsi.e., whether one person is English and
the other French.) If, however, two individuals become more proficient by labor specialization,
the costs of producing both their products decrease and both benefit by specializing and trading.
Out of this insight of Smith's arose the recognition, pivotal for the development of free trade, that
dynamically over time any nation might achieve absolute cost advantages in the production of
certain goods through specialization and division of labor, and that all nations could gain from it

Smith, who was very policy-oriented in his analysis of international trade, criticized, in
particular, mercantilist policies that had restricted the quantity of trade, concluding that those
policies erroneously assessed the wealth of a nation as consisting of the bullion the nation held,
rather than correctly defining a nation's wealth as a flow of goods. The proper governmental

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policy toward international trade, Smith held, should be the same as that toward domestic trade
one of letting voluntary exchanges take place in free-unregulated markets. A policy of laissez
faire, he believed, would lead to ever higher levels of well-being in all countries.

Modern economics, in assessing the dominant ideas of this period, has discovered another
difference between the classicals and the mercantilists that significantly influenced their views
concerning the relative importance of free markets versus government regulation. These
differences, though never fully articulated in either Smithian or subsequent classical economics,
are fundamental to classical views on the consequences of economic activity and remain
fundamental even today. They have to do with the fact that if one holds that the total quantity of
resources on our planet is fixed, then a process of exchange between two individuals or nations
must require that one gain and the other lose. In the language of some modern economists, an
economic exchange is a "zero-sum game," in which there is a winner and a loser. Thus, when
Britain trades with France, if one gains by this exchange, the other must lose. An opposing
perspective holds that economic exchanges are not zero-sum games, that both parties can benefit
from the exchange. To rigorously prove that all countries can benefit from foreign trade, one
must show that there are more goods in the world after the exchange than there were before.
While this sort of book is not the place to demonstrate such a proof, some introductory
economics texts do show how foreign trade benefits both parties and that the total amount of
trade in the goods I different places is very much greater than what after the exchange.

This insight of Smith and other classical writers that, contrary to the beliefs of many
mercantilists, all parties might gain from trading provided a tremendously powerful argument for
voluntary exchanges, whether between individuals within a country or between different
countries.

An aspect of foreign trade that did not interest Smithno doubt partly because his forte was
economic policy, not theorybut that bears on this discussion is the question of the price at
which exchange occurs and, therefore, of what determines how the gains from trade are divided
between the traders. We will address these issues when we examine David Ricardo and John
Stuart Mill.

Ricardian model
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, and trade occurs due to technological differences between countries. Unlike other
models, the Ricardian framework predicts that countries will fully specialize instead of
producing a broad array of goods.

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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 technological differences between countries.Technological gap is easily included in the
Ricardian and Ricardo-Sraffa model (See the Ricardian theory (modern development)).

The Ricardian model makes the following assumptions:

Labor is the only primary input to production (labor is considered to be the ultimate source of
value).

Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to
scale, and simple technology.)

Limited amount of labor in the economy

Labor is perfectly mobile among sectors but not internationally.

Perfect competition (price-takers).

The Ricardian model applies in the short run, so that technology may vary internationally. This
supports the fact that countries follow their comparative advantage and allows for specialization.

Heckscher-Ohlin model
In the early 1900s an international trade theory called factor proportions theory was developed
by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is therefore called the
Heckscher-Ohlin theory (H-O theory). The H-O 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. It 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 in
producing and exporting products that use the factors that are most abundant, and thus are the
cheapest to produce.

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 method of
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, such as the Leontief paradox, were exposed in

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empirical tests by Wassily Leontief who found that the United States tended to export labor-
intensive goods despite having an abundance of capital.

The H-O model makes the following core assumptions:

Labor and capital flow freely between sectors

The amount of labor and capital in two countries differ (difference in endowments)

Free trade

Technology is the same among countries (a long-term assumption)

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 emphasized by Samuelson (2001).

Reality and Applicability of the Heckscher-Ohlin Model

Many economists prefer the Heckscher-Ohlin theory to the Ricardian theory, because H-O makes
fewer simplifying assumptions.In 1953, Wassily Leontief published a study in which he tested
the validity of the Heckscher-Ohlin theory. The study showed that the U.S was more abundant in
capital compared to other countries, therefore the U.S would export capital-intensive goods and
import labor-intensive goods. Leontief found out that the U.S's exports were less capital
intensive than its imports.

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
emphasized that Leontief did not interpret H-O theory properly and claimed that with a right
interpretation, the paradox did not occur. Brecher and Choudri 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. Many textbook writers, including Krugman
and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model.
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.":321

Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems. The
assumptions of H-O are less realistic with respect to N-S than N-N (or S-S) trade. Income

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differences between North and South is the assumption that third world cares about most. There
is not much evidence of factor price equalization [a consequence of H-O theory. The H-O model
assumes identical production functions among countries, although this is highly unrealistic.
Technological gaps between developed and developing countries are the main reason why the
latter are poor.

Specific factors model

In the specific factors model, labor mobility among industries is possible while capital is
assumed to be immobile 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 assumption 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.

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 understanding income distribution but awkward for discussing the pattern
of trade.

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) that exists. New Trade theories are often based on
assumptions such as 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 faces high transportation costs, the
industry will be located in the country with most of its demand, in order to minimize cost.

Although new trade theory can explain the growing trend of trade volumes of intermediate
goods, Krugman's explanation depends too much on the strict assumption that all firms are
symmetrical, meaning that they all have the same production coefficients. Shiozawa, based on
much more general model, succeeded in giving a new explanation on why the traded volume
increases for intermediates goods when the transport cost decreases .

Gravity model
The Gravity model of trade presents a more empirical analysis of trading patterns. 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

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which also considers distance and physical size between two objects. The model has been proven
to be empirically strong through econometric analysis.

The model has been an empirical success but the theoretical justifications for the model are the
subject of some dispute. The model clearly has a relationship with a geographic view of trade,
but other theoretical justifications for the model have also been proposed.

The gravity model estimates the pattern of international trade. While the models basic form
consists of factors that have more to do with geography and spatiality, the gravity model has
been used to test hypotheses rooted in purer economic theories of trade as well. One such theory
predicts that trade will be based on relative factor abundances. One of the common relative factor
abundance models is the Heckscher-Ohlin model. This theory would predict that trade patterns
would be based on relative factor abundance. Those countries with a relative abundance of one
factor would be expected to produce goods that require a relatively large amount of that factor in
their production. While a generally accepted theory of trade, comparative advantage has suffered
empirical problems. Investigations into real world trading patterns have produced a number of
results that do not match the expectations of comparative advantage theories. Notably, a study
byWassily Leontief found that the United States, the most capital endowed country in the world,
actually exports more in labor intensive industries. Comparative advantage in factor endowments
would suggest the opposite would occur. Other theories of trade and explanations for this
relationship were proposed in order to explain the discrepancy between Leontiefs empirical
findings and economic theory. The problem has become known as the Leontief paradox.

An alternative theory, first proposed by Staffan Linder, predicts that patterns of trade will be
determined by the aggregated preferences for goods within countries. Those countries with
similar preferences would be expected to develop similar industries. With continued similar
demand, these countries would continue to trade back and forth in differentiated but similar
goods since both demand and produce similar products. For instance, both Germany and
the United States are industrialized countries with a high preference for automobiles. Both
countries have automobile industries, and both trade cars. The empirical validity of the Linder
hypothesis is somewhat unclear. Several studies have found a significant impact of the Linder
effect, but others have had weaker results. Studies that do not support Linder have only counted
countries that actually trade; they do not input zero values for the dyads where trade could
happen but does not. This has been cited as a possible explanation for their findings. Also, Linder
never presented a formal model for his theory, so different studies have tested his hypothesis in
different ways.

Elhanan Helpman and Paul Krugman asserted that the theory behind comparative advantage does
not predict the relationships in the gravity model. Using the gravity model, countries with similar
levels of income have been shown to trade more. Helpman and Krugman see this as evidence
that these countries are trading in differentiated goods because of their similarities. This casts
some doubt about the impact Heckscher-Ohlin has on the real world. Jeffrey Frankel sees the
Helpman-Krugman setup here as distinct from Linders proposal. However, he does say
Helpman-Krugman is different from the usual interpretation of Linder, but, since Linder made no
clear model, the association between the two should not be completely discounted. Alan

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Deardorff adds the possibility, that, while not immediately apparent, the basic gravity model can
be derived from Heckscher-Ohlin as well as the Linder and Helpman-Krugman hypotheses.
Deardorff concludes that, considering how many models can be tied to the gravity model
equation, it is not useful for evaluating the empirical validity of theories.

Bridging economic theory with empirical tests, James Anderson and Jeffrey Bergstrand develop
econometric models, grounded in the theories of differentiated goods, which measure the gains
from trade liberalizations and the magnitude of the border barriers on trade (see McCallum
Border puzzle).

Adding to the problem of bridging economic theory with empirical results, some economists
have pointed to the possibility of intra-industry trade not as the result of differentiated goods, but
because of reciprocal dumping. In these models, the countries involved are said to have
imperfect competition and segmented markets in homogeneous goods, which leads to intra-
industry trade as firms in imperfect competition seek to expand their markets to other countries
and trade goods that are not differentiated yet for which they do not have a comparative
advantage, since there is no specialization. This model of trade is consistent with the gravity
model as it would predict that trade depends on country size.

The reciprocal dumping model has held up to some empirical testing, suggesting that the
specialization and differentiated goods models for the gravity equation might not fully explain
the gravity equation. Feenstra, Markusen, and Rose (2001) provided evidence for reciprocal
dumping by assessing the home market effect in separate gravity equations for differentiated and
homogeneous goods. The home market effect showed a relationship in the gravity estimation for
differentiated goods, but showed the inverse relationship for homogeneous goods. The authors
show that this result matches the theoretical predictions of reciprocal dumping playing a role in
homogeneous markets.

Past research using the gravity model has also sought to evaluate the impact of various variables
in addition to the basic gravity equation. Among these, price level and exchange rate variables
have been shown to have a relationship in the gravity model that accounts for a significant
amount of the variance not explained by the basic gravity equation. According to empirical
results on price level, the effect of price level varies according the relationship being examined.
For instance, if exports are being examined, a relatively high price level on the part of the
importer would be expected to increase trade with that country. A non-linear system of equations
are used by Anderson and van Wincoop (2003) to account for the endogenous change in these
price terms from trade liberalization. A more simple method is to use a first order log-
linearization of this system of equations (Baier and Bergstrand (2009)), or exporter-country-year
and importer-country-year dummy variables. For counterfactual analysis, however, one would
still need to account for the change in world prices.

Ricardian theory of international trade (modern development)

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The Ricardian theory of comparative advantage became a basic constituent of neoclassical trade
theory. Any undergraduate course in trade theory includes a presentation of Ricardo's example of
a two-commodity, two-country model. A common representation of this model is made using an
Edgeworth Box.

This model has been expanded to many-country and many-commodity cases. Major general
results were obtained by McKenzie and Jones, including his famous formula. It is a theorem
about the possible trade pattern for N-country N-commodity cases.

Contemporary theories
Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and
Samuelson This formulation is employed for example by Matsuyama and others. These theories
use a special property that is applicable only for the two-country case.

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). This was a second round of
the Cambridge capital controversy, this time in the field of international trade.

The merit of neo-Ricardian trade theory is that input goods are explicitly included. This is in
accordance with Sraffa's idea that any commodity is a product made by means of commodities.
The limitation of their theory is that the analysis is restricted to small-country cases.

Traded intermediate goods

Ricardian trade theory ordinarily assumes that the labor is the unique input. This is a great
deficiency as trade theory, for intermediate goods occupy the major part of the world
international trade. Yeats found that 30% of world trade in manufacturing involves intermediate
inputs. Bardhan and Jafee found that intermediate inputs occupy 37 to 38% of U.S. imports for
the years 1992 and 1997, whereas the percentage of intrafirm trade grew from 43% in 1992 to
52% in 1997.

McKenzie and Jones 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." Paul Samuelson coined a term Sraffa bonus to name the
gains from trade of inputs.

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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." It took many years until Y. Shiozawa
succeeded in removing 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.

The Ricardian trade theory now provides a general theory that includes trade of intermediates
such as fuel, machine tools, machinery parts and processed materials. The traded intermediate
goods are then used as inputs to production in the importing country. Capital goods are nothing
other than inputs to the production. Thus, in the Ricardo-Sraffa trade theory, capital goods move
freely from country to country. Labor is the unique factor of production that remains immobile in
its country of origin.

In a blog post of April 28, 2007, Gregory Mankiw compared Ricardian theory and Heckscher-
Ohlin theory and stood by the Ricardian side. 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.

The neoclassical Heckscher-Ohlin-Samuelson theory only assumes productive factors and

finished goods. It has no concept of intermediate goods. Therefore, it is the Ricardo-Sraffa trade
theory that provides theoretical bases for ideas such as outsourcing, fragmentation and intra-firm
trade.

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 mercantilismmost nations had high tariffs and many restrictions on

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international trade. In the 19th century, especially in the United Kingdom, a belief in free
trade became paramount. 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
todeveloping countries.
Free trade is usually most strongly supported by the most economically powerful nations, though
they often engage in selectiveprotectionism for those industries which are strategically important
such as the protective tariffs applied to agriculture by the United
States and Europe. 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
andtrade facilitation.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. 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,
theNorth 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 theMultilateral Agreement on Investment (MAI) have also failed in recent years.

Risk in international trade

While trade barriers and unfair practices take many forms, the most common examples are listed
below:

Intellectual property infringement - including copyright, patent and trademarks. Lack of

competitive bidding for foreign government tenders. Competition from unfairly traded (i.e.,

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dumped or foreign government subsidized) imports. Unfair and trade distortive subsidies
provided by foreign governments to overseas competitors. Foreign trade remedy investigations
conducted inconsistent with international obligations. Burdensome certification and testing
requirements that are not required by domestic manufacturers. Increasing imports and unfair
competition. Concerns over other foreign trade barriers to export or investment.

Absolute advantage
In economics, the principle of absolute advantage refers to the ability of a party (an individual,
or firm, or country) to produce more of a good or service than competitors, using the same
amount of resources. Adam Smith first described the principle of absolute advantage in the
context of international trade, using labor as the only input.
Since absolute advantage is determined by a simple comparison of labor productivities, it is
possible for a party to have no absolute advantage in anything; in that case, according to the
theory of absolute advantage, no trade will occur with the other party. It can be contrasted with
the concept of comparative advantage which refers to the ability to produce a particular good at a
loweropportunity cost.
Origin of the theory

The main concept of absolute advantage is generally attributed to Adam Smith for his 1776
publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he
counteredmercantilist ideas. Smith argued that it was impossible for all nations to become rich
simultaneously by following mercantilism because the export of one nation is another nations
import and instead stated that all nations would gain simultaneously if they practiced free trade
and specialized in accordance with their absolute advantage. Smith also stated that the wealth of
nations depends upon the goods and services available to their citizens, rather than their gold
reserves. While there are possible gains from trade with absolute advantage, the gains may not be
mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial
exchanges.

Examples
Example 1

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Party B has the absolute advantage.

Party A can produce 5 widgets per hour with 3 employees.

Party B can produce 10 widgets per hour with 3 employees.

Assuming that the employees of both parties are paid equally, Party B has an absolute advantage
over Party A in producing widgets per hour. This is because Party B can produce twice as many
widgets as Party A can with the same number of employees.

Example 2

Country C has the absolute advantage.

Country A can produce 1000 parts per hour with 200 workers.

Country B can produce 2500 parts per hour with 200 workers.

Country C can produce 10000 parts per hour with 200 workers.
Considering that labor and material costs are all equivalent, Country C has the absolute
advantage over both Country B and Country A because it can produce the most parts per hour at
the same cost as other nations. Country B has an absolute advantage over Country A because it
can produce more parts per hour with the same number of employees. Country A has no absolute
advantage because it can't produce more goods than either Country B or Country C given the
same input.

Example 3

You and your friends decided to help with fundraising for a local charity group by printing t-
shirts and making birdhouses.

Scenario 1: One of your friends, Gina, can print 5 t-shirts or build 3 birdhouses an hour.
Your other friend, Mike, can print 3 t-shirts an hour or build 2 birdhouses an hour. Because
your friend Gina is more productive at printing t-shirts and building birdhouses compared to
Mike, she has an absolute advantage in both printing t-shirts and building birdhouses.

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 Scenario 2: Suppose Gina wasn't as agile with the hammer and could only make 1
birdhouse an hour, but she took a sewing class and could print 10 t-shirts an hour. Mike on
the other hand takes woodworking and so he can build 5 birdhouses an hour, but he doesn't
know the first thing about making t-shirts so he can only print 2 t-shirts an hour. While Gina
would have the absolute advantage in printing shirts, Mike would have an absolute
advantage in building birdhouses.

Comparative advantage
In economics, the theory of comparative advantage refers to the ability of a person or a country
to produce a particular good or service at a lower marginaland opportunity cost over another.
Even if one country is more efficient in the production of all goods (absolute advantage in all
goods) than the other, both countries will still gain by trading with each other, as long as they
have different relative efficiencies.

For example, if, using machinery, a worker in one country can produce both shoes and shirts at 6
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 opportunity 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.

Origins of the theory

Comparative advantage was first described by David Ricardo who explained it in his 1817
book On the Principles of Political Economy and Taxation in an example involving England and
Portugal. 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

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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.

However, it is also worth mentioning that R. Torrens was an actual pioneer in the field of
theoretical basis for the theory of comparative advantage. In 1815 he published 'An Essay on the
External Corn Trade' which involved critical elements of the law of comparative advantage.

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.

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

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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

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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 labor price of commodities, than the additional quantity of labor required to
convey them to the various markets where they were to be sold."
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."

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)."

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. 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

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 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. Global labor
arbitrage, where one country exploits the cheap labor of another, would be a case of absolute
advantage that is not mutually beneficial.

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
development.

Balance of trade

Cumulative Current Account Balance 19802008 based on the International Monetary Fund data.

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Cumulative Current Account Balance per capita 19802008 based onInternational Monetary
Fund data.

The balance of trade (or net exports, sometimes symbolized as NX) is the difference between
the monetary value ofexports and imports of output in an economy over a certain period. It is the
relationship between a nation's imports and exports.[dead link] A positive balance is known as
a trade surplus if it consists of exporting more than is imported; a negative balance is referred to
as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided into a
goods and a services balance.

Early understanding of the functioning of balance of trade informed the economic policies of
Early Modern Europe that are grouped under the heading mercantilism. An early statement
appeared in Discourse of the Common Wealth of this Realm of England, 1549: "We must always
take heed that we buy no more from strangers than we sell them, for so should we impoverish
ourselves and enrich them." Similarly a systematic and coherent explanation of balance of trade
was made public through Thomas Mun's c1630 "England's treasure by forraign trade, or, The
balance of our forraign trade is the rule of our treasure"

Definition

The balance of trade forms part of the current account, which includes other transactions such as
income from the international investment position as well as international aid. If the current
account is in surplus, the country's net international asset position increases correspondingly.
Equally, a deficit decreases the net international asset position.

The trade balance is identical to the difference between a country's output and its domestic
demand (the difference between what goods a country produces and how many goods it buys

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from abroad; this does not include money re-spent on foreign stock, nor does it factor in the
concept of importing goods to produce for the domestic market).

Measuring the balance of trade can be problematic because of problems with recording and
collecting data. As an illustration of this problem, when official data for all the world's countries
are added up, exports exceed imports by almost 1%; it appears the world is running a positive
balance of trade with itself. This cannot be true, because all transactions involve an
equal credit or debitin the account of each nation. The discrepancy is widely believed to be
explained by transactions intended to launder money or evade taxes, smuggling and other
visibility problems. However, especially for developed countries, accuracy is likely.

Factors that can affect the balance of trade include:

The cost of production (land, labor, capital, taxes, incentives, etc.) in the exporting
economy vis--vis those in the importing economy;

The cost and availability of raw materials, intermediate goods and other inputs;

Exchange rate movements;

Multilateral, bilateral and unilateral taxes or restrictions on trade;

Non-tariff barriers such as environmental, health or safety standards;

The availability of adequate foreign exchange with which to pay for imports; and

Prices of goods manufactured at home (influenced by the responsiveness of supply)

In addition, the trade balance is likely to differ across the business cycle. In export-led growth
(such as oil and early industrial goods), the balance of trade will improve during an economic
expansion. However, with domestic demand led growth (as in the United States and Australia)
the trade balance will worsen at the same stage in the business cycle.

Since the mid 1980s, the United States has had a growing deficit in tradeable goods, especially
with Asian nations (China and Japan) which now hold large sums of U.S debt that has funded the
consumption. The U.S. has a trade surplus with nations such as Australia. The issue of trade
deficits can be complex. Trade deficits generated in tradeable goods such as manufactured goods

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or software may impact domestic employment to different degrees than trade deficits in raw
materials.

Economies such as Canada, Japan, and Germany which have savings surpluses, typically run
trade surpluses. China, a high growth economy, has tended to run trade surpluses. A higher
savings rate generally corresponds to a trade surplus. Correspondingly, the U.S. with its lower
savings rate has tended to run high trade deficits, especially with Asian nations.

Views on economic impact

Conditions where trade imbalances may be problematic

Those who ignore the effects of long run trade deficits may be confusing David Ricardo's
principle of comparative advantage with Adam Smith's principle of absolute advantage,
specifically ignoring the latter. 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.Global labor arbitrage, a phenomenon described by economist Stephen
S. Roach, where one country exploits the cheap labor of another, would be a case of absolute
advantage that is not mutually beneficial. Since the stagflation of the 1970s, the U.S. economy
has been characterized by slower GDP growth. In 1985, the U.S. began its growing trade deficit
with China. Over the long run, nations with trade surpluses tend also to have a savings surplus.
The U.S. generally has lower savings rates than its trading partners, which tend to have trade
surpluses. Germany, France, Japan, and Canada have maintained higher savings rates than the
U.S. over the long run.

Few economists believe that GDP and employment can be dragged down by an over-large deficit
over the long run. Others believe that trade deficits are good for the economy. Theopportunity
cost of a forgone tax base may outweigh perceived gains, especially where artificial currency
pegs and manipulations are present to distort trade.

Wealth-producing primary sector jobs in the U.S. such as those in manufacturing and computer
software have often been replaced by much lower paying wealth-consuming jobs such as those in
retail and government in the service sector when the economy recovered from recessions. Some
economists contend that the U.S. is borrowing to fund consumption of imports while
accumulating unsustainable amounts of debt.

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In 2006, the primary economic concerns focused on: high national debt ($9 trillion), high non-
bank corporate debt ($9 trillion), high mortgage debt ($9 trillion), high financial institution debt
($12 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security
liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious
deterioration in the United States net international investment position (NIIP) (-24% of
GDP), high trade deficits, and a rise in illegal immigration.

These issues have raised concerns among economists and unfunded liabilities were mentioned as
a serious problem facing the United States in the President's 2006 State of the Union address. On
June 26, 2009, Jeff Immelt, the CEO of General Electric, called for the U.S. to increase its
manufacturing base employment to 20% of the workforce, commenting that the U.S. has
outsourced too much in some areas and can no longer rely on the financial sector and consumer
spending to drive demand.

Conditions where trade imbalances may not be problematic

Small trade deficits are generally not considered to be harmful to either the importing or
exporting economy. However, when a national trade imbalance expands beyond prudence
(generally thought to be several[clarification needed] percent of GDP, for several years), adjustments tend
to occur. While unsustainable imbalances may persist for long periods (cf, Singapore and New
Zealands surpluses and deficits, respectively), the distortions likely to be caused by large flows
of wealth out of one economy and into another tend to become intolerable.

In simple terms, trade deficits are paid for out of foreign exchange reserves, and may continue
until such reserves are depleted. At such a point, the importer can no longer continue to purchase
more than is sold abroad. This is likely to have exchange rate implications: a sharp loss of value
in the deficit economys exchange rate with the surplus economys currency will change the
relative price of tradable goods, and facilitate a return to balance or (more likely) an over-
shooting into surplus the other direction.

More complexly, an economy may be unable to export enough goods to pay for its imports, but
is able to find funds elsewhere. Service exports, for example, are more than sufficient to pay
forHong Kongs domestic goods export shortfall. In poorer countries, foreign aid may fill the gap
while in rapidly developing economies a capital account surplus often off-sets a current-
accountdeficit. There are some economies where transfers from nationals working abroad
contribute significantly to paying for imports. The Philippines, Bangladesh and Mexico are
examples of transfer-rich economies. Finally, a country may partially rebalance by use

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of quantitative easing at home. This involves a central bank buying back long term government
bonds from other domestic financial institutions without reference to the interest rate (which is
typically low when QE is called for), seriously increasing the money supply. This debases the
local currency but also reduces the debt owed to foreign creditors - effectively "exporting
inflation".

Adam Smith on trade deficits

"In the foregoing part of this chapter I have endeavoured to show, even upon the principles of the
commercial system, how unnecessary it is to lay extraordinary restraints upon the importation of
goods from those countries with which the balance of trade is supposed to be disadvantageous.
Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon
which, not only these restraints, but almost all the other regulations of commerce are founded.
When two places trade with one another, this [absurd] doctrine supposes that, if the balance be
even, neither of them either loses or gains; but if it leans in any degree to one side, that one of
them loses and the other gains in proportion to its declension from the exact equilibrium."
(Smith, 1776, book IV, ch. iii, part ii)

Frdric Bastiat on the fallacy of trade deficits

The 19th century economist and philosopher Frdric Bastiat expressed the idea that trade
deficits actually were a manifestation of profit, rather than a loss. He proposed as an example to
suppose that he, a Frenchman, exported French wine and imported British coal, turning a profit.
He supposed he was in France, and sent a cask of wine which was worth 50 francs to England.
The customhouse would record an export of 50 francs. If, in England, the wine sold for 70 francs
(or the pound equivalent), which he then used to buy coal, which he imported into France, and
was found to be worth 90 francs in France, he would have made a profit of 40 francs. But the
customhouse would say that the value of imports exceeded that of exports and was trade deficit
against the ledger of France.

By reductio ad absurdum, Bastiat argued that the national trade deficit was an indicator of a
successful economy, rather than a failing one. Bastiat predicted that a successful, growing
economy would result in greater trade deficits, and an unsuccessful, shrinking economy would
result in lower trade deficits. This was later, in the 20th century, affirmed by economist Milton
Friedman.

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John Maynard Keynes on the balance of trade

In the last few years of his life, John Maynard Keynes was much preoccupied with the question
of balance in international trade. He was the leader of the British delegation to the United
Nations Monetary and Financial Conference in 1944 that established the Bretton Woods
system of international currency management.

He was the principal author of a proposal the so-called Keynes Plan for an International
Clearing Union. The two governing principles of the plan were that the problem of settling
outstanding balances should be solved by 'creating' additional 'international money', and that
debtor and creditor should be treated almost alike as disturbers of equilibrium. In the event,
though, the plans were rejected, in part because "American opinion was naturally reluctant to
accept the principle of equality of treatment so novel in debtor-creditor relationships".

His view, supported by many economists and commentators at the time, was that creditor nations
may be just as responsible as debtor nations for disequilibrium in exchanges and that both should
be under an obligation to bring trade back into a state of balance. Failure for them to do so could
have serious consequences. In the words of Geoffrey Crowther, then editor of The Economist, "If
the economic relationships between nations are not, by one means or another, brought fairly
close to balance, then there is no set of financial arrangements that can rescue the world from the
impoverishing results of chaos."

These ideas were informed by events prior to the Great Depression when in the opinion of
Keynes and others international lending, primarily by the U.S., exceeded the capacity of
sound investment and so got diverted into non-productive and speculative uses, which in turn
invited default and a sudden stop to the process of lending.

Influenced by Keynes, economics texts in the immediate post-war period put a significant
emphasis on balance in trade. For example, the second edition of the popular introductory
textbook, An Outline of Money, devoted the last three of its ten chapters to questions of foreign
exchange management and in particular the 'problem of balance'. However, in more recent years,
since the end of the Bretton Woods system in 1971, with the increasing influence
of Monetarist schools of thought in the 1980s, and particularly in the face of large sustained trade
imbalances, these concerns and particularly concerns about the destabilising effects of large
trade surpluses have largely disappeared from mainstream economics discourse and Keynes'
insights have slipped from view. They are receiving some attention again in the wake of
the Financial crisis of 20072010.

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Milton Friedman on trade deficits

In the 1980s, Milton Friedman, the Nobel Prize-winning economist and father of Monetarism,
contended that some of the concerns of trade deficits are unfair criticisms in an attempt to push
macroeconomic policies favorable to exporting industries.

Prof. Friedman argued that trade deficits are not necessarily as important as high exports raise
the value of the currency, reducing aforementioned exports, and vice versa for imports, thus
naturally removing trade deficits not due to investment. Since 1971, when the Nixon
administration decided to abolish fixed exchange rates, America's Current Account accumulated
trade deficits have totaled $7.75 Trillion as of 2010. This deficit exists as it is matched by
investment coming in to the United States- purely by the definition of the balance of payments,
any current account deficit that exists is matched by an inflow of foreign investment.

In the late 1970s and early 1980s, the U.S. had experienced high inflation and Friedman's policy
positions tended to defend the stronger dollar at that time. He stated his belief that these trade
deficits were not necessarily harmful to the economy at the time since the currency comes back
to the country (country A sells to country B, country B sells to country C who buys from country
A, but the trade deficit only includes A and B). However, it may be in one form or another
including the possible tradeoff of foreign control of assets. In his view, the "worst case scenario"
of the currency never returning to the country of origin was actually the best possible outcome:
the country actually purchased its goods by exchanging them for pieces of cheaply-made paper.
As Friedman put it, this would be the same result as if the exporting country burned the dollars it
earned, never returning it to market circulation. This position is a more refined version of the
theorem first discovered by David Hume. Hume argued that England could not permanently gain
from exports, because hoarding gold (i.e., currency) would make gold more plentiful in England;
therefore, the prices of English goods would rise, making them less attractive exports and
making foreign goods more attractive imports. In this way, countries' trade balances would
balance out.

Friedman believed that deficits would be corrected by free markets as floating currency rates rise
or fall with time to encourage or discourage imports in favor of the exports, reversing again in
favor of imports as the currency gains strength. In the real world, a potential difficulty is that
currency markets are far from a free market, with government and central banks being major
players, and this is unlikely to change within the foreseeable future. Nevertheless, recent
developments have shown that the global economy is undergoing a fundamental shift. For many

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years, the U.S. has borrowed and bought while in general, the rest of the world has lent and sold.
However, as Friedman predicted, this paradigm appears to be changing.

As of October 2007, the U.S. dollar weakened against the euro, British pound, and many other
currencies. For instance, the euro hit $1.42 in October 2007, the strongest it has been since its
birth in 1999. Against this backdrop, American exporters are finding quite favorable overseas
markets for their products and U.S. consumers are responding to their general housing slowdown
by slowing their spending. Furthermore, China, the Middle East, central Europe and Africa are
absorbing more of the world's imports which in the end may result in a world economy that is
more evenly balanced. All of this could well add up to a major readjustment of the U.S. trade
deficit, which as a percentage of GDP, began in 1991.

Friedman contended that the structure of the balance of payments was misleading. In an
interview with Charlie Rose, he stated that "on the books" the US is a net borrower of funds,
using those funds to pay for goods and services. He essentially claimed that the foreign assets
were not carried on the books at their higher, truer value.

Friedman presented his analysis of the balance of trade in Free to Choose, widely considered his
most significant popular work.

Warren Buffett on trade deficits

The successful American businessman and investor Warren Buffett was quoted in the Associated
Press (January 20, 2006) as saying "The U.S trade deficit is a bigger threat to the domestic
economy than either the federal budget deficit or consumer debt and could lead to political
turmoil... Right now, the rest of the world owns $3 trillion more of us than we own of them."

In a more detailed 2003 Fortune article, Buffett proposed a tool called Import Certificates as a
solution to the United States' problem and ensure balanced trade. "The rest of the world owns a
staggering $2.5 trillion more of the U.S. than we own of other countries. Some of this $2.5
trillion is invested in claim checksU.S. bonds, both governmental and private and some in
such assets as property and equity securities."

Physical balance of trade

Monetary balance of trade is different from physical balance of trade (which is expressed in
amount of raw materials, known also as Total Material Consumption). Developed countries

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usually import a lot of primary raw materials from developing countries at low prices. Often,
these materials are then converted into finished products, and a significant amount of value is
added. Although for instance the EU (as well as many other developed countries) has a balanced
monetary balance of trade, its physical trade balance (especially with developing countries) is
negative, meaning that a lot less material is exported than imported. For this reason, activists talk
about the issue of ecological debt which implies a sort of predatory economic system. The nature
of the trade balance statistics is such that it conceals distorted material flow.

Free trade

Free trade is a policy by which a government does not discriminate against imports or interfere
with exports by applying tariffs (to imports) or subsidies (to exports) or quotas. According to the
law of comparative advantage the policy permits trading partners mutual gains from trade of
goods and services.

Under a free trade policy, prices emerge from supply and demand, and are the sole determinant
of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of
goods and services among trading countries are determined by price strategies that may differ
from those that would emerge under deregulation. These governed prices are the result of
government intervention in the market through price adjustments or supply restrictions,
including protectionist policies. Such government interventions can increase as well as decrease
the cost of goods and services to both consumers and producers.

Since the mid-20th century, nations have increasingly reduced tariff barriers and currency
restrictions on international trade. Other barriers, however, that may be equally effective in
hindering trade include import quotas, taxes, and diverse means of subsidizing domestic
industries. Interventions includesubsidies, taxes and tariffs, non-tariff barriers, such as
regulatory legislation and import quotas, and even inter-government managed trade agreements
such as the North American Free Trade Agreement (NAFTA) and Central America Free Trade
Agreement (CAFTA) (contrary to their formal titles) and any governmental market intervention
resulting in artificial prices.

Features of free trade

Free trade implies the following features:

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 Trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on
imports or subsidies for producers)

Trade in services without taxes or other trade barriers

The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws)

that give some firms, households, or factors of production an advantage over others

Free access to markets

Free access to market information

Current status

Most countries in the world are members of the World Trade Organization, which limits in
certain ways but does not eliminate tariffs and other trade barriers. Most countries are also
members of regional free trade areas (see map) that lower trade barriers among participating
countries.

The European Union / European Economic Area and the North American Free Trade
Agreement are the world's largest free trade areas.

Most states conduct trade policies that are to a lesser or greater degree protectionist.One
ubiquitous protectionist policy employed by states comes in the form of agricultural
subsidies whereby countries attempt to protect their agricultural industries from outside
competition by creating artificial low prices for their agricultural goods. Free trade agreements
are a key element of customs unions and free trade areas.

Notable contemporary trade barriers include ongoing tariffs, import

quotas, sanctions and embargoes, currency manipulation of the Chinese yuan with respect to the
U.S. dollar, agricultural subsidies in developed countries, and buy American laws. Most
countries also prohibit foreign airlines from cabotage (transporting passengers between two
domestic locations), and foreign landing rights are generally restricted, but open skiesagreements
have become more common.

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Protectionism

Protectionism is the economic policy of restraining trade between states through methods such
as tariffs on imported goods, restrictive quotas, and a variety of other government regulations
designed to allow (according to proponents) "fair competition" between imports and goods and
services produced domestically.

This policy contrasts with free trade, where government barriers to trade are kept to a minimum.
In recent years, it has become closely aligned withanti-globalization. The term is mostly used in
the context of economics, where protectionism refers to policies or doctrines which protect
businesses and workers within a country by restricting or regulating trade with foreign nations.

Arguments for protectionism

Protectionists believe that there is a legitimate need for government restrictions on free trade in
order to protect their countrys economy and its peoples standard of living.

Comparative advantage has lost its legitimacy

Comparative advantage is used by most economists as a basis for their support of free trade
policies. Opponents of these policies argue that comparative advantage has lost its legitimacy in
a globally integrated world in which capital is free to move internationally. Herman Daly, a
leading voice in the discipline of ecological economics, emphasizes that although Ricardo's
theory of comparative advantage is one of the most elegant theories in economics, its application
to the present day is illogical: "Free capital mobility totally undercuts Ricardo's comparative
advantage argument for free trade in goods, because that argument is explicitly and essentially
premised on capital (and other factors) being immobile between nations. Under the new global
economy, capital tends simply to flow to wherever costs are lowestthat is, to pursue absolute
advantage." Protectionists would point to the building of plants and shifting of production to
Mexico by American companies such as GE, GM, and Hershey Chocolate as proof of this
argument.

Domestic tax policies can favor foreign goods

Protectionists believe that allowing foreign goods to enter domestic markets without being
subject to tariffs or other forms of taxation, leads to a situation where domestic goods are at a
disadvantage, a kind of reverse protectionism. By ruling out revenue tariffs on foreign products,
governments must rely solely on domestic taxation to provide its revenue, which falls
disproportionately on domestic manufacturing. As Paul Craig Roberts notes: "[Foreign
discrimination of US products] is reinforced by the US tax system, which imposes no
appreciable tax burden on foreign goods and services sold in the US but imposes a heavy tax

39 | P a g e
burden on US producers of goods and services regardless of whether they are sold within the US
or exported to other countries."

Protectionists argue that this reverse protectionism is most clearly seen and most detrimental to
those countries (such as the US) that do not participate in the Value Added Tax (VAT) system.
This is a system which generates revenues from taxation on the sale of goods and services,
whether foreign or domestic. Protectionists argue that a country that does not participate is at a
distinct disadvantage when trading with a country that does. That the final selling price of a
product from a non-participating country sold in a country with a VAT tax must bear not only the
tax burden of the country of origin, but also a portion of the tax burden of the country where it is
being sold. Conversely, the selling price of a product made in a participating country and sold in
a country that does not participate, bears no part of the tax burden of the country in which it is
sold (as do the domestic products it is competing with). Moreover, the participating country
rebates VAT taxes collected in the manufacture of a product if that product is sold in a non-
participating country. This allows exporters of goods from participating countries to reduce the
price of products sold in non-participating countries.

Protectionists believe that governments should address this inequity, if not by adopting a VAT
tax, then by at least imposing compensating taxes (tariffs) on imports.

Infant industry argument

Protectionists believe that infant industries must be protected in order to allow them to grow to a
point where they can fairly compete with the larger mature industries established in foreign
countries. They believe that without this protection, infant industries will die before they reach a
size and age where economies of scale, industrial infrastructure, and skill in manufacturing have
progressed sufficiently to allow the industry to compete in the global market.

Unrestricted trade undercuts domestic policies for social good

Most industrialized governments have long held that laissez-faire capitalism creates social evils
that harm its citizens. To protect those citizens, these governments have enacted laws that restrict
what companies can and can not do in pursuit of profit. Examples are laws or (in the case of
collective bargaining, upheld freedoms) regarding:

collective bargaining

child labor

competition (antitrust)

environmental protection

equal opportunity

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 intellectual property

minimum wage

occupational safety and health

Protectionists argue that these laws, adding cost to production, place an economic burden on
domestic companies bound by them that put those companies at a disadvantage when they
compete, both domestically and abroad, with goods and services produced in countries without
such laws. They argue that governments have a responsibility to protect their corporations as
well as their citizens when putting its companies at a competitive disadvantage by enacting laws
for social good. Otherwise they believe that these laws end up destroying domestic companies
and ultimately hurting the citizens these laws were designed to protect.

Arguments against protectionism

Protectionism is frequently criticized by mainstream economists as harming the people it is

meant to help. Most mainstream economists instead support free trade. Economic theory, under
the principle of comparative advantage, shows that the gains from free trade outweigh any losses
as free trade creates more jobs than it destroys because it allows countries to specialize in the
production of goods and services in which they have a comparative advantage. Protectionism
results in deadweight loss; this loss to overall welfare gives no-one any benefit, unlike in a free
market, where there is no such total loss. According to economist Stephen P. Magee, the benefits
of free trade outweigh the losses by as much as 100 to 1.

Most economists, including Nobel prize winners Milton Friedman and Paul Krugman, believe
that free trade helps workers in developing countries, even though they are not subject to the
stringent health and labour standards of developed countries. This is because "the growth of
manufacturing and of the myriad other jobs that the new export sector creates has a ripple
effect throughout the economy" that creates competition among producers, lifting wages and
living conditions. Economists[who?] have suggested that those who support protectionism
ostensibly to further the interests of workers in least developed countries are in fact being
disingenuous, seeking only to protect jobs in developed countries. Additionally, workers in the
least developed countries only accept jobs if they are the best on offer, as all mutually consensual
exchanges must be of benefit to both sides, or else they wouldn't be entered into freely. That they
accept low-paying jobs from companies in developed countries shows that their other
employment prospects are worse. A letter reprinted in the May 2010 edition of Econ Journal
Watch identifies a similar sentiment against protectionism from sixteen British economists at the
beginning of the 20th century.

Alan Greenspan, former chair of the American Federal Reserve, has criticized protectionist
proposals as leading "to an atrophy of our competitive ability. ... If the protectionist route is
followed, newer, more efficient industries will have less scope to expand, and overall output and
economic welfare will suffer."

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Protectionism has also been accused of being one of the major causes of war. Proponents of this
theory point to the constant warfare in the 17th and 18th centuries among European countries
whose governments were predominantly mercantilist and protectionist, the American Revolution,
which came about ostensibly due to British tariffs and taxes, as well as the protective policies
preceding both World War I and World War II. According to a slogan of Frdric Bastiat (1801-
1850), "When goods cannot cross borders, armies will."

Free trade promotes equal access to domestic resources (human, natural, capital, etc.) for
domestic participants and foreign participants alike. Some thinkers [who?] extend that under free
trade, citizens of participating countries deserve equal access to resources and social welfare
(labor laws, education, etc.). Visa entrance policies tend to discourage free reallocation between
many countries, and encourage it with others. High freedom and mobility has been shown to lead
to far greater development than aid programs in many cases, for example eastern European
countries in the European Union. In other words visa entrance requirements are a form of local
protectionism.

Current world trends

Since the end of World War II, it has been the stated policy of most First World countries to
eliminate protectionism through free trade policies enforced by international treaties and
organizations such as the World Trade Organization Certain policies of First World governments
have been criticized as protectionist, however, such as the Common Agricultural Policy in the
European Union, longstanding agricultural subsidies and proposed "Buy American" provisions in
economic recovery packages in the United States .

The current round of trade talks by the World Trade Organization is the Doha Development
Round and the last session of talks in Geneva, Switzerland led to an impasse. The leaders'
statement in the G20 meeting in London in early 2009 included a promise to continue the Doha
Round.

Protectionism after the 2008 financial crisis

Heads of the G20 meeting in London on 2 April 2009 pledged "We will not repeat the historic
mistakes of protectionism of previous eras". Adherence to this pledge is monitored by the Global
Trade Alert,providing up-to-date information and informed commentary to help ensure that the
G20 pledge is met by maintaining confidence in the world trading system, detering beggar-thy-
neighbour acts, and preserving the contribution that exports could play in the future recovery of
the world economy. Although they were reiterating what they had already committed to, last
November in Washington, 17 of these 20 countries were reported by the World Bank as having
imposed trade restrictive measures since then. In its report, the World Bank says most of the
world's major economies are resorting to protectionist measures as the global economic
slowdown begins to bite. Economists who have examined the impact of new trade-restrictive
measures using detailed bilaterally monthly trade statistics estimated that new measures taken

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through late 2009 were distorting global merchandise trade by 0.25% to 0.5% (about $50 billion
a year).

International trade law

International trade law includes the appropriate rules and customs for handling trade between
countries. However, it is also used in legal writings as trade between private sectors, which is not
right. This branch of law is now an independent field of study as most governments has become
part of the world trade, as members of the World Trade Organization (WTO). Since the
transaction between private sectors of different countries is important part of the WTO activities,
this latter branch of law is now very important part of the academic works and is under study in
many universities across the world.

Overview

International trade law should be distinguished from the broader field of international economic
law. The latter could be said to encompass not only WTO law, but also law governing the
international monetary system and currency regulation, as well as the law of international
development.

The body of rules for transnational trade in the 21st century derives from medieval commercial
laws called the lex mercatoria and lex maritima respectively, "the law for merchants on land"
and "the law for merchants on sea." Modern trade law (extending beyond bilateral treaties) began
shortly after the Second World War, with the negotiation of a multilateral treaty to deal with trade
in goods: the General Agreement on Tariffs and Trade (GATT).

International trade law is based on theories of economic liberalism developed in Europe and later
the United States from the 18th century onwards.

International Trade Law is an aggregate of legal rules of international legislation and new lex
mercatoria, regulating relations in international trade. International legislation international
treaties and acts of international intergovernmental organizations regulating relations in
international trade. lex mercatoria - "the law for merchants on land". Alok Narayan defines "lex
mercatoria" as "any law relating to businesses" which was criticised by Professor Julius Stone.
and lex maritima - "the law for merchants on sea. Alok in his recent article criticised this
definition to be "too narrow" and "merely-creative". Professor Dodd and Professor Malcolm
Shaw of Leeds University supported this proposition.

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World Trade Organization

In 1995, the World Trade Organization, a formal international organization to regulate trade, was
established. It is the most important development in the history of international trade law.

The purposes and structure of the organization is governed by the Agreement Establishing The
World Trade Organization, also known as the "Marrakesh Agreement". It does not specify the
actual rules that govern international trade in specific areas. These are found in separate treaties,
annexed to the Marrakesh Agreement.

Scope of WTO :

(a) provide framework for administration and implementation of agreements; (b) forum for
further negotiations; (c) trade policy review mechanism;and (d) promote greater coherence
among members economics policies

Principles of the WTO:

(a) principle of non-discrimination (most-favoured-nation treatment obligation and the national

treatment obligation) (b) market access (reduction of tariff and non-tariff barriers to trade) (c)
balancing trade liberalisation and other societal interests (d) harmonisation of national regulation
(TRIPS agreement, TBT agreement, SPS agreement)

Trade in goods

The GATT has been the backbone of international trade law throughout most of the twentieth
century. It contains rules relating to "unfair" trading practices dumping and subsidies.

Trade and Intellectual Property

The World Trade Organisation Trade Related Intellectual Property Rights (TRIPS) agreement
required signatory nations to raise intellectual property rights (also known as intellectual
monopoly privileges). This arguably has had a negative impact on access to essential medicines
in some nations.

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Dispute settlement

Most prominent in the area of dispute settlement in international trade law is the WTO dispute
settlement system. The WTO dispute settlement body is operational since 1995 and has been
very active since then with 369 cases in the time between 1 January 1995 and 1 December
2007. Nearly a quarter of disputes reached an amicable solution, in other cases the parties to the
dispute resorted to adjudication. The WTO dispute settlement body has exclusive and
compulsory jurisdiction over disputes on WTO law (Article 23.1 Dispute Settlement
Understanding).

A trade bloc is a type of intergovernmental agreement, often part of a

regional intergovernmental organization, where regional barriers to trade, (tariffs andnon-tariff
barriers) are reduced or eliminated among the participating states.

Stages of economic integration around the World:

(each country colored according to the most advanced agreementthat it participates into.)

Economic and Monetary Union (CSME/EC$, EU/)

Economic union (CSME, EU)

Customs and Monetary Union (CEMAC/franc, UEMOA/franc)

Common market (EEA, EFTA, CES)

Customs union (CAN, CUBKR, EAC, EUCU, MERCOSUR, SACU)

(AFTA, CEFTA, CISFTA, COMESA,GAFTA, GCC, NAFTA, SAFTA, SICA, TPP)

Description

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One of the first economic blocs was the German Customs Union (Zollverein) initiated in 1834,
formed on the basis of the German Confederation and subsequently German Empire from 1871.
Surges of trade bloc formation were seen in the 1960s and 1970s, as well as in the 1990s after
the collapse of Communism. By 1997, more than 50% of all world commerce was conducted
under the auspices of regional trade blocs. Economist Jeffrey J. Scott of thePeterson Institute for
International Economics notes that members of successful trade blocs usually share four
common traits: similar levels of per capitaGNP, geographic proximity, similar or compatible
trading regimes, and political commitment to regional organization.

Advocates of worldwide free trade are generally opposed to trading blocs, which, they argue,
encourage regional as opposed to global free trade. Scholars and economists continue to debate
whether regional trade blocs are leading to a more fragmented world economy or encouraging
the extension of the existing global multilateral trading system. Trade blocs can be stand-alone
agreements between several states (such as the North American Free Trade Agreement (NAFTA)
or part of a regional organization (such as the European Union). Depending on the level
of economic integration, trade blocs can fall into different categories, such as: preferential
trading areas,free trade areas, customs unions, common markets and economic and monetary
unions.

Free Trade Vs. Protectionism

As with other theories, there are opposing views. International trade has two contrasting views
regarding the level of control placed on trade: free trade and protectionism. Free trade is the
simpler of the two theories: a laissez-faire approach, with no restrictions on trade. The main idea
is that supply and demand factors, operating on a global scale, will ensure that production
happens efficiently. Therefore, nothing needs to be done to protect or promote trade and growth,

In contrast, protectionism holds that regulation of international trade is important to ensure that
markets function properly. Advocates of this theory believe that market inefficiencies may
hamper the benefits of international trade and they aim to guide the market accordingly.
Protectionism exists in many different forms, but the most common
are tariffs, subsidies andquotas. These strategies attempt to correct any inefficiency in the
international market.

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