Trade is exchanging goods and services between two people or entities whereas international trade on the other hand is the exchange between people or entities in two different geographical boundaries for the purpose of providing a nation with commodities it lacks, in exchange for those that it produces which in turns helps improve a nation’s standard of living.

Economic theories of international trade itself have technologically advanced as means to evaluate the effects of trade policies. The International Trade Theories are classified into two:-
  • Traditional Theories
  • Modern Theories

Traditional Theories

  • Mercantilism: 
    • Let us begin with Mercantilism Theory, it is one of the oldest theories which emerged in England in the mid-16th century the theory attributes and measures the wealth of a nation by the size of its accumulated reserves measured in terms of gold. It was believed that the accumulation of gold reserves at the cost of other countries was the best way to increase the wealth of a nation. This theory focuses on the reduction of trade deficit and creates a surplus of gold reserves by maximizing exports and minimizing imports, however, there was a drawback to this theory that it didn’t recognize anything except gold as a measure of country’s wealth as also resulted in imbalance in the Balance of Trade (BOT) due to inflow of gold in a country which as a result increase the money supply leading to increase in prices (inflation) which would discourage exports due to increasing in price as there in inverse relation between Price and Export.

  • Absolute Advantage: 
    • Adam Smith in 1776, questioned the principles of mercantilism theory in “An Inquiry into the Nature and Causes of the Wealth of Nations” and proposed Absolute theory which engrossed on the ability of a country to produce a good more advantageously and cost-effectively than another nation be it in terms of natural advantage or acquired advantage and export such good of production advantage and import goods of production disadvantage from a nation which produces it advantageously.

  • Comparative Advantage:
    • It is the extension of absolute advantage theory as discussed earlier; it was given by David Ricardo in 1817. This theory elaborated upon a country having an advantage in the production of both commodities which was a shortcoming of the earlier absolute advantage theory, then compare the efficiency of both goods and produce and export the good which can be produced more efficiently it is to say the country should specialize in the production and export of a commodity in which the absolute disadvantage is less than that of another commodity or in other words, the country has got a comparative advantage in terms of more production efficiency in one good as compared it with the other good and import the goods in which it is less efficient in production.

  • Heckscher-Ohlin Theory (Factor Endowment Theory)
    • As the name suggests it was given by Eli Heckscher and Bertil Ohlin in 1993. It explains international trade in terms of available factors or Endowment in the country by producing products that utilize factors that were in abundance in the country. Their theory is based on a country’s production factors such as land, labor, and capital (Endowments) which provide the funds for investment in plants and equipment. A nation will export the commodity or goods whose production requires intensive use of the nation’s relatively abundant and cheap factors and import the commodity whose production requires intensive use of the nation’s scarce and expensive factors. Thus, a country with an abundance of cheap labor would export labor-intensive products and import capital-intensive goods, and a country with an abundance of capital would export capital-intensive goods and import labor-intensive goods. It suggests that the patterns of trade are determined by factor endowment rather than productivity and helps trade between the countries having economic structure differences. However, this theory was criticized by Wassily Leontief and found that the United States of America is the most abundant country in the world exported commodities that were more labour intensive, which is contrary to Heckscher-Ohlin Theory.


Modern Theories

  • Product Life Cycle Theory: 
    • It was given by Raymond Vernon in the mid- 1960s. this theory consists of technology-based products. A product goes through the product life cycle consisting of a new product to maturing product and later a standardized product. The country where the product is first launched is an innovator and at the end of the cycle, the innovator becomes the importer, For example, the USA is the innovator of the iPhone however in order to achieve economies of scale and have a cost-effective product the phone is manufactured in China which is a labor-intensive country and USA in turns imports it from China.
    • The theory, instigating in the field of marketing, stated that a product life cycle theory assumed that production of the new product will occur completely in the home country of its innovation. It has also been used to describe how the tech products went through their product cycle. The first-generation Apple iPhone was a new product in 2007 and developed into a mature product during the 2010s Today, the Apple iPhone is in the standardized product stage, and the majority of the manufacturing and production process is done in low-cost countries in India and China.

  • National Competitive Advantage Theory:
    • This Theory is also known as Porter’s Diamond Model given by economist Micheal Porter in 1990. The theory didn’t solely focus on the Endowments as a factor determining the pattern of trade between nations, instead talks about the competitiveness of a nation in a particular industry and such competitiveness is based on an inter-related set of location advantage, Porter postulated the factors that contribute to the success of national advantage such as Firm, Strategy, Structure & Rivalry- This factor is based on how an organization is systematized and managed, working morale and interactions between companies and the measure of rivalry within its own organisational culture.
    • According to Porter, domestic rivalry and the continuous search for competitive advantage will result in innovation and advancement within a nation which can help organizations achieve advantages.
    • Home Demand Condition- Local consumer's conditions on the basis of on-demand in a nation. The more demanding the local consumers the greater the pressure on companies to innovate and improve, if the demand for products is more in the local market, then such nation can influence the demand of the consumers in the foreign market.
    • Related & Supporting Industries- The success of one industry can be dependent on the success of related industries and gives more effective access to inputs that will promote innovation and globalization of other closely related industries.
    • Factor Condition- For the success of a nation depends on the factors present in a country such as natural resources, climate, geographic location, demographics, etc. and also factors such as skilled labor, research, technological advancement, education, and also result of investment by people, companies, and government.
    • Additional Factors:
      • Government as catalyst and challengers through Anti-Trust Laws and encourage competition in the domestic market through legislation such as “The Competition Act, 2002”.
      • Market Chance plays a critical rule which provides opportunities and ease for start-up companies to operate which in turns leads to innovation.
      • These factors are mutually reinforcing and interlinked and the overall development of this theory shows why one nation is more successful than another and for an industry to be successful, all four factors must be present along with government support.

About the Author: This Law note is prepared by Mr. Ayush Saini, a law graduate from Amity Law School, Amity University, NOIDA, and is an intern at MyLawman. He can be reached at advayushsaini@gmail.com

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