Globalisation and theories of international trade
Trade theories explain why nations trade: from mercantilist hoarding of gold to Ricardo's comparative advantage, factor endowments, the product life cycle and Porter's diamond.
International business in the globalisation era
- International business covers all commercial transactions across national borders: trade, investment, licensing, franchising and services.
- Globalisation is the growing integration of national economies through trade, investment, technology and people.
- Theodore Levitt popularised the 'globalisation of markets' in the Harvard Business Review (1983).
- Two big drivers: falling barriers to trade and investment, and cheaper transport and communication.
- India opened up in 1991 with the LPG reforms: liberalisation, privatisation and globalisation.
- Linder's overlapping-demand theory (1961): countries with similar incomes trade similar manufactured goods.
Trade theories at a glance
| Theory | Proponent and year | Core idea |
|---|---|---|
| Mercantilism | Thomas Mun and others, 16th-18th century | Wealth is gold and silver; maximise exports, minimise imports; trade is a zero-sum game |
| Absolute advantage | Adam Smith, 1776 | Each country specialises in the good it makes with less labour than others; trade is positive-sum |
| Comparative advantage | David Ricardo, 1817 | Specialise where your opportunity cost is lower, even if you are worse at everything |
| Factor endowment (H-O) | Eli Heckscher 1919, Bertil Ohlin 1933 | Export goods that use your abundant factor intensively; import goods that need your scarce factor |
| Leontief paradox | Wassily Leontief, 1953 | Capital-rich USA was found exporting labour-intensive goods, against the H-O prediction |
| International product life cycle | Raymond Vernon, 1966 | The innovating country first makes and exports a new product; production later shifts abroad and the innovator ends up importing |
| New trade theory | Paul Krugman, from 1979 | Economies of scale and first-mover advantage explain trade between similar countries |
| Competitive advantage of nations | Michael Porter, 1990 | Four interacting determinants (the diamond) make a nation's industries globally competitive |
Comparative advantage in one minute
Ricardo's figures: one unit of cloth needs 100 workers in England and 90 in Portugal; one unit of wine needs 120 in England and 80 in Portugal. Who should export what?
- Portugal needs less labour for both goods, so it has the absolute advantage in both.
- England's opportunity cost of 1 cloth = 100 ÷ 120 = 0.83 wine (rounded to two decimals).
- Portugal's opportunity cost of 1 cloth = 90 ÷ 80 = 1.125 wine.
- England gives up less wine per unit of cloth (0.83 < 1.125), so England has the comparative advantage in cloth.
- Portugal's opportunity cost of 1 wine = 80 ÷ 90 = 0.89 cloth; England's = 120 ÷ 100 = 1.2 cloth. Portugal has the comparative advantage in wine.
England exports cloth and Portugal exports wine. Both gain, even though Portugal is better at both goods.
Porter's diamond
| Determinant | Meaning | Indian illustration |
|---|---|---|
| Factor conditions | Skilled labour, infrastructure and other advanced factors a nation creates | Engineering talent behind Infosys and TCS |
| Demand conditions | Large, demanding home buyers who push firms to improve | Price-sensitive Indian buyers driving frugal products |
| Related and supporting industries | Strong local suppliers and clusters | Auto-component clusters around Chennai and Pune |
| Firm strategy, structure and rivalry | Intense domestic competition sharpens firms | Rivalry among Indian generic drug makers |
| Chance and government | Two outside influences, not part of the four determinants | The 1991 reforms (government) |
EPRG orientation (Howard Perlmutter)
| Orientation | Mindset |
|---|---|
| Ethnocentric | Home-country ways are best; home-country managers run subsidiaries |
| Polycentric | Each host country is different; local managers run local units |
| Regiocentric | A region, such as South Asia or the EU, is the unit of planning |
| Geocentric | The world is one market; the best people are chosen from anywhere |
NET asks you to match each trade theory with its proponent and year, to spot the Leontief paradox in an assertion-reason item, and to list Porter's four diamond determinants (chance and government are add-ons).
Typical MCQ: “Which theory says a country should export goods that use its abundant factor intensively?” The Heckscher-Ohlin factor endowment theory. Trap: Ricardo's theory rests on labour productivity, not factor abundance.
Typical MCQ: “Are chance and government among Porter's four diamond determinants?” No. The four are factor conditions, demand conditions, related and supporting industries, and firm strategy, structure and rivalry. Chance and government act from outside.
Typical MCQ: “Who found that US exports were labour-intensive?” Wassily Leontief (1953). Trap: his finding contradicted Heckscher-Ohlin, not Ricardo.
Theories in time order: 'My Aunt Can Hardly Lift Packed New Diamonds' = Mercantilism, Absolute (Smith), Comparative (Ricardo), Heckscher-Ohlin, Leontief, PLC (Vernon), New trade (Krugman), Diamond (Porter).