antilism is the oldest international trade theory that for . about 1500 to 1800.” According to this theory, the holdings of a country’s treasut E , form of gold constituted its wealth. This theory specifies that countries shoul i oe than they import and receive the value of trade Surplus in the form of gold fro a ics which experience trade deficits. med the foundation of economiee International Busing, Benefited Government - 41'S imposed restric aged exports in order 10 preva, ep Selon powers trade dees wens POFEM restrictions on imports and encouraged €xp itd caused Perience discontent in the 5 like the British useq trade surplus (Se Colonial power t rer ee bee a1) ‘aw materials from ar! gub fniehte® like India, Sri Lanka, te by importing the © rier ibde 2 disor exporting te na (0 export less valued goods 2 In ore valued goods, Thus, colonies were prevented fr lonies to experience trag sowed the colonial powers (t jay trade surplus and foread pee ear mee in Aart tivoty benatied the selon pews inner "Ct this was the background situation forthe American Re fi a. 8 the background situati favourable balance of trade in the form, Sndrd on, The Mercamtilism theory suggests for maintaining fa : cory sugee the validity of = r Adam Smith free trade enables 2 country to produce « variety (of goods and services. But the decay of gold standard reduced y! d services. Bul valdty oreo fF of Boos a as modified in Neo-mercantilism, Validity of this theory. Consequently, this theory wa Wit ae . q ce that countries attempt 10 produce than the d mand in Neo-mercantitism ROE Oeartee IAA IR LE occe ts tees. domestic country in order to achieve a socia file. ssisting a friendly country Country or a political objective like assisting, ee ; ster ent ground thatthe wealth of nation is based on its aval, asl eyiet nite, gold. Adam Smith developed the theory of absolute oo. goods and services rather than on gold. Ada advantage of international trade \, erent countries can get the advantag advantage which says that different s. Now we shall discuss this theory ods more efficiently than other Producing certain goods Adam Smith, the Scottish economist viewed that mercantilism weakens a country He advocated free trade among countries to increase a country’s wealth. Free trade enables country saie as @ Yariety of goods and services to its people by specialising in the production of some Boots and services and! importing others. Which goods should a country Produce and which g00ds it should import? Adam ‘Smith proposed a theory to answer this question. Adam Smith proposed Absolute Cost Advantage Theory of International Trade (1776) base gn the principle of division oF labour. According to him application oF this pi fe to international oan ai? helps the countries to specialise in the production of those goods in which they have cost advantage over other countries,rubber, t€- ThE USA climate supports the production of whe . BOX 2.2: NATURAL ADVANTAG! ee Ses re sur cashew Nuts exports accounted for 6S per cent is Righer than that of India, ™ : million) of the: global cashew exports, Th Vietnam has been or eanpalitae edn fetus nton iebourneiae the sini eps tana Sy Wecath eae at a doco as | fhe cashew skilfully and produce higher grade cashew (f0M the neighbouring countries, Now, the cashew mre ginpete with Mozambique, Indonesia and south Mult IS Used In producing canay, sams, Julee, wine, in y Saseasian countries. Indian farmers use less fertilisers °C 10 India, The unfavourable climate conditions mest’ thon those of Brazil, which gives Indian nuts a better (Nother covitries have also been helping India to i flavour and consequently better price in the global ema as the leading exporter of cashew: nag = Source: Adapted from John D. Datiels ef aly “international Dusinew, Peanion Sauapor le Pearson, Singapore: c q : a Acquired Advantage: In addition to the skilled labour and natural advantage: es Acquired . aa Sip een IL ‘al advantages, countries Acquired y also acquire a iges through technology and skill development. Japan acquired advantage in ees to technol steel production through the imports of both iron and coal. The reason for this success is that Japan acquired labour saving and. material saving technology. Denmark exports silver tableware due to the ability of Danish companies in devéloping distinctive products. skill develop | Technologically advanced countries acquired abilities to develop substitute products for a number of natural products. Thus, countries have absolute advantage in producing certain products as discussed above. For example, England had the absolute advantage in producing textiles, whereas France had the ‘absolute advantage in producing wine. Similarly, India has the absolute advantage in producing pens and Japan has the absolute advantage in producing audio tape recorders. Assumptions of the Theory: Adam Smith proposed the absolute cost advantage theory based on the following assumption: «Trade is between two countries. * Only two commodities are traded. «Free trade exists between the countries. ‘* The only element of cost of production is labour. Now, we discuss the absolute cost advantage through a numerical example. We explain the absolute advantage using two countries and two products. In this example, the countries are India and Japan and the commodities are pens and audio tape recorders. We treat the cost of production in terms of labour input. Table 2.1 shows the output of two goods per one day of labour for the two countries. Output per one day of Labour Japan India » a 6 2mre rreT mT TN) AA TU LT RANT oan ain the situation wh, ails to expl avid Ricardo a y ve theory f As indicated earlier, Absolute Cost Advantage the¢ any products. Dav and devg country has absolute cost advantage in producing mé clarify this situa ; r bsolute Cost Advantage theory [0 ¢% expanded the economist Pix the Theory of Comparative Cost Advantage ive cost advantage 4 ‘ comparat Assumptions of the Theory: The assumptions of the P include j bject to the |, © There exists full employment ‘on is the su ¢ : heated ion * The only clement of cost of production is labour, Product constant returns. i © There are no trade barriers. * Trade is free from cost of production. Trade takes place only between two countries. * © Only two products are traded. © There are.no costs of transport, etc. and export th, Comparative cost advantage theory states that a country should produce Productive than that of other countries and import thy products for which it is relatively more S00ds for which other countries are rel The comparative cost advantage theo: incorporates the concept of opportunity co atively more productive than it is. ty is based on relative Productivity differences x st. (See Exhibit 2.1). a“7 Miowuss UNIS theory. OB YAO SOMO AY On pict (OR) HE SUMO In view of the criticism cost against compar by many was: How do the countries Ohlins — Swedish economists — develo ative advanta, acquire comparative oped the theory of rel ge theory, the question pointed out Fac advantage? Eli Heckscher and Bertil &" ative factor endowments — to answer and, capital, natural resources, labour, climate, etc. The observations made by these two economists include: this question. Factor endowments are | e Factor endowments vary among countries: For ¢ resources, India is rich in labour, Saudi Arabia is ri Papua New Guinea have gold mines, etc. Table 2. of selected countries. xample, the USA is rich in capital ch in oil resources, South Africa and 5 presents relative factor endowments It is observed from Table 2.5 that Qatar had highest relative factor endowment in terms of per capita GDP (PPP) in the world in 2012 followed by Luxemburg, Singapore, Norway, Brunei and USA. USA’s got 6th rank in terms of per capita GDI in 2012. India stood at 133rd ae and its per capita GDP (PPP) in 2012 was only 3,843. Thus, India had relatively less endowments. Papua New Guinea stood at 142nd position and its per capita GDP was 2,736 in 2012.ree of competitive Significance of Innovation: innovation is the prime sourte OF COmPstitivE advaq, Leading firms innovate continuously and develop the products continuously in order to be 4, ovations can be in products, manueao™| forefront as innovations are imitated and copied. The innovati meer tAe Ulllity of innovation Process and marketing the product. Developing countries can have the lt 2 Hoping ether technology or procs fom the R&D intensive counties § 8 this stage, the firms sell most part of their prodiot O™ CANeee Te Pountry ay, limited part in other countries. Microsoft sold most part of I'S they) atthe remaining prin varios cour netoding Tada.) Labour as 8 Major Taput Production Poses omer feedback. LOTV was ment) | because, the product in this stage is improved based on custo} _ oduct is not yet standardised in this St [Sing duct eannot be developed due to frequent chap this stage is labour-intensive. Even com’ more than ten times during this stage. The pi machinery and equipment to produce the pro in the product design. As such, production during manufacturing was labour-intensive during this stage. be USA pays one ofthe highest sfaries inthe world. Tt pastes the highest labour cost customers who would be very eager t0 use the innovated product at this stage. The Pentiun PC which costs just % 20,000 today, cost % 1.50 lakh during this stage. The customers ,, could not wait purchased Pentium IV PC at € 1.50 lakh during its initial stage. © Feedback and Development: The firm’s marketing executives have to continuously the feedback from the customers and the production employees develop the product continuoy, STAGE - 2: GROWTH Increase in the sales of the new product attracts the competitors. At the same time, , increased awareness of the new product in various countries particularly in advanced coun, increases the demand for the product. Added to this, further innovation Ct aiket process,-cle. takes place resulting in increased capital intensity of the industry. Ti, ie (ato: influence eller the innovator or competitor or Both to produce in Foreigh cour 1m order to attain lower cost of production, lower transportation cost, better quality of the prod, lough tt, local production has take