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Is expanded international trade desirable from the point of view of the

development of poor nations?

Working Paper · May 2015

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Royal University of Phnom Penh
Institute of Foreign Languages
Department of International Studies
Field of Studies: International Development Economics

Topic: Is expanded international trade desirable from the point of

view of the development of poor nations? Who gains from trade, and
how are the advantages distributed among nations?

Author Name:
Im Haichou
EL Monineath
Hort Chanrathana
Date of issue: 05-May-2015
I. Introduction

International Trade is usually referred as the exchange of goods, and services across
international borders or territories. It is noticed that the initial stage of international trade is
called "Mercantilism". It has emerged since the seventeenth and eighteenth century in Europe.
For centuries, international trade is not a very new phenomenon, it has existed since the
ancient time, and the transaction of international trade has kept transforming in larger sizes
and scales. After the end of World War II and Cold war, U.S takes a leading role to invite its
war allies to form the international trade organization (ITO) in order to restore and promote
the word economy. Noticeably, there are many international organizations have been
established so far. On October 30, 1947, a multilateral agreement regulating international
trades Called General Agreement on Tariffs and Trade (GATT) was formed to handle the
problem of world trade relations. Until 1994 to the present, World Trade Organization (WTO)
has been established replacing the GATT. Moreover, the United Nations Conference on
Trade and Development (UNCTAD) is also created to provide trade-related technical
assistance. Comparing between WTO and UNCTAD, the WTO mainly deals with the rules of
international trade whereas UNCTAD deals with research and advocacy of trade relations for
developing to promote their exports. Also, until to this globalization era, it is noticed that
international trade gives consumers and countries the opportunity to be exposed to new
markets and products. Interestingly, unlike the last centuries not only the products like food,
clothes, spare parts, oil, jewelry, and other commodities are imported and exported across the
borders, but services such as tourism, banking, consulting and transportation can also be
traded in the global markets to accumulate the world states capital (Douglas A. Irwin, 2001).
Although trade has brought general economic benefits for states; some economists still have a
controversial debate over the contribution of international trade as it may bring harm too.

This paper is written to examine the costs and benefits of international trade on the
development of the poor nations by applying the vary knowledge of international trade
theories; also, to investigate between the rich & the poor nations which countries can gain
from international trade the most. On the other hand, this study is essential conducted to
understand on three main objectives:

1. Why international trade is importance?

2. What are the costs & benefits of international trade on the poor & rich nations?
 3. What are the theories that can be best explained about doing international trade?
Should the developing countries continually open or stop conducting international
trade with other countries?

II. Literature Review

Definition of International Trade:

Understanding about International trade definition gives a hint to policy makers or

economists to understand about international trade; meanwhile, it is noticed that the various
definitions of international trade given by different economists can be an indicator to
calculate the cost and benefit of doing international trade. According to Smriti Chand, (2015),
he refers international trade as the exchange of capital, goods, and services across
international borders or territories. According to Shawn Grimsley, (2015), international trade
is about the outflow and inflow of international exchange that usually result from the inward
(import) and outward (export) movement of goods and services. It is significantly created in
order to increase the global state development in term of economic, and the interaction of
trade or commerce, as well as the social and political relations between nations.

Costs and Benefits of International Trade:

According to Pung Sun & Almas Heshmati, (2010), the authors studied about the
relationships and the contributions of international trade on economic growth in the
globalization era. Meanwhile, the author found out the positive evidences regarding to the
conducting of international trade such as facilitating capital accumulation, industrial structure
upgrading, technological progress and institutional advancement. Moreover, he added that
international trade offers the states two goods opportunity to gain from international
exchange. First, domestic consumers can buy cheaper imported goods and producers can
export goods at higher foreign prices. Second, with the lowering of tariff and the removal of
trade barriers, all country could increase the total output and social welfare by making the
best use of comparative advantages and specialization while doing international trade.

Besides the positive sides of international trade, according to Vlad Spanu, (2003), the
author found out some criticisms on the industrialized countries, especially U.S, European
Union members and Japan related to their protectionist policies. In addition, World Bank and
IMF which annually publish a report on the market access in agriculture and on barriers to
trade in textiles and clothing also raised that subsidies and anti-dumping procedures imposed
by developed countries can harm the interest of exporters from developing countries. A part
from protectionist policies, it is observed that developing countries may have less competitive
on the international market since they seem to relatively receive less technology transfer than
the developed countries.

Theories and Framework for the Analysis

Understanding about international trade theories enables foreign policy makers and
economists to calculate and analyze the positive and negative contributions of conducting
international trade. There are numerous of international trade theories, but since time
constraint and word limited, only three international trade theories are raised such as absolute
advantages theory, comparative advantages theory, and Hecksher Ohlin model theory.

• Absolute Advantages Theory

Absolute advantages theory is written by economist Adam Smith in the 1700s. He

suggested that countries should find out what they can produce more efficiently by
concerning on cheaper prices, better qualities, and short-time consuming. Also, he added that
finding the specialization in what they can do the best can help to increase more
productivities in trading. (Jon Nash, 2015).

• Comparative Advantages Theory

This theory is created by English economist David Ricardo in the 19th Century. He
argued that comparative advantages exist when a nation specialize in producing the good in
which they have the lowest opportunity cost than other countries. On the other hand, the
different point between comparative and absolute advantages is that absolute advantages
focus on being more productive or cost-efficient than another country whereas comparative
advantages relates to how much productive or cost efficient one country is than another
(Economics Online, 2015).

• Hecksher Ohlin Model Theory

The model was developed by two economists, Bertil Ohlin and Eli Heckscher after
the Second World War while all countries have the exact same technology in producing
goods. The Heckscher-Ohlin model is used to evaluate international trade, specifically trade
equilibriums between countries that may have different features. “The model emphasizes how
countries with comparative advantages should export goods that require factors of production
that they have in abundance, and import goods that it cannot produce as efficiently”
(Investopedia, 2015). To Simplify, a country tends to exports goods by using its abundant
factors, and import goods that use its scarce factors intensively. As a result, the relative
abundance in capital always cause the capital-abundant country to produce the capital-
intensive good cheaper than the labor-abundant country and vice versa.

III. International Trade Theory

International trade has been conducted since ancient time; however, international
trade activities have remarkably populated for many countries when there was emerging new
commodities, sailing technique, especially international trade theories. The most well-known
international trade theories including Absolute advantages, comparative advantages and HO
model had been adopted in countries’ trade policies. When we talk about international trade,
we always come up with question “Why countries should trade?” The answer is that
countries should trade because trade makes them better off even they are rich or poor
countries. However, some commentators argued that international trade benefit the rich
countries than the poor and suggested that poor countries should not open their market or
trade liberalization.

1. Theory of Absolute advantage

When we talk about absolute advantage theory, we’ll refer to Adam Smith who is a developer
of this theory. Smith’s thought on international trade theory has related with division of labor
(SCHUMACHER, 2012). This division leads to production improvements which increase
output, technological development, skill workers and productivity. Then countries will
experience economic growth and increase wealth of their nation. In this respect international
trade has to be considered (SCHUMACHER, 2012). According to Smith, international trade
is advantageous for nation even poor or rich countries. Moreover, international trade will
enhance division of labor or specialization of each countries which can lead to increase of
exchange goods generating profits for countries, as show in figure 4.1 (SCHUMACHER,
2012). In addition, international trade can also help poor nations to enhance production
technique and productivity through transfer knowledge and technology that enable their
market expansion (Smith, 2005). This can help the poor countries to experience economic
growth and development. For example, Cambodia can get new knowledge and technology
through its trade liberalization by connecting with developed nations like Japan, South Korea,
etc. Overall, Smith has optimistic on international trade that it benefit the countries involved.
However, everything has its limitation. In
reality, developed countries always gain
more advantageous for international trade
because it has more developed technology
and bigger market which can enhance
more advance division of labor, according
to SCHUMACHER (2012). Plus, Smith
argued that international and domestic
trade are determined by the same rule; it
mean that international trade shall evolve
in free condition like domestic
(Schumacher, 2012). Countries will export
goods on which they are specialized (Smith, 2005). It means countries that can produce goods
in low cost by their specialization will export those goods to world market. So poor countries
will export goods that they are specialized for boosting their economic growth. For instance,
Cambodia has specialize in producing rice; that’s why Cambodia export rise to the rest of the
world. Even a country with an absolute disadvantage-a higher domestic cost of production for
all traded commodities-gains from free trade by exporting those goods in which its absolute
disadvantage is least (Cohen & Zysman 1983). However, Smith himself also admitted that
international trade regularly carried advantages for countries involved, however, not always
equally (Schumacher, 2012). That’s why Smith does not discuss in detail how the benefits
from trade are divided between trading nations, because he stressed only that foreign trade is
beneficial for a country and its population.

2. Theory of Comparative advantages

The theory of comparative advantage has been considered as populated theory in modern
economic. You might know the developer of this theory named David Ricardo. His intention
is to develop this theory aim to proof that free trade benefits the participating countries
(Schumacher, 2012). However, he doesn’t mention whether poor or rich countries. Overall,
we can assume that even they are rich or poor countries unless they involve in free trade; they
will be better off. Like, Smith, Ricardo has the same notion on benefit from free trade;
however, he views domestic and foreign trade differs from Smith. Opposite to domestic trade
that has mobility of capital and labor for exchanging good, international trade can exchange
for goods in different labor force and mobility of capital is insecure, according to
Schumacher (2012). Notably, he argued that international trade don’t consist of absolute cost
of production, but comparative production cost or opportunity cost. And opportunity cost
mean whatever must be given up to obtain some item (Mankiw, 2004). That’s why he
stressed countries may have comparative advantage when they can produce in a low
opportunity cost. Let see below table and example how countries have comparative
advantages.

Base on table and theory of absolute advantage, we can assume that Portugal has absolute
advantage on both good; so how England can benefit from trade. This shows the weakness of
Smith Theory. However, Ricardo argued that both countries will benefits if they start to trade
with each other, even Portugal has absolute advantage on both goods (Schumacher, 2012).
Base on comparative production cost or opportunity cost will tell which countries have
specialist in which good. To calculate comparative cost, we will cost of both goods in both
countries. Because England has relative cost in producing 1 carton of clothes (100/120=0.83)
and 1 box of wine (120/100 = 1.2). And Portugal has relative cost of producing 1 carton of
clothes (90/80=1.12) and 1 box of wine (8/9=0.88). By comparing, England has comparative
advantage in producing clothes because relative cost is less than Portugal (0.83 <1.12). While
Portugal has comparative advantage in producing wine (1.20>1.88). Hence, England export
clothes to Portugal while Portugal will export wine to England (Schumacher, 2012). Base on
this comparison, it shows that how benefit from trade is divided between both countries.
Especially, we note that less productive and unspecialized countries also can enjoy benefit
from trade. Hence, even poor countries that are unspecialized be able to get benefit from
international trade, so they shall liberalize its trade. Overall, Countries specialize in
producing goods for which they has a comparative advantage; the aggregate production will
rise; and this rise of production in economic pie will make everyone better off (Mankiw,
2004).
 3. Hecksher Ohlin Model

The two Swedish economists that classify as neo-economist on international trade theory
argue different from Ricardo on comparative advantage. HO model argued that comparative
advantage arises from different factor endowment unlike Ricardian model focusing only
labor force (Oatley, 2012). In producing good for export in the international trade, countries
need factor of productions including capital and labor. Every countries have different factor
of production in different amount. Like US has a lot of capital but relatively little labor
because labor is expensive; while China has lot of cheap labor, but little capital (Oatley,
2012). These different of factor endowment shape the cost of production; and countries’
abundant factors will be cheaper than scare resource (Schumacher, 2012). In the
contemporary world, developed countries have a lot of capital while developing countries
have relatively cheap labor. Because countries have different factor endowment, countries
will hold different comparative advantages in different good. Countries will use their
comparative advantage to produce goods on their abundant factors (Oatley, 2012). When
countries has different abundant factors in producing different goods, international trade will
be considered. As in the auto industry in developed countries need between 20 and 30
percent of labor of total cost of production; while expenditure on the machines, assembly line
nearly cover 70% (Dicken, 1998). That’s why developed counties like Japan & US produce
car and export to the rest of the world rather than exporting goods using more labor force
because they have comparative advantage from capital abundant. By the same logic, some
developing counties that has labor abundant with little capital tend to produce apparel
products, agricultural product and food. For instance, some developing countries in Africa
export agricultural and food product to the rest of the world in 2012 accounted for 90%
(WTO, 2014). Like, Cambodia that has labor abundant exports 44 and 36 percent of total
garment to US and EU respectively in 1st quarter of 2015 (World Bank, 2015). Over all, when
countries have different factor endowment in producing goods, trade will occur among
countries, and they can enjoy benefit from those trade. So, Should developing countries
liberalize the trade? Even though Cambodia garment product that is the primary export
accounted $5.5 billion out of $7.5 billion in 2014, Cambodia still has trade deficit (about $3
billion), according to World Bank (2015). Because developing counties has weak economic
institutions, infrastructures, less capital abundant, they will get unequally benefit from
international trade. This comes up with question “why most of African counties and some
Asian countries can’t walk out from poverty”.
 IV. Finding and Discussion

Having said that, once different countries possess different factor endowment in
producing goods, trade will occur among all those countries, in which they can enjoy the
mutual benefit, even some countries might gain less than the others, but still they can
maximized their benefit as much as they can. However, if we think about the cost and benefit
between the poor and the rich we can say that, the developing countries to suffer more from
the trade deficit as the trade deficit is too heavy for those from the developing countries,
while the developed countries tend to enjoy more benefit from conducting the trade.
Moreover, if we can say that developing countries seem to be able to earn a very low profit
from the trade liberalization, as they do not have advanced technology just like the rich
countries do, so what the developing countries can product are most likely to be garment
product, food or agricultural products, while the rich countries can produce some kind of
machinery, automobile, and as well as the technological product which can help the rich to
earn way better than the developing can do. For example, Cambodia exports a total of 44 and
36 percent of garment to US and EU recently in the very 1st quarter of 2015 (World Bank,
2015), and by export those kind of products Cambodia did not gain much comparing to the
developed countries. On the other hand, despise having to say that the developing countries
have to suffer a lot more than the developed countries over the trade relations, but still the
developing countries can also gain quite a handful satisfaction from it as well. For example,
from 2004 to 2011 Cambodia can reduce the poverty rate from 53% to only above 20 %
which is known to exceed the Millennium Development Goals for poverty reduction (Phnom
Penh Post, 2013). That show a very good sign for Cambodia as they allocate and make use of
the trade liberalization to help reduce the poverty rate even before the deadline. Another
benefit for the developing like Cambodia is that, there many investors who are interested in
investing in Cambodia, which can help provide more job and more income for the local
people as well.
 V. Conclusion
As trade had been emerged since a very long time ago, it doesn’t mean that each and
every countries who are involving in conducting the trade can be better off; however, as far
as we can say most of the time only for those who are in the developed countries that can
truly enjoy the benefit from trade, while most of the developing countries have to suffer more
since they gain less benefit than those of the rich countries. On the other hand, even
developing countries seem to gain less benefit from conducting the trade, but in return they
are able to attract more foreign investors to come to their countries which can be of help to
them as they can one more step able to fasten their development, as well as they don’t seem
to gain less benefit than the cost at all.

References

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