Unit-III

Prepared
by
Dr. Suvendu Barik
Basic Theories of Trade Dr. Suvendu Barik

 International Trade is the exchanging method of

goods and services across the international border.
 In 2010, the worth of international tread achieved 19
trillion (US) dollars that is about 30% of the world
GDP.
 That is almost one third of production of goods and
services are exchanged internationally around the
world.
 International trade is the exchange between two folks
or entities in two different countries.
 International trade theories are completely different
type of theories that give explanation on international
trade.
Theories of international trade:
1) The Mercantilist view of International trade: (Countries like
Britain, France, Netherlands, Japan). The most important way for
a nation to become rich and powerful was to export more than it
imported. The difference would be settled by an inflow of
precious matters (mostly gold).
2) Theory of Absolute Advantage - Adam Smith (1776): The
greater efficiency that one nation may have over another in the
production of a commodity. Smith argued that with pre-trade, a
nation should specialize in the production and export of the
goods in which it has absolute advantage & import the good in
which it has absolute disadvantage.
3) Theory of comparative advantage- David Ricardo (Principles
of political economy and taxation-1817): Produce and export
the commodity of its smallest absolute disadvantage(comparative
advantage) and imports the commodities in which its largest
absolute disadvantage(comparative disadvantage).
Theories of international trade:
4) Theory of opportunity cost- Gottfried Haberler (The Theory
of International Trade-1883): Produce and exports the
commodity in which its opportunity cost is lower and import the
commodity in which its opportunity cost is higher.

5) Heckschar-Ohlin Theory of international trade – 1933

(Modern theory/General equilibrium/Factor Endowment):
Difference in relative factor endowments and factor prices
between nations as the most important determinants of
trade(Assumptions-Similar technology and taste).Exports the
commodity produced by its relatively abundant and cheap factors
and imports the commodity produced by its relatively scarce and
expensive factors.
 TERMS OF TRADE(TOT)
 It is one of the measurements of the gains from
international trade to a particular country. In other words,
It is the rate at which a countries' export are exchanged for
imports.
 Types Of TOT
1) Net Barter TOT(Given by F. W. Taussing):
Formula: Tc = Px / Pm. Where, Tc = Net Barter TOT, Px=Price of
Export Commodity Pm = Price of Import Commodity
2) Gross Barter TOT:
Formula: TG = Qm / Qx. Where, TG = Gross Barter TOT,
Qm = Total quantity import and Qx = Total quantity exports
3) Income TOT:
Formula: TI = (Px * Qm) / Pm . Where, TI = Income TOT,
Px*Qm= Value of Exports
 TERMS OF TRADE(TOT) Dr. Suvendu Barik

4) Unilateral/Single Factoral TOT:

Formula: Ts = (Px * Zx) / Pm
Where, Zx = Index of factor productivity in exports.
5) Bilateral / Double Factoral TOT:
Formula : TD = (Px * Zx) / (Pm * Zm)
Where, Zm = Index of factor productivity in imports.
6) Real Cost TOT:
Formula : Tr = Ts * Rx. Where, Rx = Index of amount of Disutility
suffered per unit of productive resources employed in producing
exports.
7) Utility TOT:
Formula : TU = TR*UM or TU = Px/Pm. Zx*Rx*UM
Where, Um = Index of relative desirability or utility of imports as
compared to the goods that could have been produced for home
consumption .
International Trade as an Engine of Growth
 International trade has been an important engine of output
and productivity growth historically.
 But since the global financial crisis, world trade growth has
slowed, reflecting cyclical and structural forces.
 The COVID-19 pandemic and Russia’s invasion of Ukraine
have further disrupted commodity markets, global supply
chains and the trade that accompanies them.
 A removal of impediments that raise trade costs could
reinvigorate world trade. Trade costs, on average, roughly
double the cost of internationally traded goods relative to
domestically sold goods.
 Tariffs amount to only one-twentieth of average trade costs;
the bulk are incurred in shipping and logistics, and trade
procedures and processes at and behind the border.
 Prebisch–Singer hypothesis or
The Prebisch-Singer Thesis
 The idea was developed by Raúl Prebisch and Hans Singer in the late
1940s; since that time, it has served as a major pillar of dependency theory
and policies such as import substitution industrialisation (ISI). BOOK
NAME: Towards a new trade policy for development
 Raul Prebisch insists that the terms of trade of the less developed countries
have been secularly deteriorating. He maintains that there is a long run
tendency for the prices of the primary products to deteriorated relative to
the prices of the manufactured goods.
 It's argument is based on the fact that Under Developed Countries (UDCs)
are net producers of primary products Such as cofee, copper, tea, rice,
sugar, fats, etc. These products are roughly the same goods today, that these
are 50 years ago. On the other hand, the quality of manufactured goods
produced by the Developed Countries (DCs) such as automobiles,
equipments, petroleum refineries, trucks, etc. has improved tremendously.
Consequently, in the world markets, these goods fetch higher prices relative
to those faced by the primary products.
 Prebisch–Singer hypothesis or
The Prebisch-Singer Thesis
 According to Singer or Singer gives a different explanation for the
deteriorating terms of trade of the primary products producing
countries.
 According to him, the fruits of the technical progress can either can
retained by the producers in terms of the high incomes or passed on
to the consumers in the form of low prices. The fruits of technical
progress in the UDCs have been passed on to the consumers in the
DCs in the form of lower prices of primary products whereas these
have been retained by the producers in the DCs in the form of higher
incomes of the producers.
Prebisch-Singer theory:
 The Prebisch-singer theory enunciates that the secular deterioration
in TOT has been an important factor in inhibiting the growth of
lower developed countries (LDCs). The TOT between the peripheral
(LDCs) and the cyclical centres (DCs) have shifted in favour of the
latter.
Assumptions:
The Prebisch-Singer thesis is based on the following assumptions-
1) On account of the operation of Engel’s law as income rise in
DCs, the demand pattern shifts away from primary to
manufactured products.
2) Demand for the primary products of LDCs rises slowly in DCs.
3) Export market for DCs products is monopolistic and that for
LDCs products is competitive.
4) Trade unions being weak in LDCs, wages are low there.
Prebisch-Singer theory: Dr. Suvendu Barik

Assumptions:
5) Substitutes for primary products of LDCs are appearing in the
world which diminish the demands for them.
6) Producers of manufactured products in DCs do not pass on the
benefits of increase in productivity through lower prices in LDCs.
7) Income terms of trade and is the diminishing factor for economic
growth in LDCs.
EXPLANATION:
1) Technical progress: increases the income of workers and
entrepreneurs and high price for their goods, some of them are
exported to the LDC’s. But the benefits of technical progress do
not flow to the LDCs. As a result, wages of workers do not rise.
Prices of their primary goods which they export in relation to
their imports fall, thereby worsening their TOT.
 Prebisch-Singer theory: EXPLANATION-
2) Relation between Income and Productivity: The increase in incomes is
less than that in productivity in LDCs due to population pressure and weak
trade unions.
3) Monopoly Elements: Another cause for deterioration in TOT of LDCs,
according to prebisch, has been monopoly elements in product markets of
DCs. The DCs have a high degree of monopoly power in manufacture
industrial and capital goods for which they charge high prices from LDCs.
On the other hand, the world prices of primary products of LDCs are low
because they are not properly organized. As a result, the TOT have remained
unfavourable for LDCs.
4) Effects of Cyclic Instabilities and Balance of Payments Difficulties:
LDCs are unable to take advantage of a fall to process of their export
products by increasing their export due to the inelastic nature of supply of
their export goods which are mainly agricultural and mineral products. On
the contrary, increased export earnings, lead to inflationary pressure,
malallocation of investment expenditure and to balance of payments
difficulties. As a result, there has been a secular deterioration In the income
TOT (Or the capacity to import) of LDC'S.
Prebisch-Singer theory: EXPLANATION-
5) Effect of Foreign investment: Singer’s contention is that the opening of
the LDCs to foreign trade and investment tended to inhibit their
development, since the purpose and the effect of these investments have
been to open up new sources of food for people and for the machines of
developed countries.
6) Debt Problems of LDCs: 1stly, a large amount of proceeds from exports
are utilized to repay their debts instead of paying for imports. 2ndly, to
repay their debts, LDCs compete with each other to increase their export
earnings.
7) Immiserising Growth: According to Bhagwati, immiserising growth in
LDCs leads to deterioration in the TOT of LDCs when- i) the economy's
growth leads to the production of more exportables; ii) the demands for
exports is inelastic; and iii) growth reduce the domestic production of
importables at constant commodity prices.
8) Shortage of Intermediate products: Due to the shortage of intermediate
products in relation to their expanding demand, they are imported at
relatively higher prices than the prices of exportables. These price
differences, results in deteriorating in TOT.
Prebisch-Singer theory: EXPLANATION-
9) Weak Bargaining Power: Most of the primary products
exported by LDCs to DCs are perishable. So they have to accept
the conditions laid down by the DCs because of their weak
bargaining power. The price and quantity conditions for exports
are always against the LDCs which leads to worsening of their
TOT.
10) Lack of Adaptability in Production: The raw materials and
agricultural products of LDCs lack in adaptability to their world
prices. When their world prices starts declining, the producers
of primary product cannot switch over production to some
other goods whose prices are not decreasing. It leads to fall in
TOT.
11) Dependence on DCs: LDCs depend on DCs for capital
equipment, machinery and know-how for their development of
import-substitution of Industries and infrastructure. These are
supplied at high export prices as compared to their export prices
which worsen their TOT.
Prebisch-Singer theory: Criticism-
1) Faulty TOT index: The thesis is based entirely on the inverse of the
new annual index of the UK's commodity TOT. This is a weak statistical
base for the generalisation that historically the TOT of LDCs have
deteriorated between1870 – 1930.
2) Not supported by empirical evidence: One is that there has been a
substantial long-term improvement in the TOT of DCs, including the
United States; the other, that there has been a significant long-term
deterioration in the TOT of primary as compared to manufactured
products. Although there have been very large swings in US TOT since
1879, no long-run trend has emerged.
3) LDCs also Export Manufactures: It is not correct to identify that all
LDCs export primary products and all DCs export manufactures bacause
there are many LDCs like India that also export manufactures, and DCs
like Australia and Denmark also export primary products.
4) Monopolistic Elements in DCs not Proved: The argument that
monopolistic elements in DCs have kept the benefits of technical
progress with themselves and have hurt the producers of primary
products in LDCs, has not been proved by any empirical evidence.
Prebisch-Singer theory: Criticism-
5) Engel’s Law not Applicable to Raw Materials: The contention that the
operation of Engel’s law tends to reduce secularly the demand for DCs
for primary products has been exaggerated because this law applies to
food and not to raw materials.
6) Neglect of Supply Conditions: The Prebisch-Singer thesis discusses
only demand conditions and ignores supply conditions in
determining TOT. But relative prices depends not only on demand
but also on supply conditions which are likely to much over long-
period.
7) LDCs Benefit from Foreign Investment: According to Fredie
Mehta, the TOT is not the most important determinant of economic
development. Though productivity gains have not been passed on
the LDCs in the form of low priced manufactures, yet they have
been passed on to them in the form of ‘product improvement’,
‘product inventions’ and ‘product diversification’.
8) Not Possible to Assess Changes in Demand of Primary
Prebisch-Singer theory: Criticism-
8) Not Possible to Assess Changes in Demand of Primary
Products: Tremendous changes have taken place in methods of
production and transportation in the world production and trade,
and in world population …
9) Export Instability not due to Price Changes Alone: According to
Mac Bean, export instability in LDCs seems to arise …
10) Foreign Investment not the Cause: There is no empirical
evidence to prove Singer’s contention that the development of the
export sector has been at the expense of the domestic sector.
Foreign investment and trade have not always stood in the way
of…
11) Weak Policy Measures: As a policy measure, Prebisch suggest
protection while Singer favours better utilisation of foreign capital.
There is no dispute …
Prebisch-Singer theory: Criticism-
12) During the 2000s commodities boom, the terms of trade of most
developing countries improved, while east Asia (which exports mostly
manufactured goods) saw deteriorating terms of trade—the opposite of
what the hypothesis generally predicts.
13) Critics argue that it is not possible to compare the prices of manufactured
goods over time because they change rapidly. The price relationship of
Prebisch–Singer does not take into account technological change. The
important thing is not the price of the goods but the service provided by
said goods.
For example, in 1800 an American worker could buy a candle that provided
one hour of light for six hours of work. But in 1997 an American worker
could buy an hour of light provided by a light bulb with barely half a
second of work.
Thus, LDC’s have not only failed to share in the productivity gains because
of population pressures ,technological backwardness, monopoly elements,
debt problems and for the principle reason that their economic activity is
dominated by the cycles of industrial activity in the DC's.
 Myrdal’s Theory of Circular Causation
 Book: Economic Theory and underdeveloped regions(1957).
 Introduction: Prof. Gunnar Myrdal maintains that economic development results
in a circular causation process whereby the rich are awarded more favors and the
efforts of those who lag behind are thwarted. The backwash effect predominate
and spread effects are dampened.
 This tends cumulatively to accentuate international inequalities and also leads to
regional inequalities within the UDCs. In UDCs a circular and cumulative
process, also known as the VCP operates downwards and being unregulated
causes increasing inequalities. Myrdal believes that our inherited theoretical
approach in inadequate to solve the problem of economic inequalities.
 The reason is that traditional economic theory is based on the unrealistic
assumption of stable equilibrium:
1) Prof. Myrdal believes that it is wrong to apply the notion of stable equilibrium
for constructing a theory to explain the changes in a social system.
2) Another unrealistic assumption which is closely related to the stable equilibrium
approach is the economic factors. The classical economic theory had its principal
shortcoming in disregarding the non-economic factors.
It was due to these two unrealistic assumptions that the traditional theory failed to
state the dynamic problems of economic underdevelopment and development.
 Myrdal’s Thesis (Prepared by Dr. Suvendu Barik)
 Professor Myrdal builds his theory of economic underdevelopment
and development around the idea of regional inequalities on the
national and international planes. To explain it, he uses the notions
of "backwash" and "spread" effects.
 He defines backwash effects as "all relevant adverse changes…of
economic expansion in a locality…caused outside that locality. I
include under this label the effects via migration, capital
movements and trade as well as the total cumulated effects resulting
from the process of circular causation between all the factors, "non-
economic" as well as "economic”.
 The spread effects refer to certain centrifugal "spread effects" of
expansionary momentum from the centres of economic expansion
to other regions."
 The main cause of regional inequalities, according to Myrdal, has
been the strong backwash effects and the weak spread effects in
underdeveloped countries.
 Myrdal’s Thesis: A) Regional Inequalities
 The genesis of regional inequalities within a country has a
non-economic basis. It is associated with the capitalist
system which is guided by the profit motive.

 The profit motive results in the development of those

regions where the expectations of profits are high while
other regions remain underdeveloped.

 Professor Myrdal attributes this phenomenon to the free

play of market forces which tends to increase rather than
decrease regional inequalities. In this way, regional
inequalities are accentuated when some localities grow at
the expense of other regions which stagnate.
 Myrdal’s Thesis: A) Regional Inequalities
The Backwash Effects of Migration, Capital Movement and Trade:
 Myrdal analyses the backwash effects of migration, capital movements and
trade on the backward regions.
 The localities and regions where economic activity is expanding will attract
young and active people from the other parts of the country. This will tend
to favour the developing region and depress economic activity in the
backward region, where from such labour migrates.
 Capital movements also tend to increase regional inequalities. In regions
which are developed, increased demand will stimulate investment which, in
turn, will increase incomes and demand, and lead to a second round of
investment, and so on. The scope for better investment in the centres of
expansion may create capital shortage in the backward regions.
 Similarly, trade operates with a fundamental bias in favour of the developed
regions and in disfavour of the less developed regions. The development of
industries in former regions may ruin the existing industries of the
backward regions and the poorer regions remain mainly agricultural.
 Myrdal’s Thesis: A) Regional Inequalities
 The Spread Effects: There will also be spread effects to localities producing raw
materials for the growing industries in the centres and those having consumer goods
industries will be stimulated. These will overcome the backwash effects from the
older centres and encourage self-expansion of new centres,
 Similarly, the spread effects flowing from a centre of industrial expansion to other
localities and regions, operating through increased demands for their products and
in many other ways, weave themselves into the cumulating social process by
circular causation.
 Backwash vs. Spread Effects. It is, however, not possible that the backwash
effects and spread effects should be in equilibrium. In support of this, Professor
Myrdal quotes two broad correlations from the studies of the United Nations
Economic Commission for Europe: first/regional inequalities are much wider in the
poorer than in the richer countries; and second the regional inequalities are
increasing in the poorer countries and diminishing in the richer countries. As such
economic development becomes an automatic process once a country has reached a
high level of development.
 In contrast, the major cause of the backwardness of underdeveloped countries has
been the weaker spread effects and stronger backwash effects whereby in the
cumulative process "poverty becomes its own cause."
 Myrdal’s Thesis: A) Regional Inequalities
 The Role of the State:
 National policies have tended to accentuate regional inequalities
in poorer countries.
 The free play of market forces and the laissez-faire policy have
been the two potent forces in creating regional inequalities in
the presence of weaker spread effects.
 Other factors responsible for regional disparities in the poorer
countries have been built-in feudal and other inegalitarian
institutions and power structures which aid the rich in exploiting
the poor.
 The governments of underdeveloped countries should,
therefore, adopt egalitarian policies to weaken the backwash
effects and strengthen the spread effects order to bridge regional
inequalities and to strengthen the foundations for continuous
economic progress.
 Myrdal’s Thesis: A) International Inequalities
 International trade have strong backwash effects on the UDCs,
according to Myrdal.
 The rich countries have a large base of manufacturing industries
with strong spread effects.
 World Trade Organization (WTO)
https://en.wikipedia.org/wiki/World_Trade_Organization

 The World Trade Organization (WTO) is an

intergovernmental organization that regulates and facilitates
international trade.
 The WTO precursor General Agreement on Tariffs and Trade
(GATT), was established by a multilateral treaty of 23 countries
in 1947 after World War II in the wake of other new multilateral
institutions dedicated to international economic cooperation—
such as the World Bank (founded 1944) and the International
Monetary Fund (founded 1944 or 1945).
 It officially commenced operations on 1 January 1995, pursuant
to the 1994 Marrakesh Agreement, thus replacing the General
Agreement on Tariffs and Trade (GATT) that had been
established in 1948.
 The WTO is the world's largest international economic
organization, with 164 member states representing over 98% of
global trade and global GDP.
 World Trade Organization (WTO): Key Takeaway
https://www.investopedia.com/terms/w/wto.asp
 The World Trade Organization (WTO) oversees global trade
rules among nations and mediates disputes.
 The WTO has been a force for globalization, with both positive and
negative effects.
 Big businesses tend to support the WTO for its positive impact on
international economic growth.
 Skeptics see it as increasing the wealth gap and hurting local
workers and communities.
 Once negotiations are complete and an agreement is in place, the
WTO offers to interpret the agreement in case of a future dispute.
All WTO agreements include a settlement process that allows it to
conduct neutral conflict resolution.
 Important: In recent years, the U.S. relationship with the WTO has
been cool. The feeling is that the WTO is not doing enough to
counteract China's unfair trade practices.
 World Trade Organization (WTO): Leadership
https://www.investopedia.com/terms/w/wto.asp
 As of 2021, the WTO has 164 member countries, with Liberia
and Afghanistan the most recent members, having joined in July
2016, and 25 “observer” countries and governments.
 On Feb. 15, 2021, the WTO’s General Council selected two-time
Nigerian finance minister Ngozi Okonjo-Iweala as its director-
general. She is the first woman and the first African to be
selected for the position. She took office on March 1, 2021, for a
four-year term.
 No negotiation, mediation, or resolution would be possible
without the foundational WTO agreements. These agreements
set the legal ground-rules for international commerce that the
WTO oversees. They bind a country’s government to a set of
constraints that must be observed when setting future trade
policies.
 The agreements protect producers, importers, and
exporters while encouraging world governments to meet specific
social and environmental standards.
 World Trade Organization (WTO):
Advantages and Disadvantages
 The history of international trade has been a battle between protectionism and
free trade, and the WTO has fueled globalization, with both positive and adverse
effects. The organization’s efforts have increased global trade expansion. There
are side effects to globalization, including a negative impact on local
communities and human rights.
 Proponents of the WTO, particularly multinational corporations, believe that the
organization is beneficial to business, seeing the stimulation of free trade and a
decline in trade disputes as beneficial to the global economy.
 Skeptics believe that the WTO undermines the principles of organic democracy
and widens the international wealth gap. They point to the decline in domestic
industries and increasing foreign influence as negative impacts on the world
economy.
 As part of his broader attempts to renegotiate U.S. international trade deals, when
he was in office, then-President Donald Trump threatened to withdraw from the
WTO, calling it a “disaster.” A U.S. withdrawal from the WTO could have
disrupted trillions of dollars in global trade. However, he didn’t withdraw the
U.S. from the WTO during his time in office.
 Why Is the World Trade Organization Important?
 The World Trade Organization (WTO) is the body that keeps global
trade running smoothly. It oversees the rules and mediates disputes
among its member nations. It now has 164 member nations and 25
observer nations (out of a total 195 nations in the world).
 What Are the Main Functions of the World Trade
Organization?
 The World Trade Organization (WTO) administers the trade
agreements made among its member nations. It also mediates any
trade disputes that arise.
 Is the U.S. a Member of the World Trade Organization (WTO)
 The U.S. has been a member of the WTO since 1995 and signed its
General Agreement on Tariffs and Trade (GATT) in 1948.
 In 1999, then-President Bill Clinton facilitated the acceptance of
China into the WTO. The impact on China and on the world
continues to be debated to this day.
 Thank You
(Prepared by Dr. Suvendu Barik)