CHAPTER 5

TRADE & FACTOR MOBILITY By – Yazan Shakman

Dr. Alaa AlRowad
THEORY
 AFTER STUDYING THIS CHAPTER,
YOU SHOULD BE ABLE TO:
1. Understand how different approaches to international trade theories help policy makers achieve economic objectives
2. Comprehend the historical and current rationale for interventionist trade theories
3. Explain how free trade improves global efficiency
4. Distinguish factors affecting national trade patterns
5. Recognize why a country’s export capabilities are dynamic
6. Detect why production factors, especially labour and capital, move internationally
7. Describe the relationship between foreign trade and international factor mobility
8. Grasp scenarios of possible changes in trade patterns
TRADE THEORY HELPS MANAGERS
AND GOVERNMENT POLICYMAKERS
FOCUS ON THESE QUESTIONS:
1. What products should we import and export?
2. How much should we trade?
3. With whom should we trade?
TRADE THEORIES
Laissez-Faire
Free-trade theories (absolute advantage
and comparative advantage) take a
complete laissez-faire approach because
they prescribe that governments should
not intervene directly to affect trade.
Interventionist
The other extreme are mercantilism and
neomercantilism, which prescribe a
great deal of government intervention in
trade.
THEORIES OF
TRADE
PATTERNS
How much countries depend on
trade, in what products, and with
whom), including theories of country
size, factor proportions, and country
similarity.
We then consider theories dealing
with the dynamics of countries’ trade
competitiveness for particular
products, which include the product
life cycle theory and the diamond of
national competitive advantage
theory.
FACTOR-MOBILITY THEORY
Because the stability and dynamics of countries’ competitive positions depend largely on the quantity and

quality of their production factors (land, labor, capital, technology).

1. Mercantilism
2. Neomercantilism
3. Absolute advantage
4. Comparative advantage
5. Country size
6. Factor proportions
7. Country similarity
8. Product life cycle (PLC)
9. Diamond of national
MERCANTILISM -
INTERVENTIONIST THEORIES
According to mercantilism, countries should export more than they import.
Governmental Policies
Governments restricted imports and subsidized production that otherwise could not compete in
domestic or export markets.
The Concept of Balance of Trade
A favourable balance of trade (also called a trade surplus) still indicates that a country is
exporting more than it imports. An unfavourable balance of trade (also known as a trade deficit)
indicates the opposite.
 NEOMERCANTILISM -
INTERVENTIONIST THEORIES
A country that practices attempts to run an export surplus to achieve a social or political objective.
Increased employment by setting economic policies that encourage its companies to produce in
excess of the demand at home and send the surplus abroad.
Attempt to maintain political influence in an area by sending more merchandise there than it
receives from it.
ABSOLUTE ADVANTAGE
FREE-TRADE THEORIES
The real wealth of a country consists of the goods and services available to its citizens rather than its
holdings of gold. This theory of absolute advantage holds that different countries produce some goods
more efficiently than others.
Through specialization, it could increase its efficiency for three reasons:
1. Labor could become more skilled by repeating the same tasks.
2. Labor would not lose time in switching production from one kind of product to another.
3. Long production runs would provide incentives for developing more effective working methods.
Free trade will bring:
• Specialization.
• Greater efficiency.
• Higher global output.
ABSOLUTE ADVANTAGE
FREE-TRADE THEORIES
Natural Advantage –
Natural advantage considers climate, natural resources, and labor force availability.
Acquired Advantage –
Acquired advantage consists of either product or process technology.
COMPARATIVE ADVANTAGE
FREE-TRADE THEORIES
Gains from trade will occur even in a country that has absolute advantage in all
products, because the country must give up less efficient output to produce more
efficient output.
Comparative Advantage by Similarity
Production Possibility
THEORIES OF
SPECIALIZATION ON:
SOME ASSUMPTIONS AND
LIMITATIONS
Full Employment Economic Efficiency
Full employment is not a valid Countries’ goals may not be limited to
assumption of absolute and comparative economic efficiency.
advantage.
They may avoid overspecialization
When countries have many unemployed because of the vulnerability created by
or unused resources, they may seek to changes in technology and by price
restrict imports to employ or use idle fluctuations or because they do not trust
resources. foreign countries to always supply them
with essential goods.
THEORIES OF
SPECIALIZATION ON:
SOME ASSUMPTIONS AND
LIMITATIONS
Division of Gains Transport Costs
If they perceive that a trading partner is If it costs more to transport the goods
gaining too large a share of benefits, than is saved through specialization, the
they may prefer to forgo absolute gains advantages of trade are negated
for themselves so as to prevent others
from gaining a relative economic
advantage.
THEORIES OF
SPECIALIZATION ON:
SOME ASSUMPTIONS AND
LIMITATIONS
Statics and Dynamics Services
The relative conditions that give The theories of absolute and
countries production advantages and comparative advantage deal with
disadvantages change products rather than services.
THEORIES OF
SPECIALIZATION ON:
SOME ASSUMPTIONS AND
LIMITATIONS
Production Networks Mobility
Costs are saved by having activities take Resources are more mobile domestically
place in various countries where there is than they are internationally.
an absolute or comparative advantage
for their production.
TRADE PATTERN THEORIES
Country Size
Large countries usually depend less on
trade than small ones. Countries with
large land areas are apt to have varied
climates and an assortment of natural
resources, making them more self-
sufficient than smaller ones.
Size of the Economy
While land area helps explain the
relative dependence on trade, countries’
economic size helps explain differences
in the absolute amount of trade.
WHAT TYPES OF WITH WHOM
PRODUCTS DOES A DO COUNTRIES
COUNTRY TRADE? TRADE?
Factor-Proportions Theory Country-Similarity Theory
According to the factor proportions Specialization and Acquired Advantage
theory, factors in relative abundance are
cheaper than factors in relative scarcity. Product Differentiation

People and Land The Effects of Cultural Similarity

Manufacturing Locations The Effects of Political Relationships

and Economic Agreements
Capital, Labor Rates, and Specialization
The Effects of Distance
Process Technology
Overcoming Distance
Product Technology
Developed countries trade primarily with each Trading partners are affected by

other because they: • Cultural similarity.

• Produce and consume more. • Political relations between countries.

• Emphasize technical breakthroughs in different • Distance.

industrial sectors.

• Produce differentiated products and services.

THE STATICS AND DYNAMICS OF
TRADE - PRODUCT LIFE CYCLE (PLC)
THEORY
The cycle consists of four stages: introduction, growth, maturity, and decline
The introduction stage is marked by
• Innovation in response to observed
need.
• Exporting by the innovative country.
• Evolving product characteristics.
Growth is characterized by
• Increases in exports by the innovating
country.
• More competition.
• Increased capital intensity.
• Some foreign production.
THE STATICS AND DYNAMICS OF
TRADE - PRODUCT LIFE CYCLE (PLC)
THEORY
The cycle consists of four stages: introduction, growth, maturity, and decline

Maturity is characterized by Decline is characterized by

• A decline in exports from the • A concentration of production in developing
innovating country. countries.
• More product standardization. • An innovating country becoming a net
importer.
• More capital intensity.
• Increased competitiveness of price.
• Production start-ups in emerging
economies.
LIFE CYCLE OF THE
INTERNATIONAL PRODUCT
GROWTH IS CHARACTERIZED
BY
• Increases in exports by the innovating country.
• More competition.
• Increased capital intensity.
• Some foreign production.
MATURITY IS
CHARACTERIZED BY
• A decline in exports from the innovating country.
• More product standardization.
• More capital intensity.
• Increased competitiveness of price.
• Production start-ups in emerging economies.
DECLINE IS CHARACTERIZED
BY
• A concentration of production in developing countries.
• An innovating country becoming a net importer.
THE DIAMOND OF NATIONAL
COMPETITIVE ADVANTAGE
THEORY
Companies’ development and maintenance of internationally competitive products
depends on favourable:
• Demand conditions.
• Factor conditions.
• Related and supporting industries.
• Firm strategy, structure, and rivalry.
LIMITATIONS OF THE
DIAMOND OF NATIONAL
ADVANTAGE THEORY
Entrepreneurs may face favourable conditions for many different lines of business.
The industries on which this theory is premised grew when companies’ access to
competitive capabilities was much more domestically focused.
WHY PRODUCTION FACTORS
MOVE
Capital
Capital, especially short-term capital, is the most internationally mobile production
factor. Companies and private individuals primarily transfer capital because of
differences in expected return (accounting for risk).
People
People are less mobile than capital. Some, of course, travel to other countries as
tourists, students, retirees, and migration. And the main reasons for people to think
of moving from their country to another:
1. Economic Motives
2. Political Motives
EFFECTS OF FACTOR
MOVEMENTS
Countries lose potentially productive resources when educated people leave—a
situation known as a brain drain.
On the other hand, they may receive money from those people.
Transfer of funds flows to developing countries for 2011 were estimated at U.S.
$372 billion.
Countries receiving productive human resources also incur costs by providing
social services and acculturating people to a new language and society.
EFFECTS OF FACTOR
MOVEMENTS
Countries lose potentially productive resources when educated people leave—a
situation known as a brain drain.
On the other hand, they may receive money from those people.
Transfer of funds flows to developing countries for 2011 were estimated at U.S.
$372 billion.
Countries receiving productive human resources also incur costs by providing
social services and acculturating people to a new language and society.
THE RELATIONSHIP BETWEEN
TRADE
AND FACTOR MOBILITY
Substitution
When the factor proportions vary widely among countries, pressures exist for the most abundant
factors to move to countries with greater scarcity, where they can command a better return.
In countries where labour is more abundant than capital, laborers tend to be unemployed or
poorly paid. If permitted, many in the labour pool go to countries that have full employment and
higher wages.
Complementarity
Companies’ investments abroad often stimulate exports from their home countries as the
company already knows what expected challenges and needs their home country has.
Immigration enhances trade by creating ethnic enclaves that form one side of ethnic networks
linking immigrants with their native countries.
THE RELATIONSHIP BETWEEN
TRADE AND
FACTOR MOBILITY
Factor mobility through foreign investment often stimulates trade because of:
• The need for components.
• The parent company’s ability to sell complementary products.
• The need for equipment for subsidiaries.
SUMMARY
Some trade theories examine what will happen to international trade in the absence
of government interference. Other theories prescribe how governments should affect
trade flows to achieve certain national objectives.
Trade theory is useful because it helps explain what might be produced
competitively in a given locale, where a company might go to produce a given
product efficiently, and whether government practices might interfere with the free
flow of trade among countries.
The theory of absolute advantage proposes specialization through free trade because
consumers will be better off if they can buy foreign-made products priced more
cheaply than domestic ones.