International trade emerged as a controversial concept that led to the creation of various theories to justify the adoption of the practice. International trade theories explain the exchange of goods and services between entities or people from two different nations. The trade between individuals and entities results from the belief in the possibilities of benefiting from exchanging goods and services (Viner, 2016). International trade constitutes a significant number of theories, business strategies, and policies. Comparative advantage is one of the most important theories alongside absolute advantage. Other recent theories, as well as traditional ones like mercantilism, also justifies the need for embracing international trade. Thus, this essay focuses on describing theories that justify international trade. It will focus on absolute advantage, comparative advantage, and mercantilism theories.
First, absolute advantage is one of the classical theories that justify international trade. The theory emerged as a result of questions that Adam Smith raised in ‘The Wealth of Nations’ regarding mercantilism, which was the leading theory at the time. Economists and scholars have since edited the recent versions of absolute advantage theory (Chacholiades, 2017). Absolute theory is a new school of thought offered by Smith, and it focuses on a country’s ability to take part in the inefficient production of goods than other nations. In his reasoning, Smith deduced that there is no need for governments to intervene and set policies that restrict or regulate international trade. The theory thus suggests that there should be a natural flow of international trade, and it's market forces should be the only form of regulation in that respect.
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Smith used a hypothesis of a world comprising of two countries, namely country A and country B. If there are possibilities of getting cheap products from country A or at a fast rate (or both) as compared to country B, then it would imply that country A had the advantage. As a result, it would be for it to focus on specializing in the production of that product. A similar case applies if country B stands out as a better producer of a given product as it would need to focus and specialize on its strengths. The specialization approach would enable countries to generate efficiencies due to the skills that their labor force may learn from performing the same tasks (Viner, 2016). Also, the approach would improve the efficiency of the country since the country would have an incentive for creating better and faster methods of production to enhance its specialization.
The absolute theory provides reasoning that Smith puts across, suggesting that there is a need for encouraging international trade between the two countries since it would benefit citizens of both nations. The increased efficiency is the significant aspect that facilitates many benefits that the two nations may gain by engaging in international trade. Thus, Smith stated that there is no need for judging the wealth of any nation based on how much silver and gold it possessed previously. Instead, one needs to look at the standards of living of the people of such nations (Chacholiades, 2017).
Second, comparative advantage is the second theory that justifies international trade. It emerged as a result of challenges that emerged with the absolute advantage theory. Absolute advantage principle failed to consider the possibilities of some nations turning out to be good at the production of both goods, thus giving them an advantage in several sectors. Contrarily, another nation may fail to possess even a single absolute advantage. As a result, David Ricardo who was an English economist, came up with the comparative advantage theory in 1817 (Chacholiades, 2017). According to Ricardo, there are still high chances of trade and specialization to take place between the two nations even if country A enjoyed the absolute advantage of producing both products.
Comparative advantage refers to a situation where a country is not at a position of producing products efficiently as compared to the other nation; however, the country can produce the product in question more efficiently and using a better approach as compared to its p[roduction of other products. Thus, there is a subtle difference between the two theories. A comparative advantage aims at the differences between the relative productivity of the two nations, while absolute advantage focuses on absolute productivity (Chacholiades, 2017).
Mercantilism is a historical principle that justifies international trade as well. The theory became one of the guiding international trade principles of the sixteenth century. Mercantilism suggests that the amount of silver and gold holdings of a country determines its wealth (Magnusson, 2019). The simplest sense of the theory is that a country should ensure that it increases its silver and gold holdings by discouraging importation while encouraging the export of goods and services. Hence, this theory implied that if citizens from other nations purchase more products from a given country (exports) than the goods it sells (import) at that point, the country may have to use silver and gold in paying the difference. Each country had an objective of trading surplus, as well as a circumstance in which the value of goods being exported exceeds the value that the country imports (Magnusson, 2019). Also, the nations avoid trade deficit, which refers to circumstances where imports may be of greater value than exports.
The flourishing of Mercantilism resulted from the favorable historical environment of the 1500s to 1800s. The new nation-states started rising in the 1500s, and their rulers were striving to strengthen them by building larger national institutions and armies (Magnusson, 2019). The rulers increased trade and export to enable them to acquire more wealth and gold for their nations. Such countries imposed various limits on imports as one of the ways of promoting their exports through a strategy that they referred to as protectionism. Protectionism is a system that several nations still use to date.
Finally, the modern international trade theories like the principle of country similarity, also serve as one of the theories justifying international trade. In 1961, Steffan Linder who is a Swedish economist, formulated the theory of country similarity to help in explaining the Intra-industry trade concept. The principle suggests that consumers from nations in the same level of development have higher chances of sharing their preferences. The theory suggests that the first aim of companies is always to manufacture products to be consumed domestically (Viner, 2016). The countries end up finding markets that are similar to their domestic ones upon venturing in the export sector.
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