International Trade and Export Management [1 ed.] 9789350432389, 9788184883060

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT FRAN(IS (HERIJNILAM M.A., M.B.A., D.D.P., Ph.D. Professor, School of Management Studies Cochin University of Science & Technology Cochin - 682011 (Formerly Professor and Chairman, Marketing Area, IIMK) e-mail: [email protected]

© Author No part of this book shall be reproduced, reprinted or translated for any purpose whatsoever without prior permission of the Publisher in writing.

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I CONTENTS I PART I INTERNATIONAL TRADE Theories, Concepts, Trends and Organisations 1.

AN OVERVIEW OF INTERNATIONAL TRADE

3-20

Merchandise trade; trade in services; global sourcing; countertrade; global trade and developing countries; summary; references.

2.

THEORIES OF INTERNATIONAL TRADE

21-52

Mercantilism; absolute cost theory; comparative cost theory; opportunity cost theory; factor endowment theory; complementary trade theories - Stolper-Samuelson theorem; intra-industry trade; economies of scale; different tastes; technological gaps and product life cycles; availability and non-availability; trade in intermediate goods; Dutch disease; Transportation cost and international trade - competitive advantage of nations; summary; references.

3.

GAINS FROM TRADE AND TERMS OF TRADE

53-62

Gains from trade; terms of trade; summary; references.

4.

63-74

TRADE POLICY (FREE TRADE VERSUS PROTECTION) Arguments for free trade; arguments for protection; demerits of protection; trade barriers; non-tariff barriers; summary; references.

5.

REGIONAL ECONOMIC INTEGRATION (TRADE BLOCS) AND COOPERATION

75-93

Types of integration; European Union; Indo-EU trade; other regional groupings; economic integration of developing countries; south-south co-operation; SAARC; SAPT A; Indo-Lanka Free Trade agreement; summary; references. Annexure: 5.1: GSP and GSTP.

6.

INTERNATIONAL COMMODITY AGREEMENTS, CARTELS AND STATE TRADING Commodity agreements - quota agreements; buffer stock agreements state trading; bilateral/multilateral contracts; summary; references.

7.

BALANCE OF PAYMENTS

94-101

cartels;

102-110

Components of balance of payments; balance of payments disequilibrium; correction of balance of payments disequilibrim; financing of BOP deficit; summary; references.

8.

INTERNATIONAL MONETARY SYSTEM

111-121

Pre-Bretton Woods Period; Bretton Woods system; managed floating; EMS, ECU and Euro; summary; references.

9.

FOREIGN EXCHANGE MARKET

122-154

Meaning, nature and functions; determination of exchange rates; purchasing power parity theory;balance of payments theory; exchange control; exchange rate systems; exchange rate classification; convertibility of rupee; devaluation; Currency exchange risks and their management; Foreign Exchange Management Act (FEMA); summary; references.

10.

EUROCURRENCY MARKET

155-161

Meaning and scope; important features of the market; origin and growth; factors that contributed to the growth; supply and demand; an evaluation of the eurocurrency market; summary; references.

11.

INTERNATIONAL FINANCIAL AND DEVELOPMENT INSTITUTIONS

162-185

International Monetary Fund; Special Drawing Rights (SDRs); IMF and international liquidity; World Bank; International Development Association; World Bank assistance to India; an evaluation of IMF-World Bank; International Finance Corporation; Asian Development Bank; UNCTAD; UNIDO; International Trade Centre; summary; references.

12.

WORLD TRADE ORGANIZATION (WTO)

186-215

GATT; the Uruguay Round; World Trade Organisation; salient features of UR agreement; GATS; TRMs; TRIPs; patents; dispute settlement; anti-dumping measures; an evaluation of UR agreement; UR agreement and developing countries; UR agreement and India; summary; references.

13.

INTERNATIONAL INVESTMENTS

216·237

Types of foreign investment; significance of foreign investment; limitations and dangers of foreign capital; factors affecting international investment; growth of FDI; dispersion of foreign investment; portfolio investment; cross-border M&As; foreign investment in India; the new policy; FII investments; Euro/ADR issues, mergers and acquisitions; foreign investment by Indian companies; summary; references.

14.

MULTINATIONAL CORPORATIONS (MNCs)

238-247

Definition and meaning; importance and dominance of MNCs; code of conduct; multinationals in India; summary; references.

15.

GLOBALISATION

248-257

Meaning and dimensions; stages of globalisation; essential conditions for globalisation; implications and impact of globalisation; globalisation of Indian business; summary; references.

PART II INTERNATIONAL MARKETING MANAGEMENT 16.

INTERNATIONAL MARKETING - AN INTRODUCTION

261-271

International marketing v. domestic marketing; objectives of international business; international orientations; international marketing deciSions; summary; references.

17.

INTERNATIONAL MARKETING ENVIRONMENT AND MARKETING STRATEGY

272-297

An overview of business environment; environment of international business; economic environment; political environment; legal environment; demographic environment; sociallcultural environment; geographical and natural environment; summary; references.

18.

INTERNATIONAL MARKETING INTELLIGENCE

298-313

Information requirements; sources of information; MIS and MR; types of research; phases of a research project; methods of data collection; sampling; research agencies; limitations and problems; summary; references.

19.

MARKET SELECTION AND PROFILING

314-323

Market selection process; determinants of market selection; market profile; market segment selection; summary; references.

20.

FOREIGN MARKET ENTRY STRATEGIES

324-333

Licensing and franchising; contract manufacturing; management contracting; turnkey contracts; wholly owned manufacturing facilities; assembly operations; joint ventures; third-country location; mergers and acquisitions; s1rategic alliance; countertrade; summary; references.

21.

INTERNATIONAL MARKETING CHANNELS

334-345

International marketing channels; channels between nations; marketing; environment and internal distribution; summary; references.

22.

PRODUCT STRATEGIES

346-370

Business environment and product strategies; product lifecycle; PLC and international marketing; product communication strategies; globalization versus localization; branding; packaging and labelling; summary; references.

23.

PROMOTION STRATEGY

371-383

Marketing environment and promotion strategies; factors influencing promotion strategies; promotion mix; export promotion organisations; trade fairs and exhibitions; personal selling; problems in international promotion; summary; references.

24.

PRICING STRATEGY

384-402

Pricing objectives; factors affecting pricing; exporter marketing costs; pricing methods! approaches; steps in pricing; retrograde pricing; transfer pricing; dumping; export price quotations and Incoterms; factors affecting pricing; summary; references.

25.

ORGANISATION FOR EXPORT MARKETING

403-407

Built-in export department; separate export department; export sales subsidiary; international division; summary; references.

26.

BUSINESS FROM WORLD BANK AIDED PROJECTS

408-411

Areas of business; project cycle; awarding of contracts; some tips to companies; summary; references.

PART III FOREIGN TRADE OF INDIA Policy, Regulation and Promotion 27.

FOREIGN TRADE POLICY AND REGULATION

415-458

Foreign Trade Policy, 2004-09; regulation and development of foreign trade; Foreign Trade (Development and Regulation) Act; export promotion; EOUs, EPZs and SEZs; international trade financing; payment terms; institutional finance for exports; Exim Bank; export credit risk insurance; summary; references. Appendix 27.1: Forfaiting Appendix 27.2: Letter of Credit and Financing Foreign Trade

28.

TRADE AND BOP OF INDIA

459-478

Highlights of India's trade performance; determinants of exports; determinants of imports; major exports; export product-country matrix; major imports; direction of trade; trends in invisibles and current accounts; balance of payments; major problems of India's export sector; summary; references.

29.

EXPORT PROCEDURES AND DOCUMENTS

479-499

Preliminaries; documents related to payment; documents related to inspection; documents related to excisable goods; documents related to foreign exchange regulation; summary; references. Annexure Economic policy liberalisation in India; Import substitution; Export Promotion Councils.

PART IV CASES 1.

Marketing Problems Leather Goods

504

2.

Channel Selection and Product Modification

506

3.

Export Market For Carpets

508

4.

Decorative Tiles Ltd.

510

5.

Minar Biscuits

514

6.

Sind Steel Works Ltd.

518

7.

Fine Home Furnishing Co.

521

APPENDIX Special Economic Zones

523

PART I INTERNATIONAL TRADE THEORIES, CONCEPTS, TRENDS AND ORGANISATIONS

"This page is Intentionally Left Blank"

1 AN OVERVIEW OF INTERNATIONAL TRADE That the international trade has been growing faster than world output indicates that the international market is expanding faster than the domestic markets. There are indeed many Indian firms too whose foreign business is growing faster than the domestic business. Business, in fact, is increasingly becoming international or global in its competitive environment, orientation, content and strategic intent. This is manifested/ necessitated/ facilitated by the following facts: • The competition a firm - local, national or foreign - now encounters, in many cases, is global, i.e., besides the competition from the domestic firms it has to compete with products manufactured rn Indi.a by foreign firms and imports. •

Because of the liberalisation, a firm has the challenging opportunity to improve its competitiveness and scope of business by global sourcing of technology, materials, fi nance human resources etc.

• Globalisation is facilitating globalisation of operations management to optimise operations and to improve competitiveness. Global value chain management is indeed a key factor of success. • The universal liberalisation and the resultant global market opportunities are taken advantage of by firms to consolidate and expand the business. The growing competition at home is pushing many companies overseas. • The global orientation of an increasing number of companies is evident from their mission statements and corporate strategies . The combined trade in goods ($13.6 trillion) and services ($3.3 trillion) was about $16.8 trillion in 2007. The ratio of goods and services in the total global trade remained more or 3

4

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

less the same since 1990 at 4:1 (i.e., goods account for about four-fifths and services onefifth of the total trade). The average annual growth rates of both goods and services trade have been much higher than the output growth rate.

( MERCHANDISE TRADE) ~

Growth of Merchandise Trade

Table 1.1 shows the growth of world merchandise exports. The table indicates that during 1950-60, the value of world exports more than doubled. In the next decade it increased nearly 2Y2 times. During the 1970s, the value of the world exports increased by about 5Y2 times. Worldwide inflation, particularly the successive hikes in oil prices, significantly contributed to this unprecedented sharp increase in the value of world exports. During 1980-90, the value of world exports increased by 80 per cent. During 1950-2007, while the average annual GDP growth (real) was 3.8 percent the trade growth was 6.2 per cent. Historically, trade growth consistently outpaced overall economic growth for at least 250 years, except for a comparatively brief period from 1913 to 1950 characterised by heavy protectionism which was almost a by-product of the two World Wars. Between 1720 and 1913, trade growth was about one-and-a-half times the GDP growth. Slow CDP growth between 1913 and 1950 - the period with the lowest average economic growth rate since 1820 was accompanied by even slower trade growth, as war and protectionism undermined international trade. This period was also plagued by the great depression. The second half of the twentieth century has seen trade expand substantially faster than output. For a long time now, world trade has grown twice as fast as world real CDP ( 6 per cent versus 3 per cent ). Exports of developing countries have been growing faster than that of developed countries. Table 1.1 GROWTH OF WORLD MERCHANDISE EXPORTS

Year

1950 1960 1970 1980 1990 2000 2007

Value of merchandise exports (in billions of US $)

55 113 280 1846 3311 6350 16,830

Sources: IMF, International Financial Statistics (various issues) and WTO, International Trade Statistics, 2008.

AN OVERVIEW OF INTERNATIONAL TRADE

>

5

Trade-GOP Ratio

That trade has been growing faster than world output means that a growing proportion of the national output is traded internationally. The foreign trade-GOP ratio (i.e., the value of the exports expressed as a percentage of the value of GOP) generally rises with economic development. This ratio had been generally high for the economically advanced countries when compared with that of the less developed countries. However, by the beginning of the 1990s, the developing countries overtook the developed countries in the trade-GOP ratio and today it is substantially high for developing countries over the developed ones. The trade (goods + services) - GOP ratio is near to 100 per cent in respect of developing Asia and Middle East, and, North Africa. There are some extreme cases like Singapore and Hong Kong with exceptionally high foreign trade-GOP ratio of well over 200 per cent. Being free ports, these are not, however, surprising cases. In 2006, the trade-GOP ratio was 49 per cent for high income economies and 60 per cent for the developing countries. The developing countries, thl,ls, are much more integrated than the developed ones with the global economy by trade. Among the developing countries, it was 62 per cent for middle income economies and 44 per cent for low income economies. India presented an interesting case. There was near stagnation in her foreign trade-GOP ratio for about four decades since the commencement of development planning. During this period it hovered around 15 per cent. The inward looking economic policy, import compression and very slow progress on the export front were responsible for this. Since the economic I iberalisation, ushered in 1991, there has, however, been an increase in India's foreign tradeGOP ratio - it was about 35 per cent in 2007-08.

>

Composition of Merchandise Trade

There has been a considerable change in the composition of the global trade. The share of manufactures in the total exports increased substantially, while that of the primary commodities declined correspondingly. The dominant category is machinery and transport equipments which has a share of well over one-third of the total exports and about half of the manufactures. Agricultural exports accounted for almost 47 per cent of total merchandise exports in 1950, but their share dropped to about 8 per cent by 2007. Manufactures, by contrast, accounted for 38 per cent of exports in 1950. This share was about 70 per cent in 2007. Within the manufactures, office and telecom equipment was the fastest growing category. In fact, this category recorded the highest growth among the major product groups throughout the 1990s. The share of mining products in total merchandise exports has remained more stable, with fluctuations over the period reflecting mainly price movements, particularly in the case of oil.

>

Trade Balance

There is no rule or empirical evidence that any particular category of countries. will have trade deficit or surplus. There are both developed and developing countries with trade surpl us and there are countries in both these categories with trade deficit. Further, the status of trade balance of some countries changes from time to time.

6

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

The US which had been the largest goods exporter was relegated to second position by Germany and in 2007 was pushed down to third position by China. The US has consistently been the country with the largest merchandise trade deficit. In 2005, the US merchandise imports were more than 92 per cent higher than the exports. The trade deficit of USA in 2005 ($828 billion) was larger than the value of GOP of every developing country except China and a number of developed economies. Developed countries like UK, Switzerland and France also had trade deficit while countries like Japan has had very large trade surpluses. Germany also has been having substantial surplus. Among the developing economies, China has been occupying an enviable position regarding trade balance. China, which had a trade deficit of over $13 billion in 1985, had a surplus of nearly $ 9 billion in 1990, $25 billion in 2000 and nearly $261 billion in 2007. Other developing countries with significant trade surplus include Malaysia, S. Korea and Taiwan. Many developing countries have been in deficit. In the last five decades or so, India's trade balance was negative except in two years (1972-73 and 1976-77). Among the transition economies, in recent years while Russia had a large trade surplus, many others had adverse balance. China is the third largest merchandise exporter and importer now. In recent years, while the. developing countries as a group had a surplus trade balance, the high income countries had net deficit.

>

Distribution of Global Trade

Much of the trade takes place between the developed countries. Bulk of the exports of the developing countries is absorbed by the developed countries. Germany, U.S.A., China and Japan account for over 30 per cent of the global trade in goods. More than half of the world exports originate in just nine countries. 15 countries contribute about two-thirds of the total exports. 50 countries add up to more than 90 per cent of the total exports. There has been a slight decline in the trade concentration. For a long time, the first rank in terms of the value of exports was occupied by the US, with Germany and Japan in second and third positions respectively, followed by France, United Kingdom, and Italy in that order. The United States had been the largest importer followed by Germany and Japan. There are a number of developing countries in the list of the top 20 exporters. A small number of countries account for the bulk of the total exports of the developing countries. Recently, the relative ranks have been altered as shown in Table 1.2. India's share in the global exports declined from about 2 per cent in 1950 to about 0.4 per cent in1980. Since around the mid 1980s, there has been a slight improvement and in 2007, it is about one per cent of merchandise exports and 1.5 per cent of imports and her rank in exports was 26 and in imports 18. With 2.7 per cent share in global services exports her rank was 9 and with 2.5 per cent share in imports her rank was 13.

AN OVERVIEW OF INTERNATIONAL TRADE

7

Table 1.2

LEADING MERCHANDISE TRADERS, 2007 (Billion dollars and percentage) Rank

Exporters

Value

Share

Rank

Importers

Value

Share

2020.4 1058.6 956.0 621.1 619.6 615.2 504.5 491.6 413.2 389.6 372.6 370.1 93.3 356.8

14.2 7.4 6.7 4.4 4.4 4.3 3.5 3.5 2.9 2.7 2.6 2.6 0.7 2.5

1 2 3 4 5 6 7 8 9 10 11 12

Germany China United States Japan France Netherlands Italy United Kingdom Belgium Canada S. Korea Russia

1326.4 1217.8 1162.5 712.8 553.4 551.3 491.5 437.8 430.8 419.0 371.5 355.2

9.5 8.7 8.3 5.1 4.0 4.0 3.5 3.1 3.1 3.0 2.7 2.5

1 2 3 4 5 6 7 8 9 10 11 12

13

Hong Kong domestic exports re-exports Singapore domestic exports re-exports Mexico

349.4 18.1 331.3 299.3 156.0 143.3 272.0

2.5 0.1 2.4 2.1 1.1 1.0 2.0

13

United States Germany China Japan United Kingdom France Italy Netherlands Belgium Canada Spain China retained imports S. Korea

14

Mexico

296.3

2.1

15

Taipei, Chinese Spain Saudi Arabia Malaysia UAE Switzerland Sweden Austria Brazil Thailand India Australia Poland Norway Czech Republic

246.4 241.0 234.2 176.2 173.0 172.1 169.1 162.9 160.6 153.1 145.3 141.3 138.8 136.4 122.4

1.8 1.7 1.7 1.3

16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Singapore retained imports Russia Taipei, Chinese India Turkey Australia Poland Austria Switzerland Sweden Malaysia Thailand UAE Brazil Czech Republic Denmark

263.2 119.9 223.4 219.6

1.8 0.8 1.6 1.5 1.5 1.2 1.2 1.1 1.1 1.1 1.1 1.0 1.0 0.9 0.9 0.8 0.7

14

15 16 17 18 19 20 21 22 23 24 25 26

27 28 29 30

1.2 1.2

1.2 1.2

1.2 1.1 1.0 1.0 1.0 1.0 0.9

216.6

170.1 165.3 162.7 162.4 161.2 151.3 147.0 140.8 132.0 126.6 117.9 99.6

Source: WTO, International Trade Statistics, 2008.

> Growing Intra-Regional Trade An important trend has been the growth of the intra-regional trade. Some people view world trade as consisting broadly of intra-regional trade and inter-regional. There is also talk of regionalisation versus globalisation of world trade.

8

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

Regional integration schemes tend to increase intra-regional trade. For example, trade between the 12 members of the European Community (EC) increased from about 40 per cent of their total trade in 1960 to 60 per cent in 1990. In 2007, 68 per cent of the EU (27 countries) was intra-trade. Intra-trade of NAFTA in 2007 was 51 per cent compared to 56 in 2000. 25 per cent of the ASEAN trade in 2007 was intra. Between 2000 and 2007, the share of intratrade in global trade fluctuated between 55 and 58 per cent.

»

Growing Protectionism

After the Second World War, there had been a progressive liberalisation' of trade by the developed countries. Successive rounds of negotiations at the GATT have· cut tariffs on trade in manufactured goods from an average level of 40 per cent in 1947 to approximately 3 per cent in the industrial countries. Even though the process of elimination of the tariff barriers has continued, since around the mid 1970s the liberalisation trend in the developed countries has been replaced by growing protectionism. A number of problems like the currency crisis, oil crisis, debt crisis, recession and high rate of unemployment produced an atmosphere all around the world in which demands for protection increased dramatically. Added to these has been the growing competition from Japan and the newly industrialising countries. As a response to these, the developed countries have increased the non-tariff barriers (NTBs). In addition to the hard-core NTBs such as quotas, voluntary export restraints, multifibre arrangements (MFA) etc., these include measures such as price restraints or health and safety regulations. The exports of developing countries have been hit much more than those of the developed by such protectionism and the developing countries have been losing very heavily due to them.

»

Trade and Investment

Foreign trade and foreign direct investment (FDI) appear to be mutually influential. While some of the FDls increase international trade, some FDls decrease trade. FDI in the natural resource sectors, including plantations, in developing countries increase trade. The MNCs' FDls due to several reasons also increase international trade. While on the one hand investment increases trade, as stated above, on the other hand foreign production by FDI substitutes foreign trade in many cases. Due to factors like foreign exchange problems, desire to industrialise fast, etc. the policies of many developing countries preferred foreign investment (for import substitution) to imports. Due to the growing protectionism and some other factors, large amounts of FDI have been taking place in the developed countries leading to substitution of foreign production for foreign trade as described in the chapter on International Capital Flows. The regional integration schemes also tend to increase such investments to substitute production for trade. For example, many foreign companies have been setting up manufacturing and assembly facilities in the European community to overcome the 'Fortress Europe.' It may also be pointed out that to a considerable extent such investments are made possible by the past trade - the funds'generated by trade are ploughed back to investment in the foreign countries. The massive foreign investm~nts made by the Japanese companies since the mid 1980s deserve a special mention in this context.

AN OVERVIEW OF INTERNATIONAL TRADE

9

While international investment replaces international trade in certain products, it may generate trade in some other products. Drucker, who observes that although traditionally investment has followed trade, trade is increasingly becoming dependent on investment, points out that US exports in the years of the overvalued dollar would have been even lower had the European subsidiaries of American companies and American joint ventures in Japan not continued to buy machinery, chemicals and parts from the US. Similarly, the foreign subsidiaries of America's financial institutions, accounted for something like one-half of the US service income during those dismal year.1 That about half of the world trade in manufactured goods is intra-company is ample indication of the investment-trade linkage. There is growing evidence that " ... it is simply not possible to maintain substantial market standing in an important area unless one has a physical presence as a producer."2 For many years, international investment has been growing much faster than international trade. "Increasingly, world investment rather than world trade will be driving the international economy. Exchange rates, taxes and legal rules will become more important than wage rates and tariffs."3

( TRADE IN SERVICES) International trade in services, which makes up a major share of the invisibles account of the Balance of Payments, has been growing fast. It increased from $800 billion in 1990 to about $1435 billion in 2000 and to about $3.3 trillion in 2007. During the 1980s, trade in services grew faster than that of the goods increasing its share in the total global trade from 17 per cent in 1980 to 20 per cent in 1990. The share of services in the total global trade remained more or less the same (about one-fifth) since then. During 2000-07, both the services and merchandise trade grew at an average annual rate of 12 per cent. It is pointed out that the "internationalization of services is reflected in the growth of both trade and foreign direct investment flows. Both have been driven by innovations in information and communication technology that allowed increasing specialization. As of early 1990s, about 50 per cent of global stock of FDI was in services activities. The share of annual flows to many countries has been over 65 per cent in recent years."4 Economic development is, generally, characterised by an increase of the share of the services in the GDP and total employment. This trend tends to increase the international trade in services. The services sector which contributes more than 60'per cent of the world GDP is growing fast. It is the largest sector in most of the economies and it is the fastest growing sector in many of them. The developed economies are primarily service economies in the sense that the service sector generates bulk of the employment and income. The contribution of services to GDP and employment is substantially high in, particularly, the developed economies. Although the share of services in the GDP of developing economies is lower than in the developed ones, the service sector has been growing very fast in the developing world. The growing importance of services is reflected in the international trade too. The growth rate of trade in services was faster than that of goods. As a World Bank report observes, the tremendous growth of trade in services and, more recently, of electronic commerce is part of the new trade pattern. Exports of commercial

10

:>

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

services have been growing on every continent (particularly Asia) throughout the 1990s. This change has its own special significance, as services are frequently used in the production of goods and even other services. Enhanced international competition in services means reduction in price and improvements in quality that will enhance the competitiveness of downstream industries. Both industrial and developing economies have much to gain by opening their markets. Developing countries would derive large gains from an easing of barriers to agricultural products and to labour-intensive construction and maritime services. Over the longer term, electronic business will loom large as an area where expanding opportunities for trade require an expanding framework of rules. 5

»

Major Services

Travel and transportation account for major share of the services trade. In 2007, travel accounted for about 26 per cent and transportation about 23 per cent of the services exports. However, trade in other commercial services (particularly financial services - including banking and insurance - construction services, and computer and information services) has been growing faster than these two categories and they made up more than half of the service exports in 2007. International trade in many services involves international factor mobility. There are a number of international transactions involving temporary factor relocation services such as those requiring temporary residence by foreign labour to execute services transactions.

»

Major Service Traders

The world trade in services is dominated by the developed economies. (See Tables 1.3). In 2005, the four top exporters - USA, UK, Germany and France did nearly one-third of the world total. Nine countries account for over half and 13 countries nearly 60 per cent of the total service exports. It may be noted that USA which has a huge deficit on the merchandise trade has a huge surplus on the services trade. Some countries like Japan and China which have huge surplus on the goods trade have deficit on the services account. With 2.7 per cent share, India's share in global export of services in 2007, India's rank was 9th, compared to 26th rank in merchandise exports and with a 2.5 per cent share of global import of services, her rank was 13, as against 18 in merchandise imports. In recent years India has improved her share and rank in the services trade.

»

Barriers to Trade in Services

International trade in services, thus, involves intricate issues like right to establish and factor mobility. These are the problems faced in liberalising trade in services as compared to trade in goods. Due to the special characteristics and the socio-economic and political implications of certain services, they are, generally, subject to various types of national restrictions. Tariff as well as non-tariff restrictions are widespread. Protective measures include subsidies, tariffs, taxes, quotas, and technical standards, visa requirements, investment regulations, restrictions on repatriation, marketing regulation, restrictions on the employment of foreigners, compulsion to use local facilities, etc. The policy in.struments that affect international trade in services, thus, are similar to those used in the good~ context. "However, border measures in general,

c:

AN OVERVIEW OF INTERNATIONAL TRADE

11

and ad valorem tariffs in particular, are often difficult to apply to trade in services for the simple reason that customs agents in many instances will not be able to observe the services as it IIpasses the frontier." Customs agents will only observe service suppliers or consumers as they pass the frontier. The value (or volume) of any service transactions that occur cannot be known until after they have been produced/consumed, and are, therefore, not known to customs and immigration authorities."6 The Uruguay Round of ,trade negotiations has initiated measures for liberalisation of trade in services. Table 1.3

LEADING TRADERS IN COMMERCIAL SERVICES, 2005 (Billion dollars and percentage)

Rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 '16

17 18 19 20 21 22 23 24 25 26 27 28 29 30

Exporters

Value

Share

Rank

United States United Kingdom Germany France Spain Japan China Italy

456.4 273.0 205.8 136.7 128.3 127.1 121.7 110.5 89.7 89.0 87.5 82.7 75.5 67.3 63.8 62.3 61.8 61.5 61.5 61.4 55.2 43.1 40.7 39.7 39.1 30.9 28.8 28.6 28.2 28.2

13.9 8.3 6.3 4.2 3.9 3.9 3.7 3.4 2.7 2.7 2.7 2.5 2.3 2.0 1.9 1.9 1.9 1.9 1.9 1.9 1.7

1 2 3 4 5 6 7 8 9 10 11 12

India Ireland Netherlands Hong Kong Belgium Singapore Sweden Luxembourg Denmark S. Korea Switzerland Canada Austria Greece Norway Australia Russia Taipei, Chinese Thailand Poland Turkey Malaysia

1.3

1.2 1.2 1.2 0.9 0.9 0.9 0.9 0.9

Source: WTO, International Tr-ade Statistics, 2008.

Importers

Value

United States Germany United Kingdom Japan China France Italy Spain Ireland Netherlands S. Korea Canada

335.9 250.5 194.1 148.7 129.3 124.1 118.3 98.4 94.5 86.8 82.5 80.3 77.2 70.6 70.1 57.8 54.0 47.8 41.0 38.9 38.6 38.2 38.0 36.0 35.3 34.8 33.9 30.6 28.1 27.8

13

India

14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Belgium Singapore Russia Denmark Sweden Hong Kong Austria Norway Australia Thailand Luxembourg Taipei, Chinese Brazil Switzerland Saudi Arabia UA E Malaysia

Share

10.9 8.1 6.3 4.8 4.2 4.0 3.8 3.2 3.1 2.8 2.7 2.6 2.5 2.3 2.3 1.9 1.7 1.5 1.3 1.3 1.3 1.2

1.2 1.2 1.1 1.1 1.1 1.0 0.9 0.9

12

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~

LOCs vs MOCs

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

The international trade in services is subject, in general, to a lot of restrictions. The developing countries, in particular, have problems in liberalising the trade in services. Services were outside the scope of the General Agreement on Tariffs and Trade (GATT). Therefore, the GATT which tried to liberalise the trade in goods could not do the same for services. However, as mentioned above, the Uruguay Round has made a beginning in liberalising trade in servifes. In 2000, Government of India has decideGi to allow private investment, both domestic and foreign in the insurance sector. The conflicts of interest or differences of opinion between the developed and developing countries have come to the fore at the Uruguay Round when the developed countries have sought to extend the GATT negotiations to services and to liberalise the international trade in services. The developing countries have strongly opposed this move, particularly in the early stages of the Round. India and Brazil were among the prominent opponents. The fear of the developing countries is that the liberalisation of trade in services will lead to domination of the services sector in the developing countries by multinationals from industrialised countries. As a matter of fact, the trade in services is already dominated by the developed countries. The developing countries are net importers of services and their deficit has been growing. The apprehension is that a liberalisation of trade in services will accentuate the problem. Although many services are labour intensive and, therefore, the developing countries should be expected to have an advantage here, there have been several constraints in benefiting from this advantage - technical, organisational, financial and legal. Moreover, immigration laws of developed countries restrict the manpower inflow from developing countries. This severely limits the scope of developing countries in benefiting from their comparative advantage. It may be noted that the industrial countries did not like to bring up this issue at the Uruguay Round. Lack of finance is a very important handicap in developing countries. Several services require a huge amount of finance. International airlines, for example, need even larger investments in the most modern fleets and reservation systems if they are to compete internationally. Similarly, technology is also playing an increasingly important role in service industries and demanding higher levels of skill. The apprehension is that here, too, the developing countries are in danger of falling further behind, not only because they lack the necessary human skills, but because many technological improvements in services require substantial financial back up which the developing countries would find very difficult to mobilise. Even in areas where the developing countries have lot of development potential, like tourism, shortage of capital and managerial expertise often pose as serious problems. Construction is an area where the developing countries have had high hopes, much of this market being in the developing countries which represent the largest source of international construction contracts. Some countries like India have made impressive progress in certain modern areas like development of advanced software.

AN OVERVIEW OF INTERNATIONAL TRADE

c:

13

Some economists argue that liberalisation and the resultant competition will improve the efficiency of the service sector in the developing countries and this will help improve the overall efficiency of the economy and export competitiveness. It has been pointed out that several developing countries have acquired enough strength in different services to successfully compete with developed countries. For example, countries like Korea, Brazil, India, Lebanon and Taiwan have done well in international construction and design contracts. Several developing countries have great potential in the field of professional services. Some already have considerable export of tourism and shipping. It has been argued that if developing countries protect more expensive or lower quality services produced by local firms, they run the risk of handicapping their exports of goods. Many services are upstream or downstream services to producers. Access at reasonable cost to quality services can make the difference between success or failure in exporting. In many developing countries, the need for such services calls for at least selective liberalisation. If this encourages the multinational corporations of the industrial countries to provide these services to developing countries, it would help developing countries' exports of manufactured goods in three ways. First, it would lower their costs and help them to develop markets. Secondly, it would encourage the multinational corporations to move away from goods in favour of producing more services. Thirdly, if Industrial nations can sell more services, they may be more willing to lower protective barriers elsewhere'? It is cautioned, however, that unless the developing countries take measures to strengthen their services before liberalisation, it would adversely affect the domestic service industries. India has great potential in a variety of services. The large number of scientists, professionals and skilled and semi-skilled personnel working abroad is indicative of India's potential in several fields. With such a resource potential, we should be able to develop a number of service industries capable of obtaining customers abroad. For example, can we not provide health care instead of just exporting doctors and other medical personnel? Can we not provide education instead of just exporting teachers? With proper planning and development, India can make great strides in services trade.

( GLOBAL SOURCING) One of the important drivers of global trade has been the global outsourcing/production sharing. A World Bank publication, which describes this as a new pattern in international trade, observes that sourcing components from abroad is an increasingly common practice, and use of the Internet is sure to expand the process, encouraging entry by new producers throughout the developing world. While precise "numbers are difficult to come by, in the early 1990s one-third of all manufactures trade (approximately $800 billion) involved parts and components. This type of trade has generated an ever-spreading web of global production networks that connect subsidiaries within transnational firms to unrelated designers, producers, and distributors of components. These networks offer their constituent firms access to new maikets and commercial relationships and facilitate technology transfer. Advances in information technology help to link firms from developing countries into global production networks. General Electric, for instance, posts information on its component. 8

14

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

According to one survey, the reasons for offshore purchases are the following, listed in the order of importance are lower price; better quality; only source available; more advanced technology; more consistent attitude; more co-operative delivery; and, counter trade requirements. 9 It may be noted that besides the above, outsourcing has certain other advantages. It reduces the capital and manpower requirements. It may also impart more flexibility to adjust to certain conditions like a recession. International sourcing accounts for an estimated one-third of the world trade. Many developing countries have taken a lot of advantage of this trend. India, though has not benefited to any significant extent. However, with the changes in the business environment, there are positive signs of change. The Indian auto components industry has become, for instance, suppliers to foreign heavy weights like General Motors, Renault, Fiat etc. The export performance of the Indian auto components is expected to improve very significantly with the further improvement in quality and productivity which the industry is now striving to achieve. It may be noted that Indian companies have also been sourcing globally. An important emerging destination for sourcing by Indian companies is China.

( COUNTERTRADE) Countertrade is a form of international trade in which certain export and import transactions are directly linked with each other and in which import of goods is paid for by export of goods, instead of money payments. In the modern economies, most transactions involve monetary payments and receipts, either immediate or deferred. As against this, " ... countertrade refers to a variety of unconventional international trade practices which link exchange of goods - directly or indirectly - in an attempt to dispense with currency transactions. n10 ~

Forms of Countertrade Countertrade takes several forms. The following are the most common among them:

Barter: Barter refers to direct exchange of goods of equal value, with no money and no third party involved in it. For example, a countertrade deal between the MMTC and a Yugoslavian company involved import of 50,000 tonnes of rails of the value of about $ 38 million by the MMTC and the purchase by the Yugoslavian company in turn of iron ore concentrates and pellets of the same value. Buy Back: Under the buy back agreement, the supplier of plant, equipment or technology agrees to purchase goods manufactured with that equipment or technology. Under the buy back scheme, the full payment may be made in kind or a part may be made in kind and the balance in cash. Thus, a Rs. 20 crore buy back agreement with the erstwhile Soviet Union provided for the import of 200 sophisticated looms by the National Textiles Corporation. The buy back ratio was 75 per cent. Compensation Deal: Under this arrangement, the seller receives a part of the payment in cash and the rest in products.

AN OVERVIEW OF INTERNATIONAL TRADE

C

15

Counterpurchase: Under the counterpurchase agreement the seller receives the full payment in cash but agrees to spend an equivalent amount of money in that country within a specified period. A classic example of this kind of an agreement was Pepsi Cola's trade with erstwhile USSR. Pepsi Cola got paid in Roubles for the sale of its concentrates in the USSR but spent this amount for purchase of Russian products like Vodka and wine. Many countertrade deals involve more than two parties and a complex and intricate process. If the seller can get in exchange from the buyer the products which he wants or for which he has a ready market, the countertrade deal would be very smooth. However, in several cases the buyer will not be in a position to offer in exchange goods which the seller really needs. In such cases, it may become necessary, for the deal to be struck, for the seller to accept the products the buyer can offer and hunt for buyers for such products. Growth of Countertrade: A significant volume of international trade is covered by countertrade. Countertrade, of course, is not a new phenomenon but the nineteen seventies and eighties witnessed a remarkable growth in this type of international trade, encouraged by many governments and actively involved by many trading houses, both private and public, although organisations like GATT and IMF do not favour it. According to some reports, there was an increase in the number of countries practising countertrade. According to the estimate made by the Economist, London, quite sometime ago, countertrade accounted for one-fourth of all the world trade. 11 The political and economic changes in the former USSR and Eastern Europe do not appear to have adversely affected the growth of countertrade. Countertrade has been growing with government patronage. According to one report, more than 81 countries across the world had actual pro-countertrade government pol icies. 12 Countertrade has been made mandatory by a number of countries. Even though a number of other countries have no mandatory provisions, all encourage their importers to settle transactions on countertrade basis. Indian public sector agencies like STC and MMTC are active in countertrade. Government of India had set up a special cell in the Ministry of Commerce to monitor international developments in countertrade and to develop an appropriate policy to enable Indian canal ising agencies to make best use of opportunities available to. boost India's exports through countertrade. It may be noted that the South Commission has advocated countertrade as a useful mechanism for overcoming difficulties of payments, export credit, and foreign exchange which might otherwise be serious obstacles to the expansion of trade between developing countries. As the Commission points out, so far the bulk of countertrade between developing countries has been conducted mostly through intermediaries in the industrial countries. It is the developed countries who have benefited most from this type of trade, and they obviously have no interest in helping the indirect trading partners in the LDCs to establish direct contacts and develop durable trading relationships. Therefore, the developing countries need to organise themselves for countertrade as this can also pave the way for the growth of more conventional trading relations. 13 Reasons for the Growth of Countertrade: There have been several reasons that have made countertrade popular. Obvisously, the countries or companies concerned have encouraged or involved in countertrade due to certain specific advantages, although some of the benefits may be purely temporary.

16

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

(1) Countertrade was very common between the communist countries. It also became popular with respect to trade between the Communist Bloc and many developing countries because many developing countries were eagerly looking towards this Bloc for increasing their exports, among other things, and this naturally led to the acceptance of the trade practice preferred by these centrally planned econom ies. (2) Countertrade became popular in the East-West trade mainly due to the foreign exchange problems faced by the Eastern Bloc. Pespsi Cola is just one example of a multinational corporation which has made considerable international business with the USSR by countertrade. (3) When the foreign exchange problem became very severe for the developing countries following the oil price hikes, they began to actively pursue countertrade in a frantic bid to increase their exports by any means. (4) Many companies in the advanced countries have resorted to countertrade for various reasons like selling obsolete products, increasing the sale of capital goods, increasing aggregate business, etc. Countertrade has also been resorted to by several companies to mitigate the effects of recession. Such recessionary situations in the capital goods industries in the advanced countries gave the developing countries an opportunity to push their exports by typing imports of capital goods with exports by.countertrade. (5) Countertrade enables firms to penetrate difficult markets, to increase sales volume and to achieve fuller capacity utilisation. It has also been revealed that countertrade enables firms to dispose of declining products, which is particularly important given the very rapid pace of technological advance. Thirty-seven per cent of the companies surveyed reported this benefit. (6) Some countries have also made the countertrade a means to increase sales through disguised undercutting of the cartel prices (for example, the oil price fixed by the OPEC). (7) Having realised the potential of increasing business by engaging in countertrade, many international trading coporations became active in countertrade. Their trading with many countries enabled them even to take up such complex transactions. ~

Drawbacks

Although countertrade has several justifications, particularly in the short run, it suffers from a number of disadvantages and problems also, particularly in the long run. (1) Countertrade encourages bilateralism at the expense of multilateral ism.

(2) It adversely affects export market development. (3) Although several developing countries regard coundertrade as an easy route to export, they often stand to lose in terms of price. For instance, Poland bought Libyan oil at a discount and sold it at a higher price at the Rotterdam spot market. (4) It very adversely affects competition.

AN OVERVIEW OF INTERNATIONAL TRADE

C

17

( GLOBAL TRADE AND DEVELOPNG COUNTRIES) The developing countries present a mixed picture of trade performance and encounter a hostile trade environment. On the one side there is a picture of spectacular performance of some countries and on the other there is·a dismal picture presented by many. One is, therefore, tempted to draw a hypothesis that trade performance has something to do with the domestic economic factors, including the development and trade strategies, and the external environment. The salient points of the trade of the developing countries vis-a-vis the global trade may be listed as follows: (1) The trade of developing countries as a group increased faster than their GOP and the trade of developed countries. (2) There are a number of developing countries in the list of top 20 exporters. (3) As a result of their faster trade growth, the share of developing countries in the global trade has increased. Their share in the global trade is higher than their share in the global GOP. (4) The trade GOP ratio of developing countries is higher than that of the developed countries, which implies that they are more integrated with the global economy by trade than the developed countries or that they are more trade dependent than the developed countries. (5) The manufactured exports of developing countries has grown very fast so that the share of manufactures in the total exports of developing countries and share of developing countries in the global trade of manufactures have gone up. (6) The developing countries' trade relations have changed markedly from the ~raditional north-south developing countries pattern and 40 per cent of their exports now go to other developing countries. (7) The impressive picture of trade performance of developing countries as a group is the result of the rapid strides made by a small group of countries like China, S. Korea, Taiwan, Hong Kong and Singapore. While just five top developing country exporters account for about half of the aggregate exports of the developing countries, the remaining half is made up by nearly 160 developing economies. This implies that most developing c.ountries have been unable to overcome the obstacles to expanding and diversifying their exports. (8) The share of the 49 least developed countries (LOCs) in the global trade is very dismal - about 0.5 per cent. A major part of this is the contribution of a small number of oil exporters among them. (9) A number of low income countries have been marginalised by the global trading system. (10) Although the developing countries as a group stand to benefit from the multilateral trade liberalization, a number of them will be heavy losers.

18

~

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

(11) Exports of developing countries face high tariff and NTBs in developed countries. Although it was expected that the Uruguay Round Agreement would liberalise the agricultural trade, not only that many trade barriers continue to keep poor countries' agricultural products out of rich country markets, but also the developed countries are even increasing protection. (12) High trade barriers in developing countries affecting south-south trade.

( SUMMARY) For quite a long time, global trade has grown faster than world output and the trend is likely to continue in future. Importantly, exports of developing countries have been growing faster than those of the developed countries. Exports of developing countries, as a group, have been growing faster than those of the developed countries. As a result, their share in the global exports increased very significantly so that their share in world exports today is nearly 30 per cent while their share in global GNP is about 20 per cent. Much of the trade even now, however, takes place between the developed countries. Bulk of the exports of the developing countries is absorbed by the developed countries. The United States which was the the largest exporter for a long time was relegated to the second position by Germany in 2003. The largest importer of merchandise is the US, followed by Germany and China. The US, Germany and Japan account for nearly 30 per cent of the global exports of goods. More than half of the world exports originate in just eight countries. 13 countries contribute about two-thirds of the total exports. The top twenty exporters account for nearly 80 per cent of the world trade. 40 countries make up over 90 per cent, while 50 countries add up to more than 95 per cent of the total exports. India's share in the global exports declined from about 2 per cent in 1950 to about 0.4 per cent in 1980. Since around the mid 1980s, there has been a slight improvement. There has been a considerable change in the composition of the global trade. The share of manufactures in the total exports increased substantially, while that of the primary commodities declined correspondingly. A significant volume of international trade is covered by countertrade. Countertrade is a form of international trade in which certain export and import transactions are directly linked with each other and in which import of goods are paid for by export of goods, instead of money payments. International trade in services, which make up a major share of the invisibles account of the Balance of Payments, has been growing fast. According to WTO, services account for about one-fifth of the total global trade. The growth rate of trade in services was faster than that of goods: The world trade in services too is dominated by the developed economiEfs. The three top exporters - USA, UK, and France do over 30 per cent of the world total. Seven countries account for about half and 10 countries nearly 60 per cent of the total service exports. With 1.5 per cent share, India's share in global export of services in 2002, India's rank was 19th, compared to 30th rank in merchandise exports and with ~ ~.4 lJ~r cent share of global import of services, hAr '''-k w::,.: ~:;, .... 3 aYcuns[ 27 In goods.

AN OVERVIEW OF INTERNATIONAL TRADE

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19

Travel and transportation account for major share of the services trade. However trade in other commercial services (particularly financial services - including banking and insurance -:-:- construction services, and computer and information services) has been growing faster than these two categories. Due to the special characteristics and the socio-economic and political implications of certain services, they are, generally, subject to various types of national restrictions. Protective measures include visa requirements, investment regulations, restrictions on repatriation, marketing regulation, restrictions on the employment of foreigners, compulsion to use local facilities, etc. Heavily protected or restricted services in different countries include banking and insurance; transportation, television, radio, film and other forms of communication, and so on. International sourcing accounts for an estimated one-third of the world trade. [An elaborate account of topics dealt within this chapter is available in the author's International Business (PHI)).

( MODEL QUESTIONS) VERY SHORT ANSWER QUESTIONS (To be answered in 1 to 3 sentences) 1. Write a very short note on foreign trade-GDP ratio.

2. Why are developed economies regarded as primarily service economies? 3. Define countertrade. 4. What is meant by global sourcing?

5. Write a very short note on the composition of global trade.

SHORT ANSWER QUESTIONS 1. Write a note on global trade and developing countries.

2. Give a brief account of the important trends in global trade. 3. Write a note on countertrade.

4. Examine the important iSSues in trade in services. 5. What is countertrade? Give a brief account of the reasons for the growth of countertrade. Is countertrade desirable?

6. What is countertrade? Give a brief account of the different forms of countertrade.

LONG ANSWER QUESTIONS 1. Discuss the salient features of and trends in global trade in merchandise.

2. Examine the salient features of and issues in global trade in services.

( REFERENCES) 1. Peter F. Drucker, Managing for the Future, Butterworth-Heineman, Oxford, 1992, p. 30. 2. Ibid., pp. 33-34. 3. Ibid., p. 315.

20

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

4. Sir Hans Singer, Neelambar Hatti and Rameshwar Tandon (ed.), Trade in Services (New World Order Series Vol. 14), B.R.Publishing Corporation, New Delhi,1999, p.2. 5. World Bank, World Development Report, 1999/2000, Oxford University Press, New Delhi, 2000. 6. Bernard Hoekman and Carlos A. Primo Braga, "Protection and Trade in Services: A Survey", in Sir Hans Singer, Hatti and Tandon (ed.), op. cit., p.l0l. 7. Jagdish N. Bhagwati, "Trade in Services and Multinational Trade Negotiations," The World Bank Economic Review, September 1987, p. 553. 8. World Bank, World Development Report, 1999/2000, op. cit. 9. Edward W. Davis, "Global Outsourcing: have US Managers Thrown the Baby Out with the Bath Water", Business Horizon, July-August, 1992, p. 59. 10. Bruce Fitzgerald, "Countertrade Reconsidered", Finance and Development, June 1987, p. 46. 11. Cited by KGM, "Countertrade Catching on in a Big Way", Business India, Oct. 20 - Nov.2, 1986, p.l05. 12. Ibid.

13. South Commission, op.cit., p.l77.

000

2 TH~ORI~S

OF INT£RNATIONAL

TRAD~

A number of economists and management scholars have attempted to provide theoretical explanation of the reasons for and pattern of international trade and investment. This chapter provides an outline of important trade theories. A more detailed account of the trade theories is available in the author's International Economics.

( MERCANTILISM) The Mercantilist philosophy, which prevailed in Europe during 1500-1800, refers to the views of a heterogeneous group of influential people as to how a nation could regulate its domestic and international affairs so as to promote its own interests. In fact, mercantilism, cannot be regarded as a formal school of economic thought; it is rather a collection of similar attitudes reflected in the writings of a diverse group of people (merchants, bankers, government officials. and even philosophers). . The principal assertion of mercantilism was that a nation's wealth and prosperity reflected in its stock of precious metals, gold and silver. At that time, as gold and silver were the currency of trade between nations, a country could accumulate gold and silver by exporting more and importing less. The basic tenet of mercantilism is embodied in tbe British Mercantilist writer Thomas . Mun's postulate that "the ordinary means therefore to increase our wealth· and treasure is by foreign trade, wherein we must ever observe this rule: to sell more to strangers yearly than we consume of their's in value." Led by this belief, the mercantilists advocated achieving as high a trade surplus as possible. In fact, they saw no virtue in a large volume of trade per se; what mattered was 'a large trade surplus. The mercantilists, therefore, argued that Government should do everything possible to maximise exports and minimise 21

22

=

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

imports. Imports were to be restricted by .such measures as tariffs and quotas and exports were to be subsidised. Since all the nations could not simultaneously have an export surplus and as the supply of gold and silver was fixed at any particular point of time, one nation could gain, obviously, at the expense of another. In other words, according to mercantilism economic activity was a zero-sum game (i.e., one's gain is the loss of another) . Enhancement of state power was, indeed, inherent in the mercantilist philosophy. A strong army, strong navy and merchant marine, control over navigation, shipping and trade routes, colonisation of nations to ensure low-cost source of raw materials and agricultural products and export market for manufactures were all part of the statist policy under mercantilism. The importance given to precious metals under mercantilism resulted in what was referred to as bullionism, i.e., government control of the use and exchange of precious metals their export by individuals was prohibited and the governments let specie leave the country only out of necessity. Governments also attempted to control the trade. For example, certain companies were granteq : exclusive trading rights over certain routes or areas, which often tended to create monopQly and monopsony market conditions (example: East India Company) . ~

Flaws of Mercantilism

The Mercantilist ideas came in for scathing criticism in the eighteenth century. David Hume made an eloquent exposition of one of the basic flaws of Mercantilism. According to Hume's price-specie-flow doctrine, a favourable trade balance was possible only in the short run, for over a period it would be eliminated. For example, suppose that country A has a favourable trade balance. This will result in an inflow of gold and silver resulting in an increase in the money supply in country A. This will cause an increase in price and wages in that country and will adversely affect exports and encourage imports, ultimately wiping out the trade surplus. On the other hand, consequent to the outflow of gold and silver from the country with trade deficit, prices and wages will fall in that country increasing its international competitiveness which will eventually restore the equilibrium.

A~other flaw of Mercantilism is that it viewed trade as a zero-sum game. This view was challenged by Adam Smith and David Ricardo who demonstrated that trade was a positive sum game in which all trading nations can gain even if some benefit more than others. It is because of the mercantilists' static view of the world economy that they regarded trade as a zero-sum game. Adam Smith refuted the mercantilist view that the world's economic pie is of constant size and convincingly argued that international trade expanc;ls the scope of division of labour (specilisation) which increases productivity and output. The dynamic view of trade highlights the fact that all the trading partners can simultaneously enjoy higher level of production and consumption with free trade. Neo-Mercantilism: Despite the scathing criticism of mercantilism by economists, it is by no means dead. In most trade negotiations, the negotiating countries, both developed and developing, often press for more trade liberalisation in areas where their own comparative competitive advantages are the strongest and to resist liberalisation in areas where they are leSs competitive and fear that imports would replace domestic production.

e

THEORIES OF INTERNATIONAL TRADE

23

Indeed, the trade strategy of many nations is designed to simultaneously boost exports and limit imports. This has been true of developed as well as developing countries.

( ABSOLUTE COST THEORY) Adam Smith, the father of Economics, thought that the basis of international trade was absolute cost advantage. According to his theory, trade between two countries would be mutually beneficial if one country could produce one commodity at an absolute advantage (over the other country) and the other country could, in turn, produce another commodity at an absolute advantage over the first. Table 2.1 ABSOLUTE COST OF PRODUCTION

No. of units of wheat per unit of labour No. of units of cloth per unit of labour

USA

UK

10

4

3

7

In the above hypothetical example, US has an absolute advantage in the production of wheat over UK and UK has an absolute advantage in the production of cloth over US. Hence, according to Adam Smith's theory, US should specialise in the production of wheat and meet its requirement of cloth through import from UK. On the other hand, UK should specialise in the production of cloth and should obtain wheat from US. Such trade 'would be mutually beneficial. Adam Smith pointed out that the scope for division of labour (i.e., specialisation) depended on the size of the market. Free international trade, therefore, increases division of labour and economic efficiency and consequently economic welfare. Adam Smith also considered foreign trade as a vent for surplus. In short, according to Smith's theory of international trade, three kinds of gains accrue to a country from international trade: (1) Productivity gain (2) Absolute cost gain (3) Vent for surplus gain The famous classical economist David Ricardo has demonstrated that the basis of trade is the comparative cost difference - trade can take place even in the absence of absolute cost difference, provided there is comparative cost difference.

( COMPARATIVE COST THEORY) The Comparative Cost Theory was first systematically formulated by the English economist David Ricardo in his Principles of Political Economy and Taxation, published in 1817. It was later refined by J.S. Mill, Marshall, Taussig and others.

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

In a nutshell, the doctrine of comparative costs maintains that if trade is left free, each country, in the long run, tends to specialise in the production and export of those commodities in whose production it enjoys a comparative advantage in terms of real costs, and to obtain by importation those commodities which could be produced at home at a comparative disadvantage in terms of real costs, and that such specialisation is to the mutual advantage of the countries participating in it. The Ricardian theory is based on the following assumptions: (l) Labour is the only element of cost of production.

(2) Goods are exchanged against one another according to the relative amounts of labour embodied in them. (3) Labour is perfectly mobile within the country but perfectly immobile between countries.

(4) Labour is homogeneous. (5) Production is subject to the law of constant returns. (6) International trade is free from all barriers.

(7) There is no transport cost. (8) There is full employment.

(9) There is perfect competition.

(10) There are only two countries and two commodities. Ricardo's illustration of the Comparative Cost Theory, using a two country-two-commodity model, shows that trade between nations can be profitable even if one of the two nations

can produce both the commodities more efficiently than the other nation provided that it can produce one of these commodities with comparatively greater efficiency than the other commodity. The law of comparative advantage indicates that a country should specialise in the production- of those goods in which it is more efficient and leave the production of the other commodity to the other country. The two nations will then have more of both goods by engaging in trade. Ricardo, in his celebrated two-country-two-commodity model, has taken the hypothetical example of production costs of cloth and wine in England and Portugal, to illustrate the comparative cost theory. . Table 2.2 COMPARATIVE COSTS

Country

No. of units of labour per unit of cloth

No. of units of labour per unit of wine

Exchange ratio between wine and cloth

England

100

120

1 wine - 1.2 cloth

Portugal

90

80

1 wine - 0.88 cloth

From the above example, it is evident that Portugal has an absolute superiority in both branches of production. However, a comparison of the ratio of the cost of production of wine (80/120) with ratio of the cost production of cloth (90/100) in both the countries reveals

THEORIES OF INTERNATIONAL TRADE

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25

that though Portugal has an absolute superiority in both the branches of production, it will pay her to concentrate on the production of wine in which she has comparative advantage over England (80/120 < 90/100), while importing cloth from England, which has a comparative advantage in cloth production. England will gain by specialising in producing cloth and selling it in Portugal in exchange for wine. In the absence of trade between England and Portugal, one unit of wine commands 1.2 and 0.88 unit of cloth in England and Portugal, respectively. In the event of trade taking place, under the assumption that within each country, labour is perfectly mobile between various industries, Portugal will gain if it can get anything more than 0.88 units of cloth in exchange for 1 unit of wine and England will gain if it has to part with less than 1.2 units of cloth against 1 unit of wine. Hence, any exchange ratio between 0.88 units and 1.2 units of cloth against one unit of wine represents a gain for both the countries. The actual rate of exchange will be determined by the Reciprocal Demand. Thus, according to the comparative cost theory, free and unrestricted trade among nations encourages specialisation on a larger scale. It, thereby, tends to bring about: (1) The most efficient allocation of world resources as well as maximisatio'1 of world

production. (2) A redistribution of relative product demands, resulting in greater equalify of product prices among trading nations; and . (3) A redistribution of relative resource demands to correspond with relative product demands, resulting in relatively greater equality of resource prices among trading nations. ~

Evaluation

The Ricardian theory, though based on a number of wrong assump,ions, has been regarded as an important landmark in the development of the theory of international trade. Paul Samuelson remarks: "If theories, like girls, could win beauty contests, comparative advantage would certainly rate high in that it is an elegantly logical structure.'" He adds: "The theory of comparative advantage has in it a most important glimpse of truth ... A nation that neglects comparative advantage may have to pay a heavy price in terms of living standards and potential rates of growth." 2 The comparative cost doctrine, however, is not complete in itself. It has been severely criticised, particularly for its wrong assumptions. Further, as Graham has pointed out, even if we assume that all the assumptions are true, it will not lead to complete specialisation if one of the two countries is small and the other big. The small country may be able to specialise fully, but the big country cannot since it cannot sell its entire surplus in the small country and cannot get from the small country the quantity of goods which it can produce though at a comparatively higher cost. The theory of comparative cost fixes only the limit within which the exchange ratio must settle under international trade; it does not show how the exact point within these two limits is determined. In other words, the theory does not say how the terms of trade are determined.

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Though the Ricardian theory maintains that comparative differences in labour costs form the basis of international trade, it does not explaih what underlies such differences in relative costs of production. However, as Ellsworth and Leith point out, an important " .. .feature of the classical trade theory is that Ricardo, Mill and their followers appear to have regarded it not primarily as an explanation of the actual pattern of trade, but as a convincing demonstration of the gains from trade,"3 and they have used it " ... as a powerfu I argument for a more rational trade pol icy in a tariff ridden world."4

( OPPORTUNITY COST THEORY) One of the main drawbacks of the Ricardian comparative cost theory was that it was based on the labour theory of value which stated that the value or price of a commodity was equal to the amount of labour time going into the production of the commodity. Gottfried Haberler gave a new life to the comparative cost theory by restating the theory in terms of opportunity costs in 1933. The opportunity cost of anything is the value of the alternatives or other opportunities which have to be foregone in order to obtain that particular thing. For example, assume that a given amount of productive resources can produce either 10 units of cloth or 20 units of wine. Then the opportunity cost of 1 unit of cloth is 2 units of wine. Thus, the opportunity cost approach defines cost in terms of the value of the alternatives of other opportunities which have to be foregone in order to achieve a particular thing. According to the opportunity cost theory, the basis of international trade is the differences between nations in the opportunity costs of production of commodities. Accordingly, a nation with a lower opportunity cost for a commodity has a comparative advantage in that commodity and a comparative disadvantage in the other commodity. Suppose that the opportunity cost of one unit of X is 2 units of Y in country A and 1.5 unit of Y in country B. Then Country A must specialise in production of Yand import its requirements of X from B, and B should specialise in the production of X and import Y from A rather than producing it at home. ~

Assumptions

The opportunity cost theory too is based on most of the common assumptions of the classical theories. The important assumptions of this theory are the following: (1) Two-country, two-commodity model. (2) There are only two factors of production, viz., labour and capital. Factors of production are perfectly mobile within a country but immobile between countries. (3) Factors of production are fixed in supply. (4) There is perfect competition in both factor and product markets.

(5) The price of each factor is equal to its marginal productivity in each employment. (6) The price of each commodity is equal to its marginal cost of production. (7) There is full employment in each country.

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(8) There is no technological change. (9) International trade is free. ~

Evaluation

Merits: The opportunity cost approach is superior to the Ricardian theory in the following ways: (1) It recognises the existence of many different kinds of productive factors (although

for simplicity sake the theory considered only two factors) whereas Ricardo considered only labour. The opportunity cost theory tells us that even if we discard the labour theory of value as being invalid and rely on the opportunity cost theory, the comparative cost theory is still valid. (2) The opportunity cost theory considers trade under constant, increasing and decreasing costs, whereas the comparative cost theory assumes constant cost of production. (3) It recognizes the importance of factor substitution in production. (4) It provides a simple general equilibrium model of international trade.

Criticisms: The opportunity cost theory is subject to the following criticisms: (1) It is based on a number of unrealistic approaches. (2) Jacob Viner, in his Studies in the Theory of International Trade, argued that the opportunity cost approach is inferior to the classical real cost approach as tool of welfare evaluation in as much as it fails to measure real costs in terms of sacrifices, disutilities or irksomeness. (3) Viner also argued that the opportunity cost approach ignores the changes in factor supplies. However, V. C. Walsh points out that the changes in factor supplies can be measued in terms of opportunity cost by taking into account changes in commodity price ratio and marginal productivities of factors. 5 (4) Yet another criticism of the opportunity cost approach by Viner is that it fails to

take into account the preference for leisure vis-a-vis income. This criticism has also been refuted by Walsh by arguing that when the trading nations exchange at an international price ratio, there will normally be an increase in real income and part of this will be taken in the form of more leisure, so that the output of both commodities may decrease. ~

Conclusion

The opportunity cost theory of Haberler is a refinement of the Ricardian theory. As far as the basis of international specialisation and trade are concerned, the logic behind the comparative cost approach and the opportunity cost approach are the same. Paul Samuelson, who has highly appreciated the comparative cost theory makes following observation about Haberler's theory: "the opportunity cost approach is more fertile because it can be readily extended into a general equilibrium system. It is, therefore, not surprising that the opportunity cost approach has gained more and more popularity and it is used by even who, in principle, attack it. 116

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( FACTOR ENDOWMENT THEORY) The Factor Endowment theory was developed by Swedish economist Eli Heckscher and his student Bertil Ohlin. Paul Samuelson and Wolfgang Stolper have also made significant contributions to this theory. The factor endowment theory consists of two important theorems, namely, the HeckscherOhlin Theorem and the Factor Price Equalisation Theorem. The Heckscher-Ohlin theorem examines the reasons for comparative cost differences in production and states that a country has comparative advantage in the production of that commodity which uses more intensively the country's more abu'ndant factor. The factor price equalisation theorem examines the effect of international trade on factor prices and states that free international trade equalises factor prices between countries, relatively and absolutely, and thus serves as a substitute for international factor mobility.

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Heckscher-Ohlin Theorem

Heckscher and Ohlin have explained the basis of international trade in terms of factor endowments. The classical theory demonstrated that the basis of international trade was comparative cost difference. However, it made little attempt to explain the causes of such comparative cost difference. The alternative formulation of the comparative cost doctrine developed by Heckscher and Ohlin attempts to explain why comparative cost differences exist internationally. They attribute international (and inter-regional) differences in comparative costs to: (1) Different prevailing endowments of the factors of production. (2) The fact that production of various commodities requires that the factors of production be used with different degrees of intensity. In short, it is difference in factor intensities in the production functions of goods along with actual differences in relative factor endowments of the countries which explains international differences in comparative cost of production. Thus, in a nutshell, the Heckscher-Ohlin theory states that a country will specialise in the production and export of goods whose production requires a relatively large amount of the factor with which the country is relatively well endowed. In the Heckcher-Ohlin model, factors of production are regarded as scarce or abundant in relative terms and not in absolute terms. That is, ~ne factor is regarded as scarce or abundant in relation to the quantum of other factors. Hence, it is quite possible that even if a country has more capital, in absolute terms, than other countries, it could be poor in capital. A country can be regarded as richly endowed with capital only if the ratio of capital to other factors is higher when compared to other countries. (i) In country A:

Supply of labour

25 units

Supply of capital

20 units

Capital-labour ratio

0.8

THEORIES OF INTERNATIONAL TRADE

(ii) In country B:

Supply of labour

12 units

Supply of capital

15 units

Capital-labour ratio

1.25

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In the above example, even though country A has more capital in absolute terms, country B is more richly endowed with capital because the ratio of capital to labour in .country A (0.8) is less than in country B (1.25).

Fig. 2.1: Pattern of Trade under Heckscher-Ohlln Model

Figure 2.1 illustrates the pattern of world trade according to the Heckscher-Ohlin approach. The two-country-two commodity model of Heckscher and Ohlin is based on a number of explicit and implicit assumptions. The important assumptions of the model are: (1) Both product and factor markets in both countries are characterised by perfect competition. (2) Factors of production are perfectly mobile within each country but immobile between countries. (3) Factors of production are of identical quality in both countries. (4) Factor supplies in each country are fixed .

.

(5) Factors of production are fully employed in both the countries. (6) Factor endowments of one country vary from that of the other. (7) There is free trade between the countries, i.e., there are no artificial barriers to trade. (8) International trade is costless, i.e., there is no transport cost. (9) Techniques of producing identical goods are the same in both countries. Due to this, the same input mix will give the same quantity and quality of output in both the countries. (10) Factor intensity varies between goods. For instance, some goods are capital intensive (i.e., they require relatively more capital for Jheir production) and some others· are labour intensive (i.e., they require relatively more labour for their production). (11) Production is subject to the law of constant returns, i.e., the input-output ratio will remain constant irrespective of the scale of operation.

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Factor Price Equalisation Theorem

INTERNATIONAL TRADE AND EXPORT MANAGEMENT

The factor price equalisation theorem states that free international trade equalises factor prices 7 between countries relatively and absolutely, and this serves as a substitute for international factor mobility. International trade increases the demand for abundant factors (leading to an increase in their prices) and decreases the demand for scarce factors (leading to a fall in their prices) because when nations trade, specialisation takes place on the basis of factor endowments. According to Ohlin, "The effect of inter-regional trade is to equalise commodity prices. Furthermore, there is also a tendency towards equalisation of the prices of the factors of production, which means their better use and a reduction of the disadvantages arising from the unsuitable geographical distribution of the productive factors."8 Since from each region goods containing a large proportion of relatively abundant and cheap factors are exported, while goods containing a large proportion of scarce factors are imported, " ... inter-regional trade serves as a substitute for such inter-regional factor movements."9 ~

Evaluation of Factor Endowment Theory The Heckscher-Ohlin theory has been often criticised for its wrong assumptions.

Studies conducted by Leontief and some others tend to question even the validity of the theory. Despite its drawbacks, however, the Heckscher-Ohlin theory has certain definite merits. 1. The Heckscher-Ohlin theory rightly points out that the immediate basis of international trade is the difference in the final price of a commodity between countries, although the actual basis or ultimate cause of trade is comparative cost difference in production. Thus, the Heckscher-Ohlin theory provides a more comprehensive and satisfactory explanation for the existence of international trade. 2. The Heckscher-Ohlin theory is superior to the comparative cost theory in another respect. The Ricardian theory points out that comparative cost difference is the basis of international trade, but it does not explain the reasons for the existence of comparative cost differences between nations. The Heckcher-Ohlin theory explains the reasons for the differences in the cost of production in terms of differences in factor endowments. This is another aspect that makes it superior to the Ricardian analysis. 3. Further, Heckscher and. Ohlin make it very clear that "international trade is but a special case of inter-local or inter-regional trade" and hence there is no need for a special theory of international trade. Ohlin states that regions and nations trade with each other for the same reasons that individuals specialise and trade. The. comparative cost differences are the basis of all trade - inter-regional as well as international. Nations, according to Ohlin, are only regions distinguished from one another by such obvious marks as national frontiers, tariff barriers and differences in language, customs and monetal)(. systems. 4. The modern theory of trade is also called the General Equilibrium Theory of international trade because it points out that the general demand and supply analysis applicable to interregional trade can generally be used without substantial changes in dealing with problems of international trade.

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5. Another merit of the Heckscher-Ohlin theory is that it indicates the impact of trade on product and factor prices. 6. The Heckscher-Ohlin theory indicates that international trade will ultimately have the following results: (1) Equalisation of Commodity Prices: International trade tends to equalise the prices of internationally traded goods in all the regions of the world because trade causes the movement of commodities from areas where they are abundant to areas where they are scarce. This would tend to increase commodity prices where there was abundance and decrease prices where there was scarcity due to the redistribution of commodity supply between these two regions as a result of trade. International trade tends to expand up to the point where prices in all regions become equal. But perfect equality of prices can hardly be achieved due to the existence of transport costs and due to the absence of free trade and perfect competition.

(2) Equalisation of Factor Prices: International trade also tends to equalise factor prices all over the world. International trade increases the demand for abundant factors (leading to an increase in their prices) and decrease the demand for scarce factors (leading to a fall in their prices) because when nations trade, specialisation takes place on the basis of factor endowments. But, in reality, the presence of a number of imperfections make the achievement of perfect equality in factor prices impossible. ~

Empirical Testing of the H-O Model

Some notable attempts have been made to empirically test the validity of the HeckscherOhlin Model. The credit for making the first comprehensive and detailed verification of the Heckscher-Ohlin theory goes to Wassily W. Leontief. • The United States of America was believed to be a country with abundant capital endowment and scarce labour endowment. Then, if the factor proportions theory were correct, the US should have been exporting capital intensive commodities and importing labour intensive commodities. However, the result of Leontief's test disproved this hypothesis. Leontief, therefore, concluded that America's participation in the international division of labour was based on its specialisation on labour intensive, rather than capital intensive lines of production. In

other words, the country resorted to foreign trade in order to economise its capital and dispose of its surplus labour, rather than vice versa. This paradoxical result of the test, that showed that the United States was actually exporting labour intensive goods and importing capital intensive goods, came to be popularly known as the Leontlef Paradox. Several explanations have been offered to the Leontief paradox. These include differences in labour productivity; the exclusion from Leontief's study of certain factors which also determine a country's productive capacity, like natural resources; differences in production function; differences in demand pattern (Le., demand conditions within a country might be so biased towards consumption of a product embodying a relatively abundant factor of production that its relative abundance is neutralised by a high level of domestic demand); distortion of the trade pattern caused by trade barriers; exclusion of factors like human capital, R&D and technology; and, factor intensity reversal. (There is factor intensity reversal when a good is produced in

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

one country by relatively capital-intensive methods but is produced in another country by relatively labour-intensive methods). A number of other studies have also been conducted to test the H-O model but they have given mixed results. In view of these conflicting results, it is concluded that the H-O model is useful in explaining international trade in raw materials, agricultural products, and labour-intensive manufactures; which is a large component of the trade between developing and developed countries, as well as in" examining the effects of international trade, especially its effect on the distribution of income. 10 In conclusion we may say that available studies are not substantiative enough either to strongly support or to refute the Heckscher-Ohlin theory.

( COMPLEMENTARY TRADE THEORIES) There is a significant portion of the international trade that is not explained by the basic Heckscher-Ohlin model. Some theories have been propounded to explain different patterns of or reasons for trade which are not explained by the basic H-O model. Some of these theories which are described as complementary trade theories or extensions of the H-O trade model are outlined below.

STOLPER-SAMUELSON THEOREM Wolfgang Stolper and Paul Samuelson have propounded a theorem explaining the effect of change in relative product prices on factor allocation and income distribution. ~

Assumptions The 5-5 T is based on a set of assumptions. These include: (1) The 2 x 2 x 2 trade model (two factors, two commodities and two countries). (2) Each commodity is produced with two factors of production and the commodities differ in their factor intensities. (3) The factors are qualitatively identical in both the countries. (4) The technological production functions are the same in both the countries. (5) There is free trade.

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Effects of Tariffs and Trade on Income Distribution

The initial article of Stolper-Samuelson, published in 1941, focused on the income distribution effects of tariffs; but the theorem was subsequently extended to explain the income distribution effects of international trade in general. The Stolper-Samuelson theorem (S.S.T.), thus, can be used to deal with two cases: • The effects of tariff • The effects of free trade on factor allocation and income distribution The Stolper-Samuelson theorem postulates that an increase in the relative price of a commodity raises the return or earnings of the factor used intensively in the production of

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that commodity. That is, if the relative price of labour intensive commodity rises, that will cause an increase in the wages. Similarly, an increase in the relative price of capital-intensive product will raise the return on capital. Suppose that a capital abundant country imposes a tariff on the import of the labour intensive commodity. This will raise the relative price of the labour intensive commodity. This will lead to an increase in the wages. This is because when the relative price of the labour intensive product rises, the relative profitability of the labour intensive product rises leading to an increase in the production of the labour intensive commodity and a decline in the production of the capital intensive product whose relative profitability" has declined. Note that raising the production of the labour intensive commodity requires UK (i.e., capital! labour)in a higher proportion than is released by reducing the output of the capital-intensive product. As a result the w/r rises and is substituted for labour. This causes a rise in the KI L in the production of both the commodity (i.e., relatively more capital is used than previously). The use of more capital per unit of labour increases the productivity of labour, and, therefore, the wages rise. As indicated above, although the Stolper-Samuelson theorem originally dealt with the factor reallocation and income distribution resulting from a change in the relative product prices caused by imposition of import tariff, it was subsequently intended to explain the effect of trade on factor prices and income distribution. The Stolper-Samuelson theorem, accordingly, postulates, under a set of assumptions, that free trade unambiguously raises the returns to the factor used intensively in the rising price industry and lowers the returns to the factor used intensively in the falling price industry. This implies that free trade would raise the returns to the abundant factor and reduce the returns to the scarce factor. That is, in the case of a labour-abundant capital-scarce country, free trade would raise the wages and reduce the returns to capital, and a capital-abundant labour-scarce country will experience rise in returns to capital and fall in wages. This is because free trade will increase the demand for the product intensive in the country's abundant factor (for example free trade will increase the demand for the labour intensive goods of.the labour abundant country because of export demand, leading to an increase in demand for labour to increase the supply. of the labour intensive product) and will decrease the price of the product intensive in the scarce factor (because the product embodying the scarce factor will be imported). The increase in the demand for the abundant factor will raise its returns and the fall in the demand for the scarce factor will reduce its reward. This implies that trade will raise the share of labour in the national income of the labour-abundant country and reduce the share of capital. It will have the opposite effect on income distribution in the capital-abundant country. Although the S.S.T. postulates that the change in the relative product prices leads to a redistribution of income, it is important to remember that whether one will be better off or worse off will depend not only on the changes in his income but also on the prices of the goods and services one consumes. Those workers who are employed in the rising price industry and consume the import-competing goods will be better off because of the fall in the price of these' goods and the rise in the wages. However, as both the price of the exportable good and the wage rate have increased, the effect of trade on workers who consume the exportables is ambiguous. It will depend on whether the wage rate or the product price has risen higher. It becomes more difficult to find out the net effect of trade on the economic

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

welfare of labour when the labour consumes both the exportable good and the import-competing good. Further, "we may not see clear-cut income distribution effects with trade because relative factor prices in the real world do not often appear to be as responsive to trade as the H.O. model implies. In addition, personal or household income distribution reflects not only the distribution of income between factors of production but also the ownership of the factors of production. Since individuals and households often own several factors of production, the final impact of trade on personal income distribution is far from c1ear.Hll

INTRA-INDUSTRY TRADE One important pattern of international trade left unexplained by the H-O theory is the intra-industry trade or the trade in the differentiated products, i.e., products which are similar but not identical (for example, different models of motor cars). A large proportion of such trade takes place between the industrialised countr.es. Historically, the pattern of international trade has undergone major changes. Until about the mid nineteenth century, an overwhelming proportion of international trade was constituted by inter-sectoral trade, where primary commodities were exchanged for manufactured goods. This trade was, to a significant extent, based on absolute advantage derived from natural resources or climatic conditions. During the period 1950-1970, inter-industry trade in manufactures, based on differences in factor endowments, labour productivity or technological leads and lags, constituted an increasing proportion of international trade. Since 1970 intraindustry trade in manufactures, based on scale economies and product differentiation, has constituted an increasing proportion of international trade. Intra-industry trade now accounts for a major share of the international trade. As indicated above, intra-industry trade refers to the trade between countries in the products of the same industry. For example, a country simultaneously exports and imports steel, exports and imports motor cars, etc. Intra-industry trade is highly prevalent in the case of trade between developed countries. Developing countries, however, have been increasingly participating in intra-industry trade. India, for example, has been exporting as well as importing motor cars, electronic products, electrical equipments, crude oil, petrochemicals, textiles and clothing, cardamom, sugar and so on. The North-North trade growth has been driven mostly by intra-industry trade. The intraEEC trade has grown much faster than the average growth in the global trade. The trade growth between the members of the European Union has mostly been due to intra-industry trade rather than inter-industry trade. As Krugman and Obstfeld observe, "intra-industry trade tends to be prevalent between countries that are similar in their capital-labour ratios, skill levels and so on. Thus, intraindustry trade will be dominant between countries at a similar level of economic development. Gains from this trade will be large when economies of scale are strong and products are highly differentiated. This is more characteristic of sophisticated manufactured goods than of raw materials or more traditional sectors (such as textiles or footwear). Trade without serious income distribution effects, then, is most likely to happen in manufactures trade between advanced industrial countries. N12

THEORIES OF INTERNATIONAL TRADE

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Estimates of the indices of intra-industry trade for US industry in the early 1990s has shown that it is more than 90 per cent for inorganic chemicals, power generating machinery, electrical machinery and organic chemicals, more than 80 per cent for medical and pharmaceutical and office machinery and more than 60 per cent for telecommunication equipment and road vehicles. On the whole, "about one-fourth of wor~d trade consists of intra-industry trade, that is, two-way exchange of goods within standard industrial classifications ... Since the major trading nations have become similar in technology and resources there is often no clear comparative advantage within an industry, and much of international trade therefore takes the form of two-way exchanges within industries - probably driven in large part by economies of scale - rather than inter-industry specialization driven by comparative advantage." 13 Krugman and Obstfeld observe that "intra-industry trade produces extra gains from international trade, over and above those from comparative advantage, because intra-industry trade allows countries to benefit from larger markets ... by engaging in intra-industry trade a country can simultaneously reduces the number of products it produces and increase the variety of goals available to consumers. By producing few varieties, a country can produce each at large scale, with higher productivity and lower costs. At the same time consumers benefit from the increased range of choice." 14 ~

Intra-Industry Trade Theories

The interest in the intra-industry trade was largely stimulated by the studies done in the 1960s on the impact of the EEC on the trade flow between the member countries. These studies have shown that the major chunk of the trade is intra-industry trade. This encouraged economists to develop theoretical explanations for the growing intra-industry trade. There are indeed a variety of models, which seek to explain the reasons for intra-industry trade. Sodersten and Reed point out that these models, despite their variety, have the following common features: 15 First, while it is possible to deduce that intra-industry trade will emerge, it is often impossible to predict which country will export which good(s). Second, diversity of preferences among consumers, possibly coupled with income differences, plays an important role. Third, similarity of tastes between trading partners may playa major role. Fourth, economies of scale are a frequent element of intra-industry trade models, and may be an important source of gains from trade. Finally, in many of these models the move from autarchy to free trade will involve lower adjustment costs than would be the case with inter-industry trade. The explanations for the intra-industry trade vary from simple reasoning to intricate analysis. One of the simple explanations of the intra-industry trade is the transportation cost. For example, in the case of geographically very vast country like India, the cost of transporting goods from one end of the country to the other extreme end would be very high and cross border trade will be beneficial for two adjoining regions of neighbouring countries, other things remaining the same.

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Another simple explanation is the seasonal variations between different countries in the production of a particular commodity. Factors such as transport cost, seasonal variations etc. cover a small proportion of the intra-industry trade. Another explanation for the intra-industry trade is that producers cater to 'majority' tastes within each country leaving the 'minority' tastes to satisfied by imports. Such minor market segments which are overlooked or ignored by the major market players but have potential for other players are referred to as market niches in marketing management parlance. Such niches often provide an opportunity for entering the market by new or small players. For example, the large companies in the United States had ignored the market segments for small screen TVs, small cars, small horse-power tractors, etc. This provided a good opportunity for the japanese companies, for whom these products had a large domestic market, to enter the US market. It may be noted that niche marketing has been a very successful international marketing strategy employed by japanese companies. Over a period of time, sometimes consumer tastes and preferences, and demand patterns may change and a 'minor' market segment may become a large segment. Thus, the oil price hike substantially increased the demand for the fuel efficient compact cars in the US and the japanese companies enormously benefited from it. Through shrewd marketing strategies a company could succeed, in many cases, in expanding a minor segment of the market into a large segment. Further, it has also been observed, particularly with regard to the japanese companies, that after consolidating their position in a market segment, with the strength and reputation they have built up, they may gradually move to other segments and expand their total market share. Another reason for the failure of the basic H-O model to explain the intra-industry trade is, as Kindleberger and Lindert observe, " ... to recognise the inadequacy of lumping factors of production into just capital, land and couple of types of labour. In fact, there are many types and qualities of each. Further, there are factors specific to each subindustry or even each firm. Heterogeneity is especially evident in the higher reaches of management and other rate skills."16 In short, the H-O theory can be extended to the inter-industry trade if we recognise the existence within each ind_ustry of a number segments with distinctive characteristics and enlarge the definition of factor endowments to include such factors as technology, skill and management also. "Disaggregating the factors of production into finer groupings could add to the explanatory power of the H-O emphasis on factor proportions. Sectors of the economy are bound to look more different in their endowments once finer distinctions are made. In the extreme, endowments of factors of production that are specific to each sector can be very unequal across countries and very intensively used in their own sectors, thereby suggesting explanations for trade patterns. 1I17 Search for the reasons for intra-industry trade led to the development of a number of models in the imperfect competitive environment, which are often referred to as new trade theories. These explanations of the intra-industry trade revolve around factors such as product differentiation, economics of scale, monopolistic competition or oligopolistic behaviour, strategies of multin'ational corporations, etc.

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THEORIES OF INTERNATIONAL TRADE

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ECONOMIES OF SCALE The H-O model is based on the assumption of constant returns to scale. However, with increasing returns to scale (decreasing costs), i.e., when economies of scale exist in production, mutually beneficial trade can take place even when the two nations are identical in every respect. In Fig. 2.2, PEC represents the production possibility curves of both the Countries A and B (both the nations are assumed to have identical endowments and technology). The production possibility curve is convex to the origin implying economies of scale. In the absence of trade, both nations produce and consume at point E on indifference curve I. Since production is subject to increasing returns to scale, it is possible to reduce the cost of production if one country specialises in the production of wheat and the other rice. For example, Country A may specialise completely in the production of wheat (i.e., move from E to P in production) and country B may move production from E to C, specialising completely in rice. By doing so both nations gain 10 units of wheat and 10 units of rice, as shown by the new equilibrium point N on the indifference curve II, although the production possibilities of both the nations remain the same. y

40 30 20 10

c o

10

20

30

40

50

60

x

Rice

Fig. 2.2: Trade based on Economies of Scale

DIFFERENT TASTES Even if all countries are identical in their production abilities and have identical production possibility curves; there could be a basis for trade as long as tastes differ. This is illustrated with the help of Fig. 2.3. The production possibility curve shown in the figure represents the production possibility curve for wheat and rice of country A as well as of B because the production possibilities of both the countries are the same. In other words, both the countries can produce wheat or rice equally well. We assume that A is a wheat preferring country and B is a rice preferring country. In the absence trade, the preference

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

for wheat and the resultant increase in the demand for wheat will increase the price of wheat in country A. Similarly, a higher price for rice will prevail in the rice preferring country B. The pre-trade positions are represented by points F and G respectively, in Fig. 2.3. International trade alters the price structure and establishes a new equilibrium price ratio, fP. Producers in both the countries will shift their production so as to make their marginal costs equal to the same international price ratio. Since the production possibilities are the same for both the countries they will both produce at the same point E where the price line is tangent to the production possibility curve. The wheat preferring country will satisfy its greater demand for wheat by importing wheat. Its new consumption point C at a higher indifference curve implies that trade enables it to attain a higher level of satisfaction with the same productive resources. Similarly trade enables the rice preferring country B to reach the point 0 on a higher indifference curve than the pre-trade situation. Thus, even if production capabilities remain same for two or more countries when tastes differ, mutually beneficial international trade could take place.

TECHNOLOGICAL GAPS AND PRODUCT

CYCLES-

There are two models which explain international trade based on technological change, viz., (1) The Technological Gap Model (2) The Product Cycle Model

IP

o

w

~

~

~

~

~

ro

~

~

~

X

Rice

Fig. 2.3: Trade based on Differences In Taste

In the case of both the models, the key element that causes the trade is the time involved in acquiring the technology by different nations. According to the Technological Gap Model propounded by Posner, a great deal of trade among the industrialised countries is based on the introduction of new products and new production processes. In other words, technological innovation forms the basis of trade. The innovating firm and nation get a monopoly through patents and copyrights or other factors

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THEORIES OF INTERNATIONAL TRADE

39

which turns other nations into importers of these products as long as the monopoly remains. However, as foreign producers acquire this technology they may become more competitive than the innovator because of certain favourable factors (like low labour cost, for example). When this happens, the innovating country may turn into an importer of the very product it had introduced. Firms in the advanced countries, however, strive to stay ahead through frequent innovations which make the earlier products obsolete. The Product Cycle Model developed by Vernon represents a generalisation and extension of the technological model. According to this model an innovative product is often first introduced in an advanced country like the USA (because of certain favourable factors like a large market, ease of organising production, etc.). The product is then exported to other developed countries. United Slate.

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Fig. 2.4: International Trade and Production In the Product Life Cycle (Reproduced with permission from Raymond Vernon and Lewis T. Wells, Jr., Manager in the International Economy, Englewood Cliffs, Prentice·Hali Inc.,1981.)

40

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INTERNATIONAL TRADE AND EXPORT MANAGEMENT

As the markets in these developed countries enlarge, production facilities are established there. These subsidiaries, in addition to catering to the domestic markets, export to the developing countries and to the United States. Later, production facilities are established in the developing countries. They would then start exports to the United States - TV receiving sets is one such example. The situation is portrayed in Fig. 2.4. The international product life cycle model is described basically as a trickle-down model (Kenichi Ohmae has termed it as water fall model of world trade and investment - a new product is first introduced to the high-income-country markets and subsequently to the middleincome and low-income countries. An alternative to the trickle-down approach shower approach, according to which the new product is simultaneously introduced in all the markets (high income, middle income and low income countries) of the world markets. This approach is relevant because of the emergence of the global village and fast obsolescence of the product.

AVAILABILITY AND NON-AVAILABILITY The availability approach to the theory of international trade seeks to explain the pattern of trade in terms of domestic availability and non-availability of g