Trade Pattern Theories
Welcome everyone to course International Business. In the last lecture, we were talkingabout you know the theories of comparative advantage, the free trade theories basically,the theories of comparative advantage and the theory of absolute advantage. So, buttoday we will be continuing with it.And by the time when I am standing here and discussing with you in the recent G7Summit, the President of America, Donald Trump has said they would not impose tariffson Japanese’s automobiles. So, this is a news which will have a significant impact on theauto stocks and the automobile market as such.And it was also concluded in that summit that India would be importing more of oil fromUS. So, this is something that talks about the international trades that happens across thecountries ok. So, today we will be continuing from the last class, and we will bediscussing about the trade pattern theories.(Refer Slide Time: 01:23)So, the first thing that we are discussing is what factors are affecting right!. For example,the theories of country size, factor proportions, and country similarity all contribute tothe explanations of how much does a country trade? so a country trades at what volumesright!, and what kinds of products? and with whom? So, these three questions today willbe largely discussing.So, how much does a country trade? Which, what types of products does the countrytrade? Does it trade all types of products or is it confined to a few? For example, capitalintensive goods or labour intensive goods, or how does it happen right!, or natural goodsbasically.Or and with whom does it like to trade? Do you have an equal affinity to trade with anycountry, or you have a close relationship with some countries, how do you decide thetrade relationship? And what products, and how much finally so right!?(Refer Slide Time: 02:16)So, coming to the first point, how much does a country trade right!, how much? So,obviously, somebody will think, it depends on what is this requirement right!. So, takingthat point we start with the first one, which says theory of country’s size.So, what it says here is that countries which have large land areas and have a vastresources – a natural resources they have a varied climate also and large natural resource.So, these countries would be more self-sufficient then a smaller countries right!, becauseyou have for example take India and China; so, these being very huge countries, andRussia.So, these are huge countries where you have different kinds of climate,, so suitingdifferent kinds of you know products/produce. So, we produce our own most of thethings we produce on our own. So, we are self-sufficient, and we do not like to dependon others.But on the contrary there are smaller countries which do not have the advantage of landand natural resources. So, these countries would like to depend you know on exports willlargely right!. So, what it says is large countries production and market centers are morelikely to be located at a greater distance from other countries raising the transportationcost.So, this is connected with that small and large that because for example a country likeIndia is so huge and large. So, the transportation costs are also equally you know goes upright!. So, therefore, transportation becomes a challenge right!.On the other hand, smaller countries which have very close boundaries with the othergood countries developing countries and developed countries, they would tend to exportit to the other market because the transportation costs are low right!. So, and thetendency to produce more and you know be self-reliant and then sell the exports or thesurplus to the other countries is a general tendency that you find in smaller countries.(Refer Slide Time: 04:11)Second point is the size of the economy. So, what size the country economy size is. Forexample, if you look at this table now what it says 30 percent you know China, theUnited States and Germany account for over 30 percent of world merchandise trade.So, this is what it talks about how much contribution does China, United States, andGermany give more than 30 percent of the world merchandise trade ok! The top 10traders in merchandise, that means, the largest sellers basically Walmart, Tesco, and allaccount for over 52, half of the 52 percent of the World’s total trade right!Developing economies had a 44 percent share in world merchandise in 2018; so,developing economies top 10 merchandise sellers and these three countries. So, the datasuggests how size of the economy are the size of the you know companies effects thetrade right!This example if you can see this what it says, this data has been taken from the worldtrade statistical review only Angola, Bangladesh and Myanmar. Now, look at this valuenow 2008 and 2018. So, how merchandise state has changed right! so this is the leadingexporters among least developed countries 2008 and 2018.So, Angola you can see has a very large share, Bangladesh and then Myanmar, Sudanright! in 2008. But when it comes to 2018, you see Angola has also substantially fallenand Bangladesh has increased, Myanmar has increased and Cambodia also has increasedright! So, there has been some change. So, what it basically tells is size of the economyhas also an impact on the size of the trade you know how much would you trade.Now, the question second question that we are talking about is what types of productsdoes a country trade? Does a country trade in all types of products? Does India trade youknow in all types of products, does it export everything or does it import everything, or itexports a few only products? Yes, then what are they?(Refer Slide Time: 06:22)So, to explain this point, we will talk about the first some certain theories. The firsttheory says is a factor proportions theory given by Heckscher and Ohlin right! Now,what does this theory says? Now, a country tries to trade with another country on basis ofcertain factors which are called the relative endowments. Endowments means the naturalgifts or abilities to the country has in terms of what land, labor, and capital.So, the availability of land, labor and capital will determine the relative cost of thesefactors. So, suppose something is not available or is in scarcity, automatically the cost ofthat factor will go up. So, factor costs will determine which goods the country canproduce most efficiently.Now, India has got a huge coastal line. So, our fish production is very high right! Wehave got a huge amount of good land cultivable land. So, in this for because of this ourwheat production, rice production is also very high right! So, labor is very cheap in Indiaright! so that becomes one of the biggest advantages. Iran has got natural oil right! So,Bangladesh has a lot of labor cheap labor. So, it goes for export of textiles right!So, these factors Ohlin and Heckscher, they talked about this factor endowment orbasically what natural abilities does the country have, so that will decide what type ofproduct does the country trade right! So, if I am; if I am you know having a scarcity oflabor, I will try to depend more on technology. If I am having lot of labor I will try to usethat labor right!Second is people and land, what it says again you know this is connected from the firstpoint. For example, I have said Australia and Canada right! Now, these two countriesthey are have large land resource. So and natural resource being very high, they producelot of wool and wheat ok.So, we all know we have studied from childhood that Australia produces very highquality wool right! and wheat also is produced very largely in Canada and Australia. So,why because they have lot of land resources, and they have the capability to do this right!cultivate.Second, another point is the availability of capital, labor rate, that means, that the chargethat the labor takes; that means, how much labor costs basically and the specialization.Now, to explain this we see now if some company if some country has lot of capital, forexample, the US right! or Germany or let us say these countries now will have lot ofcapital Switzerland for that. So, these countries will be more having more capitalintensive goods right! So, they will try to depend more on less on labor and more oncapital intensive technology based right!Coming to this explaining, trying to explain this, I brought an example of Iran. Now, Iranwhich has you know lot of labor available. It makes handmade carpets right! which isquite different, this handmade carpets are very different by the design and style from thecarpets that are made in other places with the help of a machine. Specifically, in Indiaalso I have seen in many places, we have lots of handicraft products.Now, these handicraft products today are getting a threatening from machine madehandicrafts. So, although they should not be defined anymore as a handicraft becausehandicraft means handmade, but still those designs being made by machines today theIndians are facing a heat(competition), the Indian handicraft industry is facing aheat(competition), but still some of the Indian handicraft designs and products are sopopular and they are exported the world over right!The another point that affects the what type of products does the country trade is thelocation – manufacturing location, that is what it says is how much do you allow thebusiness to flourish in your country.That means, do you allow FDI, what is the kind of freedom you are giving? And thepoint is how much of space and you know space is available. So, suppose for example, tostart a large plant or a firm or a company right! a manufacturing plant, you need hugespace. So, do we have it the question is? So, in some countries like India maybe it is yes,we do.But in some other countries, for example, Singapore and Hong Kong, they are very smallcountries, so they do not have that capability to provide locations to for manufacturing.So, you see China has become today a manufacturing hub of the world. So, they say themanufacturing hub of the world is China right! Why? Because, China has the ability, theresource to provide to the other counterparts to come and set up their plants in Chinaright!On the other hand, you see Hong Kong, for example, I brought this example goes fortextiles rather than automobiles. Now, you see this what I am saying. Most successfulindustries in Hong Kong are those in which technology permits the minimum use ofland, the minimum use of land relative to the number of people employed that means thedensity, you can talk about the density, so land by people.It does not compete in the production of automobiles, because they understand that if youwant to set up a automobile plant the kind of space you require is very very high; on thecontrary they go for textiles which happens in multi-storey factories which requiresminimum space right! So, I can have textile industry in a multistory system in a fact amultistory way, so that will take less space of mine, but that I cannot do in an automobilecase.Another point is the product technology. Now, most new products originate in thedeveloped countries right! So, technology for example, you see the most of thedeveloped is where you talk about Denmark, Switzerland, you know USA, Germany,Sweden, whatever you talk about these countries have developed, and they have attaineda success in terms of the technology.So, the technological growth has been substantially high in comparison to the developingcountries or the under developed countries. So, most of these developed nations, theyhave their own high technology.So, what kind of a nation are you, what kind of a nation, is somebody a developednation, so they will be more rich in technology and other things. And somebody is let saydeveloping, so they are more labor intensive, so that also has an impact.So, what kind of technology are, how advanced you are in technology that also affects,what type of you know products does a country trade. So, the example you see a Swisswatches we say, German engines right! So, these are some of the examples correct!(Refer Slide Time: 13:16)Process technology, same product can be produced by different methods. So, you see inIndia or Bangladesh, for example, the Asian economies, you see the production of rice isbeing made by labor with the help of labor, because labor is intensive and cheap.On the contrary if you see, this is a case the opposite is true for Italy in the right side. So,here if you see the production and you know all the processes involved in cultivation andharvesting is being done with the help of machines now. Why? Because, these people donot have enough manpower.Now, look at the country like India versus Japan, for example, you see India is having avery huge generation, this young generation; on the contrary Japan is having a ageingpopulation. Now, the now because of this problem, Japan will tend to get more peopleyoung people from other countries who can maybe help them in nursing and other kindof support.But and India has an advantage because of this young population and you know and theyhave a maybe employment is still a very big issue in India, these people maybetomorrow they can join there. So, what kind of you know resources we are having thatwill decide what kind of products we are having.So, tomorrow there is a large possibility that Indian hospitality industry might growtremendously right! the hospital and the hospitality industry both can grow verytremendously, because there is a huge population which is young and that can doanything that they want. On the contrary, the Japan would be depending either ontechnology like robots to help them, or they would like to get young people from othercountries who can work as a nurse for them right!(Refer Slide Time: 15:04)The question is next, first we spoke about how much and what, then now with whom?Whom does the country want to trade? Do we want does any country want to trade witheverybody? Let us see. What it says is the country similarity theory. Now, what is thiscountry similarity theory? This is something like a homogeneous market.Most trade today occurs among high income countries, similar market segments andproduce and consume so much more than the emerging economies, that means, it sayscountries which have a lot of similarities in terms of their consumer base and theirconsumer behavior, their culture and all, these people will tend to do more businessamong themselves, because then you do not need to change the product time and again.So, there is a standardization of the product which leads to a scale of economy oreconomies of scale which leads in. So, the companies also gain by producing a similarkind of a product for a larger market.So, A and B today now it becomes a club as a single market maybe, so that is where yousee the European Union for example that is what it gives the advantage. So, they have alarge market today. So, this large market is what it helps them, helps the companies andthe countries to prosper.Theory says that once a company has developed a new product in response to observedmarket conditions in its home market, it turns to the market its sees as the most similar.So, if India finds there is a similar market in Mexico, so we feel Mexico is so different,but no, surprisingly Mexico and Indian markets are very similar.So, India may like to export most of its products to Mexico. See most of our business hasbeen in the past being from India has happened with Indonesia, Sri Lanka right! becauseone reason was they were close, and they were close in terms of cultural similarity ok!Another point is specialization and acquired knowledge. Germany’s traditionally strongin manufacturing luxury car like BMW, Porsche, and Volkswagen; India in IT.So, what is the specialization? So, if we have a you know if I am strong in let us saymanufacturing technology, I would like to sell my car in a market where it is it has arequirement right! So, that they do not have the advantage.Similarly, you see India has a strong advantage in IT, and so most of the outsourcingbusinesses that happen in let say US, Australia or Canada or anybody, they hire the youknow people from IT experts from India, so that is an advantage. So, here the acquiredknowledge and a specialization that we are doing that helps us to go into another countryright! and create a international trade ok.Product differentiation, so this is also connected with that point of product differentiationright! So, how different the products are? Sometimes a country you know might beproducing a particular product, but the consumers do not like the product being made bythe homemakers or the domestic manufacturers rather they would like to get a similarproduct in the same category let us say you are talking about cosmetics or let us saysome designer watches.So, Indian designer watches may not be liked by the Indian consumers, and they mightbe expecting them to get the watches from somewhere else. So, this is something like theproduct differentiation occurs because of the consumers demand in because of theconsumer change in the tastes and preferences.So, they in the same market whatever is being produced in the home market they mightnot like it. So, they have a demand for the product made in the other market. So, this isalso an, all this has happened you see easily because today the connectivity across theglobe has become very simpler. So, that is why it has become trade has become verysimple and much easier. Although it is complicated, but still it has become muchsimpler; earlier days it was very very tough.The effect of cultural similarity UK and India you see. India was a colony to the UKright! So, because of it what happened we have learnt a lot of ways of how the Britishspeak, the how the British people live, and that has become a part of our lifestyle also.So, we tend to you know we do not understand that, but it has become a part. Forexample, why do we ride you know to the left of left in a street when we ride your bikeor car, we ride to the left. It is not there in other some other countries, and it is not in US,but it is in England right!. So, we have got this habit from there.Our people speak good English, in fact, Indians students have won many spellingcompetitions you know across the world and all. How has it come? Because of thepresence of this British, although we have a colony, but still we imbibe a lot of culturefrom them right! and they also took some of our culture. So, these relationships hascreated a cultural similarity.India, US, now both are democrats, they have a democracy, the political system theyhave a democracy running at the moment. At the moment means today there US has arepublic, and India has developed, but the democracy form of government is present inboth the countries for example, let us say. So, this also creates some kind of a similarity.Effect of the political relationship, so no wonder the best example if I want to give wouldbe India and Pakistan. We share a very, very bitter relationship in terms and that effectsour economical and the trade. But here I am giving you an example of US and Cuba. So,when US and Cuba during the time of Fidel Castro right! who was the Cuban leader.So, at that time US stopped importing sugar from Cuba and they started importing itfrom Mexico and Dominican Republic of sugar for sugar right! So, they got the sugarfrom Mexico and Dominican Republic. So, they cut down, striked off the relationshipfrom with Cuba. So, this is because of the political tensions that happens.The effect of distance, now geographical distance we are now here I am meaninggeographical distance. Also is a factor which talks about whether with whom should wetrade. Now, you see Finland is very close to Russia. So, and Finland exports most of itsitems to Russia.Here a computer manufacturer Acer, you must have all heard of the name. Acer build aplant in Finland just to serve the Russian market because it found you know thiscompany Acer is basically from Taiwan.So, from Taiwan to Russia to go to is very tough rather if you set up a plant in Finlandwhich is more business friendly also, it is simpler. So, what they did, they set up theplant Acer set up a plant in Finland, and then they served the Russian market right! Ok!So, this is what we did. And now let us go to some questions.(Refer Slide Time: 21:50)So, I have prepared two-three questions. So, what you can do is you can think look at theread the questions, then try to answer them. So, let us see. Try to write in a note and thenwe will see how many correct you have made. Which theory holds the nations thatproduce those goods for which it has the greatest relative advantage? Ok, first question.So, you can see the four options, you can say what is the answer right! So, take your timeand tick the right! one. Second question, I am not going to tell you the answers now.Which of the following holds the government the holds that the government can improvethe economic wellbeing of a country by encouraging exports and discouraging importswithout a reliance; without a reliance on precious metals? Ok.Is it mercantilism, is it quotas, is it neo mercantilism, is it the Leontief paradox, what isit? So, you have not come to Leontief paradox. So, you have got a clue, you have anadvantage. So, this cannot be the answer; the answer must be among these three right!ok, fine.(Refer Slide Time: 22:53)In a country A, it takes 10 labor hours to produce cloth, and 20 labor hours to producegrain. In B, it takes 20 labor hours to produce cloth, and 10 labor hours to produce grain.Assume both the resources are same natural resources are same. Which country shouldproduce grain? No country, A, B, both A and B, tick your answer.4th last question which trade theory holds that nations can increase their economic wellbeingby specializing in the production of goods they produce more efficiently thananyone else? So, is it the theory of comparative advantage, is the theory of absoluteadvantage, is the international product life cycle theory, is the factor endowment theory,what is it? So, once you tick it, then the answers are there. So, let us see what theanswers are, if you have done it.(Refer Slide Time: 23:43)So, 1 d, 2 c, 3 c and 4 b. How many of you have done correct? You can check it on yourown ok!(Refer Slide Time: 23:51)So, now, we come to one of the very important theories in international trade. What isthis theory? This theory is named after this Swedish scientist, Heckscher-Ohlin theory isa theory which talks about the comparative advantage that arises from differences innational factor endowments.What does its saying? The comparative advantage that you had learnt in the last lecturelast class where, we said about absolute advantage and the comparative advantage,Ricardo’s comparative advantage.So, he says these arises, so that was only where you had two products and twocompanies right! Now, we can take some factors also. So, two companies, a twoproducts, two countries and two factors let us say land and labor. Now, we will introducetwo factors now.So, Heckscher and Ohlin theory said that the extent of which a country is endowed withresources like land, labor and capital that will decide what trade it will make ok. Itproduced that countries will export goods that make intensive use of those factors whichare locally abundant.So, if I have lot of land if I have lot of capital labor, then I will tend to export laborintensive or natural sources based on some kind of a goods made of natural resources.And import goods that make intensive use of factors that are locally scarce. So, I willimport all high-tech goods because in my country I do not have high amount of capital.So, I will import those items right!The model is not limited to commodities, but also incorporates other production factorssuch as labor. Labor intensive versus capital intensive that is what we were saying youcan look at this diagram. So, this is a labor intensive industry so something let us saysome production yield or something, and this is a capital intensive. So, to set up thisplant it requires huge amount of you know money and things. So, this is something likewhat a Heckscher-Ohlin theory says right!(Refer Slide Time: 25:53)Let us see the example the United States has long been a substantial exporter toBangladesh right! In contrast Bangladesh also exports goods right! But what does UnitedStates export? The top export categories in 2018, were grains, fruits, seeds, cotton, theseare natural now.Now, comes to non-natural – aircraft, iron steel and missionary. So, this is what the USexports to Bangladesh right! In contrast Bangladesh excels in the export of goodsproduced in the labor intensive manufacturing industries. So, the top categories arewoven apparel that is apparel, knit apparel, miscellaneous textile, so it is textile,headgear and footwear. So, these are some of the items which need a lot of labor right!So, this is the source right!This reflects that Bangladesh relative abundance of low cost labor and the United Stateswhich lacks abundant low cost labor has been a importer of these goods that meansBangladesh US imports those items because it does not have it has a scarcity of labor,and it exports those items in which it has an advantage ok.For example, aircraft iron steel and missionary right! Some other items also because ofthe climate advantage for example, fruits, grain, seeds because of the climatic advantageand high use of technology they also are doing good in that.But if you see the focus on aircraft, iron steel and missionary here, they have a completeadvantage because Bangladesh does not have any advantage say in that. So, this is theHeckscher Ohlin theory right! So, today I will wind up (close) here. So, I hope you haveunderstood what we discussed.So, we spoke about with whom we should trade, how we decide to trade, what productsto trade and how much to trade. So, these things we have discussed and we discussed oneof the theories by Heckscher-Ohlin theory right!So, we will meet in the next lecture. Till then bye, and thank you very much.