Theories of International Trade | International Economics

Introduction

• International trade theories postulate different aspects of trading practices like basis for trade (reasons for trade), terms of trade (exchange ratio between products), and the gains from trade. It also helps to predict the size, content and direction of trade flows.
• Depending on the differences of arguments various economists put forward different models of trade pattern. The three phases of the trade theories are pre classical, classical and modern schools.
• Mercantilism represents the pre classical version.
• Adam Smith, David Ricardo and John Stuart Mill are associated with the classical theory.
• The modern version is linked with two Swedish economists Eli Heckscher and Bertil Ohlin.

Mercantilist Approach to Trade

• The dominant system of economic thought that prevailed in Europe from 16th to 18th Century was Mercantilism. It was known by different names in different countries. In England it was called as commercial system or mercantile system because it emphasised the importance of commerce and free trade. It was also known as “Restrictive system” because its practical policies consisted of numerous restrictions and regulations on commerce.
• In France it was known as “Colbertism” after the name of Colbert, the Finance Minister of Louie the XIV. In Germany and Austria it was called “Cameralism”. It was also known as “Bullionism” because of the importance given to gold and silver.
• The trade theory that states that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports is called mercantilism. Rather than a full fledged trade theory it was actually an economic policy of wealth accumulation. According to this theory other measures of countries’ well being, such as living standards or human development, are irrelevant. They simply focused on the accumulation of gold.
• Mainly Great Britain, France, the Netherlands, Portugal and Spain used mercantilism during the 1500s to the late 1700s. Mercantilism proposed that a country should try to export more than its imports, in order to receive gold. For this they advocated strict controls on trade in the form of tariffs and quotas.
• Mercantilist countries practiced the zero-sum game, which meant that world wealth was limited and that countries could increase their share only at the expense of other countries. This protectionist policy decelerated the long term growth.

Main ideas or Characteristics of Mercantilism

• Wealth: The fundamental aim of the mercantilists was to make the country strong. The strength of the country was found in the wealth of the country, especially that portion of wealth which consisted of precious metals like gold and silver. Mercantilism firmly believed that gold was the basis of wealth and power. Hence the mercantilist slogan was ‘more gold, more wealth and more power’.
• Foreign Trade: The Mercantilist theory of foreign trade is known as the balance of trade theory. The aim of this theory was to get large amount of precious metals. Foreign trade was considered to be the only Source for getting gold and silver. They believed that all those nations which did not possess their own gold and silver mines could become rich after getting gold and silver from foreign countries through trade.
• Commerce and Industry: The mercantilists considered commerce and industry as the most important branches of the national economy. They wanted to increase the national productive efficiency by means of regulation of industry and commerce. They believed, that commerce and trade were the most productive occupation and agriculture was the least productive. They thought that agriculture did not contribute directly to the strength of the country.
• Population: Mercantilists encouraged large population for making the nation militarily strong and for increasing its productive capacity. They believed that cheap and abundant supply of labour would keep the cost of production low.
• Natural Resources: The mercantilists wanted to utilize all the natural resources to the maximum extent so as to produce more, export more and import less. They also attached importance to agriculture in order to solve the food problem.
• Taxation: the mercantilists favoured a multiple tax system based on the principle of “each should pay according to the benefits received from the state”.
• Theory of Value: According to the mercantilists the normal value of a commodity depended on the cost of production.
• Factors of Production: Mercantilists recognised three important factors of production, namely, land, labour and capital. The Mercantilists emphasised the cultivation of agricultural waste lands so that food production might increase and the country might become self-sufficient and imports might be reduced.
• Commercial Regulation: Mercantilists believed that commercial regulations were essential for maximising social welfare. Commercial laws were passed to restrict the import of food materials. But no regulation was applied to the import of raw materials because they were required for the industrial development of the country. The state supported the export industries and shipping which would secure a favourable balance of trade.
• Role of State: The mercantilists regarded the state as the supreme power for controlling the activities of the people. State was the master and its citizens, the servants. The mercantilists believed that state intervention was necessary to solve the problems of the society. They believed that for securing success in wars a strong nation was required. They suggested the policy of protection. Special acts were passed to encourage exports and the development of industries. Protection was given to the industries because their main objective was to maintain a favourable balance of trade.
• Occupation: Mercantilists believed that merchants were the most profitable members of the society. To them occupation was productive only if it increased wealth of a country.

Owing to these unrealistic practices it faded in the following era. Later by the publication of “Wealth of Nations” by Adam Smith this doctrine completely lost its relevance. But in recent times it is slowly emerging with slight variations. Neo mercantilism is the modern version of mercantilist practices, through the formation of local trading blocks and promotion of trade with imposition of tariffs and quotas.