Table of Contents
In nutshell, international business is perhaps the broadest perspective for explaining the involvement of business firms in foreign business endeavors. Considering the fact that international business operates within the broad context of global trade environment, underpins its necessity to draw the contributions of fundamental basic disciplines. These include trading services and goods within or without a nation borders (Maneschi, 2000). Additionally, international business entails the crucial trading functional fields of marketing, management, and finance.
Summarily, international business can be considered as the congruence of various areas of business activities. Importantly, international trade involves the comparative analysis of business operations in different economic systems as well as management in similar firms in different international. This paper gives a precise discussion of whether the law of comparative advantage forms the basis of international trade. The paper further elucidates David Ricardo and Heckscher-Ohlin theories and the extent they explain and affect the patterns of trade in the real world (Lowenfeld, 2008).
The law of comparative Advantage
Robert Torrens is credited as the first person to describe the law of comparative advantage in concise and precise terms. He did this in his essay on the Corn Laws operational in England at that particular dispensation. After a careful and keen observation on the progress of the English economy, he came to a conclusion that it was to the advantage of England if it could actively be involved in trading with Portugal for grain returns, although producing grain locally appeared cheap and possible (Maneschi, 2000).
The fact of the matter is that different nations participating in international trade posses different factors endowing their production processes and products. These factors in deed vary in density, raw materials, labor force, population, capital equipment, etc. Notably, the differences might be persistent as a result of factors that are immobile relatively between countries. For instance, land and climate are fully immobile, however with capital and labor there is a tendency of restrictions either socially, physically, legally, or culturally on their international market arena than fronted in the trading within their borders (Lowenfeld, 2008). Henceforth, the capability of exchanging services and goods, do differ among various countries.
Summarily the connotation of this elucidation is that, relative cost of goods production will vary in different countries. For example, the cost of producing I fridge in country X, might be equivalent to the cost of producing 6 tonnes of maize or 3 radio set, whereas in country Y the same fridge shall be produced at the cost of 3 tonnes of maize but 4 radio set. The difference in the relative production cost is therefore, the key foundation of international trade (Maneschi, 2000).
When a particular nation is in a position to produce a product at a lesser cost than another nation, it is termed to enjoy absolute advantage in trading that product. In another case, trade between two nations can still enjoy benefit even when one nation might be producing all products at cheaper cost than the other, causing 'the relative' efficiency of producing those products, this is referred to as comparative advantage (Madura, 2008).
Comparative advantage is a concept that seeks to demonstrate how different cost of production in international trade can be compared. The concept suggests that a nation will make the most by mainly focusing on its productive resources such as capital, land, and labor, in those products possessing the greatest comparative advantage; implying those goods cheaply produced locally compared to other nations. In cases where this is not applicable or beneficial, it is advised to specialize in the least comparative disadvantaged products. Many economists agreed that the 'law of comparative advantage' fronts the basis of theoretical argument in enhancing free trade between countries (Lautzenheiser & Hunt, 2011).
However, the comparative law theory is not comprehensive and rides on several assumptions. Some of these assumptions include: assuming that there are no tariffs or any trade barriers experienced by the trading countries, inclusion of transport costs in the transactions, availability of the right knowledge, and all sellers and buyers are aware of the cheapest products presence in the international market, lack of economies of scale and that costs are ever constant, limitation of sources of that product to only the two countries, assumption that products been traded are homogeneous, and production factors are mobile perfectly (Madura, 2008).
David Ricardo Theory
The law of comparative advantage is an idea that was conceptualized and attributed to David Ricardo. In his book 'on the principles of political Economy and Taxation' which was published in 1817 he exhibited a precise example pertaining England and Portugal. In his illustration he explains that it is possible to produce cloth and wine in Portugal at less labor as compared with producing the very quantities in England. But he quickly mentions that the relative costs in both countries are completely different (Lautzenheiser & Hunt, 2011). In England producing wine is quite a hard affair and likewise cloth production is moderately difficult.
On the other hand, it is easy to produce both products in Portugal. Therefore, his punch line was based on the statement that it is cheaper and easier to produce cloth in Portugal than England, contrarily to be knowledge of the day; he showed that it was cheaper for Portugal to produce excess wine and beneficially trade that for cloth made in England. From the above illustration it is clear that England advantageously trades with Portugal as it is maintaining its cost of cloth production however it can get wine at a better and lower price, slightly closer to the cost of cloth (Madura, 2008). In conclusion, David explained how each country gained by delving into specialized production of products with comparative advantage and trading them for other.
According to a survey undertaken recently, most economists' supports restrictions to free trade, such quotas, reduced economic welfare, and tariffs. The comparative advantage theory creates the basis for free trade support and structure. This law was delineated in the 1800s by David Ricardo. Until today, the law is a vital component in introducing macro and micro-economics courses and falls under the applications of opportunity cost concept. The law encourages specialization especially for the increased output. Similarly to the majority economists take on the survey, David felt that England was not exercising its economic well being by restricting trade but rather the economy was suffering (Lautzenheiser & Hunt, 2011).
Heckscher was a renowned economist from Sweden; he is famously remembered for publishing a paper in the 1919 that was titled "The effects of foreign trade on the Distribution of Income" that comprised the major points of Heckscher-Ohlin theory.
In the same way as many classical economists, Heckscher argued that trade between nations largely depended on the law of comparative advantage. He firmly and clearly elaborated the facts behind this law by demonstrating that the ratio of the production cost of two products is totally different in one nation from the other nation. However, he placed much emphasis in the manner in which the supplies of different factors utilized in the production really affected the comparative cost. Particularly he argued that the comparative cost in a particular nation varied from the other basically as a result of relative degree of scarcity of various factors of production also differed in different countries and more importantly different products needed varying portions of the production factors (Madura, 2008).
Suppose, for instance, one particular nation, A, has huge amount of land per laborer as compared with, B. The proportion of rent to wages will be slightly lower in A than in B, as the land in the first nation will be utilized to indicate where its product is small relatively. Put into consideration the two nations' comparative costs in producing two commodities, textiles and wheat. Because wheat needs a bigger amount of land per laborer than textiles, the cost of producing a single unit of wheat will be lower than the production cost of textile unit in nation A as compared with nation B. In simple terms, nation A will have a comparative advantage in producing wheat, the commodity that requires slightly huge amount of its abundant factor, meanwhile nation B shall have a comparative advantage in textiles (Lowenfeld, 2008).
How David Ricardo and Heckscher theories explain the patterns of trade in the real world
A clear understanding of David Ricardo and Heckscher theories is of great benefit to explaining various patterns affecting trading in the real world. These theories directly explain the major patterns in the world of trade and affect the economies across the globe by extension. A common phenomena experienced in real world of trade is trade deficits. Notably trade deficits do not generally result from conditions maximizing comparative advantage. As a matter of fact, majority of real world instances where comparative advantage is already attained they is need for a trade deficit (Madura, 2008). Commonly, where the amount of products is maximized, frequently it might involve net wealth transfer from one country to another, mainly contributed by the economic agents widely having varied rates of saving.
Another effect of comparative advantage law on the real trade is the accumulation of national currencies into foreign bank deposits where separate currency is utilized. This is the effect caused by the changing markets over time, as the ratio of products produced in one nation versus another changes differently while the benefits of comparative advantage are maintained in the very country. The monetary policy of Macroeconomic is adapted oftenly to handle a nation's currency depletion from domestic hands by more money assurance, and this result to numerous historical failures and successes (Maneschi, 2000).
From the above discussion it is clear that the law of comparative advantage fronts the basis of international trade. The David Ricardo and Heckscher-Ohlin trade theories adequately support the comparative advantage by explaining how specialized production leads to minimum cost of production and maximum benefit from quality and quantity of supplied product. However, the theory is not comprehensive and at times depends on several assumptions which can cause unrealistic results from (Lowenfeld, 2008). The real world trading actually has patterns which the theories can be used to describe them. For instance, the issue of trade deficits and accumulation of national currencies into foreign bank deposits where separate currency is utilized. The Economies of the world can be impacted through law of comparative advantage practice.