SOUTH EAST ASIA

TRADE POLICY
TRAINING NETWORK

INTRODUCTION TO TRADE POLICY AND THE WTO

MODULE 2

World Trade
Setting the Context
or
Why Trade?

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 Mercantilists’ View of
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Trade
According to the logic of Mercantilism (the
accepted viewpoint in the 17th-18th centuries), the
way for a nation to become rich was to export
more than it imported.
The policy implication was that the government
had to do all in its power to stimulate the
nation’s exports and to discourage and restrict
imports.
Do you agree??

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SOUTH EAST ASIA
TRADE POLICY

Value of World Trade

TRAINING NETWORK

• 2004- $ US 11 trillion
– Merchandise exports- $US 8.9 trillion
– Services exports- $US 2.1 trillion

• 2006—
– Merchandise exports--$US 11.98 trillion
– Services exports--$US 2.7 trillion

That is a very large amount of trade and a very

large number of jobs

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SOUTH EAST ASIA
TRADE POLICY

Growth of World Trade

TRAINING NETWORK

• 2004 merchandise exports up 9%

• 2004 services exports up 18%

• 2006 merchandise exports up 14.75%

• 2006 services exports up 9.6%

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SOUTH EAST ASIA
TRADE POLICY

Asian Trade Growth

TRAINING NETWORK

• Merchandise exports up:

– 2002- 9%
– 2003- 18.7%
– 2004- 29.3%
– 2005- 21%
– 2006- 17.7% (Value in 2006 –US$ 3.39 trillion)

Statistics are for Asia excluding Japan, Australia

and New Zealand

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Asian Trade Growth

• Services exports up:

– 2002- 10%
– 2003- 12.6%
– 2004- 23.6%
– 2005- 12.4%
– 2006- 12.2% (Value in 2006: US$ 0.527 trillion)

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SOUTH EAST ASIA
TRADE POLICY

Overall Growth
TRAINING NETWORK

• In comparison, Asian region’s GDP grew only:

– 2001- 3.5%
– 2002- 5.9%
– 2003- 6.5%
– 2004- 7.8%
– 2005- 7.4%
– 2006- 7.6% (Preliminary estimated)
– 2007- 7.2% (Preliminary estimated)

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SOUTH EAST ASIA
TRADE POLICY

Why Trade?
TRAINING NETWORK

• 1950 to 1988- countries that liberalized

trade regimes:
– Enjoyed annual growth rates ½ percent
higher than those who did not liberalize

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK
Why Trade?
Cont
• Trade barriers removal during 1990’s
increased growth by 2.5% year
• In 1950 merchandize exports were 8% of
world GDP
• In 2002 they were 19% of world GDP.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

• Trade represents:
– A lot of goods and services
– A lot of money
– And a lot of jobs

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 Growth of World Output, 
SOUTH EAST ASIA
TRADE POLICY

2003 to 2007 (forecast)
TRAINING NETWORK

9
8
7
2003
6
2004
5
2005
4
2006
3
2007
2
1
0
World Developed Developing South-East
countries countries Europe and CIS

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 SOUTH EAST ASIA

GDP growth in developing countries, 
TRADE POLICY
TRAINING NETWORK

2003 to 2007 (forecast) Cont

Growth rates are high in all developing regions, supported by 
net exports and domestic demand.

9
8
7 2003
6
2004
5
2005
4
2006
3
2 2007
1
0
Africa Latin America West Asia East and South
and the Asia
Caribbean

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 SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK
Terms of trade of  developing regions 
(Index numbers, 2000=100)

Gains from the terms of 
trade supported economic 
growth in West Asia, Africa 
and Latin America. 
Strong expansion in the 
volume of exports 
compensated for 
deteriorating terms of trade 
in East and South Asia.  

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

What is a Theory?

• Like a map
• Gives us a general idea, focusing on key
relationships
• Real world detail is too complex, and can’t
be described completely—theory ignores
it.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

The Key Questions

• Trade theory addresses three basic topics:

1. Why do countries trade, i.e. what are the
gains from trade?
2. What do countries trade, i.e., what determines
patterns of production and trade?
3. What are the consequences of government
measures to regulate trade, known collectively
as “trade policy?

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Classical Trade Theory

According to Adam Smith in his famous

book The Wealth of Nations, published in
1776, individuals conduct economic
affairs based on their own best interests.
This he called the “Invisible Hand.”
Thus, the classical approach to trade is
based on a fundamental belief in the
benefits of Trade Liberalization.
– The path to riches is not having an export
surplus but rather through specialization.
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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Comparative Advantage

In 1817, David Ricardo presented the law of

comparative advantage.
– Comparative advantage comes from difference in
relative efficiencies, not the absolute differences in
countries’ efficiency in producing goods.
– It is based on opportunity cost, i.e. the cost of
foregone of not producing something else.
– Ricardo proposed that countries would tend to
produce and export products in which they have a
comparative advantage.

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 Consequences of the
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Ricardian Model
• In this model there are always gains from trade,
but it says nothing about winners and losers
within each country.
• Countries always specialize in production—
exporting and importing the same product on
balance is logically impossible.
• Although simple, the theory is supported by
empirical evidence—countries tend to export
goods where they have high productivity relative
to other countries.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

20th Century Advances

The focus of classical approach was on the gains

from specialization and trade. But it did not
explain what determine comparative advantages
of countries.
Later, the neoclassical economists were
successful in answering the question of what
determines comparative advantages. Their
theories connected comparative advantage to the
productive factors that a country has.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK
The
Hecksher-Ohlin Theory
The Neoclassical theory of international trade was
developed independently by two economists in the
1930s. It is also known as the “Hecksher-Ohlin Theory”
or sometimes the “Factor Proportions Theory.”
The H-O theory is the basic 2 x 2 model of international
trade.

Two factors of production  Capital and Labor

Two goods  1 Capital-intensive good and
1 Labor-intensive good
It explains why each country has a comparative
advantage in producing a different good.

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 The Hecksher-Ohlin
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Theory Cont
A country will export the good whose
production requires the intensive use of
the country’s relatively abundant and
cheap factor and import the good whose
production requires the intensive use of
the country’s relatively scare and
expensive factor.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Prediction

The H-O theory implies that the country’s

comparative advantage and its trade pattern are
determined by its relatively abundant factor.

Thus the country that is relatively well-endowed

with capital will export the good that uses capital
intensively in its production, while the labor
abundant country will export the labor-intensive
good.

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SOUTH EAST ASIA
TRADE POLICY

Factor Endowments
TRAINING NETWORK

• Endowments are factors of production,

which a country has naturally—factors are
predetermined, not created.
• Factors of production are typically hard to
move from one country to another.
• Countries tend to produce goods for which
they have the natural endowments.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Inputs
• Inputs are necessary to the creation of all
goods and services.
• The three most important inputs are land,
capital, and labour.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK
The Hecksher-Ohlin-Samuelson
Theorem

The Hecksher-Ohlin-Samuelson Theorem (also called

the Factor-Price Equalization Theorem ) suggests that
international trade will eventually lead to equalization in
the relative and absolute returns to homogenous factors
across nations.
In other words, international trade will cause the wages of
workers with the same level of skill and productivity to
equalize across trading countries.

A similar logic is applied to the return of capital.

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SOUTH EAST ASIA
TRADE POLICY

The Stolper-Samuelson Theorem

TRAINING NETWORK

The Stolper-Samuelson Theorem suggests that

an increase in the relative price of a commodity
raises the return ( i.e. earnings) of the factor used
intensively in the production of such commodity.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Rybczynski Theorem

The Rybczynski Theorem suggests that at

constant commodity prices, an increase in
the endowment of one factor will increase
the output of the commodity intensive in
that factor by a greater proportion, and
will reduce the output of the other
commodity.

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 The 20th Century Models
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

—Summary
• Theory draws conclusions not only about gains from
trade across countries, but also winners and losers within
countries.
• Predicts large income distribution consequences from
trade—the owners of the abundant factor of production
gain.
• These insights why stakeholders behave as they do, e.g.
why unskilled labor in the US fears opening up of trade
with Asia.
• But the empirical evidence is mixed—the simpler
Ricardian model does as good or better a job explaining
actual trade patterns.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Modern developments
• Economies of scale give rise to gains from trade
through specializing, even if countries have similar
factor endowments.

• Imperfectly competitive markets give rise to gains from

trade through product differentiation.

• Together, these newer theories explain why similar

countries trade with each other, and why countries
export and import similar products. They also help
explain the links between trade and foreign investment.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK Economies of Scale

A small countries can achieve economies

of scale and gain comparative advantage
by producing large quantity of output, that
conform to international standards, at the
minimal production cost for domestic
consumption and export to other
countries.

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 Income Similarity
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

This theory explain the intensity of trade of

similar products between advanced countries
with similar factor endowments.
At the beginning, firms concentrate in supplying
domestic markets. But once the market has
become saturated, the firms seek to supply in
other countries which have the same incomes and
tastes as the home country.

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 Trade and Developing
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Countries

• Cheap labor can offset automated

production based on advanced
technology.
• Capital can purchase technology from
abroad.
• Productions systems can cross
international boundaries through global
supply chains.
• Comparative Advantage is not static.
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 Policies to change
SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

comparative advantage
• Invest in education and training
• Invest in infrastructure
• Increase research and development
• Use fiscal and monetary policies to reduce
inflation, increase economic and political
stability, etc.

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SOUTH EAST ASIA
TRADE POLICY
TRAINING NETWORK

Implications

• The logic of economic theory tends to favor freer

trade, but the theory itself recognizes that there
will be winners and losers from liberalization.
• If everyone embraced free markets, there would
not be need for trade policy or the World Trade
Organization
• But stakeholders look out for their own interests,
not for the system as whole.
• Thus there is a need for a set of rules to govern
the world trading system.

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