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The concept of comparative advantage is probably one of the most important principles in international trade theory. It implies an ability of a country to manufacture goods or offer services relatively cheaper than another. If countries specialize in the production of certain goods where they have a lower marginal and opportunity cost, this will lead to increased economic welfare. If a country has an absolute advantage in producing all goods, it will still benefit by the international trading with other countries in relation to different relative efficiencies. David Ricardo, who has formulated the law of comparative advantage, explained it on the example of Portugal and England. He noted that Portugal requires less labor to produce cloth and wine, whereas England is better at cloth production. Therefore, England will benefit by importing wine from Portugal and exporting cloth.
International trade takes place because companies in one country intend to buy commodities produced in another country providing people with a wider choice. The main cause of international trade is the price differences as a consequence of the variations of productive factors. David Ricardo has constructed a model that states that international trade occurs due to the differences in production technologies. All countries are endowed with different facilities for production; international trade enables countries to specialize in producing only those commodities that they can produce most efficiently having an absolute or a comparative advantage while importing the rest products from other countries. It leads to cost reduction by way of the international division of labor and efficient use of the factors of production.
Comparative advantage changes over time depending on several factors in national economies. The first source of comparative advantage is the quality and quantity of productive factors such as farmland, fossil fuels, oil, and gas. A difference in quantity of low-cost labor suitable for volume manufacturing is equally important. The next factor is increasing a return to scale that occurs when output increases more than proportionately to inputs. Growing demand in the markets encourages higher productivity, specialization, and exploitation of economies of scale that gives the country a significant advantage. Correct government regulation of factory emissions can contribute to comparative advantage in clean industries or comparative disadvantage in polluting industries. In addition, government is responsible for worker productivity that may vary because of differences in education quality, qualifications of students, or because education institutions in a particular country give preference to some subjects over others. The next source of comparative advantage in national economies is the investment in research and development by businesses that can drive invention and innovation. The non-price competitiveness that covers factors such as the product reliability, the standard of product innovation, and design is important in shaping productivity.Aadditional point is that countries are now creating comparative advantage specializing in definite knowledge sectors in high-knowledge industries. For example, there is a division of knowledge in the health care industry; several countries specialize in pharmaceuticals, some in heart surgery. The next source is differences in the supply of key inputs. Different industries usually require different kinds of inputs, such as energy, capital, skilled labor, natural resources, material supplies, and they differ in the intensity with which they use those multiple inputs. For example, if land prices in the country are high, the agricultural production will be expensive, so the country is likely to import agricultural products rather than export them. The cheap land lowers the cost of agricultural production, so the nation is likely to export. One more> important factor of comparative advantage as well as economic growth results from financial institution system of a country. Legal systems contribute to enforcing contracts, banking systems are required to provide capital for export credits and investment, and then the stability of democracy appears to be a key factor for international capital flows.
International movements of factors of production are movements of capital, labor, and other productive factors between countries that occur in three ways: foreign direct investment, emigration/immigration, and capital transfers through international lending and borrowing. Foreign direct investment (FDI) is defined as real investments in land, producers durable equipment, and non-residential structures in a foreign country. There are several forms of FDI such as construction of a facility, direct acquisition of a foreign company, or investment in a strategic alliance with a local company with relevant input of technology. FDI provides companies with cheaper production facilities, new marketing channels, skills, products, access to new technology and enables to have a higher expected rate of return on a capital. If a multinational corporation has production separated into several distinct stages, FDI affords it an opportunity to create production facilities in foreign markets that results in lower operating costs. However, opponents of FDI claim that multinational conglomerates can have power over the weaker and smaller economies and drive them out of the market.
Several factors such as poverty and unemployment in the source country and the high incomes of the host country cause the migration of labor. The international movement of labor leads to a salary increase in the source country and a tendency of total output to fall. The overall effect of immigration is to cause the net return to capital to fall as the owners of capital produce less output and pay higher wages. The businesses of host country, in their turn, gain from this process. As a result of immigration, wages fall and total output increases as well as the returns to the owners of capital.
International borrowing and lending represents the exchange of resources over time. By borrowing, a country purchases some quantity of current consumption in return for repayment of a larger quantity of consumption in the future. A country that borrows from the overseas market will have a low relative price of future consumption that means a high interest rate and high return on investment. Therefore, this country will have a highly productive investment opportunities, while a country that lends will be in the opposite situation.
A tariff is a tax levied as a percentage of the value of the imported good. Tariffs rates increase the price of goods that discourages their demand and thereby supports domestic producers by way of insulation them from foreign competition. Because of the reduction in demand and an increase in expenses, domestic producers of the importing country cut production that causes jobs to be lost. As a result of the reduced employment level, the demand for consumer product decreases. In the country imposing the tariffs, the reduced competition leads to lowering prices; thereby, the sales of domestic producers will also increase. Consequently, consumer spending rises, because the domestic producers hire more workers. However, on the other side, the price increase can cause consumers purchase less; thereby, domestic producers are selling less causing a decline in the economy.
Non-tariff barriers to trade (NTBs) connote trade measures, which restrict imports but not in the same manner as tariffs. Some NTBs are permitted when they are deemed necessary for the protection of safety, health, or depletable natural resources. NTBs include sanitary and phyto-sanitary measures, technical barriers to trade, countervailing duties, export subsidies, bureaucratic delays at customs, special licenses, quality requirements and so on. The impact of non-tariff barriers differs across sectors and countries and not always contributes to a decrease in trade. For example, compliance of Technical Barriers to Trade (TBT) and Sanitary and Phytosanitary (SPS) regulations can prevent exporters from market access and lead to higher costs, but also can increase demand by rising consumer confidence in the quality of imported goods. NTBs have an adverse effect on the developing countries as they do not possess the infrastructure necessary to assess a product according to the given regulation. Import levies, which are charged over tariff duties, are determined in order to establish price differences between baseline domestic prices and prices quoted on the export markets. The levies result in stabilization of domestic prices by way of isolating domestic producers of the world market.