Through the most of the post-war period, international trade has shown substantial growth compared to the world income; at the same time, the share of manufacturing of goods has substantially increased. Transportation costs in international trade go towards aspects such as the movement of goods, expenses on setting, packing, and handling, freight charges, as well as insurance fees. Regarding the effect of such costs, there are two possible outcomes:
- If transportation costs are included, the importing country, in which costs are high, will generally import and consume fewer goods; however, it will produce more of them.
- If transportation costs are included, the importing country with low costs will export and produce fewer goods while consuming more of them.
This shows that transportation costs influence the international trade volumes, economic gains from cooperation between countries, and the extent of specialization in the production of goods.
According to the factor endowment theory, nations that are rich in capital prefer cheap capital over expensive. Therefore, they export and specialize in goods that are intensive in the capital. If a nation has a comparative advantage in a good that employs endowing factors, the production efforts should only be focused on that good. This subsequently increases the demand for capital, forcing both capital and capital-intensive goods’ prices to rise. In countries that are scarce in the capital, the opposite process occurs. Any reasons for further trade and specialization on capital-intensive goods stop being relevant when the exchange of goods results in equalization, which means that capital and product prices in each country become equal.
Factor-endowment (otherwise called Hechsher-Olin) theory implies that different countries usually have various types of resources, in which they are abundant; with regards to the economic explanation, this means that nations have different capital-labor ratios (comparative advantage). The Ricardian theory also focuses on comparative advantage; however, it is focused on explaining the patterns of income distribution in societies. If to compare the explanations of two theories with regards to international trade models, one discernible difference persists. The Ricardian theory postulates that global trade patterns depend on the productivity of labor while the Hechsher-Olin theory suggests that trade patterns rely on factor endowments in the international arena.
Regarding the explanation of the trade’s effect on the income distribution among trading partners under the factor-endowment theory, it is important to mention that the approach suggests that the exports of goods that are cheap and large in volumes (abundant) make them more expensive and less abundant in countries where they are produced and exported. Therefore, such a distribution leads to higher prices domestically and thus the share of income.
According to the Leontief paradox theory, countries are expected to export those goods that intensively employ abundant factors and practices of production. Nations are more likely to import those goods, the production of which was limited to the intensive use of scarce factors. It was commonly agreed upon that the United States was the only country with the vastest endowment of capital; therefore, the country was expected to import labor-intensive products and export those intensive in the capital. This conclusion was completely opposite to the suggestions of the factor endowment theory, which expected the U.S. to export labor-intensive goods.
Inter-industry trade refers to the trade of products that are assigned to different industries. For example, the trade of technological equipment to perform agricultural work (produced in one country) and the products of agriculture (produced in another) can fall under the category of inter-industry trade. It is a common practice for countries to participate in international trade on the basis of their competitive advantages. Both Ricardian and Heckscher-Ohlin models aimed to explore inter-industry trade on the international arena through the ideas of comparative advantage.
On the other hand, intra-industry trade refers to the trade of products that are assigned to the same industry. While it may seem ineffective for countries to export and import the same products with their international partners, intra-industry trade has some substantial advantages, such as the increase in product variety, opportunities for international businesses to gain benefits from the economies of scale, and stimulation of industry innovation.
If to give an example for successful intra-industry trade, the relationship between Germany and Japan regarding care trade stands out the most. While Toyota, the Japanese manufacturer, predominantly produces family cars for a specific sector of clients, Audi, the German manufacturer, produces cars in the category of sports vehicles. The more family cars manufactured by Toyota, the lower is the cost per unit; accordingly, the more sports cars built by Audi, the lower is the price per unit. The key determinants of intra-industry trade are the following:
- Overlapping demand for specific segments in countries that participate in trade;
- Differentiation of goods in relation to the economies of scale;
- The level of ignorance of domestic products to the tastes of minority consumers.
Industrial policies refer to the official efforts of governments to strategically encourage the revival, improvement, growth, and development of the manufacturing and other economic sectors of countries. In order to foster comparative advantage in “sunrise” economic sectors, they implement such strategies as the protection of trade, guarantees on loans and low-interest loans, subsidies on research and development, and so on. The creation of comparative advantage within the economy requires governments to determine what industries present the highest prospects of growth and development. On the other hand, industrial policies are complex in nature due to the following problems:
- Issues with the identification of industries that are oriented on growth and expansion;
- Voting constituents of the national policymakers may influence their decisions regarding industrial policies.
Governmental regulatory policies are targeted at achieving the set objectives with the help of laws, regulations, and other tools that offer improved social and economic outcomes for countries, thus subsequently enhancing the overall well-being of businesses and citizens. Because governmental regulatory policies can cover a large spectrum of processes that affect companies, they can influence the competitive advantage of businesses overall.
Regulations imposed on domestic manufacturers contribute to the increase in the costs of production and the decrease in competitiveness. Therefore, regulations of this kind play a role of negative determinants of the country’s trade performance. Governments that enforce strict and costly regulations on their businesses (compared to those in foreign countries) usually weaken their competitiveness in the sphere of international trade.
Under the Foundations of Modern Trade Theory: Comparative Advantage, trade can take place even when a country is in a position of absolute cost disadvantage in the production of goods. The principle of absolute advantage considers a two-country and two-product world, in which the first country has the absolute advantage in producing one good while the second possesses the absolute advantage in manufacturing the other.
Therefore, countries that export goods are at the absolute advantage of costs while countries that import are at the absolute disadvantage. This ties in with the question of whether it is possible to keep low-skilled jobs in countries such as the United States. If the government introduces tax credits and other beneficial incentives for U.S. companies to boost their comparative advantage, keeping low-skilled workers will be possible. However, it will be more valuable for businesses to invest in training for low-skilled workers or technologies in assisting them. Such improvements are likely to overcome the wage advantages that attract workers to move overseas.
In economic terms, gains from trade refer to the overall benefits economic agents receive from being able to increase the volumes of trade between one another. Trade gains usually result from the following three factors:
- Production specialization that is reinforced by labor division, economies of scale, factor resources availability in output types (businesses, farms, etc.);
- A general increase in total possibilities of output;
- Trade occuring through markets: selling output for another (more highly valued).
When a country participates in trade, it plans to receive a large income due to the wide variety of products available for consumption. Also, the productivity levels are more likely to increase because of the active trade. Nevertheless, estimating the gains from trade is complicated since it is important to know the costs of a nation’s imports if it produced goods itself rather than bought them from a less expensive supplier that operated abroad.