Please refer to our new main site.

Monday, June 4, 2012

The Theory Behind Multiplicity of Regional and Multi-Lateral Trade Negotiations

In recent times, external policies for almost all countries are hinged on policies promoting international trade. Countries have gone ahead to engage in either regional trade negotiations or multilateral negotiations at the World Trade Organization (WTO) in Geneva. All these efforts are geared towards enabling countires engage international trade.

According to the report, as of May 2011, 296 regional trade agreements (RTAs) have been formed and notified to under either GATT article XXIV or GATS article V, or the enabling clause. More than 100 other RTAs are in the pipeline (signed, not yet in force/under negotiation). A number of other uncounted RTAs are in force but have been not been notified to WTO

But then, why do countriesengage international trade? Why do countires engage in trade negotiations? Why there are global attempts to liberalize trade rather than promote autarky-a situation of no trade? Well, this article delves into theories of international trade in an attempt to answer the questions.

Economists believe that all countries can gain from free trade. To get a clear perspective to this claim, I will glance through the Ricardian Comparative advantage Model on gains from specialization and opportunity cost theory to clearly bring out the forces behind the explosion of regional trade agreements.

According to David Ricardo (1817), countries engaging in international trade can gain if they specialize in the production of products with low opportunity cost. The Ricardian Comparative advantage emphasizes that countries should understand their factor endowments then direct production to the best alternative in utilizing the available resources. A country undertaking such specialization would then trade with other countries to get the products which are of second best alternative in utilization of resources.

The Ricardian Comparative advantage is based on opportunity cost theory. Noting that resources are scarce, a country has to give up production of one product in order to produce the other. To know which one to give up, a country has to determine where it would have higher output if the same resource available was utilized in the production of either product. A country would specialize in production of that product whose utilization of the available resource produces the most output. On the basis of the opportunity cost theory, a country should specialize in production of that product whose cost for failure to produce it is higher than that of the second alternative. According to the Ricardian Comparative advantage theory, countries are endowed differently and so they have different opportunity costs. The difference in opportunity cost is what would enable them trade with each other so as to get the products for which they are disadvantaged.

The Ricardian Comparative advantage theory sums up the above with the use of what he called the absolute advantages. To him even if a country would produce more of the two products than the other country (the absolute advantage), it should specialize in producing that product in which it has an advantage in utilization of the available resources (comparative advantage).

The theory assumes two countries enge in international trade by trading with each other two products they produce using one factor of production which is fixed and with same abilities and productivity levels at full employment. Factors are perfectly mobile within country and between sectors and can easily be shifted from production of one product to another and from one region to another. However, factors are immobile between countries in that the endowments in one country cannot move to another country. It also assumes that; factor productivity is constant and the market perfectly competitive. There is a fixed level of technology and transport costs are ignored .The theory compares a no trade situation and with a perfectly free trade (no tariff or non-tariff barriers) situation.

To Ricardo, product output from full employment of a factor of production varies between countries. One country will produce more than the other even when both are using the same units of the factor of production. One out of the two countries can have higher outputs when the available factor is employed to any of the products. In such a situation one with higher output in either product is said to have an absolute advantage over the other. However because the factor of production is one, a country has to decide on which of the two products it will have to produce. An attempt to specialize in one product will make the country forego the outputs it would have produced in the other product, phenomenon referred to as opportunity cost.

The opportunity cost is the entry point of international trade. Even if one country will have an absolute advantage over the other, there will be one product in which relatively it loses most if the two countries decided to forego production of the same product. Likewise there will be a product for which specialization produces utmost benefits. The product in which the country has the utmost benefit is the product in which the other country has the least benefit if both of them specialized in the same. On the other hand the product in which one country has the least benefit is the product in which the other country has the utmost benefit. This situation is referred to as comparative advantage. It states that if the two countries try to specialize each will have a product in which it benefits most. In other words, each country will have a product in which the opportunity cost of the foregone alternative is minimal. Therefore each country should specialize the factor in the production of that product in which the comparative advantage is higher, i.e. where the opportunity cost is lower and then exchange the products for those they are not producing.

Due to specialization and trading based on the principle of comparative advantage, output and consumption of one of the products will be more than before specialization, without reducing the quantities of the other products

In general, countries that engage in international tradegain from free trade because the output and consumption possibilities of both countries expand as opposed to no trade. Thus, enabling countries to specialize their resources in the economic activities in which they have a comparative advantage and then trade for the activities in which they have a comparative disadvantage does not only expand the size of global production, it allows for expanded " global consumption possibilities". However benefits are higher in a free trade environment, and thus the need for countries to negotiate so as gain freer trade.

No comments:

Post a Comment