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The poverty of international trade theory (1998)

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By Róbinson Rojas Sandford.- Since David Ricardo's "Economic Principles" were published in 1817, international trade theory has been based on his main tenets, even when "fine tuned" by Heckschen, Ohlin and Samuelson (trying to
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  Published in The Róbinson Rojas Archive (www.rrojasdatabank.info/capital5.htm) in 1998 THE POVERTY OF INTERNATIONAL TRADE THEORY (Notes by Róbinson Rojas Sandford) (1998) Since David Ricardo's "Economic Principles" were published in 1817, international trade theory has been based on his main tenets, even when "fine tuned" by Heckschen, Ohlin and Samuelson (trying to build a neo-classical framework for the theory), Leontieff and Vernon (attempting the introduction of the concept of technology), and Krugman (oligopoly theory). By and large, with fine tuning and all, still the three basic assumptions of the classical trade theory are the main conceptual structure of the model. That is, capital flows, technology transfer and labour migration are excluded from the model. From above: A.- factor immobility within the borders of a nation-state is the most crucial assumption of the model; B.- comparative advantage is determinated before hand, that is before the opening of an economy to trade, according to the static comparative approach, dividing economies into capital-abundant and labour-abundant. (the above leads to the historical act of "creating" situations of comparative advantage via exogeneous agents such as colonization, imperialistic behaviour, neo-colonization, neo-imperialism, and eventually "dependent capitalist development" as defined by Latin American theories of dependency) C.- nation-states are the only actors in the international economy, and thus, national economies are conceptualized as "black boxes" inside which factors of production are combined in perfectly competitite markets. Because of this the model doesn't consider firms as economic agents, and trade is reduced to a relationship among nation-states. Of course, the real world economy doesn't have any of the above features assumed by the classical theory. In contemporary world economy trade flows, capital movements, inward and outward foreign direct investment, and technology flows are component parts of the same system. The system is dominated by transnational corporations, and not nation-states. Therefore, the very nature of the world economy is the existence of close interactions between foreign direct investment, foreign speculative investement, trade, technology transfer, finance and labour movements. Unlike comparative advantage theory assumes, world-wide economic integration is no longer built solely on more intense trade flows among countries. IT IS NOW THE RESULT OF A MULTIDIMENSIONAL AND COMPLEX SET OF ASYMMETRIC RELATIONS: -industrialized countries are connected to other industrialized countries through inward and outward flows of trade, foreign direct investment, speculative investment, and technology. -less developed countries are connected to industrialized countries mainly through trade, while foreign direct investment, speculative investment, technology flows and financial flows are managed from abroad to meet the needs of discret economic agents (transnational corporations).   -thus, in contradiction with the old theory, factors of production are increasingly crossing national borders. -also, foreign direct investment is becoming a crucial determinant of a country's pattern of specialization. Therefore, "comparative advantage" now is created by foreign direct investment to serve foreign direct investment, creating dramatic economic effects within the "black box". -decisions regarding the location of new activities, or the relocation of new ones, are taken by transnational corporations. -the funding of economic activities (in both industrialized and less developed countries) is made by transnational banks operating outside the jurisdiction of central banks, which creates, from time to time, dramatic macroeconomic disequilibria. -more than 40% of international trade consist of intra-firm flows. Thus, prices of goods and services that are channeled from one foreign affiliate to the other are not determined by the market ( as assumed in the classical theory of trade ). -specialization in production is the result of transnational corporations' decisions to locate some of their activities abroad. -gains from competitiveness benefit transnational corporations and, sometimes, as a residual effect, some firms in the host countries. -oligopolistic competition is the rule. Of course, any undergraduate is aware that an oligopolistic market does not produce the conditions for an optimal allocation of resources. -more importantly, economic policies tend to fail because of the increasing asymmetry that exists between the globalization process and the national interest. Examples: with capital mobility, the targets of monetary and fiscal policies can no longer be reached with certainty. The power of transnational banks, when confronted with policies of the central banks, is inmense. national tax rates have to be adjusted to the lower existing rate if capital flight is to be avoided. by borrowing abroad, transnational corporations are able to avoid paying higher interest rates for financing domestic investments. - the rationale for industrial policy in any nation-state is to strengthen national firms, but there are mounting obstacles arising from the rationale of globalization both for transnational corporations and the local firms doing business with them: * more and more transnational corporations are moving towards a global approach, which means that investment decision-making is less local market-oriented than in the case of a multinational strategy (trying to jump over   trade barriers), and more world-market oriented, which adds to the effect of economic fragmentation in the host economy. * foreign affiliates located in different countries tend to be specialized, and flows among them are INTERNALIZED to reduce transaction costs, which makes transfer pricing easier, damaging even more the local economy's balance on current account. * as a result of the above, imports of home countries consist, in part, of imports produced abroad by the affiliates of the home country's transnational corporations. * also, an increasing share of the turnover of these transnational corporations is generated by its foreign affiliates selling in the markets of host countries, or exporting to third countries, including the home country. * by and large, in the 1990s, countries are no longer in a position to screen and control potential investors as was the case in the past decades. Now, big companies select countries on the basis of their location-specific comparative advantages...but that "comparative advantage" is not the Ricardian one, but the transnational corporation own international competitiveness. Once again, is a comparative advantage "created" by the powerful in the world of the weak to meet the needs of the powerful. Like the set of comparative advantages created by powerful armies during the period of colonization by Western European nation-states, Japan and the United States from XV to early XX century, today, late XX century, the historical process of creating comparative advantage is being done by the not with powerful armies, but with huge amounts of capital owned-managed by transnational corporations. --------------------------RRojas Research Unit/1997--------------------- TRADE, DEVELOPMENT AND THE THEORY OF COMPARATIVE ADVANTAGE Drawing from M. Todaro (1990), there are five questions related to international trade: 1) How does international trade affect the rate, structure and character of LDC economic growth? 2) How does trade alter the distribution of income and wealth within a country, and among different countries or groups of countries? 3) Under what conditions can trade help LDCs achieve their development objectives? 4) Can LDCs by their own actions determine how much and what they trade? 5) In the light of experience, what is best a) outward-looking policies b) inward-looking policies, or c) a combination of both (in a regional economic   cooperation agreement)? Neo-classical free trade model will provide a general answer stating that if capital-abundant societies specialize in capital-intensive production for exports and labour-abundant specialize in labour-intensive production for exports, trade among them will 1) be an important stimulator of economic growth, because trade enlarges consumption, increases world output, and provides universal access to scarce resources; 2) tend to promote greater international and domestic equality: equalizes prices rises real income of trading countries rises relative wages in labour-abundant countries and lowers them in capital- abundant countries 3) help countries to achieve development through specialization Neo-classical trade theory will argue that "international prices and costs of production determine how much a country should trade", and, therefore, outward-looking strategies of production are neccesary. Of course, if international prices and costs of production are mainly the business of transnational corporations and not domestic economies, then the neo-classical argument will be valid only for the welfare of transnational corporations and not the host countries. Neo-classical trade theory assumes perfectly competitive market in both the international market and each individual domestic market, and, because of that, builds the model upon the following assumptions: a) all productive resources are fixed in quantity and constant in quality across nations. They are fully employed and there is no international mobility of productive factors. ( this assumption is critical, because if there was mobility of productive factors, then "comparative advantage" will be a product of market forces competing, which will mean that powerful capitals would create comparative advantage for them all the time. Thus, eventually, there will be comparative advantage only for transnational corporations.) b) technology is fixed or similar and freely available to all nations. c) consumer tastes are also fixed and independent of the influence of producers, because international consumer sovereignty prevails. d) within national borders factors of production are perfectly mobile between different production activities, and the economy as a whole is characterized by the existence of perfect competition. Because of the latter there are no risks and uncertainties. e) the national government plays no role in international economic relations, so that trade is strictly carried out among many   tiny and anonymous producers. f) trade is balanced for each country at any point in time and all economies are readily able to adjust to changes g) the gains from trade that accrue to any country benefit the nationals of that country (the theory excludes the possibility of transnational corporations being the main producers for export in export-led economies) Apart from the possibility that the above assumptions are either extremely naive or extremely dishonest, some simple statistics prove that none of the predictions of the theory is correct. ------------------------------------------------------------------ TABLE 1 Trade as % Real GDP per capita of GDP as % of ind. cts. avg. GDP per capita 1960 1990 17 less developed countries 33% 50 44 48 less developed countries 17% 10 5 61 less developed countries 15% 11 8 Chile 30% 62 35 Brazil 7% 21 33 South Korea 29% 15 47 Papua New Guinea 36% 21 12 Nigeria 31% 12 8 Turkey 19% 27 32 Sri Lanka 30% 21 17 All less developed countries 20% 17 15 Least less dev. cts. 14% 9 5 Sub-Saharan Africa 23% 14 8 source: World Tables, World Bank, several years Data processed by Dr. Robinson Rojas ------------------------------------------------------------------ ------------------------------------------------------------------ TABLE 2 Annual average growth rate (percent) countries GDP EXPORTS as % of GDP 1970-80 1980-91 1970 1991 40 low-income 4.5 6.0 21 28 42 lower middle-income 5.5 2.7 14 26 21 upper middle-income 6.1 2.1 13 18 20 OECD 3.1 2.9 13 19 source: World Development Report 1993 Data processed by Dr. Robinson Rojas ------------------------------------------------------------------ TABLE 3 Internal distribution of income quintiles from poorest to richest country year 20% 20% 20% 20% 20% richest 10% Chile 1968 4.4 9.0 13.8 21.4 51.4 34.8 1989 3.7 6.8 10.3 16.2 62.9 48.9 1994 3.5 6.6 10.9 18.1 61.0 46.1 Brazil 1972 2.0 5.0 9.4 17.0 66.6 50.6 1989 2.1 4.9 8.9 16.8 67.5 51.3
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