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computers to automobiles. The advantage ratio for
computers is 2:1 (i.e., 20:10) in favor of the USA.
Also in favor of the USA, but to a lesser extent,
is the ratio for automobiles, 1.5:1 (i.e., 30:20).
These two ratios indicate that the USA possesses
a 100 percent advantage over Japan for computers
but only a 50 percent advantage for automobiles.
Consequently, the USA has a greater relative advan-
tage for the computer product.Therefore, the USA
should specialize in producing the computer
product. For Japan, having the least comparative
disadvantage in automobiles indicates that it should
make and export automobiles to the USA.
Consider again the analogy of the doctor and the
mechanic. The doctor may take up automobile
repair as a hobby. It is even possible, though not
probable, that the doctor may eventually be able to
repair an automobile faster and better than the
mechanic. In such an instance, the doctor would
have an absolute advantage in both the practice of
medicine and automobile repair, whereas the
mechanic would have an absolute disadvantage for
both activities. Yet this situation would not mean
that the doctor would be better off repairing auto-
mobiles as well as performing surgery, because of
the relative advantages involved.When compared to
the mechanic, the doctor may be far superior in
surgery but only slightly better in automobile
repair. If the doctor’s greatest advantage is in
surgery, then the doctor should concentrate on that
specialty. And when the doctor has automobile
problems, the mechanic should make the repairs
because the doctor has only a slight relative advan-
tage in that skill. By leaving repairs to the mechanic,
the doctor is using time more productively while
maximizing income.
It should be pointed out that comparative
advantage is not a static concept. John Maynard
Keynes, an influential English economist, opposed
India’s industrialization efforts in 1911 based on his
assumption of India’s static comparative advantage in
agriculture.However, as far back as 1791,Alexander
Hamilton had already endorsed the doctrine of
dynamic comparative advantage as a basis of
international trade.
3
This doctrine explains why
Taiwan and India’s Bangalore have now become high-
technology centers that have attracted investments
from the world’s top technology companies. It also
explains why or how the United Kingdom, forging
more steel than the rest of the world combined in
1870, lost the lead to the USA. Andrew Carnegie’s
mills among others were able to produce twice as
much steel as Great Britain three decades later.
4
EXCHANGE RATIOS, TRADE, AND GAIN
Although an analysis of relative advantage can indi-
cate what a country should export and import, that
analysis cannot explain exactly how a country will
gain from trading with a partner. In order to deter-
mine the extent of trading gain, an examination of
the domestic exchange ratio is required. Based
on Case 2 of Table 2.1, Japan’s domestic exchange
ratio between the two products in question is 1:2
(i.e., ten computers for every twenty automobiles).
In other words, Japan must give up two automobiles
to make one computer. But by exporting automo-
biles to the USA, Japan has to give up only 1.5 auto-
mobiles in order to get one computer.Thus, trading
essentially enables Japan to get more computers
than feasible without trading.
The US domestic exchange ratio is 1:1.5 (i.e.,
twenty computers for every thirty automobiles).
The incentive for the USA to trade with Japan
occurs in the form of a gain from specializing in
computer manufacturing and exchanging comput-
ers for automobiles from Japan. The extent of the
gain is determined by comparing the domestic
exchange ratios in the two countries. In the USA,
one computer brings 1.5 automobiles in exchange,
but this same computer will result in two automo-
biles in Japan. Trading thus is the most profitable
way for the USA to employ its resources.
Theoretically, trade should equalize the previ-
ously unequal domestic exchange ratios and bring
about a new ratio, known as the world market
exchange ratio, or terms of trade. This ratio,
which will replace the two different domestic
exchange ratios, will lie between the limits estab-
lished by the pre-trade domestic exchange ratios.
26
TRADE THEORIES AND ECONOMIC DEVELOPMENT
Such benefits derived from trade do not imply
that trade must always take place and that all nations
will always gain from trade.We will carry the hypo-
thetical example a step further. In Case 3 of Table
2.1, the USA now makes forty automobiles (instead
of ten as in Case 1 and thirty as in Case 2). Not only
does the USA have absolute advantage for both
products, but it also has the same domestic
exchange ratio as that of Japan. This situation is
graphically expressed by two parallel production
possibility curves (Figure 2.2).
Under these circumstances, trade probably will
not occur for two principal reasons. First, since the
USA is 100 percent better than Japan for each
product, the relative advantage for the USA is iden-
tical for both products. Second, since both countries
have the identical domestic exchange ratio, there is
no incentive or gain from trading for either party.
Whether in the USA or in Japan, one unit of com-
puter will fetch two automobiles.When such other
costs as paperwork and transportation are taken into
account, it becomes too expensive to export a
product from one country to another. Thus inter-
national trade is a function of the varying domestic
exchange ratios, and these ratios cause variations in
comparative costs or prices.
FACTOR ENDOWMENT THEORY
The principles of absolute and relative advantage
provide a primary basis for trade to occur, but the
usefulness of these principles is limited by their
assumptions. One basic assumption is that the
advantage, whether absolute or relative, is deter-
mined solely by labor in terms of time and cost.
Labor then determines comparative production
costs and subsequent product prices for the same
commodity.
If labor is indeed the only factor of production
or even a major determinant of product content,
countries with high labor cost should be in serious
trouble. An interesting fact is that Japan and
Germany, in spite of their very high labor costs, have
remained competitive and have performed well in
trade.It thus suggests that absolute labor cost is only
one of several competitive inputs that determine
product value. Tables 2.2 and 2.3 show incomes,
working hours, and vacation days across major
cities.
It is misleading to analyze labor costs without
also considering the quality of that labor. A country
may have high labor cost on an absolute basis; yet
this cost can be relatively low if productivity is high.
Countries with low wages tend to have low pro-
ductivity.Any subsequent productivity gains usually
result in higher wages and currency appreciation.
Furthermore, the price of a product is not
necessarily determined by the amount of labor it
embodies, regardless of whether or not the effi-
ciency of labor is an issue. Since product price is not
determined by labor efficiency alone, other factors
of production must be taken into considera-
tion, including land and capital (i.e., equipment).
Together, all of these production factors contribute
significantly to the creation of value within a
particular product.
One reason for the importance of identifying
other factors of production is that different com-
modities require different factor inputs and that no
country is well endowed in all production factors.
The varying proportion of these factors embodied
in various goods has a great deal of impact on what
a country should produce.Corn, for instance,is best
produced where there is an abundance of land (rel-
ative to labor and capital), even though corn can
be grown in most places in the world. Oil refining,
in contrast, requires relatively more capital and
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TRADE THEORIES AND ECONOMIC DEVELOPMENT
Units of automobile
Units
of
computer
0
Figure 2.2 Absolute advantage without relative
advantage (identical domestic exchange ratios)
28
TRADE THEORIES AND ECONOMIC DEVELOPMENT
Table 2.2 Wage levels around the globe
City Gross, Net, City Gross, Net,
Zurich = 100 Zurich = 100 Zurich = 100 Zurich = 100
Zurich 100.0 100.0
Copenhagen 98.9 74.8
Basel 97.7 95.8
Oslo 94.9 87.0
Geneva 91.1 88.5
New York 84.7 78.6
Lugano 84.3 85.1
Chicago 82.5 81.0
Los Angeles 72.2 72.9
Frankfurt 70.0 59.9
Luxembourg 69.4 75.4
Tokyo 68.3 70.5
Brussels 67.9 56.0
London 65.6 63.9
Amsterdam 64.7 57.0
Stockholm 64.7 56.5
Berlin 63.9 54.5
Dublin 63.5 66.1
Miami 62.4 63.1
Helsinki 58.2 56.6
Vienna 55.8 52.3
Paris 53.4 52.2
Toronto 52.6 48.8
Montreal 50.1 48.0
Milan 44.5 40.3
Sydney 40.2 40.7
Barcelona 38.0 41.1
Rome 37.1 33.4
Madrid 35.3 39.2
Athens 34.6 37.3
Auckland 34.5 35.3
Tel Aviv 32.8 33.2
Taipei 32.3 35.5
Hong Kong 31.1 36.4
Seoul 30.6 30.7
Source: Prices and Earnings
(Zurich: UBS AG, 2003), 7.
Singapore 26.8 28.3
Dubai 26.4 35.2
Lisbon 23.6 25.1
Manama 22.8 29.4
Ljubljana 21.2 17.6
Johannesburg 19.1 20.0
Istanbul 17.9 16.7
Budapest 16.6 15.6
Kuala Lumpur 14.5 16.3
Warsaw 13.0 11.4
Shanghai 12.8 12.5
Santiago de Chile 12.7 14.4
Riga 12.6 12.2
Tallinn 12.4 11.9
Prague 11.8 12.4
Vilnius 11.2 10.1
Moscow 11.1 13.4
Sao Paulo 10.4 11.9
Lima 9.9 11.3
Bratislava 9.7 9.8
Caracas 9.2 11.0
Mexico City 9.2 10.7
Rio de Janeiro 8.4 9.2
Bogotá 8.3 10.0
Buenos Aires 7.9 8.7
Bucarest 7.2 11.9
Bangkok 6.9 8.6
Jakarta 6.5 7.8
Manila 5.4 6.0
Sofia 5.3 5.6
Kiev 5.0 5.8
Lagos 5.0 6.5
Nairobi 4.2 4.8
Karachi 3.5 4.1
Mumbai 3.1 3.6
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TRADE THEORIES AND ECONOMIC DEVELOPMENT
Table 2.3 Working hours and vacation days around the globe
City Working hours Vacation days City Working hours Vacation days
per year per year per year per year
Hong Kong 2398 8
Mumbai 2347 25
Taipei 2327 13
Karachi 2302 27
Manila 2301 14
Mexico City 2281 14
Seoul 2270 20
Dubai 2233 26
Santiago de Chile 2195 15
Bangkok 2184 10
Jakarta 2175 11
Nairobi 2165 25
Istanbul 2154 16
Lima 2152 30
Kuala Lumpur 2152 17
Singapore 2056 14
Buenos Aires 2044 17
Manama 2034 22
Los Angeles 2022 11
Auckland 2022 21
Budapest 2012 23
Bucharest 1992 20
Caracas 1989 16
Bogotá 1987 15
Tel Aviv 1977 11
Kiev 1958 22
Shanghai 1958 13
Prague 1946 22
Sao Paulo 1936 30
Lugano 1921 22
Johannesburg 1910 18
Toronto 1909 14
Warsaw 1901 26
Geneva 895 23
Bratislava 1881 19
Source: Prices and Earnings
(Zurich: UBS AG, 2003), 23.
Zurich 1872 23
Basel 1868 23
Tokyo 1864 16
Riga 1862 20
Chicago 1858 15
Miami 1856 20
New York 1843 10
Vilnius 1833 26
Ljubljana 1830 22
Montreal 1829 19
Tallinn 1826 21
Sofia 1824 21
Rome 1810 23
Lisbon 1804 22
Rio de Janeiro 1802 30
London 1787 21
Moscow 1784 24
Madrid 1782 25
Dublin 1779 22
Stockholm 1775 25
Luxembourg 1768 25
Sydney 1757 21
Athens 1744 30
Barcelona 1743 30
Amsterdam 1741 29
Lagos 1723 31
Brussels 1722 22
Milan 1718 23
Helsinki 1714 28
Oslo 1703 25
Vienna 1696 26
Frankfurt 1682 30
Berlin 1666 28
Copenhagen 1658 28
Paris 1561 26
relatively less labor and land because of expensive
equipment and specialized personnel. In clothing
production the most important input factor is that
the economy is labor-intensive.
The varying factor inputs and proportions for
different commodities, together with the uneven
distribution of such factors of production in differ-
ent regions of the world, are the basis of the
Heckscher–Ohlin theory of factor endow-
ment.
5
This theory holds that the inequality of
relative prices is a function of regional factor
endowments and that comparative advantage is
determined by the relative abundance of such
endowments.According to Ohlin, there is a mutual
interdependence among production factors, factor
movements, income, prices, and trade. A change in
one affects the rest. Prices of factors and subsequent
product prices in each region depend on supply and
demand, which in turn are affected by the desires
of consumers, income levels, quantity of various
factors, and physical conditions of production.
Since countries have different factor endow-
ments, a country would have a relative advantage in
a commodity that embodies in some degree that
country’s comparatively abundant factors.A country
should thus export that commodity which is rela-
tively plentiful (i.e., in comparison to other com-
modities) within the relatively abundant factor (i.e.,
in comparison to other countries). This exported
item may then be exchanged for goods that would
use large quantities of the country’s scarce factors
if domestically produced. Figure 2.3 lists the
Netherland’s well-endowed factors, for example.
Table 2.4 shows countries with capital scarcity.
6
Therefore, a country that is relatively abundant
in labor but relatively scarce in capital is likely to
have a comparative advantage in the production of
labor-intensive goods and to have deficiencies in the
30
TRADE THEORIES AND ECONOMIC DEVELOPMENT
Table 2.4 Capital scarcity. Capital endowments and output per capita are much lower in
the Central and Eastern European countries than in Western Europe, implying large
potential capital inflows into the region.
GDP per worker
1
Relative marginal Potential inflows
3
product of capital
2
Bulgaria 22.9 19.1 753
Czech Republic 53.6 3.5 275
Estonia 31.1 10.3 543
Hungary 55.7 3.2 259
Latvia 20.9 22.9 825
Lithuania 28.5 12.3 596
Poland 38.6 6.7 425
Romania 26.9 13.8 634
Slovak Republic 42.2 5.6 381
Slovenia 72.8 1.9 147
Median 34.9 8.5 484
Minimum 20.9 1.9 147
Maximum 72.8 22.9 825
Notes
1 In percent of German GDP per worker (purchasing-power-parity basis).
2 Cobb-Douglas production function.
3 In percent of initial (Pre-flow) GDP.
Source:
Leslie Lipschitz,Timothy Lane, and Alex Mourmouras,“The Tosovksy Dilemma,”
Finance &
Development
, September 2002, 32.
production of capital-intensive goods.This concept
explains why China, a formidable competitor in
textile products, has to depend on US and European
firms for oil exploration within China itself.
Each nation possesses factors of production that
may be grouped into these broad categories: human
resources, physical resources,knowledge resources,
capital resources, and infrastructure. Interestingly
or surprisingly, a nation’s abundance of a particu-
lar production factor may sometimes undermine
instead of enhance the country’s competitive
advantage.
7
The quality of human resources is a function of
human development.The United Nations Develop-
ment Program has prepared the Human Devel-
opment Index (HDI) to measure well-being.
8
The
HDI, ranging from zero (low human development)
to one (high human development), is an arithmetic
average of a country’s achievements in three basic
dimensions: longevity (measured by life expectancy
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Figure 2.3 WordPerfect and the Netherlands’ relatively well-endowed factors
Source:
Courtesy of the Netherlands Investment Agency and Ogilvy Adams & Rinehart.
at birth); educational attainment (measured by com-
bination of adult literacy rate and enrollment ratio
in primary, secondary, and tertiary education); and
living standards (measured by GDP per capita in US
dollars at purchasing power parity). Both the HDI
and per capita income are highly correlated with the
other widely used measures of poverty. Table 2.5
shows a list of countries based on the HDI.
THE COMPETITIVE ADVANTAGE
OF NATIONS
Michael Porter’s book, The Competitive Advantage of
Nations, has received a great deal of interest all over
the world.
9
Based on his analysis of over a hundred
case studies of industries in ten leading developed
nations, Porter has identified four major determi-
32
TRADE THEORIES AND ECONOMIC DEVELOPMENT
Table 2.5 Human Development Index (HDI), selected countries
≤ 0.50 0.51–0.70 0.71–0.80 > 0.80
Africa Africa Asia Europe/Industrial
Sudan (0.48) South Africa (0.70) Thailand (0.74) Canada (0.93)
Mauritania (0.45) Botswana (0.59) Philippines (0.74) USA (0.93)
Nigeria (0.44) Gabon (0.59) China (0.71) Australia (0.93)
Congo, Dem. Rep. of Ghana (0.56) Japan (0.92)
the (0.43) Zimbabwe (0.56) Transition economies United Kingdom (0.92)
Zambia (0.42) Cameroon (0.53) Bulgaria (0.77) France (0.92)
Cote d’lvoire (0.42) Kenya (0.51) Russia (0.77) Germany (0.91)
Senegal (0.42) Congo, Rep. of (0.51) Romania (0.77) Italy (0.90)
Tanzania (0.41) Georgia (0.76) Spain (0.90)
Uganda (0.41) Asia Ukraine (0.74)
Angola (0.40) Vietnam (0.67) Azerbaijan (0.72) Asia
Malawi (0.38) Indonesia (0.67) Albania (0.71) Singapore (0.88)
Mozambique (0.34) India (0.56) Hong Kong SAR (0.87)
Ethiopia (0.31) Pakistan (0.52) Middle East Korea, Rep. of (0.85)
Niger (0.29) Saudi Arabia (0.75)
Sierra Leone (0.25) Transition economies Jordan (0.72) Transition economies
Moldova (0.70) Iran, Islamic Rep. of Czech Republic (0.84)
Asia Uzbekistan (0.69) (0.71) Hungary (0.82)
Lao People’s Dem. Tajikistan (0.66) Poland (0.81)
Rep. (0.48) Western Hemisphere
Nepal (0.47) Middle East Mexico (0.78) Middle East
Bangladesh (0.46) Syrian Arab Republic Colombia (0.76) Israel (0.88)
(0.66) Brazil (0.75) Kuwait (0.84)
Middle East Egypt (0.62) Peru (0.74)
Yemen (0.45) Iraq (0.58) Western Hemisphere
Argentina (0.84)
Western Hemisphere Western Hemisphere Chile (0.83)
Haiti (0.44) Bolivia (0.64) Uruguay (0.82)
Nicaragua (0.63)
Guatemala (0.62)
Source:
Paul Cashin, Paolo Mauro, and Ratna Sahay, “Macroeconomic Policies and Poverty Reduction: Some Cross-Country
Evidence,”
Finance & Development
, June 2001, 46–9.
nants of international competitiveness: (1) factor
conditions, (2) demand conditions, (3) related and
supporting industries, and (4) firm strategy, struc-
ture, and rivalry. These four determinants interact
and form the “diamond” which provides the context
in which a nation’s firms are born and compete.
A nation is competitive when it has specialized
assets and skills necessary for competitive advantage
in an industry. Firms gain competitive advantage in
industries when their home base offers better
ongoing information into product and process
needs. They gain competitive advantage when
owners, managers, and employees support intense
commitment and sustained investment. In the end,
nations succeed in particular industries because
their dynamic home environment stimulates firms
to upgrade and widen their advantages over time.
Therefore, the effect of one determinant is deter-
mined by the state of the others: the advantages
in one determinant can enhance the advantages in
others.
Porter’s theory also includes two additional
variables: chance and government. Chance events
are developments outside the control of firms, and
they include pure inventions, breakthroughs in
basic technologies, wars, external political develop-
ments, and major shifts in market demand. Govern-
ment at all levels, on the other hand, can improve
or detract from a country’s national advantage.
Regulations and investment policies can affect
domestic rivalry and home demand conditions.The
government variable explains why Bermuda and
the Cayman Islands, while not being well endowed
in terms of factors of production, capture 31.5
percent and 12 percent respectively of the world’s
captive insurance operations.
10
The “diamond” promotes the “clustering” of
a nation’s competitive industries. The country’s
successful industries are usually linked through
vertical (buyer/supplier) or horizontal (common
customers, technology) relationships. This cluster
of industries is mutually supporting,and the derived
benefits flow forward, backward, and horizontally.
As in the case of Sweden, it is successful not only in
pulp and paper but also in wood-handling machin-
ery, sulphur boilers, conveyor systems,pulp-making
machinery, control instruments, paper-making
machinery, and paper-drying machinery. Sweden is
also internationally competitive in chemicals that
are used in pulp and paper making.
Porter’s theory seems logical and is supported by
empirical evidence. Yet one may wonder whether
the broad-based generalizations are warranted. For
example, it is doubtful that the theory can explain
why Sweden, a relatively small country, is the third
largest exporter of music. Likewise, in the case of
American pastimes, one has to wonder why foreign-
born Latinos are so good at playing baseball to the
point that they account for 25 percent of the major
league rosters, not counting thousands more from
the Caribbean as well as Central and South America
who play in the minors.
In fairness, Porter does offer a number of expla-
nations or qualifications. A country’s national com-
petitive advantage in a particular industry may be
eroded when conditions in the national diamond no
longer support investment and innovation to match
the industry’s evolving structure. Some important
reasons for the loss of advantage are: deterioration
of factor conditions, local needs not compatible
with global demand, loss of home buyers’ sophisti-
cation, technological change, firms’ adjustment
inflexibility, and reduction in domestic rivalry. In
this regard, Porter has clearly stated that his theory
is dynamic.Yet by advocating clustering, the theory
also looks static in the sense that it implies that new-
comers (nations) will have difficulties in gaining
competitive advantage in a new area.
Figure 2.4 shows the world competitiveness
scoreboard for nations whose populations exceed
20 million people. Figure 2.5 provides rankings for
smaller countries.
A CRITICAL EVALUATION OF TRADE
THEORIES
The validity of trade theories
Several studies have investigated the validity of the
classical trade theories. The evidence collected by
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MacDougall shortly after World War II showed
that comparative cost was useful in explaining
trade patterns.
11
Other studies using different data
and time periods have yielded results similar to
MacDougall’s. Thus there is support for the claim
that relative labor productivities determine trade
patterns.
These positive results were subsequently ques-
tioned.The studies conducted by Leontief revealed
that the USA actually exports labor-intensive goods
and imports capital-intensive products.
12
These
paradoxical findings are now called the Leontief
Paradox. Thus, the findings are ambiguous, indi-
cating that, in its simplest form, the Heckscher–
Ohlin theory is not supported by the evidence.
In theory, the more different two countries are,
the more they stand to gain by trading with each
other.There is no reason why a country should want
to trade with another that is a mirror image of itself.
However, a look at world trade casts some doubt on
the validity of classical trade theories. Developed
countries trade more among themselves than with
developing countries. There is a tendency for cor-
porations in developed countries to prefer to form
direct-investment ties in the other more stable,
developed countries while avoiding heavy invest-
ment in the fast-growing developing world.
The trade pattern shown is surprising theoreti-
cally, because advanced economies have similar
climate and factor proportions and thus should not
trade with one another since there are no compar-
ative advantages.Apparently, other variables in addi-
tion to factor endowment play a significant role in
determining trade volume and practices because
considerable trade does occur between developed
nations.
Limitations and suggested refinements
Trade theories provide logical explanations about
why nations trade with one another, but such theo-
ries are limited by their underlying assumptions.
34
TRADE THEORIES AND ECONOMIC DEVELOPMENT
0 102030405060708090100
100.00 (1) USA 1
86.547 (3) AUSTRALIA 2
84.123 (2) CANADA 3
72.872 (6) MALAYSIA 4
69.768 (4) GERMANY 5
69.283 (7) TAIWAN 6
66.489 (5) UNITED KINGDOM 7
66.407 (9) FRANCE 8
59.758 (8) SPAIN 9
58.416 (13) THAILAND 10
56.303 (11) JAPAN 11
50.813 (12) CHINA MAINLAND 12
47.787 SAO PAULO 13
47.354 ZHEJIANG 14
46.476 (10) KOREA 15
44.499 (20) COLOMBIA 16
44.310 (14) ITALY 17
43.877 (16) SOUTH AFRICA 18
42.507 MAHARASHTRA 19
42.181 (17) INDIA 20
40.667 (15) BRAZIL 21
37.851 (18) PHILIPPINES 22
33.636 ROMANIA 23
33.337 (19) MEXICO 24
29.803 (23) TURKEY 25
24.584 (21) RUSSIA 26
21.526 (22) POLAND 27
13.213 (25) INDONESIA 28
12.464 (26) ARGENTINA 29
9.811 (24) VENEZUELA 30
Figure 2.4 The world competitiveness
scoreboard (larger nations), 2002 rankings
are in brackets
Source: IMD World Competitiveness Yearbook 2003
,4.
0 102030405060708090100
100.00 (2) FINLAND 1
98.159 (6) SINGAPORE 2
92.363 (4) DENMARK 3
90.311 (10) HONG KONG 4
89.730 (3) SWITZERLAND 5
88.683 (5) LUXEMBOURG 6
87.142 (7) SWEDEN 7
86.475 (1) NETHERLANDS 8
83.377 (11) ICELAND 9
82.579 (8) AUSTRIA 10
79.355 (9) IRELAND 11
75.761 (12) NORWAY 12
74.557 (13) BELGIUM 13
72.198 (14) NEW ZEALAND 14
67.003 ILE-DE-FRANCE 15
61.542 (15) CHILE 16
59.781 (16) ESTONIA 17
57.520 BAVARIA 18
56.060 RHONE-ALPS 19
52.243 CATALONIA 20
45.554 (19) CZECH REPUBLIC 21
43.567 (17) ISRAEL 22
42.463 (18) HUNGARY 23
41.391 LOMBARDY 24
35.174 (20) PORTUGAL 25
34.174 (21) GREECE 26
(23) SLOVAK REPUBLIC 2730.288
29.170
27.768
(22) SLOVENIA 28
JORDAN 29
Figure 2.5 The world competitiveness
scoreboard (smaller nations), 2002 rankings
are in brackets
Source: IMD World Competitiveness Yearbook 2003
,4.
Most of the world’s trade rules are based on a
traditional model that assumes that (1) trade is
bilateral, (2) trade involves products originating
primarily in the exporting country, (3) the export-
ing country has a comparative advantage, and (4)
competition focuses primarily on the importing
country’s market. However, today’s realities are
quite different. First, trade is a multilateral process.
Second, trade is often based on products assembled
from components that are produced in various
countries. Third, it is not easy to determine a
country’s comparative advantage, as evidenced by
the countries that often export and import the
same product. Finally, competition usually extends
beyond the importing country to include the
exporting country and third countries.
13
In fairness, virtually all theories require assump-
tions in order to provide a focus for investigation
while holding extraneous variables constant. But
controlling the effect of extraneous variables acts to
limit a theory’s practicality and generalization.
One limitation of classical trade theories is that
the factors of production are assumed to remain con-
stant for each country because of the assumed immo-
bility of such resources between countries. This
assumption is especially true in the case of land,
since physical transfer and ownership of land can
only be accomplished by war or purchase (e.g., the
US seizure of California from Mexico and the US
purchase of Alaska from Russia). At present,
however, such means to gain land are less and less
likely.As a matter of fact, many countries have laws
that prohibit foreigners from owning real estate.
Thus, Japan and many other countries remain land-
poor. On the other hand, outsourcing and foreign
direct investment are a means to gain or use foreign
land.Thus, in this regard, one can argue that land is
mobile – at least indirectly.
A significant difference exists in the degree of
mobility between land and capital. In spite of the
restrictions on the movement of capital imposed
by most governments, it is possible for a country
to attract foreign capital for investment or for a
country to borrow money from foreign banks or
international development agencies. Not surpris-
ingly, US banks, as financial institutions in a capital-
rich country, provide huge loans to Latin American
countries.Yet at the same time, a favorable US busi-
ness climate makes it possible for the USA to attract
capital from abroad to help finance its enormous
federal deficits.Therefore, capital is far from being
immobile.
The extent of money laundering clearly illus-
trates the high degree of capital mobility (see It’s the
Law 2.1 and Marketing Strategy 2.1). Even in the
case of legal transactions, the so-called hot capital
can move instantly in search of a better return.
Malaysia has imposed capital controls so as to
limit capital flights. It has adopted an exit tax, and
investors are taxed according to how quick they
withdraw the money. The tax gradually drops to
zero for those who leave money in Malaysia for
more than a year. The exchange controls continue
to be enforced, and the ringgit cannot be traded
outside the country.There is a limit on the amount
of money one can take out of the country. In any
case, an IMF study found that, once financial inte-
gration crosses a certain threshold, the positive
effects of international capital flows can outweigh
the negative effects.
14
Labor as a factor is relatively mobile because peo-
ple will migrate – legally or not – in search of a bet-
ter life (see Marketing Ethics 2.1). It is true that
immigration laws in most countries severely limit
the freedom of movement of labor between coun-
tries. In China, people (i.e., labor) are not even able
to select residence in a city of their choice.Still,labor
can and does move across borders.Western European
nations allow their citizens to pass across borders
rather freely.The USA has a farm program that allows
Mexican workers to work in the USA temporarily.
For Asian nations, most are so well endowed with
cheap and abundant labor that Thailand sends labor-
ers to work abroad and the Philippines has a
significant number of its citizens work as maids in
Hong Kong. China, likewise, would like to export its
labor because it is the most well-endowed nation in
the world in terms of this resource. In the mid-
nineteenth century, many Chinese peasants were
brought to the USA for railroad building.
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TRADE THEORIES AND ECONOMIC DEVELOPMENT