Essay On Natural Resources In International Trade: Theory And Practice.

1. Examine and critically assess how scarce resources get produced, consumed and allocated and how various stakeholders in the global economy make optimal decisions.

2. Employ Comparative Advantage and related trade models in analysing a country’s role in the world economy and the related effects on social, business and economic pathways

3. Examine and critically assess the extent to which traditional trade theory can explain how scarce resources are produced, consumed and allocated in the global economy.

Theories of Comparative Advantage and Hecksher-Ohlin Model

Natural resources have always played a very crucial role in international trade. Based on their geographical distribution, which is uneven among the different countries in the world, the resource endowments in different countries are different. According to the traditional trade theories or the Ricardian model, countries will specialize and export those goods and services, which they have, in abundance as they enjoy a comparative advantage in those goods and services. Therefore, differences in factor endowments prompt trade decisions. This was the allocation of resources is far more efficient which result in the country to reap out high ‘gains from trade’ as there is an increase in the social welfare.

David Ricardo in his theory of comparative advantage in the 19^th century believed that the world output would increase if countries use the theory of comparative advantage while making trade decisions. Ricardo believed that by efficiently allocating their scarce resources to make trade decisions a country can get a comparative advantage and the combined output will be increased in comparison to the output that would be produced if the countries produced all the goods and tried being self-sufficient. The comparative advantage is gained, as the opportunity cost is lower when fewer goods are produced.

According to the standard Heckscher-Ohlin model, trade decisions are governed by the relative differences in different country’s resource endowments that is a country will export in those goods that uses the country’s abundant resources or factors of production and imports those goods whose production would use the country’s scarce factor of production including trade in scarce natural resources (Sunley and Martin 2017). The immobile and scarce natural resources act as a source of comparative advantage that assist in international trade. This is consistent with Leamer’s theory of relative abundance whose findings suggest that a country with abundant oil would export crude oil and an abundance of coal and minerals would lead to raw materials to be the chief export. Similar results have been found in Trefler’s study, which is in the grounds of trade in resource-intensive goods. There are various extensions to the Hecksher-Ohlin theory, which further influence the comparative advantage. This suggests that natural and scarce resources are not the ultimate condition necessary for trade.

Scarce natural resources are identified by their finite availability ad that their extraction or consumption in the present day can make irreversible alterations to the future generations. Hotelling, in his study on the economics of exhaustible resources, developed a framework for predicting the extraction path behavior as well as the behavior of prices in the light of scare resources, which have the feature of inter-temporal trade-off (Kozlenkova, Samaha, and Palmatier 2014). The Hotelling rule suggested that a social optimum is reached when the price of the resource after the deducting extraction costs grows at a rate, which is equal to the rate of interest. If the price of the resource remains constant over time then there is no gain from the extraction or from the growing of the resource. However, in the context of scarce resources, a policy maker in a country must have in mind that, given the limited supply of scarce resources, a change in the rate of extraction in one period will lead to reduced scope of extraction in the next period (Farah and Cima 2013). This will have negative welfare effects on the future generations. Further research shows that a country, which has a relatively well endowment of scarce resources, will trade either in it or in goods that would use those scarce resources and there will not be any over exploitation unless there are any market or political economy failures. 

The Scarcity of Natural Resources and Comparative Advantage

The graph takes into consideration two periods. The horizontal axis measures the total stock of resources and the vertical axes measure the price of the resource. The amount of consumption in each period is decided on by the prevailing price. At the point of intersection, the producer of the resource is indifferent about producing in the first or second period (Debaere 2014).

By relaxing the assumption of perfect markets, previous literature shows that the predictions of standard trade models hold and the resource markets are prone to market failure. This imperfect market scenario is because these resources are limited to a few countries, there is scarcity of supply and due to high fixed cost of production, and the producers of these resources face increasing returns to scale. Additionally, some markets face a monopolistic market structure and the existence of cartels. Geographical concentration of natural resources portray that the country has a comparative advantage in the production of that resource and with the absence of barriers to trade the extraction path will be dependent on the inter-temporal global demand schedule (Bell Mollenkopf and Stolze 2013). Changes in the environment occurs due to the use of exhaustible resources in production and consumption activities for example, in the case of fossil fuels, the oil or coal extraction leads to acidification of the sea and produces carbon di-oxide. Similarly, timber extraction leads to loss of the natural habitat for plants and animal species and changes in geochemical cycles (Low 2016). Additionally extraction can give rise to environmental externalities where the prices of the resources do not reflect the full cost or benefit.

A dynamic approach is required to understand and account for the concepts of extraction and exploitation and this analysis is very complex in the purview of scarce resources. Economic literature available is fragmented and does not provide a comprehensive account of the effects of trade on the allocation and long run sustainability of resources (Foran, et al. 2013). The existing theories of trade strengthen the predictions of the traditional trade policies that scarce resources have comparative advantages. However, gains from trade can be derived only in the absence of externalities and market imperfections. The limitations to gains from trade arises also due to the dominance of scarce resources in the trading portfolio of certain countries. However, under imperfect competition the depletion of resources is slower than in a perfectly competitive market but the same cannot be said about countries with multiple resources nor in the case of complex global markets. The predictions regarding gains from trade made by the traditional trade models are reversed in cases of weak property rights or open access markets (Shohibul 2013). This means that when property rights over a resource are poor, then there is a chance of over exploitation and this will make a country who owns the resource worse off. This over-exploitation will have its impact on the environment, which will further not lead to any gains from trade.

Limits to Gains from Trade and Impact of Imperfect Markets

Now over the years there has been a lot of debate over the relationship between natural resources and economic development among economists, political scientists and policy makers. Research has reflected a negative correlation between the abundance of resources and economic growth in transition countries and this behavior poses a threat to countries who do not take measures (Feenstra 2015). Therefore, policies are being put to place to ensure sustainable growth and social wellbeing. This phenomenon is called a resource curse and is not fully understood even if several factors are responsible to bring these undesirable economic consequences of exploitation. Abundance of scarce resources has a rent seeking and corrupt attitude from the government and elites and this impedes growth and development. This rest seeking tendency in scarce resource extraction in places which has abundance of the scarce resource comes from government control or ownership over these resources and the provision of concessions to large firms both private and public (Copeland and Taylor 2013). These large firms reduce or even eliminate the probable competition and stop the flow of concession and this way they end up in monopolistic or cartel situations and once they get that position firms try to protect these positions through bribing government officials. This power concentration among a few players makes the rent seeking and corrupted environment in the manufacturing or service sectors. There also exists crowding out effects in the manufacturing sectors, as the revenues are concentrated in the hand of a few elite players (Chacholiades 2017).  Thus depressing the competition among manufacturers in export markets by raising their input costs. The boom and bust or business cycles pose as obstacles as well in front of steady government investments. Moreover, for countries dependent on a few scarce resource exports only exchange rate volatility can arise due to demand swings creating more obstacles. Excess resources can also lead to underinvestment in human capital as investments are diverted into manufacturing as the immediate revenues from resources are seen and not the future benefits of investment in human capital (Konte 2013). Scarce resource extraction also face the problem of being unsustainable has a long-term effect on economic growth if the revenues are invested in a way that total income does not fall after the depletion of resources and revenues from the extraction and export falls. The revenues can rather be invested in renewable natural resources and also in human and built in capital (Bergstrom and Randall 2016). Management practices and traditional policies narrow down decisions in the hands of a few who have not been able to manage the declining resource base or the rising demands from the side of the numerous stakeholders and the increasing complexities of the interaction between natural resources and the human systems (Yang, Pfister and Bhaduri 2013).

Rent-Seeking Behavior and Resource Curse on Economic Growth

Scarce resources approach provides basic concepts to decision makers and stakeholders so that they can understand the value to avail the natural resources for economic and social development. This approach helps the stakeholders to understand that this revenue cannot be counted as income but as capital depletion (Barnett and Morse 2013). The use of this approach by stakeholders helps in better decision-making and better management of the scarce resources, which will ensure economic growth and development in a sustainable manner.

There is diversity in the extraction of resources of resources and the factors influencing it includes availability and resource endowment, technological skills, colonial ties, trade agreements and many more and this results in the differentiation in the global markets. Natural resources account for almost 20% of the world trade and countries have taken up various policy measures to manipulate the domestic and international prices although that goes against the principles of the World Trade Organization (World Trade Report 2014). These measures include price controls, taxes and quotas. These policy measures have proven to be inefficient for the long run and are responsible for market failures. However doing away with these policy restrictions would prove detrimental to the environment, as it would lead to over-exploitation.

To sum up, scarce resources are an indispensable aspect governing trade decisions and exports. Trade in these resources is different from the trade in other resources. Countries having limited supply of domestic resources benefit by trading in those resources by specialization. This increases efficiency and provided countries revenues, which can be reinvested for further production and diversification. On the other side, this re-investment can lead many environmental issues due to over-exploitation like pollution, loss of biodiversity and many more effects that are adverse. These can be controlled by proper management of these scarce resources and mitigating the harmful effects inflicted on the environment as a side effect of these economic activities. Apart from this political debate regarding these scarce resources and their future availability for the future generations, a concern for the environment and the steady rise in prices is leading to a fall in the overall welfare of the people. Thus, the social impact is negative. Trade in these scarce resources will increase by greater degrees in the future it is important to incorporate international cooperation and domestic policies that can sufficiently contribute towards efficiency gains, elimination of the adverse effects of extraction and the use of natural resources along with increased market price stability. Policy makers require a deeper understanding of challenges to make a coherent theoretical framework. 

References

Barnett, H.J. and Morse, C., 2013. Scarcity and growth: The economics of natural resource availability. RFF Press.

Bell, J.E., Mollenkopf, D.A. and Stolze, H.J., 2013. Natural resource scarcity and the closed-loop supply chain: a resource-advantage view. International Journal of Physical Distribution & Logistics Management, 43(5/6), pp.351-379.

Bergstrom, J.C. and Randall, A., 2016. Resource economics: an economic approach to natural resource and environmental policy. Edward Elgar Publishing.

Chacholiades, M., 2017. The pure theory of international trade. Routledge.

Copeland, B.R. and Taylor, M.S., 2013. Trade and the environment: Theory and evidence. Princeton University Press.

Debaere, P., 2014. The global economics of water: is water a source of comparative advantage?. American Economic Journal: Applied Economics, 6(2), pp.32-48.

Farah, P.D. and Cima, E., 2013. Energy trade and the WTO: implications for renewable energy and the OPEC Cartel. Journal of International Economic Law, 16(3), pp.707-740.

Feenstra, R.C., 2015. Advanced international trade: theory and evidence. Princeton university press.

Konte, M., 2013. A curse or a blessing? Natural resources in a multiple growth regimes analysis. Applied Economics, 45(26), pp.3760-3769.

Kozlenkova, I.V., Samaha, S.A. and Palmatier, R.W., 2014. Resource-based theory in marketing. Journal of the Academy of Marketing Science, 42(1), pp.1-21.

Lenzen, M., Moran, D., Bhaduri, A., Kanemoto, K., Bekchanov, M., Geschke, A. and Foran, B., 2013. International trade of scarce water. Ecological Economics, 94, pp.78-85.

Low, P., 2016. International trade and the environment. UNISIA, (30), pp.95-99.

Shohibul, A., 2013. Revealed comparative advantage measure: ASEAN-China trade flows. Journal of Economics and Sustainable Development, 4(7), pp.136-145.

Sunley, P. and Martin, R., 2017. Paul Krugman’s geographical economics and its implications for regional development theory: a critical assessment. In Economy (pp. 25-58). Routledge.

World Trade Organization, 2014. World trade report 2014. World Trade Organization.

Yang, H., Pfister, S. and Bhaduri, A., 2013. Accounting for a scarce resource: virtual water and water footprint in the global water system. Current Opinion in Environmental Sustainability, 5(6), pp.599-606.