David Hume's Essay On Economic Thought And Trade Theory.

1. Explore the effects of global trading which can influence employment and growth in different countries.

2. Critically analyse ideas and suggest solutions to the crucial international problems facing the world.

3. Analyse and present findings on a researched topic.

4. Select and implement analytical techniques.

British Mercantilism and its Critique by Hume

David Hume though known better for his contribution in politics, history and philosophy, the contribution of Hume in evolving economic thought cannot be ignored. The principle argument of Hume in against British Mercantilism formed the building block in in classical economics. Mercantilism is the first international trade theory believing that a nation can maximize wealth only through government intervention, trade regulation, participation in economic activities and commerce. The mercantilists argued that a country could achieve economic prosperity by restricting import and expanding export (Ince 2018). This would help the nation to maximize gold currency in the home country. However, even before intervention in American Revolution, David Hume showed that net export in exchange of gold currency, accumulated by Britain failed to enhance wealth. Hume’s argument was essentially based on quantity theory of money, which states that changes in money supply cause a direct change in prices. The increase flow of gold along with an increase in gold currency thus increase thus causes an increase in price of exported goods (Van Marrewijk et al. 2012). For this reason, inflow of gold in England failed to increase England’s wealth.

The Hume’s proposition was later strengthened by the support of Adam Smith. Mercantilists believed that economic system is a zero sum game where gain on one country comes at an expense of loss by some other. Adam Smith however viewed trade as a mutually beneficial transaction and hence, is a positive sum game (Ince 2018). Finally, Smith criticized the trade policy of mercantilism that promotes intervention and monopolization of trade business.

The Ricardian theory of comparative advantage though successfully explained trade pattern for a significant time, the theory has the following weaknesses.

Firstly, the model is based upon only two countries and two commodities. In reality, however trade occurs between more than two countries with exchange of various commodities (Appleyard and Field 2017).

Secondly, the theory is based on labour theory of value. This is not applicable to practical world as here value of goods and services are expressed in terms of money.

Thirdly, the assumption of full employment is another unrealistic assumption of the model.

Other weaknesses of Ricardo’s trade model include ignorance of transportation cost and demand side factors (Krugman, Obsfeld and Melitz 2015). The assumption of constant return to scale also does not hold for many industries.

	WINE	CHESTNUTS	BISCUITS	SHIRTS	APPLE
GERMANY (aLiG)	5hr	6hr	10hr	14hr	4hr
UK (aLiU)	3hr	5hr	4hr	7hr	3hr
aLiG/ aLiU	5/3 = 1.667	6/5 = 1.2	10/4 = 2.5	14/ 7 = 2	4/3 = 1.333

Wage rate in Germany = 5 Euros per hour

Wage rate in UK = £6 per hour

Ricardo's Theory of Comparative Advantage and its Weaknesses

Given the exchange rate is 1.50 Euro = £1.00

Therefore, £6 = (6 * 1.50) Euros = 9 Euros

Now,

W^U/ W^G = 9/5 = 1.8

Following, allocation rule any good for which a_Li^G/ a_Li^U > W^U/ W^G  will be produced in UK while for any good with a_Li^G/ a_Li^U  < W^U/ W^G  will be produced in Germany (Salvatore 2013).

From this, it is obtained that Germany should specialize in Wine, Chestnuts and Apples and therefore export these goods.

UK on the other hand should specialize in biscuits and shirts and export these goods.

1.50 Euro = £1.00

5 Euros = £ (5 *1/1.50) = £ 10/3.

W^U/ W^G = 6/ (10/3) = 18/10 = 1.8

Upper and lower limit of wage is now given as

1.667 < W^U/ W^G < 2

1.667 < W^U/ (10/3) < 2

16.67 < 3 W^U < 20

16.67/3 < W^U < 20/3

£ 5.577 < W^U < £ 6.667 (per hour)

Upper and lower limit of wage in pounds per day

(16.67/3) *24 < W^U < (20/3)*24

133.36 < W^U < 160

With suppose original exchange rate changes to 4 Euros per hour.

Now, W^U/ W^G = 9/4 = 2.25

Followed by allocative efficiency Germany will now produce Wine, Chestnuts, Shirts and Apple while UK produce only Biscuits under the new exchange rates. 

The emerging economies of Brazil, Russia, India, China and South Korea together form the acronym BRICS. All the five economies in this group has experienced an outstanding growth rate. The Gross Domestic Product (GDP) of Brazil has accounted a growth rate of 6.1% in 2007 from 4.3% in 2001. China and India have successfully doubled their GDP growth rate for the same time range. The BRICS countries together accounts for 43.03% of world population, around 18% of world GDP with 46.3% of the global economic growth (Kahn 2018). The success of these countries in the world market is explained increasing integration with international market in form of increased share in world trade, a greater FDI flows and greater access to international financial market.

The improved economic performance of BRICS nation occurred following a greater openness of these countries to the international global market. The export of these countries accounted an average growth of 31.7% between 2000 and 2009. The corresponding percentage between 1990 and 1991 was 11.3%. Along with export, the growth of import was recorded as 31% from 10.5% in the similar time (Crescenzi and Rodríguez?Pose 2017). The growing share of export and import volume of BRICS nations shows the dominance of these countries in the global trade. China stands as the third highest exporter in the world economy, next after Germany and US. In this regard, Russia placed in tenth position.

Success of BRICS Nations in the Global Market

The total trade volume of BRICS has almost doubled to become US $ 5.7 trillion in 2015 from 2.8 trillion USD in 2006. The increased trade volume has contributed from an increased share in both import and export. The share of export volume has increased to 19.3 percent from 13.2 percent during this time. The imports volume also experienced a resultant increase in value from USD 1.3 trillion to USD 2.5 trillion. The nations enjoy a trade surplus in their balance of payment account. The surplus in the balance of trade has almost doubled from USD 314.8 billion to USD 644.7 billion USD in between 2006 and 2015 (Radulescu, Panait and Voica 2014).

The increased trade share of BRICS nation was mainly relied on raw materials. China has become a leading importer of metals (share being 20.7%) and agricultural raw materials (share being 17.4%) and third importer of oil (6.7% share). Brazil stands ninth in exporting agricultural products and fifth in exporting food. In export of fossils fuels Russia stands as first. Other exports of BRICS countries include electronic machinery and equipment (Kahn 2018). The export of electric equipment mainly includes telephone set while import in this category includes integrated circuits.

The emerging economies are generally characterized as staring their process of industrialization late as compared to developed countries. Therefore, to catch up with developed nations, the emerging economies need to pay considerable attention in the investment of Research & Development (Radulescu, Panait and Voica 2014). In order to remain maintain international competitiveness, the nations have increased their investment in innovation.

Special focus has given on the expansion of scientific research & development related to nanotechnology. In the period of 2008-2011, the number of Russian researchers engaged in field of nanotechnologies increased by 1.4 times in the period 2008-2011. This has come with an increase in internal cost of such technology at around 2.4 times. This has helped the nation to expand their export beyond the primary products (Crescenzi and Rodríguez?Pose 2017) Based upon a strong basis of innovation the nation has now given attention to the export of nanotechnologies, space and rockets civil aircraft, nuclear power and other high-tech goods. The nations sale of nanotechnology had increased to $30 billion with one fourth of these sales have derived from export.

In China, there were approximately 511175 scientists engaged in research & development to the 5941 research institutes. The highest attention has been given on the development of R&D in fields of communication and electronic equipment (53, 2%,), pharmacology (18,3%) and medical equipment (12, 5% of the researcher) (Gusarova 2013). This has contributed to sharp increase in export to GDP ratio indicating most of the growth in China is led by export. With passes of time, the export pattern of China has shifted from labour-intensive products like shoes, technology to technology intensive products such as electronic equipment. In china, there is a declining trend in processing trade and increasing trend to conventional products indicates a new phase of global competitiveness of China. No doubt, that increasing attention of innovation and an increased pool of high skilled labor are the main factors driving China’s competitiveness.

The BRICS countries together constitute 17 percent of total word expenditure in Research & development. The export of high technology product is worth $6 trillion approximately, which is 28 percent of world total (Radulescu, Panait and Voica 2014). Based on this trend it is forecasted that the BRICS nation will maintain a steady trend in international competitiveness until 2030.

Different trade theories are explained different basis for international trade. The theory developed by Heckscher-Ohlin explained the trade theory based on relative factor abundance. The Heckscher Ohlin trade model highlights the differences between countries in supplying different productive factors such as land, labour and capital (Van Marrewijk, Ottens and Schueller 2012). The main assumptions of this theory are as follows

• The model is based on a framework of 2 x 2 x 2. It assumes there are two factors, two homogenous good and two homogenous production input.
• Both the countries have identical technology reflected from identical production factors (Krugman, Obsfeld and Melitz 2015).
• Both the countries face constant return to scale in their production function.
• Different factor intensity exists for the two commodities. The factor intensities are however same at all the price ratio of the two factors.
• The taste and preferences are homothetic meaning at all the levels of income; the commodities are consumed in same relative ratios (Salvatore 2013).
• An important assumption of H-O model is the assumption of strong factor abundance. This implies a labour abundant country faces a relatively low cost for while a capital abundant nation has a relatively lower price for capital.

Based on these assumptions, Heckscher and Ohlin explained the pattern of trade. The goods in the model are classified as either labour-intensive good or capital-intensive one. A labour intensive good is one that requires a relatively high labour-capital ratio while a capital-intensive good requires a relatively high capital-labour ratio. Therefore, a country abundant with labour faces a lower cost of labour. Hence, this country should specialize in labour abundant goods (Appleyard and Field, 2017). A country where capital is the abundant factor thus enjoys a comparative advantage in capital-intensive goods. This is how relative factor abundance determines the comparative advantage of a nation and hence explains the pattern of trade.  

One aspect that has gained significant attention of the researchers in the field of international trade is growing prevalence of intra-industry trade. The traditional trade theories explain trade among nations based on difference in factor endowment and hence, a difference in comparative advantage. However, in modern world it has been observed that countries are effectively engages in exchange of products belong to similar industries. This pattern of trade is known as intra industry trade (Payne and Philips 2010). It is widely accepted that factors that are playing an important role in determining trade of similar goods is relative factor endowment. The intra industry trade mostly occurs among countries that have similar factor endowments. The importance of product differentiation, global oligopoly and monopolistic competition are some of the crucial factors for explaining intra industry trade.

Countries that have similar kind of factor endowment enjoy an increasing return to scale as against the assumption of perfect competition or constant return to scale. The presence of both internal and external economies of scale explains why countries engage in import and export of similar kind of products like computers, automobiles, alcohol or apparel. While there is different explanation for intra industry trade, one crucial is the presence of similar factors and resulted product differentiation (Balassa and Bauwens 2014). This violates the basic assumption of existence of perfect completion in the factor abundance model of Heckscher and Ohlin. Each producer in both the countries faces a downward sloping demand curve. If the internal economies of scale are moderate in relation to the total market size, then barrier free entry of new firms erodes the above normal profit. When these nations are open to global market then with similar factor endowment countries have a wide range of varieties for the imported products. The feasibility of product differentiation in a monopolistically competitive internal market is the basis of trading similar product where some varieties are exported while others are imported (Hine and Greenaway 2016).

The countries with similar factor endowments have presence of economies of scale leading to concentration in production of few goods. Firms chose production of these at times when these seems to be a relatively low cost sites. Overtime, even when these sites may not remain the lowest cost firms have no other option but to continue their production and export the similar goods (Balassa and Bauwens 2014). External scale of economies resulted from same factor endowment and similar consumption pattern provides strong rationale for intra industry trade.

The external economies of scale arise from expansion of production in particular geographic area. The expansion of demand following an increased demand for export leads to a lower marginal cost of production and hence a lower cost of price of products. In this process, some locations seem to have lower unit cost while other have higher cost and hence can lead to complete cease of production (Hine and Greenaway 2016). Even if production ceases in some plants consumers, continue to gain from the lower price of similar kind of imported product.

Tariff is a policy of restricting import in order to encourage production. The imposition of tariff has a mixed impact in an economy. However, tariff can never be considered as an excellent way to reduce unemployment (Heid and Larch 2016). Unemployment is more closely related with reforms in labour market rather than trade policy reform.

In the above figure Dd and Sd denotes the domestic demand and supply curve respectively. With free trade the existing price of a good is at P₁ with a foreign supply curve Sd + Sf. Imposition of a tariff increases the price from P₁ to P₂. Corresponding to new price the domestic supply increases from OQ₁ to OQ₃ while domestic consumption reduces to OQ₄ from OQ_2.  The tariff causes a loss in consumer surplus while provides a gain to producers in form of increased surplus. Government receives a tariff revenue shown by the area T+V. However, the possible gain to producers and government is outweighed by loss to consumer.  Tariff thus leads to a net welfare loss given by the area S+U.

The expansion of domestic supply in the short run might have a positive impact on unemployment given the country is importing labour-intensive product. However, the impact of tariff on unemployment is larger than this short-run impact. Tariff has a tendency to increase cyclical unemployment. The protectionism policy increases economic depression by raising the possible shocks for a business. A trade depression in turn means industrial dislocation accompanied by a paralysis of concerned industry (Moon 2018). Imposition of tariff provokes such interruption in domestic industries. Another source of adverse impact on employment from tariff is the retaliation policy taken by other trade partners. When one country impose tariff, then its trading partners follow the same to restrict export of this country. This by hurting export industries aggravates the problem of unemployment.

The export of East Asian countries has increased rapidly for the past two decades. Except Japan, these nations together experienced an export growth of 10% in between 1990 and 2009. The share in world manufacturing of four East Asian tigers was only 1.5% in 1965. This was increased to 5.3% in 1980 and to 7.9% in 1990 (Gereffi and Wyman 2014).

The East Asian countries initiated first stage of industrialization by adapting the policy of import substitution industrialization. The objective was to restructure peripheral economies towards the domestic market for speeding up the process of industrialization. The countries identified imports that can be possibly substituted by domestic production. Such industries generally include simple non-durable manufactured goods. The developing countries adapted ISI policy because at the initial stage of industrialization they were unable to compete with the developed countries. The incentives provided for promotion of import substituting industries include import tariff, import quotas and restricting import of certain commodities (Agrawal et al. 2016). The effective rate of protection was particularly high for manufacturing industries. In Asian countries the effective rate of protection varied around -19% to 54%. The objective is to strengthen the manufacturing sector to make is globally competitive.

After an initially protectionism policy, the Asian countries gradually shift is focus towards openness to international market. Export-led growth is the policy of making domestic economy open to foreign competition. The strategy is to provide a subsidy or any other form of assistance to the industries producing exportable goods. China, Thailand and Malaysia has adapted export oriented growth model by inviting foreign investment into the labour intensive industries. This along with supportive policies of state to enhance labour activities and repress wage helped to reduce unit cost of labour to maintain international competitiveness (Lim 2014). The export led growth in Korea is different from three mentioned nations. Instead of relying on direct foreign investment has made a quick shift from labour-intensive industries to a high value added industries. It has given focus on technological advancement rather than competitiveness in wage. Taiwan though initially adapted their export led strategy similar to that of Korea, however with China’s openness is has to take a cost down strategy like China.

Foreign Direct Investment refers to the capital investment made by companies of one country in interest of some other. Followings are some of the major factors affecting flow of foreign funds in a nation.

One attraction of multinational companies to invest in another country is a relatively low wage of the destination countries. Companies are eager to outsource labour intensive goods to nations having a relatively low wage. Outsourcing of production reduces the operation cost of firms (Buckley and Clegg 2016). Low wage cost explains why many western countries have made significant investment in clothing factories of Indian sub-continent.

Multinationals are interested in investing in countries having a combination of low wage and highly skilled labour force. Industries like pharmaceutical and electronic generally requires a high skill of the labour force (Salvatore 2013). Many developing nations have highly productive labour force but because of relative abundance of labour wages are low as compared to developed world. This help to attract investment in these countries.

Cost of transportation and existing infrastructure plays an important role in influencing FDI flow. The poor transportation system along with high cost may offset the benefits derived from low cost of labour (Appleyard and Field 2017). Countries having access to sea route are at a comparatively advantageous position than countries those are landlocked.

A relatively weak exchange rate in the destination country helps to attract more foreign funds as will be cheaper for the investors to buy assets in the host country.

Foreign companies are often encouraged to invest in the similar areas to existing FDI. This is because of the fact that by doing so countries are benefitted from existing external economies of scale (Salvatore 2013).

The other factors affecting FDI include tax rate, potential for economic growth, and access to trade areas, political stability and property rights.

Reference list 

Agrawal, P., Gokarn, S., Mishra, V., Parikh, K. and Sen, K., 2016. Economic Restructuring in East Asia and India: Perspectives on Policy Reform. Springer.

Appleyard, D. and Field, R. (2017) International Economics. Ninth Edition. New York: Mc Graw Hill/Irwin.

Balassa, B. and Bauwens, L., 2014. Changing trade patterns in manufactured goods: An econometric investigation (Vol. 176). Elsevier.

Buckley, P.J. and Clegg, J. eds., 2016. Multinational enterprises in less developed countries. Springer.

Crescenzi, R. and Rodríguez?Pose, A., 2017. The geography of innovation in China and India. International Journal of Urban and Regional Research, 41(6), pp.1010-1027.

Gereffi, G. and Wyman, D.L. eds., 2014. Manufacturing miracles: paths of industrialization in Latin America and East Asia. Princeton University Press.

Gusarova, S., 2013. FDI and Innovations in BRICS Countries. Global Journal of Management and Business Studies, 3(8), pp.873-878.

Heid, B. and Larch, M., 2016. Gravity with unemployment. Journal of International Economics, 101, pp.70-85.

Hine, R.C. and Greenaway, D., 2016. Intra-Industry Trade: An Analysis of Country-and Industry-Specific. Intra-Industry Trade and Adjustment: The European Experience, p.70.

Ince, O.U., 2018. Between commerce and empire: David Hume, colonial slavery and commercial incivility. History of Political Thought, 39(1), pp.107-134.

Kahn, M., 2018. Prospects for Cooperation in Science, Technology and Innovation among the BRICS Members. BRICS and Global Governance, p.168.

Krugman, P. R. Obsfeld, M. and Melitz, M. J. (2015). International Economics Theory and Policy. Tenth Edition. Harlow: Pearson Education Limited.

Lim, M.H., 2014. Globalization, Export-Led Growth and Inequality: The East Asian Story. South Centre.

Moon, B.E., 2018. Dilemmas of international trade. Routledge.

Payne, A. and Philips, N. (2010). Development Economics, Cambridge: Polity.

Radulescu, I.G., Panait, M. and Voica, C., 2014. BRICS countries challenge to the world economy new trends. Procedia Economics and Finance, 8, pp.605-613.

Salvatore, D. (2013). International Economics, Eleventh Edition. New Jersey: John Wiley and sons

Van Marrewijk, C., Ottens, D. and Schueller, S., 2012. International economics. Oxford University Press.