International Trade Theories

The following are different international trade theories


Mercantilism theory of international trade has its origin in England in the middle of 16th century. Mercantilism theory is based on the principle assertion that government control of foreign trade is of paramount importance for ensuring the prosperity and military security of the state.

The main tenet of this theory was that gold and silver were the mainstays of national wealth and government should endeavour to increase the inflow of gold and silver.


Absolute advantage theory

In one of the most notable book ’Wealth of Nations‘ in 1776, Adam Smith attacked the mercantilism and argued that countries differ in their ability to produce goods and services efficiently due to variety of reasons.

At that time, England, by virtue of their superior manufacturing processes, were the world’s most efficient textile manufacturers of the world. This was due to combination of several factors such as favourable climate, good soils, skilled manpower and accumulated experience and expertise in textile production. On the other hand, the French had one of the most efficient wine industries of the world.


Comparative advantage theory

David Ricardo, in his notable book ‘Principles of Political Economy’ published in 1817 came up with an improvement on Adam Smith’s ‘absolute advantage theory’. Ricardo argued what might happen if one country has an absolute advantage in the production of all goods.

Adam Smith’s theory suggests that such a country might not have benefitted from international trade as trade is positive sum game and countries prosper only if they exchange the goods in which they have absolute advantage.


Product lifecycle theory

This theory was proposed by Raymond Vernon in the mid-1960s. It was based on the observation that in the 20th century, a very large proportion of the world’s new products were developed by American firms and sold there first.

He argued that the wealth and size of the market gave American firms a strong incentive to develop new consumer products and in addition, the high cost of labour was an incentive to develop cost-saving innovations.


Porter’s diamond model

In 1990, Michael Porter analysed the reason behind some nations’ success and others’ failure in international competition. His thesis outlined four broad attributes that shape the environment in which local firms compete and these attributes promote the creation of competitive advantage. They are explained as follows:

  • Factor endowments
  • Demand conditions
  • Relating and supporting industries
  • Firm strategy, structure and rivalry

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