UNIT – I INTERNATIONAL TRADE

PART – A

1. What do you mean by trade?

Trade is the voluntary exchange of roods and services, or both. Trade is also called
commerce. The original form of trade was barter the direct exchange of goods & services.
Modern trader’s intead generally negotiate through a medium of exchange. Such as money trade
between two traders in called bilateral trade. While trade between more than two traders is called
multilateral trade.

2. Difference between domestic trade and international trade?

Domestic trade is an trade where goods and services are across with the same or home
country.
International trade is the exchange of goods and services across international boundaries
or territories.

3. What is international trade?

International trade is the exchange of goods and services across international boundaries
or territories.

4. Explain the term BOT?

Bot takes in to account only those transactions arising out of the export & imports of the
visible items, it does not consider the exchange of invisible items such as the services rendered
by shipping, insurance & banking; payment of interest, and dividend or expenditure by tourists.

5. What is BOP
BOP takes into account the exchange of both the visible and non-visible items. Hence,
balance of payments represents a better picture of a country’s economic and financial
transactions with the rest of the world than the balance of trade.

6. State the barriers to trade.

A trade barrier is a general term that describes any government policy or regulation that
restricts international trade. The barriers can take many forms, including:
1. Import duties
2. Import licenses
3. Export licenses
4. Import quotas
5. Tariffs
6. Subsidies
7. Non-tariff barriers to trade
8. Voluntary export restraints
9. Local content requirements
7. State the objective of WTO.
The following are very importance objective of WTO.

1. raising the standard of living & incomes

2. promoting full employment
3. Expanding production & trade.
4. Optimum utilization of world’s resources.
5. introduction sustainable development
6. taking positive steps to ensure that developing countries
7. Secure a better share of growth in world trade.

8. What do you understand by scale of economies?

“scale of economies means as firms increase their size(scale), cost per unit of output
declines. Therefore, the phenomenon of economics of scale is also called decreasing costs”.

9. Explain the term MFN?

Most favored nation treatment is a general obligation which applies to all services sector
and all measures by members affecting trade in services- unless, of course, a member has listed a
specific MFN exemption. The obligation requires each member to accord immediately and
unconditionally to services and service suppliers of any other member treatment no less
favorable than that it accord to like services and service suppliers of any other country. In
principle, likeness depends on attributes of the product or supplier per rather than on the means
by which the product is delivered. If two like services were treated differently because they were
delivered in different ways, then such treatment could be challenged as being inconsistent with
the MFN obligation. Few points of concern are-

a. Likeness in product electronically delivered vis-à-vis delivered via other means.

b. Related domestic measures corresponding to across border supply.

10. State some importance of foreign trade?

Some of the importance as follows.

• increase in expanding export markets

• production allows economic of scale
• surplus production
• Optimum utilization of productive resources.

11. List the advantage of import substitution?

Advantages of import substitutions:-

* Risk elements are less

* Identification of industry is easier

12. What do you mean by import substitution strategy?

Some companies have not tried to follow the export strategy based on subtition of exported
product conditions.

* Large domestic markets

* To setting up import substituting unit
* Adequate tariff & non tariff measures.

13. Explain the trade barriers?

After the Second World War, there was a progressive liberalization of trade by the
developed countries. Successive rounds of negotiations in the GATT have cut tariff on trade in
manufactures from an average level of 40% in 1947 to about 3% now in the industrial countries.
A number of problems like the currency crisis, oil crisis, debt crisis, recession, and high
unemployment and trade deficits produced an atmosphere in which demands for protection
increased dramatically. There are two types of trade barriers like
1. Tariff barriers
2. Non-tariff barriers.

14. What do you mean by staple export?

A country can also try to take advantage of staple exports, as its comparative advantage
lies in that sector. It can speed up the process of economic growth by opening the interiors of the
economy by developing modern transportations and communication infrastructure.

PART - B

1. List the reasons that give rise to international trade.

Counter trade is a form of international trade in which certain export and import
transaction is directly linked with each other and in which export goods, instead of money
payments, pay for import of goods.

Reasons for the growth of counter trade:

There have been several reasons that have made counter trade popular. Obviously, the
countries or companies concerned have encouraged or involved in counter trade due to certain
specific advantages, although some of the benefits may be purely temporary.

1. Counter trade was very common between the communist countries. It also became
popular with respect to trade between the communist bloc and many developing countries
because many developing countries were eagerly looking towards this bloc for increasing
their exports, among other things, and this naturally led tot the acceptance of the trade
practice preferred by these centrally planned economies.

2. Counter trade became popular in the east-west trade mainly due tot the foreign exchange
problems faced by the eastern bloc. Pespsi cola is just one example of a multinational
corporation which has made considerable international business with the USSR by
counter trade.
 3. When the foreign exchange problem became very severe for the developing countries
following the oil price hikes, they began to actively pursue counter trade in an frantic bid
to increase their exports by nay means.

4. Many companies in the advanced countries have resorted to counter trade for various
reasons like selling obsolete products, increasing the sale of capital goods, increasing the
aggregate business etc. counter trade has also been restored to by several companies to
mitigate the effects of recession. Such recessionary situations in the capital goods
industries in the advanced countries gave the developing countries an opportunity to push
their exports by typing imports of capital goods with exports by counter trade.

5. Counter trade enables firms to penetrate difficult markets, to increase sales volume and to
achieve fuller capacity utilization. it has been revealed that counter trade enables firms to
dispose of declining products, which is particularly important given the very rapid pace
of technological advance. Thirty seven percent of the companies surveyed reported this
benefit.

6. Some countries have also made the counter trade means to increase sales through
disguised undercutting of the cartel prices (for example, the oil price fixed by the OPEC)

7. Having realized the potential of increasing business by engaging in counter trade, much
international trading cooperation became active in counter trade. Their trading with many
countries enabled them even to take up such complex transactions.

2. Explain in details the exim policy.

Since 1993, tariff reform has brought the simple average of tariff rates down to a level
lower than 35%. Tariff reform and reduction is an ongoing process, which has been pursued by
various governments. However, the structure of the tariff remains complex, and in a large
number of bands; in several industries, notably in paper and paper products, printing and
publishing, wood and wood products, and food, beverage and tobacco, tariff escalation remains
high.

In general, products are first moved to a special import license (SIL) list, with producers
being exposed to limited foreign competition, before the product is moved to the list of freely
importable goods. The list of freely importable goods currently covers some 68% of tariff lines:
remaining restrictions cover mainly consumer goods. However, India continues to use state
trading monopolies to retain some control over export and imports of certain products through
canalization. Also, India maintains a large number of incentives programmes for export
insurance and guarantees, export marketing assistance schemes, and access to some imports that
are normally subject to restrictive licensing.

In 1991, India initiated a wide- ranging programme of trade liberalization and economic
deregulation, with the objective of integrating the Indian economy more closely with the world
economy. The objective of India’s trade policy defined in the export- import policy for 1997-
2002 are:

1. Accelerate the country’s transition to a globally oriented, vibrant economy, with a view
to deriving maximum benefits from expanding global market opportunities.

2. Stimulate sustained economies growth by giving access to essential raw materials,

intermediates, components, consumer goods, and capital goods required for augmenting
production.

3. Enhance the technologies strength and efficiency of Indian agriculture, industry and
services, thereby improving their competitive strength, while generating new employment
opportunities.

4. Encourage the attainments of internationally accepted standard of quality.

5. Provide consumers with good quality products at reasonable prices.

NEW FEATURE IN THE 2003-2007 POLICY

The exim policy for 2002-2007 was descried as pro-growth and positive with certain
concrete measures. The most welcome. Initiative of the latest exim policy is the removal of
quantitative restriction on agricultural exports and setting up of 20 agri-export zones in 12
different states, concept that was introduced in 2001. The policy also aims art making the special
economic zone (SEZs) more attractive for the unit located in them by providing them with
income tax benefits and by allowing off-shore banking united to be setup in these zones. In
addition converting four existing EPZs into SEZs, approval has been given to 13 more SEZs.
Other commendable steps are:

1. The move to allow the setting up of OBUs (overseas banking units) in the special
economic zone is specially appreciable and would lead the SEZs to have access to
money at internationally competitive rates, thereby reducing the cost of capital.
2. The continuation of all the existing export promotion and duty neutralization schemes
has been welcomed. The continuation of DEPB scheme with further simplifications is
especially appreciated.
3. The relaxation of minute’s verification of technical characteristics and specifications
of inputs would make the duty replenishments certificate scheme more attractive.
4. The reductions on interest rate from 24% to 15% in the case of non-fulfillment of
export obligation by exporters under the various schemes would be a very lucrative
incentives for the exporters.
5. Sectoral focus on leather, textiles, electronic and gems and jewelers will tap the
immense untapped export potential that would get a boost.
6. The focus on Africa and cis countries would open avenue for exporters.
7. Adoption of a new classification for commodities for imports and exports,
redemptions on the basis of shipping bills and bank certrtificate extension of exports
obligation fulfillments period from 8 to 12 years, with a five year moratorium period
 and off-shore facility in special export processing zones.
8. The moves to continue with the advance license, duty entitlement pass book and
ECGC schemes with further improvements for the next five years.
9. More freedom to bring in foreign exchange remittances within 360 days instead of the
earlier limit of 180.
10. Permission to exporters, to keep 100% export proceeds in EEFC account.

Highlight of policy amendment-2003

The highlight from the amendments on exim policy, made on 31’st march, 2003 are given now.

1. Services exports

Duty free import facility for service sector having a minimum foreign exchange earning
of Rs.10lakhs. The duty-free entitlements shall be 10% of the average foreign exchange earned
in the preceding three licensing years. However, for hotels, the same shall be 5% of the average
foreign exchange earned in the preceding three licensing years. Imports of agriculture and dairy
products shall not be allowed for imports against the entitlement.

2. Agro exports

Corporate sector with proven credentials will be encouraged to sponsor agriculture export
zone for booting agro exports. The corporate to provide services such as provision of pre/post
harvest treatment and operations, plant protection, processing packing, storage and related R&D.

3. Status holders

Duty free import entitlement for status holder having incremental growth of more than
25% in fob value of export (in free foreign exchange). This facility is available to status holder
having a minimum export turnover of 25 crores. The duty free entitlements shall be 10% of the
incremental growth in export and can be used for imports of capital goods office equipment and
inputs of their own factory of the factory of the associate/ supporting manufacture / job worker.
The entitlement/ goods shall not be transferable. This facility is available on the exports made
from 1 April 2003.

4. Hardware / software

Hardware shall be admissible for duty free import for testing and development purpose to
promote growth of exports in embedded software. Hardware up to a value of US $ 10,000 shall
be allowed to be disposed off subject to STPI certification

5. Gems and jewellery sector

 • Diamomd and jewellery dollar account for exporters dealing in purchase/ sale of
diamonds and diamond studded jewellery. Decision to accept payments in dollars
for cost of import of precious metals from EEFC account of exporter.
• Gems and diamond units in SEZ and EOU can receives precious metal, i.e.,
gold/silver/platinum prior to exports of post exports equivalent to value of the
jewellery exported.

6. Export clusters

Up graduation of infrastructure in existing cluster/ industrial locations under the

departments of industrial policy and promotion scheme to increase overall competitiveness of the
export clusters.

7. Removal of quantitative restrictions

• Import of 69 items covering animal products, vegetables and spices, antibiotics

and films removed from restricted list.
• Export of five items, namely, paddy except basmati, cotton linters, rare earth, silk
cocoons, and family planning devices except condoms, removed from the
restricted list.

8. EOU schemes

• Gems and jewellery EOUs are now being permitted sub-contracting in DTA.
• Wastage for sub-contracting /exchange by gems and jewellery units on transaction
between EOUs and DTA will now be allowed ad per norms.
• Export/import of all products through post-parcel/courier-by EOUs will be
allowed.
• Gems and jewellery eous will be now be entitled to advance domestic sales.

9. EPCG scheme
• The scheme shall now allow import of capital goods for pre-production and post-
production facilities also.
• The export obligation under the scheme shall now be liked to the duty saved and
shall be 8 times the duty saved.
• To facilitate upgradtuitons of existing plant s and machinery, import of spares
shall also be allowed under the scheme.

10. DEPB scheme

• Facility provisional DEPB rate introduced to encourage diversification and
promote export of new products.
 • DEPB rates rationalized in line with general reduction in custom duty.

11. advance license

• Standard input- output norms for 403 new products notified.

• Anti dumping and safeguard duty exemptions to advance license for deemed
exports for suppliers to EOU/SEZ/EHTP/STP.

12. DFRC scheme

• Duty free replenishments certificate scheme extended to deemed exports to

provide a boost to domestic manufacturers.
• Value addition under DFRC scheme reduced from 33% to 25%.

3. Discuss the theories of International trade

There have been number of theoretical explanations of the bases and pattern of
international trade.

The oldest of the dominant trade philosophy is known as mercantilism. The mercantilists
argued that governments should do everything possible to maximize exports and minimize
imports. Very active state intervention was required to implement the mercantilist philosophy.
According to mercantilism, economic activity was a zero-sum game. This view was challenged
by Adam smith And David Ricardo who demonstrated that trade was a positive sum game in
which all trading nations can gain even if some benefits more than others.

ABSOLUTE COST ADVANTAGE THEORIES

Adam smith believed that the basis of international trade was absolute cost
advantage. According to his theory, trade between two countries would be mutually beneficial if
one country could produce one commodity at an absolute advantage and the other country could,
in turn, produce another commodity at an absolute advantage over the first. Smith rightly pointed
out that the scope for division of labour depended on the size of the market. Free international
trade, therefore increase division of labour and efficiency and consequently economic welfare.

COMPARATIVE COST THEORY

Challenging the Smithies theory, the famous classical economist David Ricardo
has demonstrated that the basis of trade is the comparative cost difference-trade can takes place
even in the absence of absolute cost difference, provided there is comparative cost difference.
According to the comparative cost theory, if trade is left free, each country, in the long run, tends
to specialize in the production and export of those commodities in whose production it enjoys a
comparative advantage in terms of real costs, and to obtain by importation those commodities
which could be produced at home at comparative disadvantage interims of real costs, and that
such specialization is to the mutual advantage of the countries participating in it.

The classical theories were based on a number of wrong assumptions, viz., labor
is the only element of cost production and are exchanged against one another according to the
relative amount of labour embodied in them (labour cost theory of value); labour is perfectly
mobile w2ithin the country but perfectly immobile with countries; labour is homogeneous;
constant returns; international trade is free from all barriers; no transport cost; full employment;
perfect competition etc., Further the analysis was too much simplified by a two countries two
commodities model. However, although the relaxations of these assumptions make the analysis
complex and difficult, it does not negate the basic revelations made by these theories. In fact,
many extensions of the classical theories have been done by removing the assumption or adding
new dimensions.

OPPORTUNITY COST THEORY

It puts forward by Gottfried haberler by displacing one of the main drawbacks of the
Ricardian cost theory. Viz., labour cost theory of value, gave a new life to the comparative cost
theory by restating it in terms of opportunity costs. The opportunity cost of anything is the value
of the alternative or other opportunities which ahs been foregone in order to obtain that particular
thing. According to the opportunity cost theory,, the basism of international trade is the
differences between nations in the opportunity costs of production of commodities. According, a
nation with a lower opportunity cost for a commodity has a competitive advantage in that
commodity and a comparative disadvantage in the other commodity. The superiority of
haberler’s approach is that it recognizes the existence of many different kinds of productive
factors whereas Ricardo considered only labour. The opportunity cost theory is a refinement of
the Ricardian theory. As far as the basis of international specialization and trade are concerned,
the logical behind the comparative cost approach and the opportunity cost approach are the same.

FACTOR ENDOWMENT THEORY

It developed by Eli Heckscher and Bertil Ohlin, establishes that trade, whether national or
international, takes places because of the differences in the factor endowments of the various
regions and the differences in the factor intensively of various products and trade will lead to
commodity and eventually factor prices equalization internationally. The factor endowment
theory consist of two important theorem, namely,

1. Heckscher-Ohlin theorem

This theory states that a country has comparative advantage in the production of that
commodity with uses more intensively the country’s more abundant factor, and

2. Factor price equalization theorem

 This which says that free international trade equalizes factor prices between countries,
and thus, serves as a substitute for international factor mobility. The H-O theory is also
on most assumption of the classical theories mentioned above.

4. Explain the strategies that are adopted to enter into foreign trade.

Introduction
The fundamental purpose of any firm is to make profit. A firm makes profit if the price it
can charge for its output is greater than its costs of producing that output. It would be worthwhile
to look at how firms can increase their profitability by expanding their operations in foreign
markets.

Role of strategy

A firm’s strategy can be defined as “the action managers take to attain the goals of the
firm”. To be profitable in a competitive global environment, a firm must pay attention to both
reduce the cost of production and to differentiating its products offerings.

Firms use strategies to compete in the international market. These strategies can be classified as:

• international strategy
• multinational strategy
• global strategy
• transnational strategy

5. List the barriers of the international trade

One of the most important features of the international trading environment is the proliferation
of the trade barriers.

After the Second World War, there was a progressive liberalization of trade by the
developed counties. Successive round of negotiations in the GATT have cut tariffs on trade in
manufactures from n average level of 40 % in 1947 to about 3% now in the industrial
countries.

A number of problems like the currency crisis, oil crisis, debt crisis, recession, high
unemployment and trade deficit produced an atmosphere in which demand for protection
increased dramatically. Added to these has been the growing competition from Japan and the
newly industrializing countries. As a response to this the developed countries have increased
the non-tariff barriers.

There are, broadly, two type of trade barriers, viz., tariff barriers and non-tariff barriers.
Tariffs in interanional trade refer to the duties of taxes imposed on internationally traded goods
when they cross the national borders.

As noted above, after the Second World War, there has been a reduction in the average
level of tariffs in the advanced countries. However, the tariff rates are generally high in the
developing countries. With the recent economic liberalization across the world, many
developing counties have reduced the tariff rates and NTBs as part of their trade liberalization.

India has had one of the highest tariff walls in the world. The government, following
them recommendations of the tax reforms committee substantially reduced the import duty
levels. However, India is still among the countries with high countries.

If at all tariffs are essential, most economists and organizations like WTO prefer tariffs
to NTYBs because tariffs are transparent and; less regressive than NTBs. Thanks to WTO there
has been a significant replacement of NTBs by traffis. However, the developed countries
continue to be very strenuously; loasded against the developing countries.

NON-TARIFF BARRIERS

Non-tariff barriers, some of which are descried as new protectionism measure have
grown considerably, particular since around the beginning of the 1980s. the export growth of
many developing countries has been seriously affected by the NTBs.

Type of NTBs

The NTBs are of two categories. The first category includes those which are general
used by developing countries to prevent foreign exchange outflow or result fro their chosen
strategy of ecoimcs development. There are mostly traditional NTBs such as import license
import quotas, foreign exchange refutations and cancellation of imports.
The second categories of NTBs are those which are mostly used by developed
economies to protect domestic industries which have lost international competitiveness and /or
which are political sensitive for governments of these countries. One of the most important
protectionism measure under this category is the voluntary export restraint (VER).

Quotas
Quantitative restriction which a take the form of quotas is as very important traditional
means of restricting imports and exports. The impact of quota is drastic in comparison with
tariffs. Economists, therefore, normally preface tariffs to quota.
Textile exports from developing countries have been severally constrained by the
quotas restrictions imposed by the developed countries under the mulit-fibre arrangement

There are import quotas and export quotas.

type of import quotas arte described below.
1. Tariff quota:
2. unilateral quota:
3. bilateral quota:
 4. Mixing quota:

6. Narrate the scope of activities of WTO?

The world trade organization (WTO), that came into being on January 1, 1995, replacing
that GATT, is the only international organization dealing with the rules of trade between nations.
At its heart are the WTO agreements, negotiated and signed by the bulk if the world’s trading
nations and ratified in their parliaments. The WTO is to work towards the liberalization of
international trade and investment to promote economic welfare.

The function of WTO

1. The WTO shall facilitate the implementation, administration and operation and further
the objective of the multilateral trade agreements and shall also provide the frame work
for the implementation administrations and operation of plurilateral trade agreements.
2. The WTO shall provide the forum for negotiations among its members concerning their
multilateral trade relations in matters dealt with under the agreements.
3. The WTO shall administer the ‘understanding on rules and procedures governing the
settlement of disputers.’
4. The WTO shall administer the ‘trade review mechanism.’
5. With a view to achieving greater coherence in global economic policy making , the WTO
shall cooperate, as appropriate, with the IMF and IBRD and its affiliated agencies.

The general council will serve four main functions

1. To supervise on a regular basis the operations of the revised agreements and ministerial
declarations relating to (a) goods, (B) services and (c) TRIPs
2. To act as a dispute settlements body.
3. To serve a s a trade review mechanism
4. To establish goods council, services council and TRIPs council as subsidiary bodies.

The WTO is a more powerful body with enlarged functions than the GATT and is envisaged to
play a major role in the world economic affairs. To become a member of the WTO, a country
must completely accept the result of the Uruguay round.

WTO PRINCIPLES

The WTO agreements have three main objectives:

• to help trade flow as freely as possible
• to achieve further liberalization gradually through negotiation
• to set up an impartial means of settling disputes

A number of simple, fundamental principles run throughout all the WTO agreements.

They are the foundations of the multilateral trading system. They include:
 • non-discriminations (“most favored nation” treatment and “national” treatment)
• Freer trade, predictable polices, encouraging competition.
• Extra provisions for less developed countries.

Theses are described under the objective of GATT above.

The salient feature of the Uruguay round agreement are given below:

1. WTO is GATT plus a lot more. Under the GATT there was only one major agreement-
GATT. Under the wto, there are agreements related to three major reas-gatt, gats and
trips.
2. WTO is more powerful and effective organization than GATT. It has a more effective
dispute settlement mechanism.
3. The Uruguay round agreement of the UR is the measures to liberalize trade in agriculture,
which was a highly protected sector, particularly in the developed countries. These
measures are tariffication, tariff bindings tariff cuts and reduction I subsidies and
domestic support.
4. All member countries are required to adopt product patent. In India had only process
patent for drugs, food and chemical substances for which the patent period was 7 years
and 14 years for other products. Under the WTO regime the patent period for all products
is 20 years.
5. As under GATT, under who also developing counties, particularly least developed
counties, are accorded a number of concessions and favours. Their liberalization
requirement are lower and they are allowed longer period tie fulfill the liberalization from
developing countries. There are also some committees under the WTO to look after the
interests and special needs of the developing countries.
6. There is a general complaint that the fruits of the liberalization accrue mostly to the
developed countries. It is pointed out that the industrialized countries, which make up
only 20 % of the membership, will appropriate about 70% of the income generated by the
implementation of the UR agreements. The, loser mostly in Africa and Caribbean, are
some of the poorest countries in the world.
7. Even after all UR concessions are fully implemented by the industrialized courtiers,
significant trade barriers in the form of high tariff peaks will continue to affect many
exports from developing counties. The removal of such barriers needs to be given high
priority. There are several other areas of critical importance to the developing countries.

7. Discuss the basis of the international trade.

Without becoming too deeply involved with the mechanics of international trade, one
should know how it operetates and its importance to the world economy. One should know how
monetary system works because they related directly to the ability of the overseas customer to
buy from an international marketer. One should also be aware of how various governments and
international organization seeks to regulate international trade because this affects how and
where one’s goods may be exported.
Theories of international trade

The raison dieter for international trade is to be found in the diversity of economic resources in
different countries. As proof. Lerner says.” divergent scarcities of factors are the moving forces
behind international trade.” All countries have not been endowed by nature with the same
product ivies facilities. There are differences in climate conditions and geological deposits as
also in the supply of labour and capital. Due to theses differences, each country finds it
advantages to specialize in the production of some specific commodities such specialization
would not be economically Practise able but for the possibility of exchange of surplus production
through international trade. In fact, in the absence of international trade will take place when
buyer find foreign markets cheaper to buy in and sellers find them more profitable to dispose of
their products than the domestic market.

Theory of comparative cost

A country tends to specialize in the production of commodities for which it has got a
comparative cost advantage or, in other word, where its costs are lower than in other countries.
The point to be noted in this connections is that it is the comparative advantage and nor the
absolute advantage which determines whether international trade will be take will take place or
not. This point can be clarified by taking the example made famous by Ricardo in his analysis of
comparative cost.
Let it assume that here are two countries, England and Portugal. Two product, namely,
cloth ad wine are being produced. The amount of labour required to produce one unit of these
items is:

Cloth wine
England 100 120
Portugal 90 80

It is clear from the above figure that Portugal can produce both cloth and wine at a lower cost,
because the amount of labour required per unit of output is lower.

The Ricardian model of comparative costs is based on only one factor of production
namely labour, and the basis hypothesis is that each country will export that product which it can
produce at lower average labour cost.

There are certain limitations of the Ricardian theory. First, it is a one-factor model. In
reality even though labour cost constitutes an important segment of total cost, there are other cost
elements also which, in some cases, can outweigh the labour cost differences. Secondly, even
though cost differences are attributed to differential labour productivity, the Ricardian theory
does not explain the reasons why labour productivity may differ from country to country.

Factor proportions theory

The factor proportions theory, also known as factor endowment theory, was developed by
heckscher and ohlin,. This theory was further developed by Samuel son. The hecksher-ohlin
theorem is basically a two countries, two commodities and two factor model. The conclusion of
the theorem is that a country will specialize and export that product which is more intensive in
that factor which is more abundant. It will import those goods which, on the other hand, are more
intensive in that factor of production which is scarce in that country.

Human capital approach

This theory, which is also sometimes known as ‘skills theory of international trade’. Has
been advocated by a number of econometrics, especially Becker, Kennen and Kessing. Whereas
the factor proportions theory considers labour as a homogenous factor, it is not so in the real
world. In fact, for export of manufactures the skill level of labour is a very important
determinant. Labour can be basically divided into skilled and unskilled labour. It is emphercial
testing, Kessing concluded that patterns of international trade and production were determined
for a broad group of manufacture by the relatively advance of skilled and unskilled labors.

For example:
Developing countries which more abundant supply of unskilled labour will specialize and
export those goods are relatively more intensive in unskilled labour. Imports, on the other hand,
consist of those goods w2hich are more skill intensive.

Scale economies

The trade structure is also sought to be explained in terms of scale economies. According
to this theory, there is a relationship between the size the international market, average unit cost
of production and export completeness. A firm operating in a country where the domestic market
is large will able to reach a high output level, thereby reaping the advantage of largely
production. The lower cost of production ill increase its competitive enabling the firm to make an
easy into export markets. This logic appears to be valid; this hypothesis cannot be general
because it is possible that the pull of the domestic market will be so stated that export would not
be promoted, as is the case in India for certain product.

8. Explain the economic growth of the country with respect to foreign trade.

Alternative strategies
A developed country can follow alternative strategy of economic growth. Depending
upon the strategy to be adopted, the role of foreign will change. Broadly speaking, these
strategies are:

1. Prosperity through export of manufactures. This was the started pursued by the United
Kingdom. The strategy involved increasing product and export of manufactured products. The
export demand provide necessary impetus for additional investment in the domestic economy
export expansion caused the national income to record a high growth through export multiplier.

The success of this strategy which worked extremely well for the economy in the 19th and
early part of the 20th century depends upon:
 1. Expanding export markets with complete freedom of entry. Britain could export more
and more during that period because markets were provided by former colonies, such as
India, and Australia where British goods could enter without facilities substantive trade
restrictions.
2. Little or no competition in export from other countries. But of the early start the U.K.
enjoyed due to the fact that India revolution originated there, British manufactures were
faced hardly any competition in the earlier years.

2. STAPLE EXPORT STRATEGY

A country can also try to take advantage of staple exports, as its comparative advantage
lies in that sector. Canada and Australia, both of which are continental countries, enjoy a large
surplus of wheat. It was possible to develop large-scale export of wheat, which generate
consequently resource for industrializing. Staple exports can speed up the process of economic
growth by opening the interiors of the company by developing modern transportations and
communication infrastructure. Export demand for staples would increase the requirements of
inputs for the export sector, which would push up the domestic investment. Increased income in
export sector on the other hand, would lead to additional investment to satisfy the increasing
consumption needs.

The basis problems associated with the strategy are:

1. The demand for most raw materials including food items is significantly price and
income inelastic. Agriculture imports also are rigidly controlled in most developed
countries. Possibilities of substantial export expansion are, therefore, rather limited.
2. Prices of most raw materials fluctuate widely in the world market causing uncertainty and
instability in the sectors concerned.
3. The forward and backward linkages which are strong in the manufacture sector are
relatively weaker in the primary sector.

Advantages of export-led strategy

1. The country has to become internationally competitive for the strategy to be successful.
This puts tremendous pressure on the exporting firms to become price and quality
conscious.
2. The exporting firm can ignore the constraint of the small domestic market. It can plan its
production on the basis of world demand and thereby reap the benefits of economic of
scale to the maximum.
3. The technological upgrauation of the production structure becomes inevitable because in
its absence the firms would not be able to compete in the global markets.
4. The country would no suffer from balance of payments problem and, therefore would
have grater freedom in pursing the plan process of economic development.

There is however, several undesirable effects as well:

1. If the country has to improve in very large quantities inputs export production, the net
 benefits to the country may not substantial.
2. When large scale production facilities are created solely to export markets, any
fluctuations in those markets directly estabilise the domestic economy.
3. Export production tends to become more uncertain than domestic production because of
sudden and drastic change in national polices which may close or restrict market access.

3. Import substitution strategy

Some countries have not to follow the export led strategy, whether based on manufacture
staple export. They have, on the contrary, formulated the import instition strategy. This involves,
in the initial phase of plant economic growth, setting up domestic industries especially in the
initial goods sector, to replace imports. India has followed this strategy almost up to 1970. The
necessary conditions for the success of import substitution strategy are:

1. Existence of a large domestic market. Most capital good industry requires a minimum
plant size for economic efficiency may not be viable in the absence of a large domestic
demand.
2. Setting up of import subsisting unit would require sub state amount of foreign exchange
resources to fiancé initial import machinery and capital equipment.
3. Adequate tariff and non-tariff measures have to be introduced protect these infant
industries from global competition.

The basis advantage of his strategy is that it is less risky than export strategy. Since
production capacity is being created to cater to the need the domestic economy, the risk
elements are less compared to a post where the outputs are to be marketed abroad. Another
advantage of strategy is that identification of the industry is easier in as much as demand
profile of the respective products is evident from the existing volume imports.

The principal drawbacks of this strategy are :

a. Industries which would operate within a high protective wall we become inefficient and
create a high cost economy.
b. The strategy can work only for a finites period. Once the domestic economy is saturated,
the strategy would cease to work.
c. Import substitution strategy, therefore, can work basically in the short and medium term.
In the long run, the economy would be getting more benefits bough integrating with the
world economy, by specializing on the basis of its comparatives advantage.

There is, however, no reason to assume that the two strategies are mutually exclusive.
Many countries have for some years followed the import substitution strategy and than
shifted to export promotion strategies which were established earlier as import substation
units. Simultaneously pursuit of both the strategies in which it has comparative try to
promote exports of those industries in which it has comparative advantage, while going for
import substations in those sectors which are perceived to be crucial for the economy’s
strength and ability in the long run.