Two big questions: why trade & investment take place? what determines the pattern?
Knowledge of these theories helps to determine fiscal, monetary, trade & investment policy, allocate resources, calculate benefits, identify economic supply & decide where to invest.
2.2 Theories of International Trade
Strengthen political power, strong government with wealth improves welfare.
Trade when one nation produces at lower cost. Specialization & free trade.
Trade under comparative cost advantage, even if less efficient in both.
Export products using abundant factors, import scarce-factor products.
Goods for domestic market find customers with similar income abroad.
New product → export → eventually import. Introduction, growth, maturity, decline.
Demand conditions, factor endowments, related/supporting industries, firm strategy & rivalry.
Trade & factor rewards, income distribution effects.
Mercantilism
→ to strengthen political power by making strong nation and government. A strong government with wealth can improve welfare of citizen.
Absolute Advantage (Adam Smith, 1776)
“Trade takes place when one nation can produce a good at lower cost than another.” Specialization & free trade.
- Assumptions: 2 countries, 2 products; perfect competition; labour is only cost; no transport cost; market forces determine trade.
Comparative Advantage (Ricardo, 1817)
“Trade takes place as long as less efficient nation is not equally less efficient in both products.”
- Assumptions: 2 countries, 2 products; no transport cost; labour-cost prices; full employment; no tech spillover; perfect competition; constant returns.
Factor Endowment – Heckscher-Ohlin (1933)
“Countries export products requiring large amounts of their abundant factor, and import products requiring scarce factors.”
- Assumptions: different factor intensities, countries differ in endowments, 2 nations, perfect competition, no transport, fixed demand. Limitations: money, transport, technology, economies of scale.
Linder’s Overlapping Demand (1961)
Goods produced for domestic market will find customers with similar income in foreign markets. Trade is greater between nations with similar per capita income.
Product Life Cycle (Vernon, 1966)
A new/innovative product that begins as an export item ultimately becomes an import. Stages: Introduction → Growth → Maturity → Decline.
Porter’s Diamond (Competitive Advantage)
Four attributes: Demand conditions, factor endowments, related & supporting industries, firm strategy/structure/rivalry.
2.3 Theories of International Investment
Capital moves due to interest rate differences for equal risk.
FDI occurs in oligopolistic industries with technical/other advantages.
Transfer technology, IP, knowledge to foreign subsidiary for higher return.
O-Ownership, L-Location, I-Internalization advantages.
International product life cycle also applies to investment.
2.4 Implications
2.5 Current Trends
- ◆ Global trade: merchandise, commercial services, intellectual property
- ◆ Digital trade & global e‑commerce
- ◆ Global value chains
2.6 FDI & Portfolio
FDI: transfer of funds in equipment, structures, with management control.
Portfolio: purchase of stocks/bonds for return.
2.7 Current Trends of Foreign Direct Investment
Status · World FDI Prospects · World FDI Trends
2.8 Contemporary Issues in International Trade and Investment
2.10 Nepal’s Foreign Trade & Investment
Export products, trends, issues, opportunities. Import products & trends.
Prospects for trade in services.
Challenges: business environment, weak infrastructure, restrictive policies, low competitiveness, non‑tariff measures.
Contemporary issues breakdown (full list): protectionism, IP theft, agricultural subsidies, dumping, WTO/globalisation, tariff & non‑tariff measures, trade facilitation, regional integration, climate/environment, keep barriers low.
