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Question:

Explain in detail how nations can benefit from trade under the theories of absolute and comparative advantage.

What are the primary motives that drive governments to intervene in trade? Describe the instruments governments use to promote and restrict trade.

Response:

Economist Adam Smith assisted in identifying concepts in economics and international trade that highlight the opportunities countries can create by working with each other's advantages to build more efficient supply chains. These concepts of absolute advantage suggest that "countries can specialize in goods they can produce efficiently and trade with others for goods they can't produce nearly as well" (Segal, 2024). Another economist, David Ricardo, expanded upon Smith's original concepts to point out that even if a country has absolute advantage over another, the one without can still benefit from trading is what is known as comparative advantage.

Absolute advantage describes a scenario where a country can produce a higher quality product quicker and for a great gross profit than another. Its concept is based mainly around the ability of one country to produce more efficiently over another and assists them in making decisions regarding producing one product over another. Furthermore, countries can have comparative advantage when they can produce an expanded portfolio of products and take into consideration the opportunistic costs of producing one over another. For instance, if it costs the same to produce two different products but one has a potential profit that is higher than the other, then a company would produce the product that has less opportunistic cost which would be the one with higher profit.

So, with these theories of absolute and comparative advantage, nations can benefit from trade by providing them the ability to be more efficient in their manufacturing practices and to source products from other nations that they don't produce themselves. There can be gains by both countries that are trading in what our textbook describes as a positive-sum game (Wild & Wild, 2022, p. 160). Countries can benefit from the comparative advantage if another player in the international trade can provide a product more efficiently than the original country, so long as the original country can produce another product more efficiently than other countries.

Free trade exists when there aren't any barriers to the importing and exporting of goods. Governments will intervene in trade often when the economy is underperforming. They also intervene for political reasons to gain popularity with voters around the election. The government's motives can include "protecting jobs, preserving national security, responding to unfair trade practices, and gaining influence over other nations" (Wild & Wild, 2022, p. 176). Nations have also been known to restrict trade for cultural reasons, hence, reducing the availability of products that consumers can purchase in their nations to limit their exposure to different cultural influences.

Managed trade differs from free trade in that it has barriers to the importing and exporting of goods and services. Governments use different instruments to manage trade in efforts to achieve their trade objectives. These include subsidies, export assistance, foreign trade zones, and special government agencies. Subsidies assist domestic companies against the threats of international market competition in the forms of cash payments, tax breaks, and even low-interest loans. Low-interest loan, loan guarantees, and agencies such as the Ex-Im Bank provide export assistance. The International Development Finance Corporation provides investor insurance and losses due to currency conversion issues and terrorism whereas the Ex-Im Bank insures foreign accounts receivables. Foreign trade zones (FTZ) allow the transfer of goods in designated locations with lower customs fees or taxes. FTZs are created to increase employment opportunities along with increase trade. For example, Mexico has a FTZ zone along its norther border with the U.S> whereas companies, known as maquiladoras, import materials from the U.S. duty free, process them into finished goods and then export them back to the U.S. with duties imposed only on the increased value of the product that was completed and exported back into the U.S. (Wild & Wild, 2022, p. 183). Additionally, assistance is provided by special government agencies that promote importing and exporting of goods and services by providing financial assistance to businesses with limited financial resources. They also provide the means for trade officials and businesspeople to visit other countries for potential future business

Managed trade doesn't include just promoting its activities. It also involves restricting trade via tariffs, quotas, and other non-tariff barriers. These tools are used in protectionist policies to restrict international trade to the benefit of the domestic economy. "Protectionist policies are usually implemented with the goal to improve economic activity within a domestic economy but can also be implemented for safety or quality concerns" (Team, 2024). Tariffs are duties imposed on importing counties, raising the price of imports. Some tariffs are imposed on specific industries as seen in peril point tariffs or imposed on the importer but passed on the end buyer under scientific tariffs. Import quotas restrict the quantity of goods that can be imported. This might be necessary when a country is trying to get rid of excess inventory and dump it at a lower price than it cost to produce it

References

Segal, T. (2024, January 28). Absolute vs. comparative advantage: What's the difference? Investopedia. https://www.investopedia.com/ask/answers/033115/what-difference-between-comparative-advantage-and-absolute-advantage.asp

Team, T. I. (2024, February 26). Protectionism: Examples and types of trade protections. Investopedia. https://www.investopedia.com/terms/p/protectionism.asp

Wild, J. J., & Wild, K. L. (2022). International Business (10th ed.). Pearson Education (US).https://ccis.vitalsource.com/books/9780137653379