International economics

International economics is concerned with the effects upon economic activity of international differences in productive resources and consumer preferences and the institutions that affect them. It seeks to explain the patterns and consequences of transactions and interactions between the inhabitants of different countries, including trade, investment and migration.

International trade

Classical theory

The law of comparative advantage provides a logical explanation of international trade as the rational consequence of the comparative advantages that arise from inter-regional differences - regardless of how those differences arise. Since its exposition by John Stuart Mill the techniques of neo-classical economics have been applied to it to model the patterns of trade that would result from various postulated sources of comparative advantage. It has invariably been found necessary to adopt extremely restrictive (and unrealistic) assumptions in order to make the problem amenable to theoretical analysis. The best-known of the resulting models, the Heckscher-Ohlin theorem (H-O) depends upon the assumptions of no international differences of technology or consumer preferences, no obstacles to pure competition or free trade and no scale economies. On those highly restrictive assumptions, it derives a model of the trade patterns that would arise solely from international differences in the relative abundance of labor and capital (referred to as factor endowments). The resulting theorem states that, on those assumptions, a country with a relative abundance of capital would export capital-intensive products and import labor-intensive products. The theorem proved to be of very limited predictive value, as was demonstrated by what came to be known as the "Leontief Paradox" ( the discovery that, despite its capital-rich factor endowment, America was exporting labor-intensive products and importing capital-intensive products ) Nevertheless the theoretical techniques used in deriving the H-O model were subsequently applied to alternative sets of assumptions to derive further theorems. The Stolper-Samuelson theorem , which is often described as a corollary of the H-O theorem,was an early example. In its most general form it states that if the price of a good rises (falls) then the price of the factor used intensively in that industry will also rise (fall) while the price of the other factor will fall (rise). In the international trade context for which it was devised it means that trade lowers the real wage of the scarce factor of production, and protection from trade raises it. That is generally interpreted to mean that trade between an industrialized country and a developing country would lower the wages of the unskilled in the industrialized country. Another corollary of the H-O theorem is Samuelson's factor price equalization theorem which states that as trade between countries tends to equalize their product prices, it tends also to equalize the prices paid to their factors of production. It has to be remembered, however, that the corollaries to H-O hold only on its very restrictive assumptions. Very large numbers of learned papers have been produced in attempts to elaborate on the H-O and Stolper-Samuelson theorems, and while many of them are considered to provide valuable insights, they have seldom proved to be directly applicable to the task of explaining trade patterns.

(See also the Rybczynski theorem )

Modern theory

Modern trade theory attempts to move away from the restrictive assumptions of the H-O theorem and explores the effects upon trade of a range of factors, including technology, scale economies and market power. It also moves away from the mainly deductive methods of classical theory to make extensive use of econometrics to identify from the available statistics, the contribution of a particular factor among the many factors that affect trade. Michael Posner’s imitation gap theory envisages the advantage arising from a country’s development of a new technology as a temporary factor that lasts only as long as it takes other countries to adopt the same technology. Other researchers have found research and development expenditure, patents issued and the availability of skilled labor to be indicators of the technological leadership that enables some countries to produce a flow of technological innovations. and have found that technology leaders tend to export hi-tech products to others and receive imports of more standard products from them.