Mercantilism was a dominant economic school on Europe in XVI-XVIII century. The theory suggests that the global turnover of international trade is constant and the prosperity of a nation depends on the government ability to support a positive balance of trade with other nations. Mercantilism considers economic assets as a set of stock including gold, silver and trade value (bullion). The way for the government to increase the capital is to intervene into economy through the system of tariffs and restrictions aimed on increase of export and decrease of import. There are several basic flaws in mercantilism.
The first one is that is assumes that the turnover of international trade is stable. Thus, in case one state constantly benefits and another one constantly misses from trade the trade would very soon stop because the missing state would either become bankrupt or stop trading, leaving the advantageous state without income so both nations would loose. The second gap of mercantilism is that it does not consider costs of trade race. In case nations start to compete in increasing their export and reducing import this will cause them produce even the goods which are cheaper to buy in other countries.
So, in case one nation would specialize in producing one commodity and other nation would produce another commodity, they would both benefit from exchanging those commodities. The third disadvantage of mercantilism is that it does not take into account the influence of gold on the financial system. Endless accumulation of gold and silver ruined the financial system of Spain in the XVII century, as the nation suffered from enormous inflation. The entire branches of home economy were ruined resulting in dramatic reduce of export and collapse of mercantilist economy.
Absolute Advantage Theory Originally proposed by Adam Smith, this theory relies on the ability of one nation to produce commodities with fewer costs and exchange those commodities to the ones other countries produce at lower costs. The need for less resources to produce a particular good results in its lower and attractive price on the international market and allows nations to specialize in production of some exact commodities both for home market and export thusly reviving global economy. The first flaw of the absolute advantage theory is that it reviews isolated commodities.
It says “in case we produce A better than another nation and another nation produces B better than we, so we would exchange”, but it does not consider relative expenses of such production. In his famous example with wine and wool produced by Portugal and Scotland Ricardo proved that although Portugal produced both with fever relative costs, it would be more advantageous for Portugal to produce only wine and let England produce wool to exchange for wine with Portugal as the relative expenses of production of wool in England are lower than of wine.
The second gap of the theory is that it excludes countries which have no absolute advantage in any commodity out of global economy thus reducing the global turnover and excluding workers and financial resources of that nation out of global economy. In case this theory is applied, economy would turn into a club of nations which have certain absolute advantage in comparison to all other nations. Comparative Advantages Theory Originally proposed by David Ricardo, this theory suggests that every nation would benefit from production and export of only those goods and commodities which are produced with lower marginal costs than in other countries.
Given that all the goods can be produced inside one country with an absolute advantage, this country would still benefit from import of goods which are produced with lower marginal costs in the other countries. The first remarkable disadvantage of the theory is that in case every nation would hypothetically specialize in only one commodity this would result in elimination of competition in production of this commodity and let the producing nation speculate.
The lack of both home and international competition would make nation strive to reduce costs in production of this commodity reducing its quality. Other countries which are economically dependent on the import of this commodity would not be able to combat such a development. The second disadvantage which is especially obvious in the modern economy is that the relative advantages theory does considers only the flow of goods, but not capitals, investments and debts. For example, producing debts costs nothing, so it would be absolutely economically advantageous to produce debts.
Yet this gives an advantage only for a very short term, while soon the nation would face a huge demand for currency to pay for the assets, and as a result the export would be ruined while the import would boost devastating the economic grounds for prosperity. The third gap is that short-term advantages can turn into long-term disadvantages. Sometimes it can be necessary for a nation to launch new industries which would become effective in a long term, so it has to give up on the comparative advantage theory to make profits in future.
The Theory of Factor Endowment This is a mathematical theory of international trade proposed by Heckscher-Ohlin. Further developing Ricardo’s comparative advantage theory Heckscher-Ohlin offered to predict patterns of commerce based on endowments of a trading region. Comparative advantages are determined by the country’s funds like land, labor and natural resources. Assuming that both countries have equal technological development, each of them would benefit from trading goods requiring inputs of endowments that are locally abundant.
For example, in case a nation has much land but little labor it would benefit from agricultural production. The flaws of the theory are as follows. First is that the states do not initiate trade as themselves, which is usually done by firms and corporations, and those firms strive to increase their benefit but not to make use of the factor endowment Secondly, the theory would work well in the conditions of a perfect competition that no nation ever has.
The trading partners are never fully informed of the endowment factor of their vis-a-vis making it hard for them to determine the benefits of application of their own endowments. Thirdly, as the theory considers only funds, it does not look at the technological development which is never completely equal between various countries, as well as the theory does not consider the influence of organizational and management factors that can make a nation effective in production of a particular commodity even if the nation comparatively lacks endowment.
Bibliography 1. Ball, Donald; McCulloh, Wendel, Geringer, Michael; Frantz, Paul; Minor, Michael. (2003). International Business: The Challenge of Global Competition. McGraw-Hill/Irwin; 9 edition. 2. Mankiw, Gregory N. (2006). Principles of Economics. South-Western College Pub; 4 edition 3. Buchholz, Todd G. (2007) New Ideas from Dead Economists: An Introduction to Modern Economic Thought Plume; Rev Upd edition