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Quiz 6 :
International Trade Theory

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Quiz 6 :
International Trade Theory

Bangladesh saw a textile industry boom in the late 1990s and early 2000s when other countries were facing quotas for exports to the US and Europe. Bangladesh was exempted since it was ranked as a least developed nation. During the period when the garment making industry was growing, other supporting and related industries also grew. In 2005 when the Multi-Fiber Agreement was abolished it was felt that the industry in Bangladesh would collapse. This did not happen due to a few factors mentioned below: 1) Bangladesh was making only very low cost garments. Due to economic growth the labor costs in all other countries which were competing with Bangladesh were going up. 2) There was a world-wide recession which meant that the demand for these low cost garments tended to go up and so the demand for their production was still going up. 3) Its labor costs are low. The wages for a garment worker here are about half those paid to a Chinese worker in the same industry. This is because Bangladesh's GNI is very low. So, a low wage of about $60 a month is a decent wage in that country. 4) Most of the workers are women who are not educated and do not have any other method to earn a living. 5) They also have a large network of supporting and related industries.

Original Mercantilist theory held that wealth was based on a nation's ownership of gold and silver. In order to increase the amount of gold and silver, mercantilists advocated government intervention such as tariffs on imports and subsidies on exports to increase and maintain a positive net inflow of gold and silver. Gold, silver, or paper currency representing a certain value of gold/silver acted as money for much of capitalist history. Economist David Hume argued that if country A held a positive inflow of gold/silver from country B, then, A would undergo inflation due to an increasing amount of circulating currency. B would undergo deflation due to a decreasing amount of circulating currency. Inflation would cause prices in country A to increase, while the opposite would happen in B. This would cause currency inflows from country A to country B to occur. Therefore, increasing gold reserves was difficult or even futile. Adam Smith pointed out that the best case scenario was that there might be some more precious metals in a nation's vaults. People would not necessarily be better off. In fact they may be worse off. Subsidies require taxes to pay for them. Tariffs increase the price of goods for consumers. The economic dislocation would cause people to expensively make goods in country A that country B could make much cheaper, leaving A to focus its efforts on goods that it was better at making. If a country is better at making a certain good than other countries, then that country has an absolute advantage. If each country produces goods in which it has an absolute advantage , then the result is the most efficient allocation of resources for the lowest price. Adam Smith defined the wealth of nations not as the amount of gold/silver but in the amount of goods a country owned. As free trade allowed a focus on absolute advantage, free trade was the key to maintaining and improving a country's wealth. Free trade has certainly become the common wisdom of many nations today. With the assistance of organizations such as the World Trade Organization, tariffs and subsidies have been cut and trade has been increased. However, not only have tariffs and subsidies not completely been eliminated, many modern day workarounds limit trade. Some country's get government favor, access to cheap loans from state owned banks, favorable regulations, dumping, artificially cheap land/electricity, bureaucracy and other enticements/discouragements that effectively act as subsidies and tariffs. The neo-mercantilists adopt mercantilist policies that have many differences from the old. In the past currency was gold, silver, or paper notes representing a certain amount of gold/silver. Today currency is based on fiat, essentially the government says the money has value and the people believe it has value so it acts as an accepted medium of exchange. Central banks can decrease the amount of money in circulation to combat inflation due to mercantilist policies. Countries adopt currency controls to keep money from leaving the country, or use the excess foreign currency as savings or to invest in other countries in the form of a Sovereign Wealth Fund (organization that invests a government's excess foreign currency). While a number of countries adopt these policies, the best examples are Japan in the 60s-80s, China today, and East Asia in general. Thus, in light of these nations economic growth, it is too soon to say mercantilism is a bankrupt theory.

Most of the products that one manufactures have three or four distinct stages. This is true for many products especially hi-tech products like electronics. In today's connected world it makes sense to locate these stages in places which are most suited for the activity from the point of view of getting the right resources at the right price. 1) Design - This usually involves using highly skilled manpower that would be well educated and at the same time available at a reasonable price. Originally most US companies used to do the design work in the US. This was the case with the Japanese and the Europeans. Today, a lot of the second level of design and testing of new products is being done in India and other countries in SE Asia. 2) Sourcing Components or sub-Assemblies - This would be done from various countries where these components and sub-assemblies are being manufactured in large quantities to avail of the benefit of the economies of scale. The exact location from which these are sourced would depend on the logistics of the procurement. 3) Assembly - This one would like to undertake in a low-labor cost location preferably near to the ultimate market. This has the benefit of logistics as also provide one with the flexibility to change the product mix based on market conditions. Thus, the different value creations activities have to be necessarily conducted at locations which are most suitable for the same. This is the way to gain a competitive advantage in the market.