Strategic Management: Formulation and Implementation

Why Do Nations Trade?

This question and the equally important proposition of predicting the direction, composition, and volume of goods traded are what international trade theory attempts to answer.

International Trade Theory

International trade theory seeks to explain why trading occurs between the nationals of various countries. The study of trade emerged in the mercantilism era (roughly the 16th century through the 18th century in Europe) as a crude set of arguments about how a nation should trade.

Mercantilism Theory was an economic philosophy which held that the government could improve the well-being of a nation's people by means of laws and regulations. The logic of mercantilistic theory of trade is a follows. The power and strength a nation, and especially its government, increases as the nation's wealth increases.

When a country exports goods, it receives payments from other countries in gold, which increase the exporting country's wealth and power. Mercantilism concludes that exports are good and should be encouraged but imports are bad and should be discouraged.

Additional support for the mercantilistic system, based on this theory, was found in the impact of trade on domestic production and employment. An example of modern-day mercantilism was the new industrial policy based on heavy state intervention that the socialists were creating for France. In the United States, there is a growing opinion that Japan is the present-day "Fortress of Mercantilism."

More recent theories, that of absolute advantage and comparative advantage, conclude that countries benefit only in the short run from a mercantilism policy, while two-way trade serves to increase the long term benefit (i.e., encouragement of both exports and imports).