Question

Protection and liberalization of global business environment

Answer 1

The link between trade and economic development, it can be argued, started with the policy of mercantilism.  Mercantilist policy was highly protectionist in nature and, was the dominant view of international commerce in Western Europe from approximately 1500 to 1800.  The protectionist nature of mercantilist policy was evident in its underlying objective, which was to maintain a favourable balance of trade.  This was to be achieved by countries exporting more than they import.  The restricting of imports was seen as one way of promoting the manufacturing of raw materials at home.

Adam Smith, in The Wealth of Nations (1776), challenged mercantilist policy, particularly its protectionist nature.  Smith argued that if two nations traded with each other voluntarily, both must gain otherwise trade would not take place.  He further asserted that mutually beneficial trade would emerge if each country specialized in the production and export of the good in which it had an ‘absolute advantage’.  By absolute advantage, Smith meant that in a two country two good world one country could be more efficient in producing one good, while less efficient in producing the other.  In such a case a country should export the good that it is more efficient in producing and import the good that it is less efficient in producing.

Smith’s theory of absolute advantage was challenged by David Ricardo’s theory of comparative advantage.  Ricardo asked the question: what if one country was more efficient in the production of all commodities, would countries cease to trade since the more efficient country could produce the goods it needed more cheaply in terms of real resources?  The answer to this was no.  Ricardo argued that as long as their relative efficiencies differ, trade will take place and be beneficial to both countries.  He further argued that the country with the absolute advantage in the production of both goods should specialize in the production and export of the good in which its absolute advantage is greatest.  It should however, import the good in which its absolute advantage is least.