Economic Environment Of Business Economics Essay

States have over the decennaries adopted an import permutation attack whereby limitations in the signifier of duty and non- duty barriers ( for illustration, quotas and prohibitions on importing ) were imposed with a greater accent of local production. The thought was that promoting local production would hike the economic system, cut down unemployment and promote growing of local houses. However, economic experts like Ricardo, Smith and Hecksher-Ohlin have established to a great extent that free trade would be more good to a state than protectionism. The trade forms, hence, moved to merchandise liberalisation in the 1980s ( Niroomand and Nissan 1997 ) . The deductions of international trade and competitory advantage for an exporting economic system like China and for an importing state like the United States of America are explored in this paper.

2.0 Theories of international trade

China is one of the major exporter in the universe as depicted in the figure below followed by the US. China has besides joined the World Trade Organisation in 2001 and has since so embarked on a policy of increasing trade liberalisation ( Chen and Tian 2011 ) .

The US in add-on to being the 2nd major exporter it is besides the first importer in the universe.

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2.1 Mercantilism

Harmonizing to the mercantilist position, success of a state depended on exporting the upper limit and importing the lower limit required. The mercantilist position encouraged protectionism at the disbursal of productive efficiency. States like China adopted a stance of ego sufficiency and anti-commercial trade boulder clay tardily 1970s whereby the degree of imports were limited in nature taking to the US opening its market in 1980 to China ( CATO Organisation ) . Zhao et Al. ( 2008 ) noted that a lessening in protectionism in China led to higher income and productiveness additions which was the antonym of what the mercantilist position suggested.

Both the USA and China have moved beyond the traditional mercantilist position to an unfastened trade place so as to profit from the diverging chance costs involved in non being self sufficient and alternatively concentrating on bring forthing additions from trade through equal resource allotment.

2.2 Adam Smith ‘s theory of absolute advantage

Harmonizing to Adam Smith ‘s theory of absolute advantage a state should specialise in the production of goods and services in which it has an absolute cost advantage. Smit ( 2010 ) pointed out that the paradox of the theory of absolute advantage stemmed from the fact that states should non import all the merchandises and services which they can bring forth more expeditiously. This attack would non needfully ensue in additions from trade ( Smit 2010 ) .

China, given its comparatively low labor costs and high labor productiveness should, harmonizing to this peculiar theory, focal point on production of goods and services which, if produced in other states, would be more in footings of labor costs and labour hours. China ‘s natural resources are coal, Fe ore, crude oil, natural gas, quicksilver, Sn, wolfram, Sb, manganese, Mo, V, magnetic iron-ore, aluminium, lead, Zn, rare Earth elements and U. It has the universe ‘s largest hydropower potency with a working population of approximately 70 % ( Cardinal Intelligence Agency Factbook ) .

The United States, on the other manus, besides has an of import beginning of natural resources like coal, Cu, lead, Mo, phosphates, rare Earth elements, U, bauxite, gold, Fe, quicksilver, Ni, potassium hydroxide, Ag, tungsten, Zn, crude oil, natural gas and lumber. It has the largest coal militias in the universe, a working population of 66.5 % and is the largest technological economic system in the universe ( Cardinal Intelligence Agency Factbook ) .

Advocates of the absolute advantage would, based on the above list of natural resources and strengths, recommend that the US focal point on the production of technological merchandises and development of all its natural resources to the fullest whilst China should besides concentrate on development of its natural resources and use its labor for such development. Hence, the two states would stop up bring forthing all the goods and services even though their production procedure is non efficient.

2.3 David Ricardo ‘s theory of comparative advantage

In contrast to the theory of absolute advantage, the theory of comparative advantage advocates the specialisation of a state in the production of goods which it can bring forth comparatively more expeditiously than other states. This theory nevertheless, assumes that labor in add-on to being homogeneous, is the lone production cost that affairs.

Vaidya et Al. ( 2007 ) established through their survey that the comparative advantage of China was loosely based and spanned telecommunication merchandises, hi-tech merchandise groups whilst the state still had a competitory advantage in the low-tech labor intensive merchandises.

Agarwal and Wu ( 2004 ) besides estimate that China ‘s exports will increase with clip due to its inexpensive labor and authorities initiated structural reforms thereby taking to US importing more merchandises and services from China in order to derive from production and resource allotment.

Top Ten US Exports to China, 2011 ( $ billion )


Commodity Description


% Change Over 2010


Power coevals equipment


9.70 %


Oil seeds and buttery fruits


-3.10 %


Electrical machinery and equipment


-16.60 %


Vehicles, excepting rail


55.60 %


Aircraft and ballistic capsule


10.80 %


Opticss and medical equipment


8.30 %


Plastics and articles thereof


7.20 %


Pulp and poster board


27.10 %


Copper and articles thereof


32.70 %


Organic chemicals


17.80 %

( Beginning: The US-China Business Council n.d. )

Top US Imports from China, 2011 ( $ billion )


Commodity description


% alteration over 2010


Electrical machinery and equipment




Power coevals equipment




Toys, games, and athleticss equipment








Footwear and parts thereof




Apparel, knitted or crocheted




Apparel, non knitted or crocheted




Plastics and articles thereof




Iron, steel




Vehicles, excepting rail



( Beginning: The US-China Business Council n.d. )

The above tabular arraies help to picture the trade composing between US and China for the twelvemonth 2011. The figures above can besides be used to construe the comparative advantage of both states. For illustration, the comparative advantage of the US stems from largely power coevals equipment, oil seeds, electrical machinery and aircraft. Surprisingly plenty, it is seen that the US besides imports electrical machinery and power coevals equipment. Further research shows that China tends to hold a comparative advantage in the production of medium tech and low tech merchandises ( Vaidya et al. 2007 ) .

2. 4 Hecksher-Ohlin ‘s factor proportion theory

The Hecksher-Ohlin theory establishes that states differ in regard of their labor and capital strengths. This peculiar theory properties comparative advantage to the factor copiousness or gifts ( Smit 2010 ) . Hence, states will concentrate on the production and exportation of goods that exploit the factors of production that these states have in copiousness and import merchandises that require production from a factor that is scarce ( Morgan and Katsikeas 1997 )

The deductions of the Hecksher-Ohlin theory is that China should, presumptively, concentrate more on the production of medium and low-tech merchandises, merchandises doing usage of its copiousness of natural resources and labor intensive merchandises.

The US should, on the other manus, focal point on bring forthing the high tech merchandises which makes usage of its copiousness in factor gifts in that sector.

2.5 The Leontief Paradox

The Leontief paradox undermined the popular belief that the US is an exporter of capital intensive merchandises and an importer of labour intensive merchandises in 1953. As per Agarwal and Wu ( 2004 ) , China is the universe ‘s major centre for labour intensive industries every bit good as engineering intensive industries like computing machines and telecommunication merchandises, thereby reenforcing the Leontief paradox. Leontief ‘s paradox helps to set up that the degree of imports and exports should be analyzed in order to see the composing of the existent trade forms. Firms in a state will be given to bring forth and exports those goods in which they have a comparative advantage.

2.6 R. Vernon ‘s Product Life Cycle Theory

Vernon ‘s merchandise life rhythm theory provinces that in the early phases of the life rhythm of a merchandise the merchandise originates from the innovating state and, as other states start utilizing the merchandise, production bit by bit shifts off from the state of beginning to a state whose comparative production costs is lower ( Ietto Gillies 2007 )

( Beginning: Proven Models n.d. )

The chief underlying job with the merchandise life rhythm theory is that it focused on the US. The writer believed that most inventions came from the US which was true to some extent. However, with globalisation and the rise of transnational companies all around the universe, invention is no longer concentrated in the US. The increasing figure of patents in China shows that China is besides concentrating on conveying advanced merchandise to the market. It can therefore be argued that the merchandise life rhythm theory is no longer applicable in today ‘s trade forms.

2.7 Michael Porter ‘s theory of national competitory advantage

The theory of national competitory advantage goes one measure in front by replacing the classical construct of comparative advantage with competitory advantage.

Michael Porter ‘s theory of national competitory advantage stems from the fact that, similar to companies who strive and perform extremely good because of invention sustained by changeless betterment to maintain and keep a grade of competitory advantage, states besides have got to vie based on their competitory advantage. Porter came up with a diamond ( factor conditions, demand conditions, related and back uping industries and house scheme, construction and competition ) exemplifying the assorted facets on which a state must work in order to make and prolong competitory advantage.

Davies and Ellis ( 2000 ) reported that, contrary to Porter ‘s suggestion, states focus chiefly on constructing a comparative advantage. China is said to hold exploited its comparative advantage in labor-intensive sectors alternatively of following a scheme of competitory advantage. In contradiction with this position, Javalgi et Al. ( 2011 ) noted that both China and the US have non followed the traditional position of trade. The writers pointed out that China has got a broad pool of unskilled labors and should hold by default specialized in the production of labour intensive goods and services and a developed economic system like US with its high labor costs and educated labor should hold concentrated in the production of capital intensive service production. However, the competitory advantage of China is presently centered on both its lupus erythematosus skilled service sector and its advanced skilled service sector ( Javalgi et al. 2011 ) . The usage of the footings ‘comparative advantage ‘ and ‘competitive advantage ‘ to explicate the base adopted by China or the US is used interchangeably in the literature and the different writers do non look to hold on which scheme the two states, and most peculiarly China, has adopted. But gratuitous to state, China is on the right way as shown by its increasing degree of exports and imports.

Table: entire value of China ‘s imports and exports for the twelvemonth ended 31 December 2011

( Beginning: ETCN n.d. )

From an empirical analysis, the Global Competitiveness Report 2012-2013 depicts the United States of America as being really competitory ; the economic system is supported by a flexible labor market backed by a good instruction system. On the other manus, China ranked far behind the US ; its economic system being less competitory than the economic system of US by comparing and the grounds stated in the Global Competitiveness Report 2012-2013 are the unequal entree to funding and the high rising prices rate of the state.

3.0 Decision

After holding reviewed the major theories of international trade and their deductions on China, an exporting state and the US an importation industry, it can be seen that the theory of comparative advantage suits, to some extent, the current trade forms of the two states. The two states have focused on bring forthing and exporting those goods and services in which they have a comparative advantage compared to other states and importing goods and services in which their comparative advantage is lowest. This reappraisal besides shows that the trade forms of states change over clip presumptively because of alterations in their factor gifts. Some theories like the theory of absolute advantage and the merchandise life rhythm theory have been established as being irrelevant in the prevailing fortunes.


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