Evaluate the Relevance of Two Trade (or FDI) Theories for Policy Makers and for the Strategy of Multinational Enterprises. Discuss Possible Limitations in the Explanatory Power of these Theories.
The two trade theories that I am going to evaluate on their impact on policy makers and the strategies adopted by multinational enterprises are ‘comparative advantage theory’ and ‘country size theory’.
Adam Smith first developed the theory of Absolute advantage in 1776. Smith explained that ‘if trade was unrestricted, each country would specialize in those products which it had a competitive advantage.’ These competitive advantages could be gained from natural advantages (through a specific climate or other natural resource), or from acquired advantage (from having more efficient production techniques or technology). The countries resources would therefore shift towards these industries and improve their efficiency through specialization. The labour force would also become more efficient from repeating the same tasks and developing more efficient working methods. Comparative advantage is a step further than absolute advantage theory. David Ricardo in 1817 developed comparative advantage to show there were ‘still benefits to be gained from trade if a single country were more efficient at both products’ .
Country size theory assesses how the size of a country affects the extent to which international trade patterns affect it. The theory states that larger a larger country will have a greater variety of natural resources ‘making them more self-sufficient than smaller countries’ . It also states that a larger country will have higher transport costs in order to deliver resources and goods across its b ...