Gains from International Trade and Investment

The major gain of international trade is that it has brought about increased prosperity by allowing nations to specialize in producing those goods and services at which they are relatively efficient. The relative efficiency of a country in producing a particular product can be described in terms of the amounts of other, alternative products that could be produced by the same inputs. When considered this way, relative efficiencies are described as the comparative advantages. All nations can do simultaneously gain from exploiting their comparative advantages, as well as from the large-scale production and broader choice of products that are made possible by the international trade.

Suppose that Japan is relatively more efficient in producing steel than food and the United States is relatively more efficient in producing food than steel. So we can expect food to be cheap relative to steel in United States, and steel to be cheap relative to food in Japan. This suggests that by exporting foods to Japan, the United States can receive a relatively large amount of steel in return. Similarly, by exporting steel to United States, Japan can receive a relatively large amount of food. Therefore, via exchange of products through trade, both countries can be better off. This gain is pure exchange gain and would be enjoyed even without specialization of production. Here we implicitly assumed constant returns to scale, that is, the number of people required to produce the food and steel are same. However, if there is increasing returns to scale, it will take fewer people to produce a given quantity of output for which the country has a comparative advantage. In this case economies of scale is the further gain from international trade. Another gain from trade comes in the form of an increased product variety. In addition, international trade can make a brooder range of inputs and technology available and thereby increase economic growth.

Among the gains of international investment has been improvement in the global allocation of capital and an enhanced ability to diversify investment portfolios. The gain from the better allocation of capital arises from the fact that international investment reduces the extent to which investment opportunities with high returns in some countries are forgone for want of available capital, while low-return investment opportunities in other countries with abundant capital receive funding. The flow of capital between countries moves rates of return in different locations closer together, thereby offering investors overall better returns. There is an additional gain from increased international capital flows enjoyed via an enhanced ability to smooth consumption over time by lending and borrowing.

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