Trade Theory

In today’s globalized world, countries are interconnected by establishing trade relation with each other. Countries export goods that it can produce efficiently and import goods that involve high production cost or not supported by the countries abundant factor of production. Different trade theories have been developed to indicate the direction of trade. Three widely used trade theories are the theory of absolute advantage, theory of comparative advantage and Heckscher-Ohlin model of trade. The pioneering theory of trade is the model of absolute advantage. Absolute advantage is defined in terms of country’s efficiency in producing a good in a better way than others produce. The efficiency is determined in terms of absolute production cost. Comparative advantage on the other hand defines relative efficiency in terms of opportunity cost of production. In the Heckscher-Ohlin model, specialization depends on the abundant factor of production. The paper discusses trade theory and trade policy of United Kingdom giving reference to Ricardian theory of comparative advantage.

In 1817, David Ricardo refined the fundamental trade theory of absolute advantage possessed by Adam Smith. The theory developed by David Ricardo is known as the principle of comparative advantage. The theory states that trade would take place when ratio of opportunity cost differs between countries and each country specializes in goods in which it enjoys a comparative advantage. The Ricardian trade model includes technological difference between nations. Ricardo suggests that every country benefits from trade resulting in a higher welfare for the world as a whole (Levchenko and Zhang 2016). The problem with absolute cost advantage is that often nations have absolute cost advantage over all goods. The direction of trade then needs to be determined by considering the opportunity cost of production. The country with a lower opportunity cost export the particular goods while country faced with a higher opportunity cost import that good. It has been observed that when countries specialize based on their comparative advantages the resources are allocated efficiently benefitting the nations participating in trade.

United Kingdom ranks fifth in terms of international trade. The economy of UK is very much dependent on the international trade. This encourages small and medium sized enterprises to participate in trade and enjoys significant benefits. The main imports of UK include metals such as copper, lead, zinc, hides and skins, ferrous metals and other raw materials. UK imports one third of its food. UK’s heavy reliance on imports reflects its comparative disadvantage in producing these items (Salvatore 2014). The main import sectors of UK are machinery, Industrial supplies, consumer goods, Transportation, Food and fuels. The major export sectors in UK are financial services, Business services, Transport, and Travel.  

International Trade of UK

Table 1: Summary of total import and export in 2016

UK’s trade summary in 2016 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Export (million US $)	4,11,463
No of Products	4501
No of Partners	230
Import (million US $)	636368
No of Products	4539
No of Partners	226

(Source: wits.worldbank.org 2018)

As per the statistics obtained in 2016, UK’s total export of goods and services worth around 411463 US $ million. Total number of exported items are 4501. UK’s export market has expanded to 230 nations. As against the export statistics the worth of import is 636368 million US $. Globally 226 nations export 4539 items to UK.

Figure 1: Top five export partners of UK

(Source: stat.wto.org 2018)

The top five export partners of UK are United States, Germany, France, Netherlands and Ireland. The largest share in the export market is capture by United States with the share being 34%. In terms of export share Germany, France, Netherland and Ireland followed United States.

Figure 2: Top five import partners of UK

(Source: stat.wto.org 2018)

Top five import partners of UK are Germany, China, United States, Netherlands and France. Among the top five nations, Germany has the largest share followed by China, United States, Netherland and France.

UK participates in international trade both in terms of visible and invisible trade. The visible trade implies trade of commodities or goods while invisible trade refers to trade of services.

Figure 3: Export and import volume in last few years

(Source: data.worldbank.org 2018)

The above figure shows the volume of export and import in UK in the last fifteen years. In every year, the export volume exceeds that of import volume. This implies the nation in the last few years export a larger volume of goods as compared to its import (Stay and Kulkarni 2016). However, an interesting trade pattern in obtained when export and imports are seen as a percentage of gross domestic product.

Figure 4: Export and import as percentage of GDP

(Source: data.worldbank.org 2018)

In terms of percentage share, import constitutes a larger percentage of GDP than export. This shows the importance of imported items in UK’s GDP. The nation often exports the same goods, which it imports. Thus. Import has a higher share in GDP than export.

Export composition of a country shows comparative advantage of a nation. The three major export categories of UK are Machinery and transport equipment, manufactured articles and Chemicals (Gibson and Thirlwall 2016). Export share of these three groups are 39.2 percent, 14.0 percent and 16.6 percent.  In the transport group, the country exports motor cars and motor vehicles. United States, Germany and Switzerland are the three main export destination having respective trade shares of 14.1 percent, 10.3 percent and 6.4 percent.

Export Composition of UK

Figure 5: Top exported goods in last three years

(Source: comtrade.un.org 2018)

The export of Motor cars has remained more or less same in the three years. The Gold export has declined recently.

The largest commodity group in the imported category is Machinery and transport equipment followed by miscellaneous manufactured article and Chemicals. The trade share in these three categories are 35.9%, 15.0% and 11.3% respectively. In the imported group Motor cars and motor vehicles holds the most important position. Top three import partners of UK are Germany, China and United States. The respective trade shares of these three nations are 14.4%, 9.5% and 8.5% percent respectively.

Figure 6: Top imported goods in UK in past three years

(Source: comtrade.un.org 2018)

The import of motor cars and motor vehicle remain same as like export. However, gold import in recent years has increased. This is due to decline in Gold production in UK as reflected from the falling export of gold.

The financial service sector is one of the key areas of comparative advantage for United Kingdom. There are several reasons that explains the comparative advantage of UK in financial service. There are several factors responsible for UK’s rising comparative advantage (Cobham, Janský and Meinzer 2015). In order to have comparative advantage in service sector countries need to have highly qualified labor force, efficient training program, strong English base and availability of capitals to support such programs. In UK, English is the native tongue (Gilbert and Muchová 2018). The labor force in UK has great academic base. The efficient labor-training program contributes to increasing skills of laborers. Moreover, the extensive levels of trading and steady flows of capital build the base for financial service in UK. The favorable condition for financial sectors makes UK an attractive place for institutional banks globally. The composition of service export in UK is given as follows.

Figure 7: UK’s service export with respective share

(Source: comtrade.un.org 2018)

The financial service constitutes the largest share in total service export with the share being 28%. After financial services, business services are in next important place. Travel and transport service constitutes 25% in total service export. The other groups of service exports are Insurance, Royalties and fees and others (Francois, Manchin and Tomberger 2015).

Figure 8: Share of trade in GDP

(Source: data.worldbank.org 2018)

As shown from the figure, trade in UK constitutes a significant share in GDP. In 2016, trade share in GDP was 58.03%.

Service Sector Export of UK

Figure 9: External balance in goods, service and in overall trade

(Source: wits.worldbank.org 2018)

For commodity trade, UK run with a negative trade balance. However, for the service sector the trade balance is positive. This supports the Ricardian theory of comparative advantage that shows when countries export goods in which it has a comparative advantage. In case of UK, the comparative advantage is in service sector (Sturmey 2017). Therefore, from the service sector UK gains a trade surplus.

Owing to heavy reliance on import, UK has liberalized all the import barriers. The import tariff in UK has declined gradually and remained flat around 1-2 percent.

Figure 10: Trend in tariff rate in UK

(Source: data.worldbank.org 2018)

Conclusion

The paper discusses trade in UK in reference to Ricrdian theory of comparative advantage. UK involves in trading goods and services across the world. UK has a comparative advantage in its service sector. The services that UK export worldwide include financial services, business services, travel and transport, Royalties and license, Insurance and others. The major trade partners of UK are United States, Germany, China, Netherland, France and Ireland. UK gains significantly from its service trade and enjoys a surplus. The country has followed a liberal trade policy with setting the tariff rate at a standard level. The external sector in UK plays an important role in UK economy with its considerable contribution in nation’s GDP.

Reference list 

Cobham, A., Janský, P. and Meinzer, M., 2015. The financial secrecy index: Shedding new light on the geography of secrecy. Economic geography, 91(3), pp.281-303.

Comtrade.un.org. (2018). UN Comtrade | International Trade Statistics Database. [online] Available at: https://comtrade.un.org/ [Accessed 8 Mar. 2018].

Data.worldbank.org. (2018). Exports of goods and services (% of GDP) | Data. [online] Available at: https://data.worldbank.org/indicator/NE.EXP.GNFS.ZS?locations=GB [Accessed 8 Mar. 2018].

Francois, J., Manchin, M. and Tomberger, P., 2015. Services linkages and the value added content of trade. The World Economy, 38(11), pp.1631-1649.

Gibson, H.D. and Thirlwall, A.P., 2016. Balance-of-payments theory and the United Kingdom experience. Springer.

Gilbert, J. and Muchová, E., 2018. Export competitiveness of Central and Eastern Europe since the enlargement of the EU. International Review of Economics & Finance.

Levchenko, A.A. and Zhang, J., 2016. The evolution of comparative advantage: Measurement and welfare implications. Journal of Monetary Economics, 78, pp.96-111.

Salvatore, D. ed., 2014. National Trade Policies. Elsevier.

Stat.wto.org. (2018). Trade Profiles. [online] Available at: https://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx?Country=GB&Language=S [Accessed 8 Mar. 2018].

Stay, K. and Kulkarni, K.G., 2016. The Gravity Model of International Trade, a Case Study: The United Kingdom and Her Trading Partners. Amity Global Business Review, 11.

Sturmey, S.G., 2017. British shipping and world competition. Oxford University Press.

Wits.worldbank.org. (2018). United Kingdom Trade Statistics | WITS. [online] Available at: https://wits.worldbank.org/CountryProfile/en/GBR [Accessed 8 Mar. 2018].