Fourth Edition

1
International Business
Fourth Edition
2
CHAPTER 4

• International Trade Theory

3
Chapter Focus

• Explain why it is beneficial for a country to
  engage in international trade.

4
Chapter Focus

• Explain why it is beneficial for a country to
  engage in international trade.
• Explain the pattern of international trade
  observed in the world economy.

5

• 1st British African colony to win independence
  (1957).
• Nkrumah espoused pan African socialism.
• High tariffs.
• Anti export (trade) policy.

6

• Kept lowering tariffs on manufactured goods.
• Created incentives to export (trade).
• Reduced quotas.
• Reduced subsidies.
• 1950s 77 of employment in agriculture. Now 20.
• Manufacturing GNP went from 10 to over 30.

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The Impact of Trade Policies
4-6

• Ghana
• 1970
• GNP/capita
• 250
• 1992
• GNP/per capita
• 450
• GNP Growth/year
• 1.5
• Shift from productive uses (cocoa) to
  unproductive uses
  (subsistence agriculture).

• Korea
• 1970
• GNP/per capita
• 260
• 1992
• GNP/per capita
• 6790
• GNP Growth/year
• 9
• Shift from non-comparative advantage uses
  (agriculture) to productive uses (labor-intensive
  manufacturing).

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An Overview of Trade Theory
4-7

• Free Trade occurs when a government does not
  attempt to influence, through quotas or duties,
  what its citizens can buy from another country or
  what they can produce and sell to another country.

9
An Overview of Trade Theory
4-7

• Free Trade occurs when a government does not
  attempt to influence, through quotas or duties,
  what its citizens can buy from another country or
  what they can produce and sell to another
  country.
• The Benefits of Trade allow a country to
  specialize in the manufacture and export of
  products that can be produced most efficiently in
  that country.

10
An Overview of Trade Theory
4-7

• Free Trade occurs when a government does not
  attempt to influence, through quotas or duties,
  what its citizens can buy from another country or
  what they can produce and sell to another
  country.
• The Benefits of Trade allow a country to
  specialize in the manufacture and export of
  products that can be produced most efficiently in
  that country.
• The Pattern of International Trade displays
  patterns that are easy to understand (Saudi
  Arabia/oil or China/crawfish). Others are not so
  easy to understand (Japan and cars).

11
An Overview of Trade Theory
4-7

• Free Trade occurs when a government does not
  attempt to influence, through quotas or duties,
  what its citizens can buy from another country or
  what they can produce and sell to another
  country.
• The Benefits of Trade allow a country to
  specialize in the manufacture and export of
  products that can be produced most efficiently in
  that country.
• The Pattern of International Trade displays
  patterns that are easy to understand (Saudi
  Arabia/oil or China/crawfish). Others are not so
  easy to understand (Japan and cars).
• The history of Trade Theory and Government
  Involvement presents a mixed case for the role of
  government in promoting exports and limiting
  imports. Later theories appear to make a case
  for limited involvement.

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Mercantilism mid-16th century
4-8

• A nations wealth depends on accumulated treasure

13
Mercantilism mid-16th century
4-8

• A nations wealth depends on accumulated treasure
• Gold and silver are the currency
  of trade.

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Mercantilism mid-16th century
4-8

• A nations wealth depends on accumulated treasure
• Gold and silver are the currency
  of trade.
• Theory says you should have
  a trade surplus.

15
Mercantilism mid-16th century
4-8

• A nations wealth depends on accumulated treasure
• Gold and silver are the currency
  of trade.
• Theory says you should have
  a trade surplus.
• Maximize exports
  through subsidies.
• Minimize imports through tariffs
  and quotas.

16
Mercantilism mid-16th century
4-8

• A nations wealth depends on accumulated treasure
• Gold and silver are the currency
  of trade.
• Theory says you should have
  a trade surplus.
• Maximize exports
  through subsidies.
• Minimize imports through tariffs
  and quotas.
• Flaw zero-sum game.

17
Theory of Absolute AdvantageAdam Smith Wealth
of Nations (1776).
4-10

• Capability of one country to produce more of a
  product with the same amount of input than
  another country.

18
Theory of Absolute AdvantageAdam Smith Wealth
of Nations (1776).
4-10

• Capability of one country to produce more of a
  product with the same amount of input than
  another country.
• Produce only goods where you are most efficient,
  trade for those where you are not efficient.

19
Theory of Absolute AdvantageAdam Smith Wealth
of Nations (1776).
4-10

• Capability of one country to produce more of a
  product with the same amount of input than
  another country.
• Produce only goods where you are most efficient,
  trade for those where you are not efficient.
• Assumes there is an
  absolute advantage
  balance among nations, e.g., Ghana/cocoa.

20
The Theory of Absolute Advantage
Cocoa
Figure 4.1
Rice
21
The Theory of Absolute Advantage and the Gains
from Trade
Production and Consumption without Trade
S. Korea 2.5 10.0
Total production 20 20
S. Korea 6.0 14.0
Table 4.1
22
Theory of Comparative AdvantageDavid Ricardo
Principles of Political Economy (1817).
4-13

• Should trade even if country is more efficient in
  the production than its trading partner.

23
The Theory of Comparative Advantage
Figure 4.2
2.5
G
3.75
7.5
24
Comparative Advantage and the Gains from Trade
Table 4.2
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Extensions of the Ricardian Model
4-16

• Immobile resources
• Resources do not always move easily from one
  economic activity to another.
• Diminishing returns
• More a country produces, at some point, will
  require more resources (diminishing returns to
  specialization).
• Different goods use resources in different
  proportions.
• However
• Free trade might increase a countrys stock of
  resources (as labor and capital arrives from
  abroad), and
• Increase the efficiency of resource utilization.

26
Ghanas PPF under Diminishing Returns
Figure 4.3
27
The Influence of Free Trade on the PPF
Figure 4.4
28
A Link Between Trade and Growth
29
Heckscher (1919)-Olin (1933) Theory
4-20

• Labor is not the only Factor of production. We
  need to account for land, capital, and technology.

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Heckscher (1919)-Olin (1933) Theory
4-20

• Factor endowments extent to which a country is
  endowed with such resources as land, labor, and
  capital.

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Heckscher (1919)-Olin (1933) Theory
4-20

• Export goods that intensively use factor
  endowments which are locally abundant.

32
Heckscher (1919)-Olin (1933) Theory
4-20

• Export goods that intensively use factor
  endowments which are locally abundant.
• Corollary import goods made from locally scarce
  factors.

33
Heckscher (1919)-Olin (1933) Theory
4-20

• Patterns of trade are determined by differences
  in factor endowments - not productivity.
• Remember, focus on relative advantage, not
  absolute advantage.

34
The Leontief Paradox, 1953
4-21

• Disputes Heckscher-Olin in some instances.
• Factor endowments can be impacted by government
  policy - minimum wage.
• US tends to export labor-intensive products, but
  is regarded as a capital intensive country.

35
Product Life-Cycle Theory(Raymond Vernon, 1966)
4-23

• Article in the Quarterly Journal of Economics.
• As products mature, both location of sales and
  optimal production changes.
• Affects the direction and flow of imports and
  exports.
• Globalization and integration of the economy
  makes this theory less valid.

36
The Product Life-Cycle Theory
4-24
Exports
Figure 4.5
37
The New Trade Theory
4-25

• Began to be recognized in the 1970s.
• Deals with the returns on specialization where
  substantial economies of scale are present.
• Specialization increases output, ability to
  enhance economies of scale increase.
• In addition to economies of scale, learning
  effects also exist.
• Learning effects are cost savings that come from
  learning by doing.

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Application of the New Trade Theory
4-26

• Typically, requires industries with high, fixed
  costs.
• World demand will support few competitors.
• Competitors may emerge because they got there
  first.
• First-mover advantage.
• Some argue that it generates government
  intervention and strategic trade policy.

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First-Mover Advantage
4-27

• Economies of scale may preclude new entrants.
• Role of the government.

40
Porters Diamond(Harvard Business School, 1990)
4-28

• The Competitive Advantage of Nations.
• Looked at 100 industries in 10 nations.
• Thought existing theories didnt go far enough.
• Question Why does a nation achieve
  international success in a particular industry?

41
Determinants of National Competitive Advantage

• Factor endowmentsnations position in factors of
  production such as skilled labor or
  infrastructure necessary to compete in a given
  industry.

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Determinants of National Competitive Advantage

• Factor endowmentsnations position in factors of
  production such as skilled labor or
  infrastructure necessary to compete in a given
  industry.
• Demand conditionsthe nature of home demand for
  the industrys product or service.

43
Determinants of National Competitive Advantage

• Factor endowmentsnations position in factors of
  production such as skilled labor or
  infrastructure necessary to compete in a given
  industry.
• Demand conditionsthe nature of home demand for
  the industrys product or service.
• Related and supporting industriesthe presence or
  absence in a nation of supplier industries or
  related industries that are nationally
  competitive.

44
Determinants of National Competitive Advantage

• Factor endowmentsnations position in factors of
  production such as skilled labor or
  infrastructure necessary to compete in a given
  industry.
• Demand conditionsthe nature of home demand for
  the industrys product or service.
• Related and supporting industriesthe presence or
  absence in a nation of supplier industries or
  related industries that are nationally
  competitive.
• Firm strategy, structure and rivalrythe
  conditions in the nation governing how companies
  are created, organized, and managed and the
  nature of domestic rivalry.

45
Porters DiamondDeterminants of National
Competitive Advantage
4-30
Figure 4.6
46
The Diamond
4-31

• Success occurs where these attributes exist.
• More/greater the attribute, the higher chance of
  success.
• The diamond is mutually reinforcing.

47
Determinants of National Competitive Advantage
4-32
48
Factor Endowments
4-33

• Taken from Heckscher-Olin
• Basic factors
• natural resources
• climate
• location
• demographics
• Advanced factors
• communications
• skilled labor
• research
• technology

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Advanced Factor Endowments
4-34

• More likely to lead to competitive advantage.
• Are the result of investment by people,
  companies, government.

50
Relationship of Basic to Advanced Factors
4-35

• Basic can provide an initial advantage.
• Must be supported by advanced factors to maintain
  success.
• No basics, then must invest in advanced factors.

51
Demand Conditions
4-36

• Demand creates the capabilities.
• Look for sophisticated and demanding consumers.
• impacts quality and innovation.

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Related and Supporting Industries
4-37

• Creates clusters of supporting industries that
  are internationally competitive.
• Must also meet requirements of other parts of
  the Diamond.

53
Firm Strategy, Structure and Rivalry
4-38

• Management ideology can either help or hurt
  you.
• Presence of domestic rivalry improves a companys
  competitiveness.

54
Evaluating Porters Theory
4-39

• If Porter is right, we would expect his model to
  predict the pattern of international trade that
  we observe in the real world. Countries should be
  exporting products from those industries where
  all four components of the diamond are favorable,
  while importing in those areas where the
  components are not favorable.
• Too soon to tell.

55
Implications for Business

• Location implicationsmakes sense to disperse
  production activities to countries where they can
  be performed most efficiently.
• First-mover implicationsIt pays to invest
  substantial financial resources in building a
  first-mover, or early-mover, advantage.
• Policy implicationspromoting free trade is
  generally in the best interests of the
  home-country, although not always in the best
  interests of the firm. Even though, many firms
  promote open markets.