International Business

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International Business
International Business 10e Daniels/Radebaugh/Sulli
van

• Chapter Five
• International Trade Theory

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2004 Prentice Hall, Inc
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Rewrite requirements and opportunities

• If you get C or less you can rewrite for extra
  credit
• Final grade will be average of the old and new
  grades
• If you get D or less you must rewrite
• People with B-, B can also rewrite, but will get
  less extra credit

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Daewoo
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Todays Objectives

• Explain key trade theories
• Discuss how global efficiency can be increased
  through free trade
• Understand how and why the World Trade
  Organization promotes (relatively) free trade
• Understand the ways governments affect trade

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Why have economists believed in free
laissez-faire trade? (free trade)

• Laissez-faire means to leave alone (in
  French)

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Laissez faire is the opposite of mercantilism

• Mercantilism dates from when large nation-states
  were just emerging in Europe (1500-1800)
• the oldest trade theory we will study
• It said the goal of trade is to increase a
  countrys treasure, especially holdings of gold

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• Under mercantilism, nations often imposed
  restrictions on imports
• They did not want their treasure moving to
  another country to pay for the imports
• Leaders also sought to run a trade surplus with
  their nations colonies

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Mercantilism Terminology

• Favorable balance of trade country is exporting
  more than it is importing
• Unfavorable balance of trade country is
  importing more than it is exporting, i.e. a trade
  deficit
• Neomercantilism the approach of countries in
  recent years that have tried to run favorable
  balances of trade to achieve some social or
  political gains

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In the 18th century, economists challenged
mercantilism

• Why compete to pile up treasure?
• Every individual seeks the most advantageous
  employment for his capital.
• Study of his own advantage necessarily leads him
  to prefer that employment most advantageous to
  society - Adam Smith, 1776

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Natural Advantage

• Countries have inherent advantages
• Climate
• Natural resources
• Labor forces
• Two countries that have opposite natural
  advantages should favor trade with one another
• England Wool cloth
• Portugal Wine

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Acquired Advantage

• Most contemporary trade is manufactured goods and
  services
• Countries with acquired advantage produce
  manufactured goods and services competitively
• Product technology
• Process technology

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Absolute Trade Advantage
Figure 5.2
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There may also be long-term benefits to free trade

• As people specialize and seek higher incomes,
  they may learn to do their specialties more
  efficiently

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Comparative Advantage

• Suppose one country is more efficient than
  another in everything?
• There are still global gains to be made if a
  country specializes in products it produces more
  efficiently than other products

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When there is no trade
Time required in each country to produce 1 ton of
each good
Maximum production in 100 hours of work for each
country without trade
Tea
20 tons
U.S.
12.5 tons
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Sri Lanka
25 tons
2.5
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Wheat
5 tons
3.0
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• Your country has comparative advantage in the
  product or service where the ratio Cost in
  your country . Cost in the other countryis
  lowest

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How Comparative Advantage works
U.S. has absolute advantage in both tea and
wheat, but its comparative advantage is in wheat.
Sri Lanka has comparative advantage in tea.
Let Sri Lanka specialize in tea U.S. expands
wheat production to replace all Sri Lankan wheat
production lost
Tea
200 tons
U.S.
125 tons
The U.S. can replace all Sri Lankas wheat
production and the combined countries have 181
tons of tea instead of 105 tons with no trade.
56 tons
Sri Lanka
250 tons
180 tons
50 tons
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Basic Assumptions

• The argument for letting free trade work isnt
  perfect. It assumes
• Full employment
• Mobility of workers and resources to new jobs
• Acceptable division of gains
• Transportation costs dont absorb all the gains
• Economic efficiency is the key goal

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Country similarity theory

• While basic trade theory describes trade between
  very different countries, much trade occurs
  between very similar rich countries
• U.S. and Canada
• Germany and France
• When companies develop products, they often seek
  markets in countries similar to the home market

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Conclusion Economies can gain enormously from
trade

• Basic comparative advantage means they produce
  more of what theyre good at
• Competition causes people to improve how well
  they work
• Some nations/firms become good in things others
  cant produce at all

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Categories of World Trade
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Free trade means trade with no barriers

• Most economists believe in completely free trade
  (laissez-faire)
• They argue that any restriction on trade reduces
  efficiency
• People are not doing what they are best at
• Businesses spend energy fighting for favors from
  government rather than improving their
  performance

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Some basic free-market economics

• Two fundamental principles
• The price for which sellers are willing to sell a
  product indicates what all the resources to
  produce and market it are worth.
• The price for which buyers will buy indicates
  what the product is worth to the buyer
• So economists think anything that manipulates
  prices is dangerous

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• Economists prefer income taxes or sales taxes (on
  everything) rather than tariffs (on particular
  imports)
• For any given amount of revenue raised, income
  and sales taxes disrupt the market less than
  tariffs
• Most economists only make exception for tariffs
  to protect infant industries industries that
  lack comparative advantage, but could develop it
  soon

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In the 19th century, free trade was widely
practiced

• In Europe, tariffs were low or non-existent
• But after WW I and especially in the early 1930s,
  nations raised tariffs to protect their domestic
  economies
• A disastrous depression followed that lasted
  through most of the 1930s

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General Agreement on Tariffs and Trade (GATT)

• Formed in 1947 by 23 countries to abolish quotas
  and reduce tariffs
• Laid the foundation to liberalize world trade
• Required members to open markets equally to every
  other member
• However, it could not enforce compliance
• The World Trade Organization replaced GATT in 1995

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GATT was created to prevent the mistakes of the
30s from repeating

• It provided a framework for negotiating
  reductions in tariffs and non-tariff barriers
• The World Trade Organization
• continued the process and
• provided an enforcement mechanism to prevent new
  barriers

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World Trade Organization (WTO)

• 140 current members (90 of trade)
• Adopted the principles and trade agreements of
  GATT
• Expanded to cover trade in
• Services
• Investment
• Intellectual property
• Governments bring charges of unfair trade
  practices to the WTO
• WTO rulings are binding

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The WTO often allows poorer countries to keep
more barriers

• They are believed to have more infant
  industries
• They often have less efficient government
  officials, have difficulty collecting income or
  sales tax
• So their governments may rely on tariffs for
  revenue

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Strategic Trade Policy

• Governments sometimes target industries where
  they think they can succeed
• In rich nations, this often fails
• If the industry were good, private investors
  would invest in it
• In poor nations, there is often no alternative to
  targeting a few industries
• Few local investors
• Infrastructure (road-building, etc.) must focus
  on something

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Dependence

• Many developing countries depend heavily on one
  primary commodity and a few foreign markets
• Sri Lanka tea to the U.S. and U.K.
• Columbia coffee to the U.S.
• Ghana chocolate
• Commodity prices often change rapidly

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Absolute Advantage

• Absolute advantage holds that different countries
  produce some goods more efficiently than others
• Thus, global efficiency can be increased through
  international free trade

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Country Specialization

• Absolute advantage theory says countries can
  increase efficiency by specializing
• Labor can become more skilled by repeating the
  same tasks
• Labor would not lose time switching from the
  production of one kind of product to another
• Long production runs encourage finding more
  effective work methods