International Business_Chapter 4_International Trade Theory_Charles W. Hill

Chapter

International Trade

Theory

4

McGraw-Hill/Irwin

International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

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Trade theory-overview

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

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Trade theory-overview

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

A nation’s wealth depends on accumulated treasure

Gold and silver are the currency of trade

Theory says you should have a trade surplus.

Maximize export through subsidies.

Minimize imports through tariffs and quotas

Flaw: “zero-sum game”

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Mercantilism-zero-sum game

David Hume in 1752 pointed out that:

Increased exports leads to inflation and higher prices

Increased imports lead to lower prices

Result: Country A sells less because of high prices and Country B sells more because of lower prices

In the long run, no one can keep a trade surplus

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Theory of absolute advantage

Adam Smith: Wealth of Nations (1776) argued:

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

A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient

Trade between countries is, therefore, beneficial

Assumes there is an absolute balance among nations Example: Ghana/cocoa

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Theory of absolute advantage

Fig 4.1

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Absolute advantage and the gains from

trade

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Theory of comparative advantage

David Ricardo: Principles of Political Economy (1817).

Extends free trade argument

Efficiency of resource utilization leads to more productivity.

Should import even if country is more efficient in the product’s production than country from which it is buying.

Look to see how much more efficient. If only comparatively efficient, than import.

Makes better use of resources

Trade is a positive-sum game

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Theory of comparative advantage

Fig 4.2

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Comparative advantage and the gains

from trade

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Simple extensions of the Ricardian

model

Immobile resources:

Resources do not always move easily from one economic activity to another

Diminishing returns:

Diminishing returns to specialization suggests that after some point, the more units of a good the country produces, the greater the additional resources required to produce an additional item

Different goods use resources in different proportions

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Simple extensions of the Ricardian

model

Free trade (open economies):

Free trade might increase a country’s stock of

resources (as labor and capital arrives from

abroad)

Increase the efficiency of resource utilization

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PPF under diminishing returns

Fig 4.3

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Influence of free trade on PPF

Fig 4.4

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Heckscher (1919)-Olin (1933) Theory

Export goods that intensively use factor endowments which are locally abundant

Corollary: import goods made from locally scarce factors

Note: Factor endowments can be impacted by government policy - minimum wage

Patterns of trade are determined by differences in factor endowments - not productivity

Remember, focus on relative advantage, not absolute advantage

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Product life-cycle Theory- R.

Vernon,(1966)

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

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Product life cycle theory

Fig 4.5

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New trade theory

In industries with high fixed costs:

Specialization increases output, and the ability

to enhance economies of scale increases

learning effects are high. These are cost

savings that come from “learning by doing”

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New trade theory-applications

Typically, requires industries with high, fixed costs

World demand will support few competitors

Competitors may emerge because of “ First-mover advantage”

Economies of scale may preclude new entrants

Role of the government becomes significant

Some argue that it generates government intervention and strategic trade policy

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Theory of national competitive

advantage The theory attempts to analyze the reasons for

a nations success in a particular industry

Porter studied 100 industries in 10 nations

postulated determinants of competitive advantage of a nation were based on four major attributes

Factor endowments

Demand conditions

Related and supporting industries

Firm strategy, structure and rivalry

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Porter’s diamond

Success occurs where these attributes exist.

More/greater the attribute, the higher chance of success

The diamond is mutually reinforcing

Fig 4.6

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Factor endowments

Factor endowments:- A nation’s position in

factors of production such as skilled labor or

infrastructure necessary to compete in a given

industry

Basic factor endowments

Advanced factor endowments

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Basic factor endowments

Basic factors: Factors present in a country

Natural resources

Climate

Geographic location

Demographics

While basic factors can provide an initial

advantage they must be supported by

advanced factors to maintain success

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Advanced factors: Are the result of investment

by people, companies, government and are more

likely to lead to competitive advantage

If a country has no basic factors,

it must invest in

advanced factors

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communications

skilled labor

research

Technology

education

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Demand conditions

Demand:

creates capabilities

creates sophisticated

and demanding

consumers

Demand impacts quality

and innovation

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Related and supporting industries

Creates clusters of supporting industries that

are internationally competitive

Must also meet requirements of other parts

of the Diamond

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Firm Strategy, Structure and Rivalry

Long term corporate vision is a determinant of

success

Management ‘ideology’ and structure of the

firm can either help or hurt you

Presence of domestic rivalry improves a

company’s competitiveness

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Determinants of Competitive Advantage

in nations

Government

Company Strategy, Structure, and Rivalry

Demand Conditions

Related and Supporting

Industries

Factor Conditions

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Porter’s Theory-predictions

Porter’s theory should 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

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Implications for business

Location implications:

Disperse production activities to countries where they can be performed most efficiently

First-mover implications: Invest substantial financial resources in building

a first-mover, or early-mover advantage

Policy implications: Promoting free trade is in the best interests of the

home-country, not always in the best interests of the firm, even though, many firms promote open markets

International Business_Chapter 4_International Trade Theory_Charles W. Hill

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Transcript of International Business_Chapter 4_International Trade Theory_Charles W. Hill