Theories of International Trade and International Investment

By:Dewa Ayu Kartika Venska

Dwi PardiantoZakky Zamrudi

Chapter Outline

- International Trade in general and its Importance- Mercantilism- Theory of Absolut Advantage- Theory of Comparative Advantage- The Heckschers-Ohlin Model- The product Life cycle theory of trade- Contemporary trade theories- Porter’s diamond

International Trade in general and its Importance

country countryculture Political

Socialcommerce

International Trade in general and its Importance

commerce

background:- Cost production- Increases the welfare

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Mercantilism

• Economic cultural philosophy at 16th-17th century (economic state building)

• The mercantilist is an expert in mercantilism• involve governmental intervention in economic

life• Self sufficiency• wealth which they believe is measured by the

amount of gold bullions• Extend power and prestige of countryInte

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Mercantilism

• How???– Tax exemptions– Loans– Subsidies– Building a network of overseas colonies– Forbidding colonies to trade with other

nations– And other form of state regulation

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• Another mercantilism form (Austria-Prusia)– Cameralism– Developed at central Europe

• How???– Encouragement towards new industry– Immigrant openness (economic capabilities)– Model farm– Taxation reformationIn

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Mercantilism

Mercantilism

• The rivalries was the colonialism

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A B C

Mother country

A B C

Mother country

goods Raw materialgoods

Mercantilism

• Critics towards mercantilism– Vincent de Gournay (1712–1759): “laissez

faire, laissez passer,” whichmay be freely translated as “leave things alone, let goods pass.”

– David Hume (1711–1776)—who proved that bullionism was self-defeating because it was necessarily inflationary

– Adam Smith (1723–1790), Wealth of Nations

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Theory of Absolut Advantage(Adam smith)

• “An Inquiry into the Nature and Causes of the Wealth of Nations”

• factors that led to increased wealth in a community• recognizing the parallel contribution of the

manufacturing industry

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Theory of Absolut Advantage(Adam smith)

• Problems that found:1. Labor skill2. Proportion of productive to unproductive labor

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“People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public, or on some contrivance to raise prices.”

Theory of Absolut Advantage(David Ricardo )

• a country can produce some goods more efficiently than other countries– Based on the fact that advantage is:• Natural (climate)• Acquired (technology)

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Theory of Comparative Advantage(David Ricardo )

• Comparative advantage refers to a country’s ability to produce a particular good with a lower opportunity cost than another country.

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Theory of Comparative Advantage(David Ricardo )

Spain Italy

80= 1 olive oil90= 1 shoes

If Spain want to produce shoes80/90= 0.889 gain

120= 1 olive oil100= 1 shoes

If Italy want to foster shoes120/100= 1.2 gain

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The Heckscher-Ohlin

Proportions Factor : 1920

Eli Heckscher and Bertil Ohlin

Nobel Prize in Economics in 1977.

International Trade

Capitalist Economy

GovernmentSocialist Economy

Individual and BusinessPhysical Capital

Productive Capital

Most Economy Today

Productivity Capital : GovernmentMost Of the Capital : Private Citizens

International Trade

H-O Models

Ratio of the quantity of capital to the quantity of labor in process as the capital-

labor ratio

H-O theorem predicts: The pattern of trade between countries based on the characteristics of the countries

International Trade

Distinction between

H-O

production technologies are the same

Ricardian

Production technologies differ between countries

International Trade

Main Result

Overall, the H-O factor proportions theory of comparative advantage states that international commerce compensates for the uneven geographic distribution of productive resources (land, labor, and capital) factors are abundant to locations where they are scarce

International Trade

Raymond Vernon and the Product Life

Cycle

Concept

Advanced countries, which have the ability and the competence to innovate besides having high-income

levels, and engage in mass consumption become initial exporters of goods. However, they lose their

exports initially to developing countries and subsequently to less developed countries and eventually become importers of these goods.

International Trade

Louis Wells identifies these four phases

• 1. United States exports strength• 2. Foreign production starts• 3. Foreign production becomes

competitive in export markets• 4. Import competition begins.

International Trade

Product Cycle

In the introductory stage of a product’s life, sales are typically slow and profits negative. In the growth stage, both sales and profits rise at a rapid rate. During maturity, sales volume may continue to rise at a declining rate and profit may stay high. In the decline state, both sales and profit decrease.

International Trade

The product cycle hypothesis

Does not refer to the willingness to buy, which is a function of culture. Culture influences greatly the willingness to buy through changes in values, norms, attitudes, business customs, and practices

International Trade

product life cycle andIPLC

• Product Life Cycle: to rejuvenation or rebirth in international markets of a product that is in decline domestically for market-related reasons or is close to extinction

• IPLC: essentially circular and from the product life cycle concept with its numerous variations. . The sequential stages are introduction, growth, maturity, decline, and extinction in the international markets

International Trade

Porter’s Diamond of National Advantage

• Michael Porter (1990),20 a Harvard business professor, believes that standard classical theories on comparative advantage are inadequate.

• According to Porter, a nation attains a competitive advantage if its firms are competitive.

Porter’s Diamond

Four Keys Elements

• Factor conditions (i.e., the nation’s position in factors of production, such as skilled labor and infrastructure)

• Demand conditions (i.e., sophisticated customers in home market)

• Related and supporting industries (i.e., the importance of clustering)

• Firm strategy, structure, and rivalry (i.e., conditions for organization of companies, and the nature of domestic rivalry).

Factor condition

• Factor conditions refer to inputs used as factors of production—such as labor, land, natural resources, capital, and infrastructure.

Demand Conditions

• Porter states that a sophisticated domestic market is an important element in producing competitiveness.

Related and Supporting Industries

• Porter continues with his theory by stating that a set of strongly related and supporting industries is important for firms to be competitive.

Avantages• Potential technology

knowledge spillovers.• An association of a region on

the part of consumers with a product and high quality and therefore some market power.

• An association of a region on the part of applicable labor force.

Disavantages• Potential poaching of your

employees by rival companies.

• Obvious increase in competition possibly decreasing markups.

Firm Strategy, Structure, and Rivalry

1. Strategy Capital markets Individual’s Career Choises2. Structure3. Rivalry

The Diamond as a System

• When there is a large industry presence in an area.

• Upstream firms• Downstream firms• Attracted by the good set of specific factors

Implications for GovernmentsGovernments can influence all four of Porter’s determinants

through a variety of actions such as:• subsidies to firms, either directly (money) or indirectly

(through infrastructure)• tax codes applicable to corporation, business, or property

ownership• educational policies that affect the skill level of workers• establishment of technical standards and product standards,

including environmental regulations• government’s purchase of goods and services• antitrust regulation.

Porter has emphasized the role of chance in the model. Random events can either benefit or harm a firm’s competitive position

• major technological breakthroughs or inventions• political decisions by foreign governments• acts of war and destruction• dramatic shifts in exchange rates• sudden price shocks affecting input goods (such as the oil price

shock in the early 1970s)• sudden surges or drops in world demand or sudden shifts in

consumer preferences.

1. It focuses too strongly on developed economies.2. The government’s role can be both positive and negative. 3. Chance is difficult to predict. Situations can change very quickly and unexpectedly.4. Porter says that firms, not countries, compete in international markets.5. Porter describes four distinct stages of national competitive development:

• Factor-driven (e.g., Singapore)• Investment-driven (e.g., Korea)• Innovation-driven (e.g., Japan, Italy, Sweden)• Wealth-driven (e.g., Great Britain, with the United States and Germany somewhere between innovation-driven and wealthdriven), which is characterized by decline.

6. Porter argues that only outward foreign direct investment (FDI) is valuable in creating competitive advantage and inbound FDI does not increase domestic competition significantly because the domestic firms lack the capability to defend their own markets and face a process of market share erosion and decline.

7. Porter contends that reliance on natural resources alone is insufficient.8. The Porter model does not adequately address the role of MNCs.

Closing Case

• Question: What issues of international trade are addressed in this case? What international trade theories are implied?

1. Have big resources2. The factors of big resources is coffe its easy to

plant and have long lifetime in everywhere.3. Five traders domination to make

comproming the price

• Porters diamond theory

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