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7/29/2017
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Copyright © 2017 Pearson Education, Inc.
International Business: The New Realities, 4th Edition
by
Cavusgil, Knight, and Riesenberger
Theories of International
Trade and Investment
5-1
Learning Objectives
5.1 Appreciate why nations trade.
5.2 Learn about how nations can enhance their
competitive advantage.
5.3 Understand why and how firms
internationalize.
5.4 Explain the strategies internationalizing firms
use to gain and sustain competitive
advantage.Copyright © 2017 Pearson Education, Inc.
5-2
Theories of International Trade and Investment
Copyright © 2017 Pearson Education, Inc. 5-3
Mercantilism and Neomercantilism
• Mercantilism: A belief popular in the 16th century
that national prosperity results from maximizing
exports and minimizing imports.
• Today, some argue for neomercantilism – the idea
that the nation should run a trade surplus.
• Supporters of neomercantilism include:
▪ Labor unions (who want to protect domestic jobs),
▪ Farmers (who want to keep crop prices high), and
▪ Some manufacturers (that rely on exports).
Copyright © 2017 Pearson Education, Inc. 5-4
Free Trade
• Free trade is usually best because it leads to:
▪ More and better choices for consumers and firms.
▪ Lower prices of goods for consumers and firms.
▪ Higher profits and better worker wages (because
imported input goods are usually cheaper).
▪ Higher living standards for consumers (because their
costs are lower).
▪ Greater prosperity in poor countries.
The absence of restrictions to the
flow of goods and services among nations.
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Comparative Advantage
• The foundation concept of international trade,
which answers the question of how nations can
achieve and sustain economic success and
prosperity.
• It refers to the superior features of a country that
provide it with unique benefits in global
competition.
• Comparative advantages are derived either from
natural endowments or from deliberate national
policies.
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Examples of National Comparative Advantage
• France has a climate and soil superior for producing
wine.
• Saudi Arabia has a natural abundance of oil, for the
production of petroleum products.
• Over time, Japan has acquired a superior base of
knowledge and experience for producing cars.
• Over time, India has acquired a superior base of IT
workers for producing computer software.
What are the comparative advantages in your country?
Copyright © 2017 Pearson Education, Inc. 5-7
Competitive Advantage
• A foundation concept that explains how individual
firms gain and maintain distinctive competencies,
relative to competitors, that lead to superior
performance.
• It refers to the distinctive assets, competencies, and
capabilities that are developed or acquired by the
firm.
• The collective competitive advantages held by the
firms in a nation are the basis for the competitive
advantages of the nation at large.
Copyright © 2017 Pearson Education, Inc. 5--8
Examples of Firm Competitive Advantage
• Dell’s prowess in the management of its global
supply chain.
• Samsung’s technological leadership in flat-panel
televisions.
• Cadbury’s capabilities in international
marketing and distribution.
• Herman Miller’s design strengths in
office furniture (e.g., Aeron chairs).
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Absolute Advantage Principle
A country should produce only those products in which
it has absolute advantage or can produce using fewer
resources than another country.
(Labor Cost in Days of Production for One Ton)
Copyright © 2017 Pearson Education, Inc. 5-10
Adam Smith (1723-1790)
Copyright © 2017 Pearson Education, Inc. 5-11
Source: creativehearts/123RF
Comparative Advantage Principle
It is beneficial for two countries to trade even if one has
absolute advantage in the production of all products; what
matters is not the absolute cost of production but the
relative efficiency with which it can produce the product.
(Labor Cost in Days of Production for One Ton)
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Comparative Advantage Principle (cont’d)
“Two men can make both shoes and hats, and one is superiorto the other in both employments, but in making hats he can only exceed his competitor by one fifth or 20 percent, and in making shoes he can excel him by one third or 33 percent; Will it not be for the interest of both that the superior man should employ himself exclusively in making shoes and theinferior man in making hats?” David Ricardo, 1817
Copyright © 2017 Pearson Education, Inc. 5-13
Comparative Advantage Principle (cont’d)
• While Germany can make both items cheaper than France,
it is still beneficial for Germany to trade with France.
• The key is the ratio of production costs. In the exhibit,
Germany is comparatively more efficient at producing cloth
than wheat: it can produce three times as much cloth as
France (30/10), but only two times as much wheat (40/20).
• Germany should specialize in producing cloth and import all
the wheat it needs from France. France should specialize in
producing wheat and import all its cloth from Germany.
• Each country benefits by specializing in the product in
which it has a comparative advantage and importing the
other product. Copyright © 2017 Pearson Education, Inc.
5-14
Comparative Advantage Principle (cont’d)
• The principle applies to all goods. It reveals how countries use scarce resources more efficiently.
Example:
• Arguably, no country is better than Japan at making
cars and cell phones. But because Japan is especially
good at making cars, it concentrates its resources on
making them.
• Other countries, such as China and Finland, focus on
making cell phones.
• In this way, Japan makes maximal use of its
resources, and the world gets great cars.
Copyright © 2017 Pearson Education, Inc. 5-15
Limitations of Early Trade Theories
• Fail to account for international transportation costs.
• Governments distort normal trade by selectively
imposing protectionism (e.g., tariffs) or investing in
certain industries (e.g., via subsidies).
• Services: Some cannot be traded; others can be
traded freely via the Internet or global telephony.
• For many firms, scale economies and superior
business strategies provide efficiencies and other
advantages. Early trade theories failed to account for
this. (e.g., Japan lacks comparative advantages, but
its firms succeeded anyway, via superior strategies.)
Copyright © 2017 Pearson Education, Inc. 5-16
Factor Proportions Theory
• Also known as Factor Endowments Theory. It argues
that each country should produce and export
products that intensively use relatively abundant
factors of production, and import goods that
intensively use relatively scarce factors of production.
Copyright © 2017 Pearson Education, Inc. 5-17
Factor Proportions Theory
• Also known as Factor Endowments Theory. It argues that
each country should produce and export products that
intensively use relatively abundant factors of production, and
import goods that intensively use relatively scarce factors of
production.
• However, the Leontief Paradox revealed that countries can
successfully export products that use less abundant
resources (e.g., the U.S. often exports labor-intensive
goods). Implies that international trade is complex and
cannot be fully explained by a single theory.
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5-18
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International Product Life Cycle Theory
Copyright © 2017 Pearson Education, Inc.
Source: Adapted from Raymond Vernon, “International Investment and International Trade in the Product Cycle,”
Quarterly Journal of Economics 80 May 1966), pp. 190–207 and http://www.provenmodels.com/583/international-product-
life-cycle/raymond-vernon. 5-19
International Product Life Cycle Theory
• Each product and its associated manufacturing
technologies go through three stages of
evolution: Introduction, maturity, and
standardization.
• In the introduction stage, the inventor country
enjoys a monopoly both in manufacturing and
exports. Example: The television set.
Copyright © 2017 Pearson Education, Inc. 5-20
International Product life Cycle Theory (cont’d)
• Each product and its associated manufacturing
technologies go through three stages of evolution:
Introduction, maturity, and standardization.
• In the maturity stage, the product’s manufacturing
becomes relatively standardized, other countries
start producing and exporting the product.
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• Each product and its associated manufacturing
technologies go through three stages of evolution:
introduction, maturity, and standardization.
• In the standardization stage, manufacturing ceases
in the original innovator country, and it becomes a
net importer of the product. Today under globali-
zation, for many products, the cycle occurs quickly.
International Product life Cycle Theory (cont’d)
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New Trade Theory
• Argues that economies of scale are an important
factor in some industries for superior international
performance, even in the absence superior
comparative advantages. Some industries succeed
best as their volume of production increases.
Example
The commercial aircraft industry has very high fixed
costs that necessitate high-volume sales to achieve
profitability.
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Comparative vs. Competitive Advantage
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Critical Role of Innovation
in National Economic Success
• Innovation is a key source of competitive advantage.
• The firm innovates in four major ways. It can
develop:
(1) A new product or improve an existing product.
(2) New ways of manufacturing.
(3) New ways of marketing.
(4) New ways of organizing company operations.
• Many innovative firms in a nation leads to national
competitive advantage Copyright © 2017 Pearson Education, Inc.
5-25
Critical Role of Productivityin National Economic Success
• Productivity is the value of the output produced by a
unit of labor or capital.
• It is a key source of competitive advantage for firms.
• The greater the productivity of the firm, the more
efficiently it uses its resources.
• The productive the firms in a nation, the more
efficiently the nation uses its resources.
• Aggregate productivity is a key determinant of the
nation’s standard of living.Copyright © 2017 Pearson Education, Inc.
5-26
Labor Productivity Levels in Selected Countries(Output per hour in manufacturing, 2005–2016; Index scale where 2010=100)
Copyright © 2017 Pearson Education, Inc.
Source: OECD, OECD Data: Productivity (Organisation for Economic Cooperation and Development, 2015),
https://data.oecd.org/lprdty/labour-productivity-forecast.htm#indicator-chart. 5-27
Michael Porter’s Diamond Model:
Sources of National Competitive Advantage
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Diamond ModelSources of National Competitive Advantage (cont’d)
• Factor conditions – Quality and quantity of labor,
natural resources, capital, technology, know-how,
entrepreneurship, and other factors of production.
Example
An abundance of cost-effective and well-educated
workers give China a competitive advantage in the
production of laptop computers.
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• Related and supporting industries – the
presence of suppliers, competitors, and
complementary firms that excel within a given
industry.
Diamond ModelSources of National Competitive Advantage (cont’d)
Example
The Silicon Valley in California is a great place to
launch a computer software firm, because it is home
to thousands of knowledgeable firms and workers in
the software industry.
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• Demand conditions at home – the strengths
and sophistication of customer demand.
Diamond ModelSources of National Competitive Advantage (cont’d)
ExampleJapan is a densely populated, hot, and humid countrywith very demanding consumers. These conditionsled Japan to become one of the leading producers ofsuperior, compact air conditioners
Copyright © 2017 Pearson Education, Inc. 5-31
• Firm strategy, structure, and rivalry – The nature of
domestic rivalry, and conditions that determine how a
nation’s firms are created, organized, and managed.
Diamond ModelSources of National Competitive Advantage (cont’d)
Example
Italy has many top firms in
design industries such as
textiles, furniture, lighting, and
fashion. Vigorous competitive
rivalry puts these firms under
constant pressure to innovate,
which has propelled Italy to a
leading position in design,
worldwide. Copyright © 2017 Pearson Education, Inc. 5-32
Industrial Cluster
• A concentration of suppliers and supporting firms
from the same industry located within the same
geographic area. Similar to Porter’s Related and
Supporting Industries.
• A strong cluster can serve as an export platform for
the nation.
Examples
Silicon Valley; pharmaceutical cluster in Switzerland;
footwear industry in Pusan, South Korea; IT industry in
Bangalore, India; fashion cluster in northern Italy; and
Silicon Valley North near Ottawa, Canada.
Copyright © 2017 Pearson Education, Inc. 5-33
National Industrial Policy
• A proactive economic development plan
employed by the government to nurture or
support promising industry sectors with potential
for regional or global dominance. Initiatives can
include:
▪ Tax incentives.
▪ Monetary and fiscal policies.
▪ Rigorous educational system.
▪ Investment in national infrastructure.
▪ Strong legal and regulatory systems.
Copyright © 2017 Pearson Education, Inc. 5-34
Examples of National Industrial Policy
• Vietnam’s government in the 1990s privatized state
enterprises and modernized the economy,
emphasizing competitive, export-driven industries.
Vietnam became one of the fastest-growing
economies, averaging around 8 percent annual GDP
growth.
• Singapore adopted probusiness, proinvestment,
export-oriented policies, combined with state-
directed investments in strategic corporations. The
approach stimulated economic growth that averaged
8 percent annually from 1960 to 1999.
Copyright © 2017 Pearson Education, Inc. 5-35
Examples of National Industrial Policy (cont’d)
• The Czech government in the 1990s created a
business-friendly legal and regulatory environment.
The country privatized state-owned companies.
Government FDI incentives attracted numerous
MNEs, such as Daewoo, ING, Siemens, and Toyota.
• New Zealand’s government, starting in 1984,
transformed the country from an agrarian,
protectionist, regulated economy to an industrialized,
free-market economy that today competes globally.
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New Zealand’s success resulted from:
• Implemented pro-business policies – fiscal, monetary,
tax; investment in education
• Emphasized high-value industries such as IT and
pharmaceuticals that greatly grew GDP and reduced
unemployment.
Transformation of New
Zealand’s Economy, 1992 to 2014
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New Zealand (cont’d)
• Government-controlled wages, prices, and interest rates
were freed, allowed to fluctuate as per market forces.
• The banking sector was liberalized, foreign exchange
controls were eliminated, and New Zealand dollar was
allowed to float according to market forces.
• Most trade barriers were removed and New Zealand
joined several free trade agreements.
• Agricultural and other subsidies were eliminated.
• The government worked earnestly with labor unions to
reduce wage inflation, helping maintain jobs in New
Zealand and not outsourced to lower-wage countries.
Copyright © 2017 Pearson Education, Inc. 5-38
New Zealand (cont’d)
• The government initiated programs to encourage
development of a knowledge economy. New Zealanders
continuously upgraded skills and knowledge, providing a
supply of scientists, engineers, and trained managers.
• Personal and corporate income tax rates were cut. Tax
base was diversified to stabilize government revenues.
This helped foster entrepreneurship, boosted consumer
spending, and attracted FDI into New Zealand.
• The government cut spending and borrowing, leading to
lower interest rates and stimulating the economy.
• State-owned enterprises – such as the national airline,
telecom, and other utilities – were privatized.Copyright © 2017 Pearson Education, Inc.
5-39
Stages in Company Internationalization
Experimental Involvement
Committed Involvement
Active Involvement
Pre-export Stage
Domestic Focus
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Stock and Growth of Inward FDI: Leading FDI
Destinations, 2003 to 2013 (Billions of U.S. dollars)
Copyright © 2017 Pearson Education, Inc.
Sources: UNCTAD, UNCTAD Stat 2014 (New York: United Nations, 2014), retrieved May 3, 2015, at http://unctad.org/
en/pages/Statistics.aspx. 5-41
Stock and Growth of Outward FDI: Top Sources
of FDI, 2003 to 2013 (Billions of U.S. dollars)
Copyright © 2017 Pearson Education, Inc.
Sources: UNCTAD, UNCTAD Stat 2014 (New York: United Nations, 2014), retrieved May 3, 2015, at http://unctad.org/en/
pages/Statistics.aspx. 5-42
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How Firms Gain and Sustain
International Competitive Advantage
• Since the MNE was traditionally the major player in
international business, scholars have offered
numerous explanations of what makes these firms
pursue, and succeed in, internationalization.
• Because FDI has been MNEs’ main strategy in
international expansion, theoretical explanations
have tended to emphasize it.
Copyright © 2017 Pearson Education, Inc.
5-43
FDI Based Explanations:
Monopolistic Advantage Theory
• Argues that MNEs prefer FDI because it provides
the firm with control over resources and capabilities
in the foreign market, and a degree of monopoly
power relative to foreign competitors.
• Key sources of monopolistic advantage include
proprietary knowledge, patents, unique know-how,
and sole ownership of other assets.
Example
Novartis earns substantial profits by marketing various
patent medications through its subsidiaries worldwide.
Copyright © 2017 Pearson Education, Inc. 5-44
FDI Based Explanations:
Internalization Theory
• Explains how the MNE chooses to acquire and retain
one or more value-chain activities inside itself.
• Such “internalization” provides the MNE with greater
control over its foreign operations.
• Internalization avoids the drawbacks of dealing with
external partners, such as reduced quality control
and the risk of losing proprietary assets to outsiders.
Example
In China, Intel owns much of its value chain, to ensure
that Intel knowledge, patents, and other assets are not
misused or illicitly obtained by potential rivals.Copyright © 2017 Pearson Education, Inc.
5-45
FDI Based Explanations:
Dunning’s Eclectic Paradigm
• Three conditions determine whether or not a
company will enter a given foreign country via FDI:
1.Ownership-specific advantages – knowledge, skills,
capabilities, relationships, or physical assets that the firm
owns and which are the basis of its competitive advantages.
2.Location-specific advantages – similar to comparative
advantages, they are specific advantages that exist in the
country that the MNE has entered, or is seeking to enter, such
as natural resources, low-cost labor, or skilled labor.
3.Internalization advantages – control derived from internalizing
foreign-based manufacturing, distribution, or other value chain
activities.
Copyright © 2017 Pearson Education, Inc. 5-46
Example of the Eclectic Paradigm: Sony in China
• Ownership specific advantages: Sony possesses a huge stock of knowledge and patents in the consumer electronics industry, as represented by products like the Playstation and Vaio laptop.
• Location specific advantages: Sony desires to manufacture in China, to take advantage of China’s low-cost, highly knowledgeable labor.
• Internalization advantages: Sony wants to maintain control over its knowledge, patents, manufacturing processes, and quality of its products.
Thus, Sony entered China via FDI
Copyright © 2017 Pearson Education, Inc. 5-47
Non-FDI Based Explanations:
International Collaborative Ventures
• A form of cooperation between two or more firms.
Partners pool resources and capabilities to create
synergies, and share the risk of joint efforts.
• Starting in the 1980s, firms increasingly began
using collaborative ventures to venture abroad.
• Collaboration provides access to foreign partners’
know-how, capital, distribution channels, or
marketing assets. Also helps overcome
government imposed obstacles.
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Two Types of
International Collaborative Ventures
• Equity-based joint ventures result in the formation of
a new legal entity. In contrast to the wholly-owned
FDI, the firm collaborates with local partner(s) to
reduce risk and commitment of capital.
• Project-based alliances do not require equity
commitment from the partners but simply a willingness
to cooperate in R&D, manufacturing, design, or any
other value-adding activity. Since project-based
alliances have a narrowly defined scope of activities
and timeline, they provide greater flexibility to the firm
than equity-based ventures.
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