Chapter 02

International Trade and Investment

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Volume of International Trade

• All Global exports exceeded $19.5 trillion in 2008.

• The dollar volume of world exports is greater than the GNP of every nation in the world except the U.S.

• 25% of everything made or grown world-wide is exported.

• 70% of developed nations exports go to industrialized nations, not to developing countries.

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Relevance of Major Trading Partners

for Managers1. Business climate favorable2. Export and import regulations not

insurmountable3. No strong cultural objections4. Transportation facilities5. Import channel members experienced6. Foreign exchange available7. Government may apply pressure

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Explaining Trade: International Trade Theories

Mercantilism – an economic philosophy states that:1. “A nation’s wealth depends on

accumulated treasure, usually gold, and

2. To increase wealth, government policies should promote exports and discourage imports.”

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Explaining Trade: International Trade TheoriesTheory of Absolute Advantage

Country “A” has ABSOLUTE ADVANTAGE when it can produce a larger amount of goods or services for the same amount of inputs as country “B” or when “A” can product the same amount using fewer inputs than “B.”

Example:

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Theory of Absolute Advantage

• Country Specialization:

• Terms of Trade (Ratio of International Prices)

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Theory of Comparative AdvantageCountry “A” has a absolute DISADVANTAGE in production of 2 goods in respect to country “B” who has a comparative or relative advantage in the production of the good in which its absolute disadvantage is less. Example:

Country Specialization:

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Theory of Comparative Advantage

• Terms of TradeTerms will settle between pre-trade price ratios by mutual agreement between countries

Example:

The Gains from Specialization of Trade in this case are 1 bolt of cloth for the U.S. and China and +/-1 ton of soybeans for China.

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The Importance of Understanding Currency

Exchange RatesExchange rates determine if it is better to by buy locally or import.– The exchange rate is the price of one currency stated in

terms of another country. – Example: If the prevailing rate is 1$ = 8 yuan, the yuan

is worth 0.125 USD:

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Newer Explanations for the Direction of Trade

• Differences in Resource Endowments

• Overlapping Demand

• National Competitive Advantage from Regional Clusters

• Differences in Resource Endowments

• Overlapping Demand

• National Competitive Advantage from Regional Clusters

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Michael Porter’s Diamond Model of National Advantage

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Summary of International Trade Theory

• International trade occurs because of:– Price differences – Production cost differences, resulting in:

1. Differences in the endowments of the factors of production

2. Differences in the levels of technology that determine the factor intensities used

3. Differences in the efficiencies with which factor intensities are utilized

4. Foreign exchange rates

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Foreign Direct Investment (FDI)

• Annual Outflow of FDI– The amount invested annually into other

nations was $1.2 trillion in 2000– Global economic decline resulted in outflow

fluctuations• Decline $647 billion in 2002• Increase to $2.1 trillion in 2007• Decline to $1.9 trillion in 2008

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Outward FDI Results from Growth of Global Mergers and Acquisitions.

The opportunities to buy existing foreign companies is growing, because:1. U.S corporate restructuring = saleable assets

2. Foreigners want rapid access to advanced U.S. technology

3. Easier U.S. market with established U.S. brands

4. Increasing global competition = restructuring & consolidation = saleable foreign assets

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Annual Inflows of FDI• Where does FDI

go?• Where does FDI

go?– 70% to developed

countries– Down to 57%, 2008– Regional fluctuations

exist; must be studied before FDI made

• Where does FDI go?

• Where does FDI go?– 70% to developed

countries– Down to 57%, 2008– Regional fluctuations

exist; must be studied before FDI made

• Where does FDI come from?– Impossible to value,

but, if a country or region’s FDI is increasing:

• The investment climate must be good

• Political forces are attractive for FDI

• Profit potential is greater than in other areas

• Other reasons for investment exist

• Where does FDI come from?– Impossible to value,

but, if a country or region’s FDI is increasing:

• The investment climate must be good

• Political forces are attractive for FDI

• Profit potential is greater than in other areas

• Other reasons for investment exist

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Factors Influencing a Nation’s Export Performance

• External Factors– Market access

conditions:• Transportation costs• Geography• Physical

infrastructure• Trade barriers• Competition• Other demand-

influencing factors

• External Factors– Market access

conditions:• Transportation costs• Geography• Physical

infrastructure• Trade barriers• Competition• Other demand-

influencing factors

• Internal Factors– Internal supply

conditions:• Raw materials• Labor costs• Capital costs• Access to technology• Economic policy• Institutional

environment• Limited access to

foreign markets

• Internal Factors– Internal supply

conditions:• Raw materials• Labor costs• Capital costs• Access to technology• Economic policy• Institutional

environment• Limited access to

foreign markets

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Does FDI Lead to Trade?• Yes, because of these changes in

today’s global business environment:– Fewer government trade barriers – Increasing global competition– New production technologies– New communications technologies– Greater integration of the global supply chain

and production– A growing focus to identify global business

opportunities

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Explaining FDI: Theories of International Investment

Monopolistic Advantage TheoryFDI is made by firms in oligopolistic industries possessing

technical and other advantages over indigenous firms.

Internationalization TheoryTo obtain a higher ROI, a firm will transfer its superior

knowledge to a foreign subsidiary rather than sell it in the open market.

Monopolistic Advantage TheoryFDI is made by firms in oligopolistic industries possessing

technical and other advantages over indigenous firms.

Internationalization TheoryTo obtain a higher ROI, a firm will transfer its superior

knowledge to a foreign subsidiary rather than sell it in the open market.

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Explaining FDI:

Theory of Dynamic CapabilitiesDynamic capabilities from knowledge or resources must be created and transferred to foreign markets to create competitive advantage.

Eclectic Theory of International ProductionFor a firm to invest overseas, it must have 3 kinds of advantages: ownership specific, location specific, and internationalization. Sometimes referred as the OLI Model

Theory of Dynamic CapabilitiesDynamic capabilities from knowledge or resources must be created and transferred to foreign markets to create competitive advantage.

Eclectic Theory of International ProductionFor a firm to invest overseas, it must have 3 kinds of advantages: ownership specific, location specific, and internationalization. Sometimes referred as the OLI Model

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