Chapter International Trade Theory 4. McGraw-Hill/Irwin International Business, 5/e © 2005 The...

Chapter

International Trade Theory

4

McGraw-Hill/IrwinInternational Business, 5/e

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

4-2

Case- The hollowing out of the U.S. based economy

Economic assumption: free trade produces gains for all participating countries

Recently, US economy indicate a movement of knowledge based jobs to developing economies.

Economists believe that: only routine skill jobs go overseas. Most managerial

and , marketing and R &D jobs retained in the country.

Lower price of services means consumer can consume more for less

Economic growth overseas will benefit the U.S.



4-3

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



4-4

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



4-5

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”



4-6

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



4-7

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



4-8

Theory of absolute advantage

Fig 4.1



4-9

Absolute advantage and the gains from trade



4-10

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



4-11

Theory of comparative advantage

Fig 4.2



4-12

Comparative advantage and the gains from trade



4-13

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



4-14

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



4-15

PPF under diminishing returns

Fig 4.3



4-16

Influence of free trade on PPF

Fig 4.4



4-17

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



4-18

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



4-19

Product life cycle theory

Fig 4.5



4-20

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”



4-21

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



4-22

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



4-23

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



4-24

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



4-25

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



4-26

Advanced factor endowments

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



4-27

Advanced factor endowments

communications skilled labor research Technology education



4-28

Demand conditions

Demand: creates capabilities creates sophisticated

and demanding consumers

Demand impacts quality and innovation



4-29

Related and supporting industries

Creates clusters of supporting industries that are internationally competitive

Must also meet requirements of other parts of the Diamond



4-30

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



4-31

Determinants of Competitive Advantage in nations

GovernmentGovernment

Company Strategy,Structure,

and Rivalry

DemandConditions

Relatedand Supporting

Industries

FactorConditions

ChanceChance

Two external factors that influence the four determinants.

Fig 4.8



4-32

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



4-33

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

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