International Business Management - Lecture No 08

Lecture No: 08

Course Facilitator: Khurshid Alam Swati

University of Swat, Swat Email your query to:

[email protected]

Economic Structure & Trade Theories

Economic Structure

The main source of income in a town or city (National) it is used to determine the growth rate of a cities economy (National)

The economic structure of an economy is a function of the sum of all the different economic activities in the geo-political boundaries of that area

The major features of a country or region's economy, including what and how much it produces and trades, and how it spends its income

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Pakistan Economic Structure

Pakistan was an agrarian economy in which a small number of powerful landowners with large holdings dominated the countryside

West Pakistan forced farmers to rely on the extensive irrigation system developed by the British

Indus water disputes

Pakistan had almost no industry in 1947


Pakistan Economic Structure (Cont’d)

Energy sources were rudimentary, with wood and animal dung furnishing the bulk of the energy consumed. Ports, transportation, and other services, such as banking and government, were underdeveloped

Despite formidable problems, Pakistan achieved rapid economic expansion. From FY 1951 to FY 1986, the GDP growth rate measured at a constant FY 1960 factor averaged 5.2 percent.



Floods in 1992

A substantial industrial base was added as industry (including mining, manufacturing, and utilities) became the fastest growing sector of the economy

Industry's share of GDP rose from 8 percent in FY 1950 to 21.7 percent in FY 1993

Various services (including construction, trade, transportation and communications, and other services) accounted for the rest of GDP.



The economy of Pakistan is the 26th largest in the world in terms of purchasing power parity (PPP),

A population of over 183 million (the world's 6th-largest)

Pakistan ranks as the 15th largest trader of goods in the world

While it is the worlds 6th largest trader of services

Major industries includes textiles (garments, bed linen, cotton cloth, yarn), chemicals, food processing (mainly sugar, salt, wheat, rice, fruit), agriculture, fertilizer, cement, dairy and rugs



Pakistan's economic progress has been impeded by internal disputes and its long confrontation with India within the country for many years. The country's decades-long battle with India over territorial disputes had choked up large military spending, resulting in huge nation debt burden.

Pakistan's weak economy also depends heavily on foreign donors, such as the World Trade Organization, IMF, World Bank, and countries like the US. For instance, the US have reduced Pakistan's bilateral debts by 1 billion in 2003, and a further 500 million in 2004. Pakistan also receives US$2.11 billion in aid from its ally countries


International Trade Theories

1. Mercantilism

2. Absolute advantage (Classical)

3. Comparative advantage

4. Factor Proportions Trade

5. International Product Cycle

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1. Mercantilism: Mid-16th Century

Mercantilism is a philosophy from about 300 years ago

The base of this theory was the “commercial revolution”, the transition from local economies to national economies, from feudalism to capitalism, from a rudimentary trade to a larger international trade

The theory states that the world only contained a fixed amount of wealth and that to increase a country wealth; one country had to take some wealth from another, either through having a higher import/export ratio.

This tendency, to export more and import less and to receive in exchange gold (the deficit is paid in gold) is called mercantilism

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Mercantilism (Cont’d)

Trade theory holding that nations should accumulate financial wealth, usually in the form of gold (forget things like living standards or human development) by encouraging exports and discouraging imports

Their policy was to export in the countries that they controlled and not to import (to have a positive Balance of Trade)

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

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2.Theory of Absolute Advantage

The principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources - labor as the only input

Adam Smith (1776) argued:

Capability of one country to produce more of a product with the same amount of input than another country – Done through Management

A country should produce only goods where it is most efficient, and trade for those goods where inefficient

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Theory of Absolute Advantage (Cont’d)

Adam Smith’s theory starts with the idea that export is profitable if you can import goods that could satisfy better the necessities of consumers instead of producing them on the internal market

Trade between countries is, therefore, beneficial

One country would have an absolute advantage over the other if it can produce same amount of goods with fewer resources

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3.Theory of Comparative Advantage

Refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another

Extends free trade argument

Makes better use of resources

Trade is a positive-sum game

Abundant, low-cost labor in China

Mass of IT workers in India

Oil in Saudi Arabia

Abundant agricultural land in Pakistan

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Limitations of Early Trade Theories

Do not take into account the cost of international transportation Tariffs and import restrictions can distort trade flows Scale economies can bring about additional efficiencies When governments selectively target certain industries for strategic investment, this may cause trade patterns contrary to theoretical explanations Today, countries can access needed low-cost capital in global markets

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4. Factor Proportions Theory Countries produce and export those goods that

require resources (factors) that are abundant (and thus cheapest) and import those goods that require resources that are in short supply Pakistan - ????

Export goods that intensively use factor endowments which are locally abundant Import goods made from locally scarce factors and exports goods that are abundant Patterns of trade are determined by differences in factor endowments - not productivity

Examples: China and labor

USA and pharmaceuticals

Canada and electric power


5. Product life-Cycle Theory

The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin

In some situations, the product becomes an item that is imported by its original country of invention A commonly used example of this is the invention, growth and production of the personal computer with respect to the United States

A company will begin by exporting its product and later undertake foreign direct investment as the product moves through its lifecycle

Affects the direction and flow of imports and exports

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International Business Management - Lecture No 08

Business

Transcript of International Business Management - Lecture No 08