International Trade Theories & FDI

Mercantilism:

Mercantilism is an economic theory, considered to be a form of economic nationalism that holds that the prosperity of a nation is dependent upon its supply of capital, and that the global volume of international trade is "unchangeable". Economic assets (or capital) are represented by bullion (gold, silver, and trade value) held by the state, which is best increased through a positive balance of trade with other nations (exports minus imports).

Absolute Advantage:

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. Countries should produce those goods in which they have absolute advantage.

Comparative Advantage:

The law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party. It is the ability to produce a product most efficiently given all the other products that could be produced. “Abilities are compared and if other countries are efficient in production of some goods you should not produce that rather switch to other product.” Assume that no difference in currency value and factor of production are movable.

Heckscher-Ohlin Theorem:

The Heckscher–Ohlin theorem says "A capital-abundant country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good."

Product Life-Cycle Theory:

The product life-cycle theory suggests 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.

New Trade Theory:

New Trade Theory (NTT) is a collection of economic models in international trade which focuses on the role of increasing economies of scale and network effects (words of mouth).

Michael Porter Diamond Model:

The Diamond model of Michael Porter for the Competitive Advantage of Nations offers a model that can help understand the competitive position of a nation in global competition. This model can also be used for other major geographic regions.

These interlinked advanced factors for Competitive Advantage for countries or regions in Porters Diamond framework are:

1. Firm Strategy, Structure and RivalryThe world is dominated by dynamic conditions, and it is direct competition that impels firms to work for increases in productivity and innovation

2. Demand ConditionsThe more demanding the customers in an economy, the greater the pressure facing firms to constantly improve their competitiveness via innovative products, through high quality, etc)

3. Related Supporting IndustriesSpatial proximity of upstream or downstream industries facilitates the exchange of information and promotes a continuous exchange of ideas and innovations

4. Factor ConditionsContrary to conventional wisdom, Porter argues that the "key" factors of production (or specialized factors) are created, not inherited. Specialized factors of production are skilled labor, capital and infrastructure.

Factor Endowment: It is commonly understood as the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing.

Instruments of Trade Policy:

1) Tariffs2) Subsidies3) Import Quotas & voluntary export restraints4) Local content requirement5) Administrative policies6) Anti-dumping policies

Foreign Direct Investment

Foreign Direct Investment (FDI) refers to long term participation by country A into country B. It usually involves participation in management, joint-venture, transfer of technology and "know-how". There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow.

Types of FDI:

Horizontal FDI is FDI in the same industry abroad as that in which a firm operates at home.

Vertical FDI is FDI in associated industries in the chain of vertical integration.

Factors for FDI:

1) Transportation Cost2) Market Imperfection3) Strategic Behavior4) Product Life Cycle5) Location Advantage

Radical View: MNEs are coming to just extract the profits from the host country and they won’t return anything. Keep the developing or under-developed countries as they are.

Free Market View: MNEs should produce in other countries to balance the production.

Pragmatic Nationalism: There are some benefits & cost for both counties.