Ch05_international Trade Theory by Daniels

8/6/2019 Ch05_international Trade Theory by Daniels

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2001 Prentice Hall 5-1

International BusinessbyDaniels and Radebaugh

Chapter 5

International TradeTheory


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ObjectivesTo explain trade theories

To discuss how global efficiency can be increased throughfree trade

To introduce prescriptions for altering trade patterns

To explore how business decisions influence internationaltrade


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Companies International Operations Link Countries Economically

OBJECTIVES

STRATEGY

MEANS OF OPERATING

Importing and exporting

goods and services (trade)

Transferring productionfactors, such as labor and

capital, internationally

Country BCountry A


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IntroductionTrade in goods and services is one means by which countries

are linked economicallyTypes of trade theories

Descriptivedeal with natural order of trade

examine and explain trade patterns under laissez-faire conditions

Prescriptiveconcerned with government interference inthe free movement of goods and services

considers governments affect on the amount,composition, and direction of trade

Both types of theories

provide insights about markets for exports andpotentially successful export products

help companies determine where to locateproduction facilities


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MercantilismFoundation of economic thought from 15001800

Intended to benefit colonial powers colonies supplied commodities to the mother country

mother country tried to run trade surpluses with theirown colonies

A countrys wealth determined by its holding of treasure,

usually gold Countries should export more than they import

favorable balance of trade

governments imposed restrictions on imports

governments subsidized many products that could

not otherwise compete in domestic or export markets Mercantilism faded after 1800

Neomercantilismattempt to achieve favorable trade balancesto achieve social or political objectives


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Absolute AdvantageAdam Smithdifferent countries produce some goods more

efficiently than other countries Free trade increases global efficiency

Each country will specialize in products that give it acompetitive advantage

labor becomes more skilled by repeating tasks

no time lost switching from production of one kind toproduction of another kind

long production runs provide incentives fordevelopment of more effective work methods

Natural advantagestems from climatic conditions,access to certain natural resources, or availability ofcertain labor forces

Acquired advantage based on technology and skilldevelopment

product technology

process technology


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Production Possibilities with Absolute Advantage

ASSUMPTIONS for Sri Lanka

1. 100 units of resources available2. 10 units to produce a ton of wheat

3. 4 units to produce a ton of tea

4. Uses half of total resources per product

when there is no foreign trade

ASSUMPTIONS for United States

1. 100 units of resources available2. 5 units to produce a ton of wheat




PRODUCTION Tea Wheat(tons) (tons)

Without Trade:

Sri Lanka (point A) 12.5 5

U.S. (point B) 2.5 10

Total 15.0 15

With Trade:Sri Lanka (point C) 25 0

U.S. (point D) 0 20

Total 25 20

U.S. production possibilities

10

Quantity of Wheat (tons)

0 5 15 20 25

5

10

15

20

25

Quantity

ofTea(to

ns)

A

B

C

D

Sri Lankan production possibilities


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Comparative AdvantageDavid Ricardogains from trade will occur even in a country

that has absolute advantage in all products because thecountry must give up less-efficient output to produce more-efficient output

Country should specialize in products it can make mostefficiently, even if other countries can make the productmore efficiently

Theory accepted by most economists

Theory is influential in promoting policies for freer trade


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Production Possibilities with Comparative Advantage

ASSUMPTIONS for Sri Lanka

1. 100 units of resources available

2. 10 units to produce a ton of wheat




PRODUCTION Tea Wheat(tons) (tons)

Without Trade:

Sri Lanka (point A) 5 5

U.S. (point B) 10 12.5

Total 15 17.5

With Trade (increasing

tea production):

Sri Lanka (point C) 10 0U.S. (point D) 6 17.5

Total 16 17.5

ASSUMPTIONS for United States

1. 100 units of resources available

2. 4 units to produce a ton of wheat




10Quantity of Wheat (tons)

0 5 15 20 25

5

10

15

20

25

QuantityofTea(to

ns)

C

DE

U.S. production possibilities

A

B

Sri Lankan production possibilities

With Trade (increasing

tea production):

Sri Lanka (point C) 10 0

U.S. (point E) 5 18.75

Total 15 18.75


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Assumptions and Limitations of Theories ofSpecialization

Both absolute and comparative advantage theories are basedon specialization

Countries should trade output based on their ownspecialization for the output from other countriesspecialization

Full employment not valid assumptionEconomic efficiency objectivecountries goals may not be

limited to economic efficiency

Division of gainsif trading partner is perceived to be gainingtoo large a share of benefits, other partner may forgoabsolute gains to prevent relative losses

Two countries, two commoditiesoriginal two-country, two-product logic applies to more complex situations

Transport costsmay negate advantages of trading

Size of economy and production scaleslonger productionruns, less production abroad


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Factor-Proportion TheoryEli Heckscher and Bertil Ohlinrelative factor costs lead

countries to excel in the production and export of productsthat used their abundant, and therefore cheaper, productionfactors

Land-labor relationshipin countries in which there are manypeople relative to the amount of land, land price is very highbecause its in demand

Land costs and technology dictate what types ofindustries choose to locate in a country

Labor-capital relationship production factors, especially labor,are not as homogeneous as assumed

Labor skills vary within and among countries due to

differences in training and education led to international specialization by task to produce

a given product

Technological complexitiesthe same product can be producedby different methods (labor or capital)


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Product Life Cycle Theory of Trade (PLC)Raymond Vernonthe production location for many products

moves from one country to another depending on the stagein the products life cycle

Stage 1: Introduction

Innovation, production, and sales in same country

new products developed in response to nearbyobserved need and markets for them

early production occurs in domestic location

Location and importance of technology

most new technology that results in new productsand production methods originates in industrialcountries

Exports and labor

export small part of production

production process likely to be labor intensive

capital machinery for large-scale production developslater in industrialized countries


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Product Life Cycle Theory of Trade (cont.)Stage 2: Growth

Increases in exports by the innovating country More competition

Increased capital intensity

growing sales offer incentives to companies todevelop process technology

Some foreign productionStage 3: Maturity

Decline in exports from the innovating country

More product standardization

More capital intensity

Increased competitiveness of price Production start-ups in emerging countries

Stage 4: Decline

Production increased in emerging economies

Innovating country becoming net importer


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Product Life Cycle Theory of Trade (cont.)Verification and limitations of plc theory

High transportation costs limit export opportunities,regardless of the life cycle stage

Shifts in production site do not change for many types ofproducts

innovating country maintains its export ability

throughout the life cycle products with very short life cycles

luxury products for which cost is not a concernfor the consumer

products used to promote differentiation strategy

products requiring specialized technical labor toevolve

MNEs increasingly introduce new products at home andabroad simultaneously


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Country-Similarity TheoryEconomic similarity of industrial countries

Most of the worlds trade occurs among countries thathave similar characteristics

country similarity theoryonce a company hasdeveloped a new product to serve needs in a localmarket, it will turn to markets it sees as most similarto those at home

most trade takes place among industrial countriesbecause:

growing importance of acquired advantage asopposed to natural advantage

markets in industrial countries can support

products and their variations importance of industrial markets due to their size

incomes are high and people buy more

Few emerging countries trade with each other


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World Trade by Major Product Category as

Percentage of Total World Trade for Selected Years

1980 1990 199

8

100

80

60

40

20

0

Percent a

ge

53.9

27.7

14.7

3.7

70.7

14.2

12.3

2.8

62.8

7.9

8.6

20.7

Commercial services

Manufactured products

Mining products

Agricultural products


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Country-Similarity Theory (cont.)Similarity of location

Distances among countries accounts for many worldtrade relationships

Methods to overcome distance disadvantages are difficultto maintain

Cultural similarity

Importers and exporters find it easier to do business in acountry perceived as being similar

Historic colonial relationships explain much ofinternational trade

Similarity of political and economic interests

Political relationships and economic agreements amongcountries may discourage or encourage trade betweenthem or their companies

Military conflicts disrupt trade patterns

Political animosity may interfere with trading channels


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Degree of DependenceIndependencecomplete economic independence

Country has no reliance on other countries for goods,services, or technologies

Price of independence is having to do without goods thatcannot be produced domestically

Hinders countrys ability to borrow and adapt existing

technologiesInterdependence trade based on mutual need

Neither trading partner is likely to cut off supplies ormarkets for fear of retaliation

Governments may be pressured to sustain trade

Dependencedeveloping countries rely heavily on:

The sale of one commodity for export earnings

25 % of emerging countries sell one commodity

One country as supplier or customer

Industrialized countries


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Strategic Trade PolicyGovernmental role and influence in affecting the acquired

advantage of production within their borders Alter conditions for industries in general

change conditions that affect factor proportions,efficiency, and innovation

Target conditions for a specific industry

typically results in no more than small payoffs hard to identify and target appropriate industries

too many countries identify the same industry,leading to excessive competition

relative conditions change, causing relativecapabilities to change as well

have been a few notable government successes intargeting a specific industry


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The Porter DiamondIndicates four important conditions for competitive superiority

Demand conditionsobservation of need or demand usually in home country

production started near the observed market

Factor conditions availability and terms for acquiringthem

Related and supporting industriesexistence ofinfrastructure

Firm strategy, structure, and rivalry

influenced by other three conditions

Existence of the four favorable conditions does not guaranteethat an industry will develop in a locale

Absence of one of the four conditions from a country may notinhibit companies from becoming globally competitive


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Determinants of Global Competitive Advantage:

The Porter Diamond

Demand

Conditions

Factor

Conditions

Related and

Supporting

Industries

Firm Strategy,

Structure, and

Rivalry


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Companies Role in TradeMost trade theories based on a national perspective

Decisions to trade are usually made by companiesStrategic advantages of exports

Use of excess capacitycompanies leverage theircompetencies by using them abroad

Cost reduction

experience curve effectcost reductions stemmingfrom increased output

Freater profitabilitymay have higher profit margins inforeign markets

Risk spreadingcounterbalance business cycles indifferent countries

Strategic advantages of imports

Procurement of supplies abroad may lower costs

Foreign products complement existing products

Reduces dependence on single suppliers

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Ch05_international Trade Theory by Daniels