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Chapter Six

International Trade and Factor Mobility Theory

International Business Part Three

Theories and Institutions: Trade and Investment

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Chapter Objectives

• To understand theories of international trade• To explain how global efficiency can be

improved through free trade• To identify factors affecting national trade

patterns• To explain why a country’s export capabilities

are dynamic• To understand why production factors• To explain the relationship between foreign trade

and international factor mobility

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International Operations and Economic Connections

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Laissez-Faire versus Interventionist Approaches to Exports & Imports

• Interventionist: Mercantilism Neomercantilism

• Free-trade theories: Absolute advantage Comparative advantage

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Theories of Trade Patterns

• Explaining trade patterns: Country size Factor proportions Country similarity

• Trade competitiveness: Product life cycle theory Porter diamond

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What the major trade theories Do and Don’t discuss

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Mercantilist Theory

Mercantilist theory proposed that a country should try to achieve a favorable balance of trade (export more than it imports)

Neomercantilist policy also seeks a favorable balance of trade, but its purpose is to achieve some social or political objective

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Theory of Absolute Advantage

• Suggests specialization through free trade because consumers will be better off if they can buy foreign-made products that are priced more cheaply than domestic ones

• A country may produce goods more efficiently because of a natural advantage or because of an acquired advantage

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Theory of Comparative Advantage

• Also proposes specialization through free trade because it says that total global output can increase even if one country has an absolute advantage in the production of all products

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Theories of Specialization

• Both absolute and comparative advantage theories are based on specialization

• Assumptions policymakers question: full employment economic efficiency division of gains transport costs statics and dynamics services production networks mobility

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Trade Pattern Theories

• How much a country will depend on trade if it follows a free trade policy

• What types of products countries will export and import

• With which partners countries will primarily trade

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Theory Of Country Size

• Countries with large land areas are apt to have varied climates and natural resources

• They are generally more self-sufficient than smaller countries are

• Large countries’ production and market centers are more likely to be located at a greater distance from other countries, raising the transport costs of foreign trade

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Factor-Proportions Theory   

• A country’s relative endowments of land, labor, and capital will determine the relative costs of these factors

• Factor costs will determine which goods the country can produce most efficiently

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Worldwide trade of major manufactured goods

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Country-similarity Theory

• Most trade today occurs among high-income countries because they share similar market segments and because they produce and consume so much more than emerging economies

• Much of the pattern of two-way trading partners may be explained by cultural similarity between the countries, political and economic agreements, and by the distance between them

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Product Life Cycle (PLC) Theory

• Companies will manufacture products first in the countries in which they were researched and developed, almost always developed countries

• Over the product’s life cycle, production will shift to foreign locations, especially to developing economies as the product reaches the stages of maturity and decline

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Life Cycle of the International Product

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The Porter Diamond

• Four conditions as important for competitive superiority: demand conditions factor conditions related and supporting industries firm strategy, structure, and rivalry

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Limitations of the Porter Diamond Theory

• Production factors and finished goods are only partially mobile internationally

• The cost and feasibility of transferring production factors rather than exporting finished goods internationally will determine which alternative is better

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The Relationshipbetween Trade and Factor Mobility

• Capital and labor move internationally to gain more income and flee adverse political situations

• Although international mobility of production factors may be a substitute for trade, the mobility may stimulate trade through sales of components, equipment, and complementary products