New trade theories New trade theories

Lecture 8Lecture 8

Modern Firm-Based Trade Modern Firm-Based Trade TheoriesTheories

•Product Life Cycle TheoryProduct Life Cycle Theory

•New trade theoryNew trade theory

•Porter’s National Competitive Porter’s National Competitive AdvantageAdvantage

PRODUCT LIFE CYCLE THEORYPRODUCT LIFE CYCLE THEORY

• Raymond Vernon 1966Raymond Vernon 1966

Vernon’s Product Life Cycle Theory differs from previous trade theories because it puts less emphasis on comparative cost doctrine and moreupon the timing of innovationthe effects of scale economiesthe roles of ignorance and uncertaintyin influencing trade patterns

• Product Life Cycle Theory of Trade Product Life Cycle Theory of Trade (PLC) Raymond Vernon—The (PLC) Raymond Vernon—The production location for many production location for many products moves from one country to products moves from one country to another depending on the stage in another depending on the stage in the product’s life cycle.the product’s life cycle.

4 stages in a product life cycle4 stages in a product life cycle• 1. INTRODUCTION1. INTRODUCTION• 2. GROWTH2. GROWTH• 3.MATURITY3.MATURITY• 4 DECLINE4 DECLINE

Product life cycle theoryProduct life cycle theory

Stage in product life cycleStage in product life cycleStage 1: Introduction : Innovation of a Stage 1: Introduction : Innovation of a

product with some exportsproduct with some exports

Stage 2 Growth: Production in innovating Stage 2 Growth: Production in innovating country and other industrial countries due country and other industrial countries due to increase in sales, more competition.to increase in sales, more competition.

Stage 3 Maturity- product standardization Stage 3 Maturity- product standardization Production in multiple countriesProduction in multiple countries

Stage 4 Decline –Production in developing Stage 4 Decline –Production in developing countries, Innovating country becoming countries, Innovating country becoming net importer. net importer.

New trade theoryNew trade theory• In 1980s Paul krugmanIn 1980s Paul krugman

• It stress that in some cases countries specialize in It stress that in some cases countries specialize in production and export of particular product not production and export of particular product not because of difference in factor endowments but because of difference in factor endowments but because in certain industries world market can because in certain industries world market can support only limited number of industries.support only limited number of industries.

• Specialization due toSpecialization due to

• Economies of scale Economies of scale

• First movers advantage: chemical industry, First movers advantage: chemical industry, computer software, tire industry.computer software, tire industry.

• Learning effects-comes by learning by doing, Learning effects-comes by learning by doing, learns by repetition.learns by repetition.

Example :commercial aerospace dominated Example :commercial aerospace dominated by two firms: Boeing and airbusby two firms: Boeing and airbus

• Boeing spends $5 billion to Boeing spends $5 billion to develop its Boeing 777.develop its Boeing 777.

• If Boeing makes 199 If Boeing makes 199 Boeing 777 then fixed cost Boeing 777 then fixed cost =$5billion/100=$50 million=$5billion/100=$50 million

• Variable cost per aircraft-Variable cost per aircraft-$80 million$80 million

• Total cost of each aircraft-Total cost of each aircraft-$50 million+$50 million+$80million=$130 million$80million=$130 million

• If it makes 500 aircraft:If it makes 500 aircraft:

• Total cost=$90 millionTotal cost=$90 million

MICHAEL PORTER…Originator of the MICHAEL PORTER…Originator of the THEORY OF NATIONAL COMPETITIVE THEORY OF NATIONAL COMPETITIVE ADVANTAGEADVANTAGE

• Michael Porter’sMichael Porter’s Theory of National Theory of National Competitive Competitive Advantage/Advantage/Porter’s Porter’s DiamondDiamond published in published in 1990 was based on a 1990 was based on a study of 100 firms in study of 100 firms in 10 developed nations10 developed nations

• PorterPorter questions how questions how Switzerland and Japan Switzerland and Japan could become success could become success stories without stories without assumed prerequisites.assumed prerequisites.

Determinants of Determinants of National Competitive AdvantageNational Competitive Advantage

GovernmentGovernment

Company Strategy,Structure,

and Rivalry

DemandConditions

Relatedand Supporting

Industries

FactorConditions

ChanceChance

Two external factors that influence the four determinants.

4-32

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Factor endowments can be divided into two parts:1)Basic factors-• Natural resources• climate,• Location• Demographics2)Advanced factors-• Communication• Infrastructure• Skilled labor• Research facilities• Technological know-how Advanced factors are product of investment by individuals.

Companies, government

FactorFactor conditions conditions

DemandDemand condition conditionss

These include :1. The size and growth rate of the home demand;2. The ways through which domestic demand is

internationalized and pulls a nation’s products and services abroad.

FirmFirm strategy, structure, and strategy, structure, and rivalryrivalry

These include:1. Different nations are chartericed by different management

idelogies2. The ways in which firms are managed and choose to

compete;3. The goals that companies seek to attain as well as the

motivations of their employees and managers;4. The amount of domestic rivalry and the creation and

persistence of competitive advantage in the respective industry .

Related and supporting Related and supporting industriesindustries

These include:

1. The presence of internationally competitive supplier industries that create advantages in downstream industries through efficient , early , or rapid access to cost-effective inputs.

2. Internationally competitive related industries that can coordinate and share activities in the value chain when competing or those that involve complementary products.

The role of The role of chancechanceChance events can nullify the advantages of some competitors and bring about a shift in overall competitive position because of developments such as:

1. new inventions and innovations

2. significant shifts in world financial markets or exchange rates;3. discontinuities in input costs such as oil shocks

The role of The role of governmentgovernment Government can i nfluence all 4 of the major determinants through actions such as:

1. SUBSIDIES2. EDUCATION POLICIES;3. THE REGULATION OR DEREGULATION OF CAPITAL MARKETS;4. THE ESTABLISHMENT OF LOCAL PRODUCT STANDARDS AND REGULATIONS;5. THE PURCHASE OF GOODS AND SERVICE;6. TAX LAWS;7. ANTITRUST REGULATION.

Question Question

• WHICH THEORIES OF WHICH THEORIES OF INTERNATIONAL TRADE PREDICTS INTERNATIONAL TRADE PREDICTS THE RISE OF INDIAN SOFTWARE THE RISE OF INDIAN SOFTWARE INDUSTRIES?INDUSTRIES?

Implications for BusinessImplications for Business• Location implications:Location implications:makes sense to disperse makes sense to disperse

production activities to countries where they can production activities to countries where they can be performed most efficiently.be performed most efficiently.

• First-mover implications:First-mover implications:It pays to invest It pays to invest substantial financial resources in building a first-substantial financial resources in building a first-mover, or early-mover, advantage.mover, or early-mover, advantage.

• Policy implications:Policy implications:promoting free trade is promoting free trade is generally in the best interests of the home-generally in the best interests of the home-country, although not always in the best country, although not always in the best

interests of the firm. Eveninterests of the firm. Even though, many though, many firms promote open marketsfirms promote open markets..