Session International Trade Theory. Topic Outline National Competitive Advantage Factor Proportions Mercantilism PLC Theory Strategic Trade Foreign Investment

Session

International Trade Theory

Topic Outline

National Competitive Advantage Factor Proportions Mercantilism PLC Theory Strategic Trade Foreign Investment

This Session Weekly Activity: Political Risk Discuss this potential dilemma: “High political risk requires organisations to

seek a quick payback on their investments. Striving for a quick payback, does have it’s dangers”.

Consider how this practice could expose businesses to charges of exploitation.

Could this result in increased political risk. Justify your argument with examples.

Word Count: 200 - 300

International Trade Theory

What is international trade? Exchange of raw materials and manufactured goods

(and services) across national borders Classical trade theories:

explain national economy conditions--country advantages--that enable such exchange to happen

New trade theories: explain links among natural country advantages,

government action, and industry characteristics that enable such exchange to happen

Implications for International Business

Evolution of Trade Theory

The Age of Mercantilism Classical Trade Theory Factor Proportions Trade

Theory International Investment and

Product Cycle Theory The New Trade Theory:

Strategic Trade The Theory of International

Investment

Trade Theories

classical trade theories - major theories typically studied consist of mercantilism, absolute advantage, and comparative advantage

modern trade theories - major theories typically studied consist of product life cycle, strategic trade, and national competitive advantage

Classic Trade Theory Contributions

Adam Smith—Division of Labor Industrial societies increase output using

same labor-hours as pre-industrial society David Ricardo—Comparative

Advantage Countries with no obvious reason for

trade can specialize in production, and trade for products they do not produce

Gains From Trade A nation can achieve consumption levels

beyond what it could produce by itself

Classical Trade Theories

Mercantilism (pre-16th century) Takes an us-versus-them view of trade Other country’s gain is our country’s loss

Free Trade theories Absolute Advantage (Adam Smith, 1776) Comparative Advantage (David Ricardo, 1817) Specialization of production and free flow of goods

benefit all trading partners’ economies

Free Trade refined Factor-proportions (Heckscher-Ohlin, 1919) International product life cycle (Ray Vernon, 1966)

Topic Example Video

The following video explains what is Mercantilism.

Take note of the key points. http://www.youtube.com/watch?

v=9W4e_rN15xA

Mercantilism

Mixed exchange through trade with accumulation of wealth

Conducted under authority of government

Demise of mercantilism inevitable

The Age of Mercantilism Between 1600 and 1800 most of Western Europe pursued a policy of mercantilism

What was mercantilism? Belief that exports should exceed imports

Bullionism – the belief that the economic health of a nation was measured by the amount of precious metals (gold and silver) it possessed

Colonialism – colonies were viewed as sources of raw materials

Heavy government control of trade, with the goals of trade being the goals of governments

Free Trade occurs when a government does not attempt to influence, through quotas or duties, what its citizens can buy from another country or what they can produce and sell to another country.

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

Trade Theory Overview


The Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country.

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The Pattern of International Trade displays patterns that are easy to understand (Saudi Arabia/oil or China/crawfish). Others are not so easy to understand (Japan and cars).

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The Pattern of International Trade displays patterns that are easy to understand (Saudi Arabia/oil or China/crawfish). Others are not so easy to understand (Japan and cars).

The history of Trade Theory and Government Involvement presents a mixed case for the role of government in promoting exports and limiting imports. Later theories appear to make a case for limited involvement.

4-7


Classical Trade Theory

The Theory of Absolute Advantage The ability of a country to produce a

product with fewer inputs than another country

The Theory of Comparative Advantage The notion that although a country may

produce both products more cheaply than another country, it is relatively better at producing one product than the other

Topic Example Video

The following video explains the difference between absolute and comparative advantage.

Take note of the key points http://www.youtube.com/watch?

v=Vvfzaq72wd0

Theory of Absolute Advantage

Absolute advantage Theory that a nation has absolute

advantage when it can produce a larger amount of a good or service for the same amount of inputs as can another country or

When it can produce the same amount of a good or service using fewer inputs than could another country

Capability of one country to produce more of a product with the same amount of input than another country.

Produce only goods where you are most efficient, trade for those where you are not efficient.

Assumes there is an absolute advantage balance among nations.

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Theory of Absolute Advantage

Absolute Advantage: Problems

What about a country (like the U.S.) that has an absolute advantage in most products?

How can it possibly produce enough of everything to satisfy the whole world? As production increased, competition for scarce inputs would drive up production costs, taking away many absolute advantages

What about a country (like Nepal) that has an absolute disadvantage in nearly all products?

Why should its resources sit around unused? As production fell, prices of inputs would fall, lowering production costs and creating some absolute advantages

Theory of Comparative Advantage

Comparative Advantage A nation having absolute disadvantages in

the production of two goods with respect to another nation has a comparative or relative advantage in the production of the good in which its absolute disadvantage is less

Comparative Advantage Example

More on Comparative Advantage

Even a country at an absolute disadvantage in everything will have a comparative advantage in something

Each country specializes in the production and export of what it does relatively well

Prices of goods and inputs in a free-market economy will adjust in order to lead to this outcome

More on Comparative Advantage

Countries rely on imports to meet consumer demands for goods in which they don’t have a comparative advantage

A country can achieve consumption levels beyond what it could achieve on its own

Government policy can alter free-market outcomes (import tariffs, import quotas, export subsidies, etc.)

Topic Example Video

The following video discusses what Adam Smith meant by the “invisible hand” in his book.


v=EBifN69gcKY

Immobile resources: Resources do not always move easily from one economic

activity to another. Diminishing returns:

More a country produces, at some point, will require more resources (diminishing returns to specialization).

Different goods use resources in different proportions. However:

Free trade might increase a country’s stock of resources (as labor and capital arrives from abroad), and

Increase the efficiency of resource utilization.

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Extensions of the Ricardian Model

Activity: Trade Statistics

Go to: www.dfat.gov.au/publications/ and go to the

“Trade Statistics” menu. Search for e-publications (pdf’s) on export

statistics from Australia relevent to your product group and potential import location.

What do these statistics tell you? What are the trends? Does it look favourable?

Discuss your options. Word count: 300 - 500 words

Factor Proportions Trade Theory

Developed by Eli HeckscherDeveloped by Eli Heckscher

Expanded by Bertil OhlinExpanded by Bertil Ohlin

Trade Theory Considerations

Labor

Capital

Factor Proportions Trade Theory

A country that is relatively abundant in a factor of production should export goods that use a lot of that factor in the production process, and import other goods

Example: a country like China with a lot of labor should export labor-intensive goods

Why? If a factor is relatively abundant, it will be relatively cheap, and a country will be more globally competitive in products that use a lot of that factor

Heckscher (1919)-Ohlin (1933)

Differences in factor endowments not on differences in productivity determine patterns of trade

Absolute amounts of factor endowments matter Leontief paradox:

US has relatively more abundant capital yet imports goods more capital intensive than those it exports

Explanation(?): US has special advantage on producing new products made

with innovative technologies These may be less capital intensive till they reach mass-

production state

Some Definitionsfactor endowments - extent to which different countries possess various factors, such as labor, land, and technology

resource mobility - assumption that a resourceremoved from one industry can be moved to another

Influences of Exchange Rate Currency devaluation

The lowering of a currency’s price in terms of other currencies

Can Money Change Trade?

Modern Trade Theories

product life cycle theory - economic theory that accounts for changes in the patterns of trade over time

strategic trade theory - theory that suggests thatstrategic intervention by governments in certain industries can enhance their odds for international success

first-mover advantages - Advantages that first entrants enjoy (economies of scale) and do not share with late entrants (barrier to entry creation)

strategic trade policy - Economic policies that provide companies a strategic advantage through governmentsubsidies

Topic Example Video

The following video explains how first mover advantage strategies are often a myth.


v=GChy_5NdPwk

Product Cycle Theory

Raymond Vernon

Focus on the product, not its factor proportions

Two technology-based premises

Topic Example Video

The following video explains product life cycle for organisations.


v=65nxKV5Ij7A

PLC Theory: Vernon’s Premises

Technical innovations leading to new and profitable products require large quantities of capital and skilled labor

The product and the methods for manufacture go through three stages of maturation, with competitive advantage shifting each time

Stages of the Product Cycle

The New Product•Flexible production•Innovator Monopoly•concentrationThe Maturing Product•Intl market & competition•More standardized productionThe Standardized Product•Low-margin cost-based production•Highly competitive

PLC & Trade Implications

Increased emphasis on technology’s impact on product cost

Explained international investment

Limitations Most appropriate for technology-based

products Some products not easily characterized by

stages of maturity Most relevant to products produced through

mass production

Activity: Industry Profile

Go to: www.austrade.gov.au and select

“industry” on the menu toolbar. Review the Australian Exporters Overview

to determine if there are any useful links or contacts.

On this page there should also be a menu profiling markets to this industry. Select a market and discuss it’s market potential.

Word count: 300 - 400 words

Strategic Trade

Can Government shift the balance in Imperfect

Competition?

PricePrice CostCost

RepetitionRepetition ExternalitiesExternalities

Modern Trade Theories

Theory of national competitive advantage of industries (or Porter’s diamond theory)The theory that the competitive advantage of certain industries in different nations depends on four aspects that form a “diamond”

Competitive advantage is created by technological and institutional change, not just inherited from a country’s natural endowments

Porter’s Diamond Theory

Topic Example Video

The following video is a speech by Dr Michael Porter on competitiveness.


v=k3mYMWcrsBc

Factor endowments land, labor, capital, workforce, infrastructure

(some factors can be created...) Demand conditions

large, sophisticated domestic consumer base: offers an innovation friendly environment and a testing ground

Related and supporting industries local suppliers cluster around producers and add to

innovation Firm strategy, structure, rivalry

competition good, national governments can create conditions which facilitate and nurture such conditions

National Competitive Advantage

GovernmentGovernment

Company Strategy,Structure,

and Rivalry

DemandConditions

Relatedand Supporting

Industries

FactorConditions

ChanceChance

Two external factors that influence the four determinants.


Success occurs where these attributes exist. More/greater the attribute, the higher chance of

success. The diamond is mutually reinforcing.

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Strategic Trade

Krugman’s Economics of Scale:

Internal Economies of ScaleInternal Economies of Scale

External Economies of ScaleExternal Economies of Scale

Topic Example Video

The following video is an interview with Paul Krugman on new trade theory.

Take note of the key points. http://www.youtube.com/watch?v=fb6-

PIM0NtQ

Overlapping Demand Theory

Linder Theory of Overlapping Demand

Customers’ tastes are strongly affected by income levels; therefore a nation’s income per capita level determines the kinds of goods they will demand

Overlapping Demand

Trade in manufactured goods dictated not by cost concerns, but by similarity in product demands across countries (overlapping product demands).

Work focused on preferences of consumer demand.

Today, product ranges termed market segments.

Next Session

Weekly Activity: Doing Business in Another Country Go to: http://www.worldbusinessculture.com Select the country you are thinking of exporting to and go

through each of the sections in “Doing Business” for that country:

background business structure management style meetings teams communication style women in business business dress code

Comment on your findings. Word Count: 300 - 400 words

Documents

Session International Trade Theory. Topic Outline National Competitive Advantage Factor Proportions Mercantilism PLC Theory Strategic Trade Foreign Investment