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07/05/2014
1
Topic 2
International
Trade Theories
INTERNATIONAL BUSINESS ENVIRONMENT
2
WHY STUDY INTERNATIONAL TRADE THEORIES?
International Business Environment – JG DITTER
Common knowledge base forAcademics – Managers – Policy-makers
Helps understand business internationalisation drivers
(why – where – how)Legitimates the role of business in society and policy-
makers' decisions
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International Business Environment – JG DITTER 3
KEY INTERNATIONAL TRADE THEORIES
Traditional (country-based) theoriesAbsolute advantage
Comparative advantage
Factor proportion
Eclectic theoriesNational competitiveness diamond
Internalisation theory
Eclectic (OLI) paradigm
(Neo-) Mercantilism
Modern (firm-based) theoriesVernon's product life-cycle
New trade theory
Country similarity, Country size, gravity model
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MERCANTILISM
Original XVII th century mercantilists, such as John Law, a Scots financier, believed that a country's economic prosperity and political power came from its stocks of precious metals.
To maximise these stocks they argued against free trade, favouring protectionist policies designed to minimise imports and maximise exports, creating a trade surplus that could be used to acquire more precious metal
http://www. econom i st .com/res ea rc h/Eco nom ics/a l pha be t ic .c fm? le tte r
=M#mercant i l is m
International Business Environment – JG DITTER 407/05/2014
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3
VARIOUS FORMS OF MERCANTILISM
International Business Environment – JG DITTER 5
Bullionism(gold
accumulation)
Colbertism(import
substitution)
Commercialism(export
promotion)
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MERCANTILISM TODAY
International Business Environment – JG DITTER 6
Neo-mercantilism is a term used to describe a policy regime which encourages exports, discourages imports, controls capital movement
and centralises currency decisions in the hands of a central government
The objectives of neo-mercantilist policies are to:
(1) Increase the level of foreign currency deposits and bonds held by central banks and monetary authorities (foreign exchange reserves)
(2) Support growth in GDP and employment at home.
Adapted from: http://www.project-syndicate.org/print/mercantilism-reconsidered
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ECONOMICS OF NEO-MERCANTILISM
International Business Environment – JG DITTER 707/05/2014
National income accounts
Y = C + I + G + EX – IM
A country running a trade surplus earns more income from exports
than it spends on imports
Balance of payments
Current account + (financial account) = 0
A country running a trade surplus is a creditor to the world and can
increase its reserve assets
Net foreign wealth is increasing
AN ASIAN MODEL?
International Business Environment – JG DITTER 8
The growth champions of the past few decades – Japan in the 1950s and 1960s, South Korea from the 1960s to the 1980s, and China
since the early 1980s – have all had activist governments collaborating closely with large business. All aggressively promoted investment and exports while discouraging (or remaining agnostic
about) imports.
China's pursuit of a high-saving, large-trade-surplus economy in recent years embodies mercantilist teachings.
http://www.europeanceo.com/news/commentaries//article672.html
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International Business Environment – JG DITTER 9
THE CHINESE CASE
2011, Md USD
PPPY C I G X M
CHN 11300 3902 5490 1484 3230 2938
USA 14991 10729 2236 2594 2094 2662
X-M C/Y I/Y G/Y X+M/2Y
CHN 292 0,35 0,49 0,13 0,27
USA -568 0,72 0,15 0,17 0,16
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07/05/2014 International Business Environment – JG DITTER 10
GOVERNMENT-BUSINESS ISSUES
Business organisations must take into account governments' involvement in supporting exports and
limiting imports
Microeconomic policiesIndustrial policy – Education and
infrastructure – Public procurement –Market regulation
Macroenomic policiesFiscal – Monetary policiesForeign exchange policy
Trade policyExport promotion – Import restriction
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07/05/2014 International Business Environment – JG DITTER 11
FOOD FOR THOUGHT …
"Hymns to export are only stupidity and lies.
They assume not to be aware of the futility of any distinction
between domestic and international trade."
Jacques Rueff, L'Ordre Social, 1981
MERCANTILISM DEFICIENCIES
International Business Environment – JG DITTER 12
"Beggar-thy-neighbour" strategy …
Carried-out at the expense of trade partners, likely to turn into
trade war
Generating imbalances between creditors and debtors, likely to
result in economic crisis
Leading to global depression if applied by all players
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Promotes exports and savings at the expense of domestic demand /
living standards
Renders the domestic economy dependent on trade partners' business
cycle
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07/05/2014 International Business Environment – JG DITTER 13
MERCANTILISM DEFICIENCIES (REMINDER)
Y = C + I + G + X – M
→ X – M = Y – (C + G + I)→ X – M = (Y – (C + G)) – I
X – M = S – I
X > M ↔ S > I
C: Household consumption G: Government spendingI: Business investment EX: ExportsS: Savings IM: ImportsT: taxes
Germany is sometimes called a mercantil ist country (see below). Please explain and discuss.
The text argues that Germany's trade surplus is a problem for the Eurozone ... and Germany itself. Please explain and discuss.
07/05/2014 International Business Environment – JG DITTER 14
ASSIGNMENT – GERMANY
"Euro membership has encouraged Germany into a costly mercantilist strategy at the expense of its people and the productivity of the economy".
Martin Wolf, Financial Timeshttp://www.ft.com/intl/cms/s/0/1e2f2cd0-064e-11e2-bd29-00144feabdc0.html#axzz2znVp8kP7
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FOOD FOR THOUGHT …
International Business Environment – JG DITTER 16
"An international economics course should drive home to
students the point that international trade is not about
competition, it is about mutually beneficial exchange.
Even more fundamentally, we should be able to teach
students that imports, not exports, are the purpose of
trade. That is, what a country gains from trade is the
ability to import what it wants.
Exports are not an objective in and of themselves: the
need to export is a burden that the country must bear
because its import suppliers are crass enough to
demand payment".
Paul KRUGMAN, Pop Internationalism
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ABSOLUTE / COMPARATIVE ADVANTAGE
International Business Environment – JG DITTER 1707/05/2014
Absolute advantage refers to the ability of a person or a country to produce a particular good at a lower absolute cost than another.
Comparative advantage refers to the ability of a country to produce a particular good at a lower marginal or opportunity cost than another country.
The net benefits of such an outcome are called gains from trade.
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International Business Environment – JG DITTER 18
ABSOLUTE / COMPARATIVE ADVANTAGE ( C W H I L L )
Absolute advantage Comparative advantage200 units of resources available per country
(+2.5) (+1.25)
❶
❷
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International Business Environment – JG DITTER 19
COMPARATIVE ADVANTAGE: GRAPH
Cocoa
Rice
GhanaSouth Korea
10
2,5
❶
❷
❶
❷
5 7,5 10
15
3,7507/05/2014
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International Business Environment – JG DITTER 20
THE FACTOR PROPORTION THEORY
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For Eli Heckscher and Bertil Ohlin, comparative advantage arises from differences in relative national factor
endowments – the extent to which a country is endowed with resources like labour and capital
The Heckscher-Ohlin-Samuelson (H-O-S) model predicts that countries will export goods that make intensive use of those factors that are locally abundant, while importing goods that
make intensive use of factors that are locally scarce
COMPARING FACTOR ENDOWMENTS
International Business Environment – JG DITTER 21
US Mexico
Labour 300 units 120 units
Capital 100 units 20 units
The US is the relatively capital abundant country
Mexican capital-labor ratio: KMex / LMex is 20/120 or 1/6 U.S. capital-labor ratio: KUS / LUS is 100/300 or 1/3
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International Business Environment – JG DITTER 23
LEONTIEF'S PARADOX
An analysis carried-out in 1947 concluded that the US exported labour-intensive commodities and imported capital-intensive commodities
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07/05/2014 International Business Environment – JG DITTER 24
GOVERNMENT / BUSINESS ISSUES
DIFFERENT COUNTRIES HAVE ADVANTAGES IN DIFFERENT PRODUCTIVE ACTIVITIES
Firms should disperse their various productive activities across countries taking these advantages into accountFirms that fail to do this, may be at a
competitive disadvantage
Governments should promote free trade to let the domestic economy gain from its
comparative advantages
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QUESTIONING TRADITIONAL THEORIES
International Business Environment – JG DITTER 2607/05/2014
Assumes mobility of production factors within each country and no mobility between countries (no FDI)
Static model, does not explain changes in comparative advantage or long-term effect of specialisation
Does not explain intra-industry trade or trade between similar countries
According to Raymond Vernon's product life-cycle theory, both the
location of sales and the optimal production location will change as
products mature, affecting the flow and direction of trade, as well as
foreign direct investment
International Business Environment – JG DITTER 27
THE PRODUCT LIFE-CYCLE THEORY
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THE NEW TRADE THEORY (P. KRUGMAN)
… Tries to explain why trade is growing fastest between industrial countries
With similar economies and endowments of the factors of production
Trading similar goods (intra-industry trade)
… Considers
Markets of imperfect competition (oligopolies)
Movement of capital (foreign direct investment)
Business and government strategies (session 3)
International Business Environment – JG DITTER 2807/05/2014
International Business Environment – JG DITTER 29
ECONOMIES OF SCALE …
… Are the reduction in average production costs arising from a larger output
Fixed costs are spread over a large
output
Production facilities are used more
intensively
Bargaining power with suppliers is
increased
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THE CASE OF TRANSPORT
International Business Environment – JG DITTER 30
The first wave of globalization in the 19th century increased trade based on comparative advantage. Countries exchanged what they could not
produce themselves. So Europe traded machinery for Central American bananas, or for South Asian spices.
But in the 20th century, transportation costs fell so much that even trade in similar goods or in parts and components made economic sense.
But these costs have not fallen equally everywhere. Economies of scale in transportation, such as giant container ships plying the seas on lucrative
routes between Northeast Asia and North America, imply that lower costs will increase trade, which will further lower costs.
http://www.imf.org/external/pubs/ft/fandd/2008/12/deichmann.htm
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International Business Environment – JG DITTER 31
IMPERFECT COMPETITION MARKETS
A
Firm 1
Firm 2
Lower pricesTechnological leadership
Access to resourcesConsumer's switching cost
Research & DevelopmentMarketing
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CAPITAL INTENSIVE INDUSTRIES
Sunk costs / Economies of scaleEconomies of learning
1st mover advantage Barriers to entry
OLIGOPOLISTIC MARKETS
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International Business Environment – JG DITTER 32
BUSINESS INTERNATIONALISATION
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Capital intensive industriesOligopolistic markets
INTERNATIONALISATION
Economies of scale
Economies of learning
First-mover advantage
Global dominant position
Strategic trade policies
Product differentiation
International Business Environment – JG DITTER 33
THE EXAMPLE OF SOFTWARE
Software development is characterized by substantial economies of scale. The fixed costs of producing software, including applications, is
very high. By contrast, marginal costs are very low.
Moreover, the costs of developing software are "sunk" -- once expended to develop software, resources so devoted cannot be used
for another purpose.
The result of economies of scale and sunk costs is that application developers seek to sell as many copies of their applications as
possible. […]
The [negative] experiences of IBM and Apple, Microsoft's most significant operating system rivals in the mid- and late 1990s, confirm
the strength of [such a] barrier to entry.
http://www.albion.com/microsoft/findings-8.html
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07/05/2014 International Business Environment – JG DITTER 34
GOVERNMENT/BUSINESS ISSUES
In capital intensive industries that can only support a few competitors, firms that establish a first-mover advantage may
dominate global trade
What one firm does has an immediate effect on its competitors, forcing them to take similar actions (herd / mimetic
behavior)Firms will try to match each others’
moves as a way of keeping each other in check (multipoint competition)
Governments should enforce strategic trade policies to help domestic firms achieve first
mover advantages.
GAINS FROM TRADE
International Business Environment – JG DITTER 35
A
C
B
D
A
C
B
D
A
C
B
D
A
C
B
D
A B
C D
Without trade:Small and monopolistic domestic marketsNo economies of scale Limited range of products, high pricesDifferent national standards
With trade:Static gains: lower prices due to tariff cuts
Dynamic gains: lower prices due to economies of scale, competitive pressure and specialization
Innovation, broader range of productsHomogeneous standards
Country 1
Country 3
Country 2
Country 4
Country 1
Country 3
Country 2
Country 4
http://www.codart.nl/news/439/
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International Business Environment – JG DITTER 36
STATIC GAINS FROM TRADE
d1
qd
P1Worldprice
Q
s1
qs
Trade creation (imports) D
S
P*Domesticprice
P
E*
q*
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The size of the domestic market influences global competitive advantage
Larger countries are more self-sufficient and therefore less dependent on international trade than smaller ones
International Business Environment – JG DITTER 37
NEW TRADE vs. COUNTRY SIZE THEORY
2011 GDP X M (X+M) / (2*GDP)Ireland 189 199 158 0.94Belgium 427 360 355 0.84Netherlands 714 593 528 0.79France 2,306 622 687 0.28Germany 3,308 1,711 1,521 0.49Japan 4,385 668 708 0.16China 11,300 3,230 2,938 0.27United States 14,991 2,094 2,662 0.16
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International Business Environment – JG DITTER 38
EXAMPLES OF OPENNESS RATIOS
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International Business Environment – JG DITTER 39
THE NATIONAL COMPETITIVENESS FRAMEWORK
National competitive advantages
Firms' competitive advantages
National comparative advantages
M. Porter's thesis is that national competitive advantage is not dependent on factor endowment alone, but on various (country- and industry-based)
factors that interact with each other to create conditions where innovation and improved competitiveness occurs
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Firm strategy, structure and
rivalry
Demand conditions
Related and supporting industries
Factor endowments
International Business Environment – JG DITTER 40
THE COMPETITIVENESS DIAMOND
ChanceGov't
policies
National competitive advantage
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BASIC FACTORS
Labour
Capital
Location, climate
Land and natural resources
ADVANCED FACTORS
Skilled labour
Infrastructure
Technological know-how
International Business Environment – JG DITTER 41
FACTOR ENDOWMENTS
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International Business Environment – JG DITTER 42
DEMAND CONDITIONS
Demand conditions refer to the nature of home-market demand for specific products and services.
The strength and sophistication of demand pressures firms to innovate more quickly and produce better products.
Japan is a densely populated, hot,
and humid country with very
demanding consumers. These
conditions led Japan to become
one of the leading producers of
superior, compact air conditioners.
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International Business Environment – JG DITTER 43
STRATEGIC RIVALRY
The presence of strong competitors in a nation helps create and maintain national competitive advantage, putting firms under
constant pressure to innovate
Japan has the world’s most competitive consumer
electronics industry, with major players like
Nintendo, NEC, Sharp, and Sony producing
semiconductors, computers, video games, and liquid
crystal displays.
Vigorous competitive rivalry puts these firms under
continual pressure to innovate and improve.
See: http://www.techaction.org/the-japans-consumer-electronics-industry
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International Business Environment – JG DITTER 44
RELATED AND SUPPORTING INDUSTRIES
It refers to the presence of clusters of suppliers, competitors, and complementary firms that excel in particular industries.
↓
The resulting business environment is highly supportive for the founding of particular types of firms.
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07/05/2014 International Business Environment – JG DITTER 45
THE ROLE OF GOVERNMENTS
Governments should promote the development of a national competitive advantage through proactive national industrial policy
Support to development of high value-
adding industries
Tax incentives
Investment in education
Stable business-friendly legal
system
Investment in infrastructure
Low interest loans
07/05/2014
22
TRADE vs. FOREIGN DIRECT INVESTMENT
Foreign direct investment (export of capital) will
prevail over exports in case of …
Actual or threatened trade barriers
High transportation costs
International Business Environment – JG DITTER 47
H-O-S modelNew trade theory
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TRADE vs. FOREIGN DIRECT INVESTMENT (CTD)
International trade and foreign direct investment
are combined
Resource seekingNatural resources, workforce,
technology, brand
Market seeking
International Business Environment – JG DITTER 48
Eclectic theories
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1. What particular limitations of international trade theories does Logitech's case highlight?
2. How can international trade theories nonetheless be used to explain Logitech's internationalization and the configuration of its international operations?
CASE STUDY – LOGITECH
International Business Environment – JG DITTER 4907/05/2014
07/05/2014 International Business Development - JG DITTER 50
THE INTERNATIONAL VALUE CHAIN/NETWORK
The value chain describes the categories of activities within an organisation which, together, create a product or service.
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International Business Environment – JG DITTER 51
THE INTERNATIONAL VALUE CHAIN/NETWORK (CTD)
The value network is the set of inter-organisational links and relationships that are necessary to create a product or service.
07/05/2014
International firms will exploit specific advantages in various locations in order to optimise their value
chain / network
Foreign direct investmentInvesting directly in new facilities to produce and/or market in a foreign
country
Global sourcingPurchasing components and services from the most appropriate suppliers
around the world
International Business Environment – JG DITTER 53
THE INTERNATIONAL VALUE CHAIN/NETWORK ( C T D )
The firm's ability to coordinate activities in different locations is a distinctive capability that will contribute to its global competitiveness
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International Business Environment – JG DITTER 54
EXAMPLE: DELL'S INTERNATIONAL VALUE CHAIN
http://www.youtube.com/watch?v=owQzo82ac_M
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