1. International Trade Theory Chapter 4
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2. International Trade Theory
Overview
Mercantilism
Absolute Advantage
Comparative Advantage
Heckscher-Olin Theory
Product Life Cycle Theory
New Trade Theory
Porter’s Diamond
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3. 1st British African colony to win independence (1957).
Nkrumah espoused pan African socialism.
High tariffs.
Anti-exporting policy.
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4. Kept lowering tariffs on manufactured goods.
Created incentives to export.
Reduced quotas.
Reduced subsidies.
1950s: 77% of employment in agriculture. Now 20%.
Manufacturing GNP went from 10% to over 30%.
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5. The Impact of Trade Policies
Ghana
1970
GNP/capita
$250
1992
GNP/per capita
$450
GNP Growth/year
1.5%
Shift from productive uses (cocoa) to unproductive uses (subsistence agriculture).
Korea
1970
GNP/per capita
$260
1992
$6790
GNP Growth/year 9%
Shift from non-comparative advantage uses (agriculture) to productive uses (labor-intensive manufacturing).
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6. An Overview of Trade Theory
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.
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.
The Pattern of International Trade displays patterns that are are easy to understand (Saudi Arabia/oil or Mexico/labor intensive goods). Others are not so easy to understand (Japan and cars).
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7. Mercantilism: mid-16th century
A nation’s wealth depends on accumulated treasure
Gold and silver are the currency of trade.
Theory says you should have a trade surplus.
Maximize exports through subsidies.
Minimize imports through tariffs and quotas.
Flaw: “Zero-sum game”.
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8. David Hume
Increased exports leads to inflation and higher prices.
Increased imports lead to lower prices.
Result: Country A sells less because of high prices and Country B sells more because of lower prices.
In the long run, no one can keep a trade surplus.
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9. Theory of Absolute Advantage
Adam Smith: Wealth of Nations (1776).
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.
Trade between countries is, therefore, beneficial.
Assumes there is an absolute advantage balance among nations.
Ghana/cocoa.
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10. The Theory of Absolute Advantage
Cocoa A
Figure 4.1 K B G’ K’
Rice
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11. The Theory of Absolute Advantage and the Gains from Trade
Resources Required to Produce 1 Ton of Cocoa and Rice
Cocoa Rice
Ghana
S. Korea
Production and Consumption without Trade
Ghana
S. Korea
Total production
Production with Specialization
Ghana
S. Korea
Total production
Consumption after Ghana Trades 6T of Cocoa for 6TSouth Korean Rice
Ghana
S. Korea
Increase in Consumption as a Result of Specialization and Trade
Ghana
Table 4.1
S. Korea
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12. Theory of Comparative Advantage
David Ricardo: Principles of Political Economy (1817).
Extends free trade argument
Efficiency of resource utilization leads to more productivity.
Should import even if country is more efficient in the product’s production than country from which it is buying.
Look to see how much more efficient. If only comparatively efficient, than import.
Makes better use of resources
Trade is a positive-sum game.
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13. The Theory of Comparative Advantage
Cocoa A
Figure 4.2 K B
2.5 K’ G’
3.75
7.5
Rice
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14. Comparative Advantage and the Gains from Trade
Resources Required to Produce 1 Ton of Cocoa and Rice
Cocoa Rice
Ghana
S. Korea
Production and Consumption without Trade
Ghana
S. Korea
Total production
Production with Specialization
Ghana
S. Korea
Total production
Consumption after Ghana Trades 4T of Cocoa for 4TSouth Korean Rice
Ghana
S. Korea
Increase in Consumption as a Result of Specialization and Trade
Ghana
Table 4.2
S. Korea
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15. Simple Extensions of the Ricardian Model
Diminishing returns:
More a country produces, at some point, will require more resources.
However:
Free trade can increase a country’s production resources, and
Increase the efficiency of resource utilization.
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16. Ghana’s PPF under Diminishing Returns
Cocoa
Figure 4.3 G’
Rice
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17. The Influence of Free Trade on the PPF
Cocoa
Figure 4.4 G’
Rice
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18. Is the Mercantilist Theory Still Valid?
A qualified Yes.
Equate political power with economic power and economic power with a trade surplus.
Japan
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19. Heckscher (1919)-Olin (1933) Theory
Export goods that intensively use factor endowments which are locally abundant.
Corollary: import goods made from locally scarce factors.
Patterns of trade are determined by differences in factor endowments - not productivity.
Remember, focus on relative advantage, not absolute advantage.
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20. The Leontief Paradox, 1953 Disputes Heckscher-Olin in some instances.
Factor endowments can be impacted by government policy - minimum wage.
US tends to export labor-intensive products, but is regarded as a capital intensive country.
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21. Heckscher vs Ricardo
Economists prefer Heckscher on theoretical grounds but is a relatively poor predictor of trade patterns.
Ricardo’s Comparative Advantage Theory, regarded as too limited for predicting trade patterns, actually predicts them with greater accuracy.
In the end, differences in productivity may be the key to determining trade patterns.
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22. Product Life-Cycle Theory (Raymond Vernon, 1966)
Article in the Quarterly Journal of Economics.
As products mature, both location of sales and optimal production changes.
Affects the direction and flow of imports and exports.
Globalization and integration of the economy makes this theory less valid.
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23. International Product Trade Cycle Model
High Income Countries
production
Exports
Imports
consumption
Quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Medium Income Countries
Exports
Imports 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Low Income Countries
Exports
Imports 1
Time 2 3 4 5 6 7 8 9 10 11 12 13 14 15
New Product
Maturing Product
Standardized Product
Figure 4.5
Stages of Production Development
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24. The New Trade Theory Began to be recognized in the 1970s.
Deals with the returns on specialization where substantial economies of scale are present.
Specialization increases output, ability to enhance economies of scale increase.
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25. Application of the New Trade Theory
Typically, requires industries with high, fixed costs.
World demand will support few competitors.
Competitors may emerge because “they got there first”.
first-mover advantage.
Some argue that it generates government intervention and strategic trade policy.
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26. First-Mover Advantage
Economies of scale may preclude new entrants.
Role of the government.
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27. Founded 1915 by William Boeing
Largest commercial airplane manufacturer.
9,000 commercial jetliners in service.
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28. Western Europe buying 25% of aircraft ,but selling only 10%.
Established 1967
Western Europe buying 25% of aircraft ,but selling only 10%.
France, Germany, Great Britain
To date: 3,203 orders - 1,890 deliveries.
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29. Airbus vs Boeing Airplane Orders 4-28
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30. Porter’s Diamond (Harvard Business School, 1990)
The Competitive Advantage of Nations.
Looked at 100 industries in 10 nations.
Thought existing theories didn’t go far enough.
Question: “Why does a nation achieve international success in a particular industry?”
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31. Determinants of National Competitive Advantage
Factor endowments:nation’s position in factors of production such as skilled labor or infrastructure necessary to compete in a given industry.
Firm strategy, structure and rivalry:the conditions in the nation governing how companies are created, organized, and managed and the nature of domestic rivalry.
Demand conditions:the nature of home demand for the industry’s product or service.
Related and supporting industries:the presence or absence in a nation of supplier industries or related industries that are nationally competitive.
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32. Porter’s Diamond Determinants of National Competitive Advantage
Firm Strategy,
Structure and
Rivalry
Factor Endowments
Demand Conditions
Related and
Supporting
Industries
Figure 4.6
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33. The Diamond Success occurs where these attributes exist.
More/greater the attribute, the higher chance of success.
The diamond is mutually reinforcing.
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34. Factor Endowments Taken from Heckscher-Olin Basic factors:
natural resources,
climate,
location.
Advanced factors:
communications,
skilled labor,
technology.
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35. Advanced Factor Endowments
More likely to lead to competitive advantage.
Are the result of investment by people, companies, government.
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36. Relationship of Basic to Advanced Factors
Basic can provide an initial advantage.
Must be supported by advanced factors to maintain success.
No basics, then must invest in advanced factors.
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37. Demand Conditions Demand creates the capabilities.
Look for sophisticated and demanding consumers.
impacts quality and innovation.
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38. Related and Supporting Industries
Creates clusters of supporting industries that are internationally competitive.
Must also meet requirements of other parts of the Diamond.
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39. Firm Strategy, Structure and Rivalry
Management ‘ideology’ can either help or hurt you.
Presence of domestic rivalry improves a company’s competitiveness.
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40. Evaluating Porter’s Theory
If Porter is right, country exports should reflect the presence of the four ‘diamond’ components. Countries will import goods from industries where some or all the components are missing.
Too soon to tell.
World Trade
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41. Determinants of National Competitive Advantage
Chance
Company Strategy,
Structure,
and Rivalry
Two external factors that influence the four determinants.
Factor
Conditions
Demand
Conditions
Related
and Supporting
Industries
Government
Source: Michael Porter, The Competitive Advantage of Nations
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42. Porter’s diamond, but...
‘Double Diamond’ - look to attributes of both countries.
Professor Alan Rugman, University of Toronto
Home country may ‘sound’ good, but
Company can rely on the host country.
Neighboring countries can too.
Canada and the U.S.
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43. Implications for Business
Location implications:makes sense to disperse production activities to countries where they can be performed most efficiently.
First-mover implications:It pays to invest substantial financial resources in building a first-mover, or early-mover, advantage.
Policy implications:promoting free trade is generally in the best interests of the home-country, although not always in the best interests of the firm. Even though, many firms promote open markets.
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