1. International Trade Theory
Session
International Trade Theory

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

3. 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:

4. 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

5. 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

6. 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 6

7. 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

8. 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)

9. Topic Example Video The following video explains what is Mercantilism.
Take note of the key points.

10. Mercantilism Mixed exchange through trade with accumulation of wealth
Conducted under authority of government
Demise of mercantilism inevitable

11. 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 11

12. 4-7
Trade Theory Overview
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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

13. 4-7
Trade Theory Overview
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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

14. 4-7
Trade Theory Overview
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 easy to understand (Saudi Arabia/oil or China/crawfish). Others are not so easy to understand (Japan and cars).
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

15. 4-7
Trade Theory Overview
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 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.

16. 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

17. Topic Example Video
The following video explains the difference between absolute and comparative advantage.
Take note of the key points

18. Theory of 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

19. Theory of Absolute Advantage
4-10
Theory of Absolute Advantage
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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

20. 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 20

21. Theory of 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

22. Comparative Advantage Example22

23. 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 23

24. 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.) 24

25. Topic Example Video
The following video discusses what Adam Smith meant by the “invisible hand” in his book.
Take note of the key points.

26. Extensions of the Ricardian Model
4-16
Extensions of the Ricardian Model
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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

27. Activity: Trade Statistics
Go to:
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: words

28. Factor Proportions Trade Theory
Developed by Eli Heckscher
Expanded by Bertil Ohlin

29. Trade Theory Considerations
Labor
Capital

30. 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 30

31. 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

32. Some Definitions
factor endowments - extent to which different countries possess various factors, such as labor, land, and technology
resource mobility - assumption that a resource
removed from one industry can be moved to another 32

33. Can Money Change Trade? Influences of Exchange Rate
Currency devaluation
The lowering of a currency’s price in terms of other currencies

34. 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 that
strategic 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 government
subsidies 34

35. Topic Example Video
The following video explains how first mover advantage strategies are often a myth.
Take note of the key points.

36. Product Cycle Theory Raymond Vernon
Focus on the product, not its factor proportions
Two technology-based premises

37. Topic Example Video
The following video explains product life cycle for organisations.
Take note of the key points.

38. 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

39. Stages of the Product Cycle
The New Product
Flexible production
Innovator Monopoly
concentration
The Maturing Product
Intl market & competition
More standardized production
The Standardized Product
Low-margin cost-based production
Highly competitive

40. 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

41. Activity: Industry Profile
Go to:
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: words

42. Can Government shift the balance in Imperfect Competition?
Strategic Trade
Can Government shift the balance in Imperfect Competition?
Price
Cost
Externalities
Repetition

43. 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 43

44. Porter’s Diamond Theory

45. Topic Example Video
The following video is a speech by Dr Michael Porter on competitiveness.
Take note of the key points.

46. National Competitive Advantage
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
Factor Endowments:
basic factors: natural resources, climate, location, demographics
advanced factors: communications infrastructure, sophisticated and skilled labor, R&D, technological know-how
advanced factors are most important: they are the result of investment by individuals, companies and government (education, general skill and knowledge stimulation, basic R&D support)
Demand conditions: sophisticated home demand can create impetus for enhancing competitive advantage (Japanese consumer knowledgeable on cameras pushed J. industry to create advantage)
Related and Supporting industries:
internationally competitive suppliers. Creation of clusters of related industries. ex. German textile and apparel sector (high qual. cotton, wool, synthetic fibers, sewing machine needles, textile machinery)
Firm Strategy, Structure, and Rivalry within a nation:
Management ideologies: predominance of engineers in TMTs of Germ. and J. cos. helped improve manufacturing processes and product designs (Porter found top execs with finance backgrounds in US 70s. most CEOs of the 40 companies I studies were marketing specialists).
Vigorous domestic rivalry creates persistent comp. advantage in and industry: impr. efficiency and leads to international competitiveness.

47. National Competitive Advantage
Government
Company Strategy,
Structure,
and Rivalry
Demand
Conditions
Related
and Supporting
Industries
Factor
Chance
Two external factors that influence the four determinants.

48. National Competitive Advantage
4-31
National Competitive Advantage
Success occurs where these attributes exist.
More/greater the attribute, the higher chance of success.
The diamond is mutually reinforcing.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

49. Internal Economies of Scale External Economies of Scale
Strategic Trade
Krugman’s Economics of Scale:
Internal Economies of Scale
External Economies of Scale

50. Topic Example Video
The following video is an interview with Paul Krugman on new trade theory.
Take note of the key points.

51. 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

52. 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.

53. Next Session Weekly Activity: Doing Business in Another Country
Go to:
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: words