Chapter 02 International Trade and Investment McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2-2 The Volume of International Trade All Global exports exceeded $19.5 trillion in The dollar volume of world exports is greater than the GNP of every nation in the world except the U.S. 25% of everything made or grown world-wide is exported. 70% of developed nations exports go to industrialized nations, not to developing countries. LO1

2-3 Relevance of Major Trading Partners for Managers 1.Business climate favorable 2.Export and import regulations not insurmountable 3.No strong cultural objections 4.Transportation facilities 5.Import channel members experienced 6.Foreign exchange available 7.Government may apply pressure LO2

2-4 Explaining Trade: International Trade Theories Mercantilism – an economic philosophy states that: 1.“A nation’s wealth depends on accumulated treasure, usually gold, and 2.To increase wealth, government policies should promote exports and discourage imports.” LO3

2-5 Explaining Trade: International Trade Theories Theory of Absolute Advantage Country “A” has ABSOLUTE ADVANTAGE when it can produce a larger amount of goods or services for the same amount of inputs as country “B” or when “A” can product the same amount using fewer inputs than “B.” Example: LO3

2-6 Theory of Absolute Advantage Country Specialization: Terms of Trade (Ratio of International Prices) LO3

2-7 Theory of Comparative Advantage Country “A” has a absolute DISADVANTAGE in production of 2 goods in respect to country “B” who has a comparative or relative advantage in the production of the good in which its absolute disadvantage is less. Example: Country Specialization: LO3

2-8 Theory of Comparative Advantage Terms of Trade Terms will settle between pre-trade price ratios by mutual agreement between countries Example: The Gains from Specialization of Trade in this case are 1 bolt of cloth for the U.S. and China and +/-1 ton of soybeans for China. LO3

2-9 The Importance of Understanding Currency Exchange Rates Exchange rates determine if it is better to by buy locally or import. –The exchange rate is the price of one currency stated in terms of another country. –Example: If the prevailing rate is 1$ = 8 yuan, the yuan is worth USD: LO3

2-10 Newer Explanations for the Direction of Trade Differences in Resource Endowments Overlapping Demand National Competitive Advantage from Regional Clusters Differences in Resource Endowments Overlapping Demand National Competitive Advantage from Regional Clusters LO3

2-11 Michael Porter’s Diamond Model of National Advantage LO3

2-12 Summary of International Trade Theory International trade occurs because of: –Price differences –Production cost differences, resulting in: 1.Differences in the endowments of the factors of production 2.Differences in the levels of technology that determine the factor intensities used 3.Differences in the efficiencies with which factor intensities are utilized 4.Foreign exchange rates LO3

2-13 Foreign Direct Investment (FDI) Annual Outflow of FDI –The amount invested annually into other nations was $1.2 trillion in 2000 –Global economic decline resulted in outflow fluctuations Decline $647 billion in 2002 Increase to $2.1 trillion in 2007 Decline to $1.9 trillion in 2008 LO4

2-14 Outward FDI Results from Growth of Global Mergers and Acquisitions. The opportunities to buy existing foreign companies is growing, because: 1.U.S corporate restructuring = saleable assets 2.Foreigners want rapid access to advanced U.S. technology 3.Easier U.S. market with established U.S. brands 4.Increasing global competition = restructuring & consolidation = saleable foreign assets LO4

2-15 Annual Inflows of FDI Where does FDI go? –70% to developed countries –Down to 57%, 2008 –Regional fluctuations exist; must be studied before FDI made Where does FDI go? –70% to developed countries –Down to 57%, 2008 –Regional fluctuations exist; must be studied before FDI made Where does FDI come from? –Impossible to value, but, if a country or region’s FDI is increasing: The investment climate must be good Political forces are attractive for FDI Profit potential is greater than in other areas Other reasons for investment exi st Where does FDI come from? –Impossible to value, but, if a country or region’s FDI is increasing: The investment climate must be good Political forces are attractive for FDI Profit potential is greater than in other areas Other reasons for investment exi st LO4

2-16 Factors Influencing a Nation’s Export Performance External Factors –Market access conditions: Transportation costs Geography Physical infrastructure Trade barriers Competition Other demand- influencing factors External Factors –Market access conditions: Transportation costs Geography Physical infrastructure Trade barriers Competition Other demand- influencing factors Internal Factors –Internal supply conditions: Raw materials Labor costs Capital costs Access to technology Economic policy Institutional environment Limited access to foreign markets Internal Factors –Internal supply conditions: Raw materials Labor costs Capital costs Access to technology Economic policy Institutional environment Limited access to foreign markets LO4

2-17 Does FDI Lead to Trade? Yes, because of these changes in today’s global business environment: –Fewer government trade barriers –Increasing global competition –New production technologies –New communications technologies –Greater integration of the global supply chain and production –A growing focus to identify global business opportunities LO4

2-18 Explaining FDI: Theories of International Investment Monopolistic Advantage Theory FDI is made by firms in oligopolistic industries possessing technical and other advantages over indigenous firms. Internationalization Theory To obtain a higher ROI, a firm will transfer its superior knowledge to a foreign subsidiary rather than sell it in the open market. Monopolistic Advantage Theory FDI is made by firms in oligopolistic industries possessing technical and other advantages over indigenous firms. Internationalization Theory To obtain a higher ROI, a firm will transfer its superior knowledge to a foreign subsidiary rather than sell it in the open market. LO5

2-19 Explaining FDI: Theory of Dynamic Capabilities Dynamic capabilities from knowledge or resources must be created and transferred to foreign markets to create competitive advantage. Eclectic Theory of International Production For a firm to invest overseas, it must have 3 kinds of advantages: ownership specific, location specific, and internationalization. Sometimes referred as the OLI Model Theory of Dynamic Capabilities Dynamic capabilities from knowledge or resources must be created and transferred to foreign markets to create competitive advantage. Eclectic Theory of International Production For a firm to invest overseas, it must have 3 kinds of advantages: ownership specific, location specific, and internationalization. Sometimes referred as the OLI Model LO5