1. Theories of International Trade and Investment
UNIT II
Theories of International Trade and Investment

2. GLOBALIZATION
IMF defines globalization as, “the growing economic interdependence of countries worldwide through increasing volume and variety of cross border transactions in goods and services and of international capital flows and also through the more rapid and widespread diffusion of technology”

3. COMPONENTS OF GLOBALISATION
Globalization of
Markets
Globalization of
Production
Globalization of
Investment
Globalization of
Technology
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4. GLOBALIZATION OF MARKETS
Globalization of markets refers to the process of integrating and merging of the distinct world markets into a single market
EXAMPLE: Coca-Cola, Pepsi, McDonald’s burgers, Levis Jeans etc.,
FEATURES:
Size of the company need not be too large
Distinction of national markets still prevail
Most of the foreign markets are markets for non-consumer goods 08

5. REASONS FOR GLOBALIZATION OF MARKETS
Large scale industrialization enabled mass production
Risk reduction by diversification
Increase profits and achieve goals
Adverse business environment in home country
Demand for their products in foreign markets
Failure of domestic companies to cater the needs of customers

6. GLOBALIZATION OF PRODUCTION
Globalization of production is locating the manufacturing facilities in a number of locations around the globe. EXAMPLE: Jet airlines Boeing 777 and Swan opticals
REASONS:
Impositions of imports by the foreign country
Availability of high quality raw materials and components
Availability of inputs at low cost
Skilled human resource at low cost
Liberal labour laws
To reduce cost of transport
To cater to varying tastes of customers

7. GLOBALIZATION OF PRODUCTION
Globalization of investment refers to investment of capital by a global company in any part of the world.
REASONS:
Increase in volume of global trade
Limitations of exporting and importing
Liberalization
Avoid restrictions

8. GLOBALIZATION OF TECHNOLOGY
Latest technology and distinctive competencies
Technological collaboration
Usage of technology by paying royalty

9. GLOBALIZATION ADVANTAGES DISADVANTAGES Kills domestic business
Free flow of capital, technology
Industrialization
Production facilities throughout the world
Increase in production and consumption
Lower prices and high quality
Jobs and Incomes
Higher standard of living
Balanced Human development
Welfare and prosperity
Kills domestic business
Exploits human resource
Unemployment and underemployment
Widening gap between rich and poor
Transfer of natural resources
National sovereignty at stake
Commercial and political colonialism

10. INTERNATIONAL BUSINESS ENVIRONMENT
EXTERNAL
INTERNAL
Organisational Structure
Organisational Structure
Production
Production
Finance
Finance
Marketing
Marketing HR HR
R&D
R&D
External Micro Environment
External Micro Environment
External Macro Environment
External Macro Environment
Market & Intermediary
Shareholders
Creditors
Bankers & Financial Institutions
Competitors
Suppliers
Customers
Social &Cultural Factors
Technological Factors
Economic
Political
International Factors
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Natural Factors

11. INTRODUCTION TO GATT
There were many barrier for free trade were laid down to support the government expenditure
After II world war several international measures were undertaken to liberalize trade and payment between nations
International monetary funds and international bank for reconstruction and development were set up
International trade organization to deal with international trade was sought to be set up
GATT (general agreement for trade and tariff)was set to liberalize the trade and reduce the tariff amount

12. GATT
The General Agreement on Tariffs and Trade (GATT) was originally created by the Bretton Woods Conference as part of a larger plan for economic recovery after World War II.
The GATT’s main purpose was to reduce barriers to international trade.
This was achieved through the reduction of tariff barriers, quantitative restrictions and subsidies on trade through a series of different agreements.
The GATT was an agreement, not an organization.
Originally, the GATT was supposed to become a full international organization like the World Bank or IMF called the International Trade Organization
The agreement was not ratified, so the GATT remained simply an agreement.
The functions of the GATT have been replaced by the World Trade Organization.

13. GATT trade rounds
Geneva Round – The first round’s duration was 7 months. 23 countries took part in the round. The main focus was Tariffs Signing of GATT, 45,000 tariff concessions affecting $10 billion of trade.
Annecy Round – 1949 The second round took place in in Annecy, France. 13 countries took part in the round. The main focus of the talks was more tariff reductions.
Torquay Round – 1951 The third round occurred in Torquay, England in countries took part in the round. 8,700 tariff concessions were made totaling the remaining amount of tariffs to ¾ of the tariffs which were in effect in 1948.

14. Geneva Round The fourth round returned to Geneva in 1955 and lasted until May Twenty-six countries took part in the round. $2.5 billion in tariffs were eliminated or reduced.
Dillon Round The fifth round occurred once more in Geneva and lasted from The talks were named after U.S. Treasury Secretary and former Under Secretary of State, Douglas Dillion, who first proposed the talks. 26 countries took part in the round. Along with reducing over $4.9 billion in tariffs, it also yielded discussion relating to the creation of the European Economic Community (EEC).

15. Kennedy - 1964 The sixth round’s duration was 37 months
Kennedy The sixth round’s duration was 37 months. 62 countries took part in the round and the main focus was Tariffs, Anti-dumping. Its achievement was Tariff concessions worth $40 billion of world trade
Tokyo Round Reduced tariffs and established new regulations aimed at controlling the proliferation of non-tariff barriers and voluntary export restrictions. 102 countries took part in the round. Concessions were made on $190 billion worth.

16. Uruguay Round - 1986-1994 The Uruguay Round began in 1986
Uruguay Round The Uruguay Round began in It was the most ambitious round to date, hoping to expand the competence of the GATT to important new areas such as service, capital, intellectual property, textiles, and agriculture. 123 countries took part in the round. The Uruguay Round was also the first set of multilateral trade negotiations in which developing countries had played an active role

17. OBJECTIVES OF GATT To raise standard of living
To ensure full employment and a large and steadily growing volume of real income and effective demand
To develop the full use of the resource of the world
To expand production and international trade

18. ACTIVITIES OF GATT Tariff bargaining
Bargaining on non- tariff trade barriers
Elimination of quantum restriction
Settlement of disputes between contracting parties

19. WORLD TRADE ORGANIZATION
WTO was established on January 1, 1995
WTO is the embodiment of the Uruguay Round results and the successor to GATT
Government became member of the WTO on its first day
As of December 2000 there are 142 members of the WTO and 34 countries have an observer status
28 members are there in waiting list

20. Functions of WTO
Administering and implementing the multilateral and plurilateral trade agreements which together make up WTO
Acting as a forum for multilateral trade negotiation
Seeking to resolve trade disputes
Overseeing national trade policies
Cooperating with other international institution involved in global policy making

21. Difference between GATT and WTO
It is a set of rules and multilateral agreement
It was designed with an attempt to establish International Trade Organization
It was applied on a provisional basis
Its rules are applicable to trade in merchandise goods
GATT was originally a multilateral instrument, but plurilateral agreement were added at a later stage
Its disputes settlement system was not faster and automatic
It is a permanent institution
It is established to serve its own purpose
Its activities are full and permanent
Its rules are applicable to trade in merchandise and trade in services and trade in related aspects of intellectual property
Its agreements are almost multilateral
Its disputes settlement systems is fast and automatic

23. Classical Country-Based Trade Theories
Mercantilism
Absolute Advantage
Comparative Advantage
Comparative Advantage with Money
Relative Factor Endowments
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24. Foundation Concepts
Comparative advantage Superior features of a country that provide it with unique benefits in global competition – derived from either national endowments or deliberate national policies
Competitive advantage Distinctive assets or competencies of a firm – derived from cost, size, or innovation strengths that are difficult for competitors to replicate or imitate

25. Mercantilism
A country’s wealth is measured by its holdings of gold and silver
A country’s goal should be to enlarge holdings of gold and silver by
Promoting exports
Discouraging imports
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26. Examples of National Comparative Advantage
Abundant, low-cost labor in China
Mass of IT workers in India
Huge reserves of bauxite in Australia
Abundant agricultural land in the USA
Oil in Saudi Arabia

27. Examples of Firm Competitive Advantage
Dell’s prowess (ability) in global supply chain management
Procter & Gamble’s skill in marketing
Samsung’s leadership in flat-panel TV
Apple’s design leadership in cell phones and personal music players

28. Modern Mercantilism Neomercantilists or protectionists
American Federation of Labor-Congress of Industrial Organizations
Textile manufacturers
Steel companies
Sugar growers
Peanut farmers
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29. Why Nations Trade: Classical Theories
Mercantilism: the belief that national prosperity is the result of a positive balance of trade – maximize exports and minimize imports
Absolute advantage principle: a country should produce only those products in which it has absolute advantage or can produce using fewer resources than another country

30. Absolute Advantage
Export those goods and services for which a country is more productive than other countries
Import those goods and services for which other countries are more productive than it is
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31. --------------------------------------------- France 30 40
One ton of
Cloth Wheat
France
Germany
Example of Absolute Advantage (labor cost in days of production for one ton)

32. Disadvantages of Mercantilism
Confuses the acquisition of treasure with the acquisition of wealth
Weakens the country because it robs individuals of the ability
To trade freely
To benefit from voluntary exchanges
Forces countries to produce products it would otherwise not in order to minimize imports

33. Why Nations Trade: Classical Theories
Comparative advantage principle: it is beneficial for two countries to trade even if one has absolute advantage in the production of all products; what matters is not the absolute cost of production but the relative efficiency with which it can produce the product.

34. --------------------------------------------- France 30 40
One ton of
Cloth Wheat
France
Germany
Example of Comparative Advantage (labor cost in days of production for one ton)

35. Classical Theories: Factor Proportions Theory
Factor proportions (endowments) theory: each country should produce and export products that intensively use relatively abundant factors of production, and import goods that intensively use relatively scarce factors of production
Examples:
China and labor
USA and pharmaceuticals
Canada and electric power

36. Relative Factor Endowments_2
A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance
China: labor
Saudi Arabia: oil
Argentina: wheat

37. Modern Firm-Based Trade Theories
Country Similarity Theory
Product Life Cycle Theory
Global Strategic Rivalry Theory
Porter’s National Competitive Advantage
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38. Firm-Based Trade Theories
Incorporate additional factors into explanations of trade flows
Quality
Technology
Brand names
Customer quality
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39. Growth of Firm-Based Theories
Growing importance of MNCs
Inability of the country-based theories to explain and predict the existence and growth of intraindustry trade
Failure of Leontief and others to empirically validate country-based Heckscher-Ohlin Theory
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40. Firm-Based Trade Theories
Incorporate additional factors into explanations of trade flows
Quality
Technology
Brand names
Customer quality

41. Country Similarity Theory
Explains the phenomenon of intraindustry trade
Trade between two countries of goods produced by the same industry
Japan exports Toyotas to Germany
Germany exports BMWs to Japan

42. Country Similarity Theory_2
Trade results from similarities of preferences among consumers in countries that are at the same stage of economic development
Most trade in manufactured goods should be between countries with similar per capita incomes

43. Product Life Cycle Theory
Describes the evolution of marketing strategies
Stages
New product
Maturing product
Standardized product

44. Figure 6.4 The International Product Life Cycle: Innovating Firm’s Country
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45. Figure 6.4 The International Product Life Cycle: Other Industrialized Countries
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46. Figure 6.4 The International Product Life Cycle: Less Developed Countries

47. Sustaining Competitive Advantage
Owning intellectual property rights
Investing in research and development
Achieving economies of scale or scope
Exploiting the experience curve

48. Porter’s National Competitive Advantage
Success in trade comes from the interaction of four country and firm specific elements
Factor conditions
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry

49. Figure 6.5 Porter’s Diamond of National Competitive Advantage
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Firm Strategy,
Structure,
and Rivalry
Factor
Conditions
Demand
Conditions
Related and
Supporting
Industries

50. How Nations Enhance Competitive Advantage
The contemporary view suggests that governments can proactively implement policies to enhance a nation’s competitive advantage, beyond the natural endowments the country possesses
Governments can create national economic advantage by: stimulating innovation, targeting industries for development, providing low-cost capital, minimizing taxes, investing in IT, etc.

51. Michael Porter’s Diamond Model: Sources of National Competitive Advantage
Firm strategy, structure, and rivalry – the presence of strong competitors at home serves as a national competitive advantage
Factor conditions – labor, natural resources, capital, technology, entrepreneurship, and know how
Demand conditions at home – the strengths and sophistication of customer demand
Related and supporting industries – availability of clusters of suppliers and complementary firms with distinctive competences

53. Industrial Clusters
A concentration of suppliers and supporting firms from the same industry located within the same geographic area
Examples include: the Silicon Valley, fashion cluster in northern Italy, pharma cluster in Switzerland, footwear industry in Pusan, South Korea, and the IT industry in Bangalore, India
Can serve as a nation’s export platform

54. National Industrial Policy
Proactive economic development plan enacted by the government to nurture or support promising industries sectors.
Typical initiatives:
Tax incentives
Investment incentives
Monetary and fiscal policies
Rigorous educational systems
Investment in national infrastructure
Strong legal and regulatory systems
(Examples: Japan, Dubai, and Ireland)

55. Dominance of FDI-Based explanations of the International Firm
Most IB theories about the firm emphasize the MNE, since it was long the major player in international business.
Foreign direct investment (FDI) is the main strategy used by MNEs in international expansion; thus, earlier theories emphasized motives for, and patterns of, FDI

56. FDI BASED EXPLANATIONS: Monopolistic Advantage Theory
Suggests that FDI is preferred by MNEs because it provides the firm with control over resources and capabilities in the foreign market, and a degree of monopoly power relative to foreign competitors
Key sources of monopolistic advantage include proprietary knowledge, patents, unique know- how, and sole ownership of other assets

57. FDI BASED EXPLANATIONS: Internalization Theory
Explains the process by which firms acquire and retain one or more value-chain activities inside the firm – retaining control over foreign operations and avoiding the disadvantages of dealing with external partners.
In contrast to arm’s-length entry strategies (such as exporting and licensing) which imply developing contractual relationships with external business partners, FDI provides the firm with control and ownership of resources

58. FDI BASED EXPLANATIONS: Dunning’s Eclectic Paradigm
Three conditions determine whether or not a company will internalize via FDI:
Ownership-specific advantages – knowledge, skills, capabilities, relationships, or physical assets that form the basis for the firm’s competitive advantage
Location-specific advantages – advantages associated with the country in which the MNE is invested, including natural resources, skilled or low cost labor, and inexpensive capital
Internalization advantages – control derived from internalizing foreign-based manufacturing, distribution, or other value chain activities

59. NON-FDI BASED EXPLANATIONS: International Collaborative Ventures
While FDI-based internationalization is still common, beginning in the 1980s firms have emphasized non- equity, flexible collaborative ventures to internationalize.
Collaborative venture: a form of cooperation between two or more firms. Through collaboration, a firm can gain access to foreign partner’s know-how, capital, distribution channels, and marketing assets, and overcome government imposed obstacles.
Venture partners share the risk of their joint efforts, and pool resources and capabilities to create synergy.

60. Two Types of International Collaborative Ventures
Equity-based joint ventures result in the formation of a new legal entity. Here, the firm collaborates with local partner(s) to reduce risk and commitment of capital.
Project-based alliances involve cooperation in R&D, manufacturing, design, or any other value-adding activity, a partnership aimed at a narrowly defined scope of activities and timeline