1. Theories of International Trade
And Investment

2. Why do nations trade?
“You could say…that globalization, driven not by human goodness but by the profit motive, has done far more good for far more people than all the foreign aid and soft loans ever provided by well-intentioned governments and international agencies.”
Paul Krugman, “The Magic Mountain,” New York Times, January 23, 2001

3. Why do nations trade?
Nearly all economic theories suggest that the benefits of international trade far exceed the costs.
“Specialization and international trade increase the productivity of a nation’s resources and allow for greater total output than would otherwise be possible. “
McConnell and Brue, 16th edition

4. Why do nations trade?
Demand and supply conditions differ between countries, so prices differ between countries if there is no international trade. Trade begins as someone conducts arbitrage to earn profits from the price difference between previously separated markets.

5. The Benefits of Trade
When people trade, both parties expect to benefit from the trade.
Otherwise, why would they have traded in the first place?

6. The Benefits of Trade
The argument for the benefits of trade underlies the general policy of laissez-faire.
Laissez-faire – an economic policy of leaving coordination of individuals’ actions to the market.

7. How Firms Internationalize
Internationalization is usually gradual and evolutionary (Internationalization Process Model)
Slow internationalization results from the uncertainty and uneasiness that managers have about doing international business
A predictable pattern of internationalization may include the following stages:
1. domestic focus
2. pre-export stage
3. experimental involvement
4. active involvement
5. committed involvement

8. Important Terms to Know
Specialization: Division of labor into specific tasks and roles intended to increase the productivity of workers.
Globalization: Name for the process of increasing the connectivity and interdependence of the world's markets and businesses.
Imports: Goods and services purchased from other countries
Exports: Goods and services sold to other countries

9. Mercantilism
Mercantilism is: An economic Philosophy An economic Theory An economic Policy An economic System

10. The British perspective:
Mercantilism was explained by its proponents, as a "a philosophy of nation building, a series of economic controls intended to strengthen a country ... against other … empires. A major tenant of this view was self-sufficiency: sources of supply--raw materials, agriculture, and industry--should be developed domestically, or in colonies, to prevent interruptions by hostile foreigners”

11. Introduction
In the 1600 and 1700 centuries, mercantilism stressed that countries should simultaneously encourage exports and discourage imports.
Although mercantilism is an old theory it echoes (repeat) in modern politics and trade policies of many countries
The neoclassical economist Adam Smith, who developed the theory of absolute advantage, was the first to explain why unrestricted free trade is beneficial to a country.
Two theories have been developed from Adam Smith's absolute advantage theory.
First is the English neoclassical economist David Ricardo's comparative advantage.
Two Swedish economists, Eli Hecksher and Bertil Ohlin, develop the second theory.

12. A zero-sum game
Because of its peculiar emphasis on gold and silver, mercantilism viewed trade as a zero-sum activity – one country’s gains come at the expense of some countries, since a surplus in international trade for one country must be a deficit for some other(s).

13. Mercantilism
-Mercantilism is an economic theory popular in the 1600s and was the biggest reason for Europe’s desire to colonize new lands  -the theory states that there is a certain amount of wealth in the world and it is in a nations best interest to accumulate it  -through wealth, a nation can achieve power  -a country achieves wealth through producing and exporting more good then they import  -this theory was invented to serve the interest of the empire, not the colony

14. Early Mercantilists Mercantilism
Mercantilism was established during the early modern period (starting in
the 16th to the 18th century, which roughly corresponded to the
emergence of the nation-state) .
Mercantilism is an economic theory that holds the prosperity of a nation
depends upon its supply of capital, and that the global volume of trade
is “unchangeable.” Economic assets, or capital, are represented by bullion
(gold, silver, and trade value) held by the state, which is best increased
through a positive balance of trade with other nations (exports minus
imports). Mercantilism suggests that the ruling government should
advance these goals by playing a protectionist role in the economy, by
encouraging exports and discouraging imports, especially through the
use of tariffs. The economic policy based upon these ideas is often
called the mercantile system.

15. Early Mercantilists Early Mercantilists
The Early Mercantilists: Thomas Mun (1571–1641), Edward Misselden
(1608–1634) And Gerard De Malynes (1586–1623)
Thomas Mun( )
- Representative Works
England’s Treasure by Foreign Trade published in 1664
- Experiences
Thomas Mun , English Writer on Economics, was the third son of John
Mun, mercer of London. He began by engaging in Mediterranean trade,
and afterwards settled down in London, amassing a large fortune . He
was a member of the committee of east India company and of the
standing commission on trade appointed in In 1621 Mun
published A Discourse of Trade from England unto the East Indies

16. Main Views on Trade Why do nations trade?
zero-sum gain—one nation gains at the expense of the other
Main Views on Trade
The Mercantilist School common outlook:
(1) the idea of specie or bullion as the essence of wealth
(2) the notion that a positive balance of trade (trade surplus) is an index
of national welfare.
(3) It is also associated with an emphasis on population growth and low wages, a concern with full employment
(4) zero-sum gain — one nation gains at the expense of the other ,
denying foreign trade as a source of net gain to the world as a whole.
(5) A permanent balance of trade surplus should be beneficial to a nation has been a source of discussion right down to the present day.

17. The main goal of mercantilism: increase the money in a country’s treasury by creating a favorable balance of trade.
Colonies helped a country produce/acquire the goods to maintain a favorable balance of trade.
Say Spain sold $500 in sugar to France, and France sold $300 in cloth to Spain. France would also have to pay Spain $200 worth of precious metals to pay for all the sugar. Spain would then have a favorable balance of trade because the value of its exports (sugar) was greater than the value of its imports (cloth). Spain would become richer because of the precious metals it received from France.

18. Characteristics of Mercantilism
“Bullionism”  the eco. health of a nation could be measured by the amount of precious metal [gold or silver] which it possessed.
‘Hard’ money was the source of prosperity, prestige, and strength for a nation.
Bullionism dictated a “favorable balance of trade.”
Export more than you import [a trade surplus].
High tariffs on imported manufactured good.
Low tariffs on imported raw materials.
Each nation must try to achieve economic self-sufficiency.
Those founding new industries should be rewarded by the state.

19. Characteristics of Mercantilism
Thriving agriculture should be carefully encouraged.
Less of need to import foods.
Prosperous farmers could provide a base for taxation.
Sea power was necessary to control foreign markets.
Less need to use the ships of other nations to carry your trade goods.
Your own fleet adds to the power and prestige of the nation.
Impose internal taxes of all kinds.

20. Characteristics of Mercantilism
A large population was needed to provide a domestic labor force to people the colonies.
Luxury items should be avoided
They took money out of the economy unnecessarily.
State action was needed to regulate and enforce all of these economic policies.
State-sponsored trade monopolies.

21. Conclusion
Early mercantilist writers embraced bullionism, the belief that that quantities of gold and silver were the measure of a nation’s wealth. Later mercantilists developed a somewhat more sophisticated view.
Many European economists between 1500 and 1750 are today generally considered mercantilists .
“Mercantilist Literature” appeared in the 1620s in Great Britain.
Economic Nationalism
Belief in mercantilism began to fade in the late 18th century, as the arguments of Adam Smith and the other classical economists won favour in the British Empire

22. Mercantilism – 9-point plan
That every inch of a country's soil be utilized for agriculture, mining or manufacturing.
That all raw materials found in a country be used in domestic manufacture, since finished goods have a higher value than raw materials.
That a large, working population be encouraged.
That all export of gold and silver be prohibited and all domestic money be kept in circulation.
That all imports of foreign goods be discouraged as much as possible.
That where certain imports are indispensable they be obtained at first hand, in exchange for other domestic goods instead of gold and silver.
That as much as possible, imports be confined to raw materials that can be finished [in the home country].
That opportunities be constantly sought for selling a country's surplus manufactures to foreigners, so far as necessary, for gold and silver.
That no importation be allowed if such goods are sufficiently and suitably supplied at home.

23. Mercantilism: Flaws impaired economic growth Ignores living standards
Ignores human development

24. The circular flow model
The colonists supplied raw materials to England for either manufacture or re-export and they provided additional markets for the finished products produced from those resources (England also sold them in European markets).
The colonies played a large role in England’s becoming self-sufficient.
For this system to succeed, the Parliament needed to pass laws and regulations to protect wealthy British merchants and industrialists, even at the expense of its colonists (i.e. those laws were intended to benefit the English economy exclusively).
A mercantilist economy is a managed economy, managed by the larger and stronger power (i.e. the home/mother country).

25. Colonies Colonies helped nations grow rich in several ways.
Colony: a country or area under the full or partial political control of another country and occupied by settlers from that country
Colonies helped nations grow rich in several ways.
They provided various raw materials
They provided mines that produced gold and silver.
They served as markets for goods made in the home country.
Trade expansion enabled English manufacturing base to grow and it necessitated an enlarged merchant fleet.
Additional bases for the royal navy (i.e.outposts).
As suppliers of raw materials only, the colonists could not compete with England in manufacturing (unless the goods could not be produced in England).

26. Absolute Advantage

27. Origin of the theory
The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he countered mercantilist ideas.
Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism.
Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves.

28. Assumptions Two Commodities and two countries
Assumes total world production and emphasis on efficiency.
Factors are easily mobile within a country and immobile between the countries
The only factor of production, and is fully utilized
Technology and production costs are constant
Transportation costs are zero and the countries barter (trade) for goods
Full employment.

29. Theory of absolute advantage
Adam Smith ideas based on…
The capability of one country to produce more of a product with the same amount of input than another country
(same thing) The ability of a country to produce a good using fewer resources than another country (lower opportunity cost)

30. Theory of absolute advantage
Adam Smith argued:
A country should produce only goods where it is most efficient …. and trade for those goods where it is not efficient
Trade between countries is, therefore, beneficial

31. Theory of absolute advantage
… destroys the mercantilist idea since there are gains to be had by both countries party to an exchange
… questions the objective of national governments to acquire “wealth”: through restrictive trade policies
… also measures a nation’s wealth by the living standards of its people

32. Trade Based on Absolute Advantage: Adam Smith (Wealth of Nations: 1776)
According to Adam Smith, trade between two nations is based on absolute advantage.
When one nation is more efficient than (has an absolute advantage over) another in the production of one commodity but is less efficient than (has an absolute disadvantage with respect to) the other nation in producing a second commodity, then both nations can gain by each specializing in the production of the commodity of its absolute advantage and exchanging part of its output with the other nations for the commodity of its absolute disadvantage.

33. By this process, resources are efficiently utilized and the output of both commodities will rise.
The growth in output measures the gains from specialization in production available to be divided between the two nations through trade.
In contrast to the mercantilists, Smith believed that all nations would gain from free trade and strongly advocated a policy of laissez-faire:
As little government interference with the economic system as possible.
Free trade would lead to efficient use of resources and would maximize world welfare.
Only few exceptions were allowed to this policy.

34. Main Content of Absolute Advantage
When one nation is more efficient than another in the production of one
commodity but is less efficient than the other nation in producing a second
commodity, then both nations can gain by each specializing in the
production of the commodity of its absolute advantage and exchanging
part of its output with the other nation for the commodity of its absolute
disadvantage. By this process, resources are utilized in the most efficient
way and the output of both commodities will rise. This increase in the
output of both commodities measures the gains from specialization in
production available to be divided between the two nations through free
trade.
Trade only happens under the mutually beneficial gains ,otherwise, no

35. The Theory of Absolute Advantage: An Example

36. The accompanying figure shows the amount of output
The accompanying figure shows the amount of output. Country A and Country B can produce in a given period of time . Country A uses less time than Country B to make either food or clothing. Country A makes 6 units of food while Country B makes one unit, and Country A makes three units of clothing while Country B makes two. In other words, Country A has an absolute advantage in making both food and clothing.

37. The Theory of Absolute Advantage: An Example
Country
No. of workers needed to produce units SHOES
No. of workers needed to produce units REFRIGERATORS US
4 workers
1 worker
Mexico
5 workers

38. The Theory of Absolute Advantage: An Example
In this example, it takes four U.S. workers to produce 1,000 pairs of shoes, but it takes five Mexican workers to do so. It takes one U.S. worker to produce 1,000 refrigerators, but it takes four Mexican workers to do so. The United States has an absolute advantage in productivity with regard to both shoes and refrigerators; that is, it takes fewer workers in the United States than in Mexico to produce both a given number of shoes and a given number of refrigerators.

39. The Theory of Absolute Advantage: An Example
Days of Labors required to produce one unit of
Nation A
Nation B
Commodity 1 3 6
Commodity 2 8 4

40. The Theory of Absolute Advantage: An Example
: Nation A has an absolute advantage in the production of commodity 1 because it needs only 3 labor days to produce one unit of it while Nation B needs 6 labor days. Nation B has an absolute advantage in commodity 2.
If both nations start trading with each other, each nation will specialize in the production of the good it has an absolute advantage in and obtain the other commodity through international trade. More units of both commodities can be produced overall because the given resources are utilized more efficiently. Through trade, both nations are able to consume more units of at least one commodity. In our example, Nation A would specialize completely in commodity 1, and Nation B in commodity 2.

41. Conclusion The Principle of Absolute Advantage (Cost Advantage)
In a two-nation, two-product world, international trade and
specialization will be beneficial when one nation has an absolute cost
advantage (that is, uses less labor to produce a unit of output) in one good
and the other nation has an absolute cost advantage in the other good. A
nation will import those goods in which it has an absolute cost advantage;
and it will export those goods in which it has an absolute cost advantage.
Mutually beneficial game
Each nation benefits by specializing in the production of the good that it
produces at a lower cost than the other nation, while importing the good
that it produces at a higher cost.
Increase of the world’s output
More efficient used resources as the result of specializing to increase the
world’ output , which is distributed to the two nations through trade.

42. Comparison of Mercantilism and Absolute Advantage
Mercantilism-zero sum game-one nation gains at the expense of the other
Adam Smith-both nations can gain from trade
Absolute Advantage-each nation should specialize in production of good which is the most efficient at producing

43. The Theory of
Comparative Advantage

44. ABSOLUTE ADVANTAGE v/s COMPARATIVE ADVANTAGE
Absolute Advantage : occurs when a country can produce a product using fewer factor of production than another nation
Comparative Advantage: State that a country should specialized in the goods or service it can produce at the lowest opportunity cost and trade to other country
* opportunity cost : the loss of other alternative when one alternative is chosen. It is the cost of a missed opportunity

45. Background of the Theory
the original description of the idea can be found in an Essay on the External Corn Trade by Robert Torrens in 1815.
David Ricardo formalized the idea using a compelling, yet simple, numerical example in his 1817 book titled, On the Principles of Political Economy and Taxation.
The idea appeared again in James Mill's Elements of Political Economy in Finally, the concept became a key feature of international political economy upon the publication of Principles of Political Economy by John Stuart Mill in 1848.

46. Ricardo’s Idea of Comparative Advantage
Ricardo's Law of Comparative Advantage improved upon the earlier Law of Absolute Advantage. How?
If A (Advancedland) is more productive than B (Backwardland) in every productive activity, would both countries benefit from trade?
The law of absolute advantage has no answer to this question.
Ricardo's law of comparative advantage showed that the answer is yes.

47. The Law of Comparative Advantage
Assumptions of the model:
Only two countries and two commodities in the world (Home and Foreign)
Free Trade
Perfect mobility of labor within each nation but immobility between the two nations
Constant costs of production
No transportation cost
No technical change
The labor theory of value

48. Comparative Advantage Definition;
Comparative advantage is the basis for all trade between individuals, regions, and nations.
The ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins.

49. Comparative Advantage
A person has a comparative advantage if s/he can produce something at a lower cost than others.
This is not the same as being the best at something.

50. With Comparative Advantage, everyone wins through trade.
Those with absolute advantages can buy goods and services from businesses who produce them at a comparatively lower cost.

51. The Law of Comparative Advantage
The Concept of Law of Comparative Advantage
In a two-nation and two-commodity world economy, even if one nation
is less efficient than the other nation in the production of both
commodities, there is still a basis for mutually beneficial trade. The first
nation should specialize in the production of and export the commodity in
which its absolute disadvantage is smaller (the commodity of its
comparative advantage) and import the commodity in which its absolute
disadvantage is greater (the commodity of its comparative disadvantage).
Note that in a two-nation, two-commodity world, once it is determined
that one nation has a comparative advantage in one commodity, then the
other nation must necessarily have a comparative advantage in the other
commodity.

52. Trade Based on Comparative Advantage: David Ricardo (1815, Principles of Polit. Econ. & Taxation)
The Law of Comparative Advantage (LCA)
According to LCA, even if one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, there is still a basis for mutually beneficial trade.
This nation should specialize in the production and export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage in greater (this is the commodity of its comparative disadvantage).

53. DAVID RICARDO THEORY In simple Words: The Law of Comparative Advantage
“countries can specialize in the production of goods it produces EFFICIENTLY- & buy the goods it produce less efficiently from other countries. Even it means Buying goods from other countries it could produce efficiently itself”

54. Example US 10 units 1 BARBIE DOLL 13.5 units 1 KEN DOLL Japan 40 units

55. THINK? US have Absolute Advantage over Japan in both the products .
Can international trade between both the countries be mutually benefit?
If yes HOW?

56. What if : With input of 200 units of input
US = 20 Barbie Doll & 0 Ken Dolls or
0 Barbie Dolls & 15 Ken Dolls
Where as Japan
= 5 Barbie Dolls or 0Ken Dolls
0 Barbie Dolls or 10 Ken Dolls

57. So Comparatively
US have FOUR TIMES the advantage over the production Barbie Dolls or
1.5 times advantage over the Ken Dolls
So, in reality it would be effective and efficient if US specialized in Barbie Dolls & Japan 0n Ken Dolls

58. Example:
The UK has an absolute disadvantage in the production of both commodities with respect to the US
However, since the UK is half as productive in cloth but 6 times less productive in wheat, it has a comparative advantage in cloth.
The US has an absolute advantage in the production of both commodities with respect to UK.
Since the US absolute advantage is greater in wheat (6:1) than in cloth (4:2), it has a comparative advantage in wheat.
U.S.
U.K.
Wheat (bushels/man-hour) 6 1
Cloth (yards/man-hour) 4 2

59. Conclusion
We examined the Ricardian model, the simplest model that shows how differences between countries give rise to trade and gains from trade.
In this model, labor is the only factor of production and countries differ only in the productivity of labor in different industries.
In the Ricardian model, a country will export that commodity in which it has comparative (as opposed to absolute) labor productivity advantage.

60. Conclusion
The fact that trade benefits a country can be shown in either of two ways:
We can think of trade as an indirect method of production.
We can show that trade enlarges a country’s consumption possibilities.
The distribution of the gains from trade depends on the relative prices of the goods countries produce.

61. Conclusion
Extending the one-factor, two-good model to a world of many commodities makes it possible to illustrate that transportation costs can give rise to the existence of nontraded goods.
The basic prediction of the Ricardian model-that countries will tend to export goods in which they have relatively high productivity- has been confirmed by a number of studies.

62. Absolute Advantage versus Comparative Advantage
A country enjoys an absolute advantage over another country in the production of a product when it uses fewer resources to produce that product than the other country does.

63. Absolute Advantage versus Comparative Advantage
A country enjoys a comparative advantage in the production of a good when that good can be produced at a lower cost in terms of other goods.

64. 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.
the product life cycle - explain how trade patterns change overtime.

65. The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented
After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin.
In some situations, the product becomes an item that is imported by its original country of invention

66. Assumptions: International product life cycle has 3 distinct :
New product.
Maturity product.
Standardized product.
Initially production of new product will occur completely in home country of its innovation.
Factor and production are mobile internationally.

67. The International Product Life Cycle
Introduction
and Growth
Stages
Growth
Maturity
Decline
Developing
Country
Competitor
Exports Product
To MNC Home
Country;
Competes
with MNC
Imports
MNC Manufactures
Product new innovated product in Developed
Countries; Exports to
Developing Countries
MNC Moves
Production to
Developing
Country; Begins
Importing to
Home Country
Developing Country
Markets Remain Viable
Target Markets for
MNC; MNC Home
Country Market Is
Diminishing . In some case
the product becomes an item
that is imported
by its original country of invention
Time

68. Product life-cycle: Example
Stage 1: Introduction
Stage 2: Growth
Stage 3: Maturity
Stage 4: Decline

69. international product life cycle: EXPORT NET VS TIME VS PRODUCT(PRODUCT MOVEMENT)
new
product
mature
product
standardised
product
time
developed
country
developing
country
inventor’s
country
country where new product is launched
other advanced, high-income country
developing, low-income country

70. 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
Stages of Production Development

71. Stage 1: Introduction
New products are introduced to meet local (i.e., national) needs, and new products are first exported to similar countries, countries with similar needs, preferences, and incomes.
(E.g., the IBM PCs were produced in the US and spread quickly throughout the industrialized countries.)

72. Stage 2: Growth
Increase in sale of new production attracts competitors.
Increase of demand in advanced countries; exports – increase
further innovation in production, cost reduction, market process takes place (tech equipped)
Shift manufacturing to foreign countries

73. Stage 3: Maturity World wide production; Export decline.
Large scale of production
Low cost production – shift manufacturing to developing countries
Technology become standard

74. Stage 4: Decline
Market for the production concentrate in less developed countries as the customers in advanced countries shift their demand to further new production –thus production in developing countries
Original innovator becomes importer

75. Life Cycle of the International Product

76. Product Life Cycle Theory
goods undergo a predictable trade cycle shifting from export to import over the following stages:
introduction of good in home market
domestic industry exports
foreign production begins
domestic industry loses comparative advantage
imports become more likely
implications:
gains from trade are based on technological innovation and spread of that innovation to other countries
continual innovation needed to remain competitive

77. Factor Endowment Theory
Heckscher and Ohlin (H-O Theory)
Factor Price Equalization

78. Factor Endowment Theory
Model based on two concepts:
Factor endowments—the quantities of productive resources possessed by a country
Factor intensity—the amount of labor per unit of capital used in production of a product

79. Assumption: Factor Endowment Theory
Only two countries and two commodities in the world (Home and Foreign)
Consumer preferences are identical for all individuals
The same technological knowledge is available everywhere
The mix of labor and capital used in production varies across goods.
The supply of labor and capital in each country is constant and varies across countries.
Both labor and capital can move across sectors.
They use factor inputs which are of uniform quality

80. Factor Endowment - Example
U.S.: capital/labor ratio = 0.5 (100/200)
China: capital/labor ratio = 0.02 (20/1,000)
Since the U.S. has relatively more abundant capital, the U.S. will produce capital-intensive goods with China producing goods that are more labor-intensive.

81. Factor Endowment Theory
A country’s factors of production (a country’s endowments of inputs) are used to make each good give rise to productivity differences between countries
Factor endowments:
Factor abundance versus factor scarcity: When a country enjoys a relative abundance of a factor, the factor’s relative cost is less than in countries where the factor is relatively scarce
A country’s comparative advantage lies in the production of goods that use relatively abundant factors

82. Factor Endowment Theory
Export goods that intensively use factor endowments which are locally abundant
So … A country that is relatively labor abundant (capital abundant) should specialize in the production and export of that product which is relatively labor intensive (capital intensive)
Corollary: import goods made from locally scarce factors
Patterns of trade are determined by differences in factor endowments - not productivity

83. NOTE :
The relatively importance of labor and capital to a specific business can be described broadly in terms of their "intensity" (or to put it another way, significance)
Labor-intensive production relies mainly on labor
Capital-intensive production relies mainly on capital

84. Factor Endowment Theory (H-O Model)
4-20
Factor Endowment Theory (H-O Model)
Export goods that intensively use factor endowments which are locally abundant.
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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

85. Factor Price Equalization
Factor price equalization is an economic theory, by Paul A. Samuelson (1948), which states that the prices of identical factors of production, such as the wage rate, or the rent of capital, will be equalized across countries as a result of international trade in commodities
Simply stated the theorem says that when the prices of the output goods are equalized between countries as they move to free trade, then the prices of the input factors (capital and labor) will also be equalized between countries.
For example NAFTA- When two countries enter a free trade agreement, wages for identical jobs in both countries tend to approach each other.

86. THEORY OF COMPETITIVE ADVANTAGE

87. Competitiveness : A Definition
International Business View : The degree to which a nation can, under free and fair market conditions, produce goods and services that will meet the test of international markets while simultaneously maintaining or expanding the real income of its citizens.

88. How Nations Enhance Competitive Advantage
Traditionally (Natural Resources)
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.

89. THEORY OF COMPETITIVE ADVANTAGE
Acc to Heckscher-Ohlin theory and Comparative Advantage theory
E.g. A nation uses its resources very productively… BUT HOW?
Above theories give only Partial Explanation to the Question.
Porter’s Diamond Model is used to solve this puzzle
Developed in 1990, by Michael Porter of the Harvard Business School.
Porter theorizes FOUR Broad attributes – Factor Endowment, Demand conditions, Related/Support industry, Firm Strategy and rivalry.
Additional Variables that influence are Government and Chance

90. Michael Porter’s Diamond Model: 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

92. Home Diamond (Porter, M.E. 1990)
Firm Strategy Structure, & Rivalry
Do management & organisational structures in nation match industry needs?
Does industry attract outstanding talent?
Do investors goals meet industry needs?
Are there capable domestic rivals?
Factor conditions:
Demand conditions:
Does the nation have advanced factors of production?
Are there advanced factor creating mechanisms? E.g. 1st rate University research, Top grade Universities.
Are selective factor conditions indicators of foreign circumstances?
Are the nations buyers sophisticated & demanding?
Does the nation have unusual needs?
Do home \customer needs emulate those elsewhere?
Does the nation have sophisticated distribution channels
Demand conditions:
Does the nation have world-class supply industries
Are there strong related industries

93. DEMAND CONDITIONS Home country Demand plays an important role
Enables better understand the needs and desires of the customers
It shapes the attributes of domestically made products and creates pressure for innovation and quality

94. FACTOR ENDOWMENT
BASIC FACTORS – Natural resources, climate, location and demographics
ADVANCE FACTORS – Communication Infrastructure, skilled labor, Research facilities and so on.
Basic factors can provide only an initial advantage
They must be supported by advanced factors to maintain success

95. Related/Supporting Industry
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, footwear industry in South Korea, and the IT industry in Bangalore, India
Can serve as a nation’s export platform

96. Firm Strategy, Structure, Rivalry
Long term corporate vision (Strategy) is a determinant of success
Presence of domestic rivalry improves a company’s competitiveness

97. PORTER DIAMOND’S PREDICTIONS
Countries should be exporting products from those industries where all four components of the diamond are favorable.
while importing in those areas where the components are not favorable.

98. Example: Korea’s IT

99. Foreign Direct Investment Based Theories

100. DEFINING FDI
Is a process where by residents of one country(source country) acquire ownership of assets for the purpose of controlling the production and distribution and other activities.
IMF’s Balance of Payment manual defines “FDI as an investment that is made to acquire lasting interest in an enterprise operating in an economy other than that of an investor, the investor’s purpose being to have voice in the management of the enterprise”.
The United Nations(1999)World Investment Report(UNICTAD)defines FDI as an investment having involving long term relationship and reflecting a lasting interest and control of resident entity in one economy in an enterprise resident in an economy other than that of the foreign direct investor.

101. Dominance of FDI-Based Explanations of the International Firm
Most IB theories about the firm emphasize the MNE(multinational enterprise), 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

104. FDI BASED EXPLANATIONS: Monopolistic Advantage Theory
Suggests that FDI is preferred by MNE’s(multinational enterprise) 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

105. 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

106. FDI BASED EXPLANATIONS: Mac Dougall-Kemp Hypothesis.
FDI moves from capital abundant economy to capital scarce economy till the marginal production is equal in both countries. This leads to improvement in efficiency in utilization of resources in which leads to ultimate increase in welfare .According to this theory, foreing direct investment is a result of differences in capital abundance between economies. This theory was developed by MacDougal(1958) and was later elaborated by Kemp(1964)

107. FDI BASED EXPLANATIONS: Industrial Organization Theory.
According to this theory, MNC with superior technology moves to different countries to supply innovated products making in turn ample gains .Krugman (1989) points out that it was technological advantage possessed by European countries which led to massive investment in USA .According to this theory, technological superiority is the main driving force for foreign direct investment rather that capital abundance.

108. FDI BASED EXPLANATIONS: Currency Based Approaches.
A firm moves from strong currency country to weak currency country. Aliber(1971)postulates that firms from strong currency countries move out to weak currency countries. Froot and Stain(1989)holds that, depreciation in real value of currency of a country lowers the wealth of a domestic residents visa avis the wealth of the foreign residents ,thus being cheaper for foreign firms to acquire assets in such countries. Therefore, foreign direct investments will move from countries with strong currencies to those with weak or depreciating currencies.

109. FDI BASED EXPLANATIONS: Location –Specific Theory.
Hood and Young(1979) stress on the location factor. According to them, FDI moves to a countries with abundant raw materials and cheap labor force. Since real wage cost varies among countries, firms with low-cost technology move to low wage countries. Abundance of raw materials and cheap labor force are the main factors for FDI.Countries with cheap labor and abundant raw material will tend to attract FDI.

110. Cost and Benefits of FDI
Benefits to The Host Country.(host country - foreign country where the company invests) 1.Availability of scarce factors of production 2.Improvement in Balance of Payments through export and import substitution. 3.Building of economic and social infrastructure. 4.Fostering of economic linkages. 5.Strengthening of the government budget. 6. Stimulation of national economy. Subsidiaries of Trans-National Corporations (TNCs), which bring the vast portion of FDI, are estimated to produce around a third of total global exports (UNCTAD 1999).

111. Benefits to The Home Country home country - when company’s HQ is and where the company came from
1.Availability of raw material. 2.Improvement in Balance of Payments. 3.Revenue to the government 4.Employement generation 5.Improved political relations.

112. Cost to the Home Country
1.Cultural and political interference. 2.Un healthy competition 3.Over utilization of local resources(both natural and human resources) 4.Vilation of human rights(child labor eg. the case of NIKE in Vietnam). 5.Threat to indigenous technology. 6.Threat to local products.

113. Cost to the Home Country.
It is little compared to the host country. 1.Investment abroad takes away employment opportunities. 2.It takes away capital. 3.Out flow of factors of production.

114. Implications of International Trade and Investment Theories

115. International Trade Theory :Implication
Managers Implication
Location : most efficiently
First-Mover Advantages
Government Policy

116. Product Life Cycle Theory
goods undergo a predictable trade cycle shifting from export to import over the following stages:
introduction of good in home market
domestic industry exports
foreign production begins
domestic industry loses comparative advantage
imports become more likely
implications:
gains from trade are based on technological innovation and spread of that innovation to other countries
continual innovation needed to remain competitive

117. Examples of Comparative Advantage
Abundant, low-cost labor in China
Mass of IT workers in India
Abundant agricultural land in the USA
Oil in Saudi Arabia

118. Examples of Firm Competitive Advantage
Dell’s prowess 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

119. Example: 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

120. International Business
Contemporary Issues
International Business

121. Contemporary Issues Working in International Environments
Main areas a manager must deal
Political
Legal
Socio-cultural
Economic
Technical environments

122. Contemporary Issues
Trade issues occasionally dominate and are a continuing theme of the international scene: the global market, labor, child labor, trade deficits, the euro, sanctions, tariffs, and the EU, NAFTA, WTO – the seemingly endless alphabet of interest groups, treaties, organizations, and trade agreements

123. Contemporary Issues Global Competition Technology Resources Cost
Brand Image
Logistic Cost
Global Economic Recession
Political Instability
International and Regional Institution(WTO, SAFTA)