1. C h a p t e r Four International Trade Theory
Global Trade and Investment Environment
International Trade Theory
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2. International Trade Theory
Slide 4-1
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
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3. Classical Country-Based Theories
Slide 4-2
Classical Country-Based Theories
Mercantilism (pre-16th century)
Takes an us-versus-them view of trade; other country’s gain is our country’s loss
Neo-mercantilism views persist today
Free Trade supporting theories
Show that specialization of production and free flow of goods grow all trading partners’ economies
Absolute Advantage (Adam Smith, 1776)
Comparative Advantage (David Ricardo, 1817)
Free Trade refined
Factor-proportions (Heckscher-Ohlin, 1919)
International product life cycle (Ray Vernon, 1966)
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4. Slide 4-3
The New Trade Theory
In many industries, as output expands with specialization, the ability to realize economies of scale increases and unit costs should decrease
Because of such scale economies, world demand supports only a few firms in such industries (e.g., commercial aircraft, automobiles)
Countries that had an early entrant to such an industry have an advantage in such an industry:
Fist-mover advantage
Barrier to entry (Airbus overcame through government subsidies?)
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5. New Trade Theory Global Strategic Rivalry
Slide 4-4
New Trade Theory
Global Strategic Rivalry
Firms gain competitive advantage trough: intellectual property, R&D, economies of scale and scope, experience
National Competitive Advantage (Porter, 1990)
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6. Mercantilism/Neomercantilism
Slide 4-5
Prevailed from 1500 to 1800
Export more to “strangers” than we import to amass treasure, expand kingdom
Maximize exports and minimize imports: no advantage in increased trade
Government intervenes to achieve a surplus in exports
King, exporters, domestic producers: happy
Subjects: unhappy because domestic goods stay expensive and of limited variety
Today neo-mercantilists=protectionists: some segments of society shielded short term
Zero-sum vs positive-sum game view of trade
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7. Absolute Advantage Adam Smith: The Wealth of Nations, 1776
Slide 4-6
Absolute Advantage
Adam Smith: The Wealth of Nations, 1776
Mercantilism weakens a country in the long run and enriches only a few segments
A country should specialize in and export products for which it has absolute advantage; import others
A country has absolute advantage when it is more productive than another country in producing a particular product
Rice
Cocoa G G' K K'
G: Ghana
K: S. Korea
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8. Comparative Advantage
Slide 4-7
Comparative Advantage
David Ricardo: Principals of Political Economy, 1817
Country should specialize in the production of those goods in which it is relatively more productive... even if it has absolute advantage in all goods it produces
Absolute advantage is really a special case of comparative advantage
Cocoa G
Example: Medical Specialist is also the best medical secretary. Should this doctor spend any time on the secretarial part of the business? No? Why?
Lets continue with SL and the USA...
This time the terms have changed to give the USA the absolute adv. in both tea and wheat...
G: Ghana -Cocoa
K: S. Korea -Rice K K' G'
Rice
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9. Heckscher (1919)-Ohlin (1933) Theory
Slide 4-8
Heckscher (1919)-Ohlin (1933) Theory
The pattern of international trade depends on differences in factor endowments not on differences in productivity
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
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10. Theory of Relative Factor Endowments (Heckscher-Ohlin)
Slide 4-9
Theory of Relative Factor Endowments (Heckscher-Ohlin)
Factor endowments vary among countries
Products differ according to the types of factors that they need as inputs
A country has a comparative advantage in producing products that intensively use factors of production (resources) it has in abundance
Factors of production: labor, capital, land, human resources, technology
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11. International Product Life-Cycle (Vernon)
Slide 4-10
International Product Life-Cycle (Vernon)
Most new products initially conceived and produced in the US in 20th century
US firms kept production close to the market
Aid decisions; minimize risk of new product introductions
Demand not based on price yet; low production cost not an issue
Limited initial demand in other advanced countries
Exports more attractive than production there initially
With demand increase in advanced countries
Production follows there.
With demand expansion elsewhere
Product becomes standardized
production moves to low production cost areas
Product now imported to US and to advanced countries
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12. Classic Theory Limitations/Conclusion
Slide 4-11
Classic Theory Limitations/Conclusion
Fundamentally: Free Trade expands the world “pie” for goods/services
Theory Limitations
Simple world (two countries, two products)
no transportation costs
no price differences in resources
resources immobile across countries
constant returns to scale
each country has a fixed stock of resources and no efficiency gains in resource use from trade
full employment
Real world: many countries and many goods
Transportation costs may decline with specialization
Prices in different countries can be (are) effected by exchange rates. Wheat and Tea are not necessarily a one-to-one swap
resources can move from country to country: labor (Mexico to US), capital
(constant returns to scale: specialization does not effect the amount of resources required to produce one ton of wheat or tea) both diminishing and increasing returns to specialization exist
assumed fixed stock of resources in each country. Trade can change the efficiency with which the resources are used and the stock of resources may change too (more people, more natural resources, more efficient use due to technology)
Full employment implies use of resources at full efficiency...
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13. Slide 4-12
New Trade Theories
Increasing returns of specialization due to economies of scale (unit costs of prod. decrease)
First mover advantages (economies of scale such that barrier to entry crated for second or third company)
Luck... first mover may be simply lucky.
Government intervention: strategic trade policy
Commercial jet industry: studies show that 3 major manufacturers can survive. Boeing, McDonnell Douglas and Airbus already there... New entries discouraged... however, the largest potential customer is China and they want the capacity to produce... hence the battle Boeing is having with unions... either give China some of the value added activity to keep them out of mainline or lose out to Airbus or to a non-economic decision to start an industry.
Luck: DeHaviland in 50s. Comet fell out of sky. 707 captured the market. (some say it was not only luck but resources. B. had produced 707 on the back of technology developed for US military--spillover effect?? what of our claim that Airbus was subsidized??)
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14. National Competitive Advantage (Porter, 1990)
Slide 4-13
National Competitive Advantage (Porter, 1990)
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.
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15. Porter’s diamond Success occurs where these attributes exist.
More/greater the attribute, the higher chance of success
The diamond is mutually reinforcing
Fig 4.6
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16. Determinants of Competitive Advantage in nations
Government
Company Strategy,
Structure,
and Rivalry
Demand
Conditions
Related
and Supporting
Industries
Factor
Chance
Two external factors that influence the four determinants.
Fig 4.8
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17. Porter’s Theory-predictions
Porter’s theory should predict the pattern of international trade that we observe in the real world
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
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18. Implications for business
Location implications:
Disperse production activities to countries where they can be performed most efficiently
First-mover implications:
Invest substantial financial resources in building a first-mover, or early-mover advantage
Policy implications:
Promoting free trade is in the best interests of the home-country, not always in the best interests of the firm, even though, many firms promote open markets
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19. “So What” for business? First mover implications Location Implication
Slide 4-14
“So What” for business?
First mover implications
invest to be first, particularly in global industries or in markets which can support a few firms
Location Implication
if countries have comparative advantages MNEs want to locate appropriate activities in those countries…
Foreign Investment Decisions (Chapter 6)
Government Policy implications
companies generate imports and exports. Thus can influence government decisions on trade policy...
Infant industry protection
Location: To produce laptop four stages:
Basic research and development of product design (US, Japan: Apple, IBM, Motorola, TI, Toshiba, Sony)
manufacture of standard electronic components (capital intensive, semi-skilled labor, high unit cost pressures: Sing., Taiwan, Malaysia)
manuf. of advanced components (screens) (cap. intensive, high skilled labor, no cost pressure: Japan)
final assembly (labor intensive, low skill, intense cost pressures: Mexico)
First mover implications: high initial investment with years of losses... Japan LCD displays, US abandoned early tech. leadership in this technology.
Policy:
Apple and IBM lobbied against tariffs on LCD display imports: J. was the low cost producer, A. and IBM used these displays, the increase in import duty would reduce the world competitiveness of the A. and IBM products...
Auto industry induced govt. to negotiate voluntary restraints in machine tools. result: limited competition from world-wide efficient suppliers caused the US companies to lose their WW competitive edge and lost its WW share since 85.
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