1. International Business Environments & Operations
Daniels ● Radebaugh ● Sullivan
International Business Environments and Operations 15e by Daniels, Radebaugh, and Sullivan
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2. International Trade and Factor-Mobility Theory
Chapter 5
International Trade and Factor-Mobility Theory
Chapter 5: International Trade and Factor Mobility
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Learning Objectives
Understand how different approaches to international trade theories help policy makers achieve economic objectives
Comprehend the historical and current rationale for interventionist trade theories
Explain why production factors, especially labor and capital, move internationally
Describe the relationship between foreign trade and international factor mobility
The Learning Objectives for this chapter are
To understand theories of international trade
To explain how free trade improves global efficiency
To identify factors affecting national trade patterns
To explain why a country’s export capabilities are dynamic
To understand why production factors, especially labor and capital, move internationally
To explain the relationship between foreign trade and international factor mobility
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4. Laissez-Faire vs. Intervention
In trade theory the basic questions asked are…
Why nations (or companies in a nation) trade?
What factors determine trade?
How much and with whom should a nation trade?
Should a government intervene trade?
Two different approaches that answer these questions are…
Laissez-faire approach-absolute advantage and comparative advantage
Intervention approach-Mercantilism and neomercantilism
Why do countries trade? Countries trade in order to meet certain economic objectives, but they struggle with questions on what, how much, and with whom they should trade. They need to ensure that their decisions on what to produce make sense from an efficiency standpoint, and whether there are ways to improve competitiveness.
Some countries allow market forces to determine trade relations, others intervene to control the process.
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Trade Theories
Mercantilism (and Neomercantilism)
Adam Smith’s Absolute Advantage
Ricardo’s Comparative Advantage
Heckscher-Ohlin’s Theory of Factor Proportion
International Product Life Cycle (IPLC)
Porter’s Diamond and International Competitiveness of Nations
The Learning Objectives for this chapter are
To understand theories of international trade
To explain how free trade improves global efficiency
To identify factors affecting national trade patterns
To explain why a country’s export capabilities are dynamic
To understand why production factors, especially labor and capital, move internationally
To explain the relationship between foreign trade and international factor mobility
Copyright © 2015 Pearson Education, Inc.

6. Trade Theories and Business
What Major Trade Theories Do and Don’t Discuss: A Checklist
This Figure shows the major trade theories and their emphases. Managers can use the theories to predict and understand how government policy decisions could affect business competitiveness.
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7. Mercantilism
Initial trade theory that was the foundation of economic thought from 1500–1800 AD
The mercantilists believed that the way for nations to become rich and powerful was to have a favorable balance of trade, i.e., we should export more and import less.
They advocated strict government control of all economic activity and preached economic nationalism.
Neomercantilism preaches export surplus to achieve a country’s social and political objective. It also tacitly supports colonialism—it is alright to have colonies to generate trade surplus.

8. Theory of Absolute Advantage (Adam Smith, 1776)
Believed that countries are at different levels in terms of trade because of natural or acquired advantage. Resource base, country size, technology or resource efficiencies (as absolute advantages) is the basis (or reason) for trade.
A country can (i) maximize its economic wellbeing by specializing in the production of those goods and services in which it has absolute advantage and (ii) enhance global efficiency through participation in free trade.
Advocated that market forces, and not the government, should determine the direction, volume, and composition of international trade.

9. Theory of Absolute Advantage
Production Possibilities under Conditions of Absolute Advantage
This Figure illustrates the production possibilities for two countries under the conditions of absolute advantage. Notice that with free trade and specialization both countries benefit.
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10. Theory of Comparative Advantage (David Ricardo, 1817)
Relative or comparative advantage or efficiency is the main argument.
Comparative advantage stems from the relative efficiency of one nation over another. A country will produce and export those goods and services in which it has comparative advantage.
Free trade fosters global efficiency. Global gains are made through comparative efficiency. Everyone is producing those products in which they are best.
If an individual happens to be the best lawyer and the best typist in a town, which profession will s/he choose? Answer: the one that offers relative efficiency

11. Theory of Comparative Advantage
Production Possibilities under Conditions of Comparative Advantage
This Figure illustrates the production possibilities for two countries under the conditions of comparative advantage. Notice that by specializing in the production of goods in which a country has a comparative advantage and trading for goods in which a country has an absolute disadvantage both countries still gain.
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12. Theory of Factor Proportion (Eli Heckscher, 1919 and Bertil Ohlin, 1933)
Inputs, factors of production is the main issue.
Differences in a country’s relative endowments of land, labor, and capital explain differences in the cost of production factors. A country will produce and export those goods and services in which it is relatively better endowed.
The comparative advantage in relative prices and factor inputs would be the basis for trade. Given this, a capital abundant country will have comparative advantage in capital-intensive goods and will export those for labor-intensive goods.

13. Assumptions and Limitations of the Three Trade Theories
The assumptions of the three trade theories based on specialization may not be valid
full employment
economic efficiency
division of gains
transport costs
statics and dynamics
services
production networks
mobility
While the theories of specialization – absolute advantage and comparative advantage – offer policymakers a greater understanding of free trade, they are based on a number of assumptions that may not always be valid.
Specifically, the theories assume that full employment exists, that economic efficiency is the primary goal of countries, that the division of gains is acceptable to both countries, that the world is composed of only two countries and two products, that there are no transportation costs, that advantages are static, and that while resources can move freely within a country, they are immobile internationally.
Keep in mind that the theories can apply to trade in services as well as trade in products and that they apply to situations in which multi-country production takes place.
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14. Product Life Cycle Theory
Life Cycle of the International Product
This Figure provides more details on exactly what occurs at each stage in a product’s life cycle. Keep in mind that while the theory holds for many products, it does not explain all products. In fact, today, many products are introduced at home and abroad simultaneously. Moreover, because costs drive production decisions, the initial production location may or may not be in the home country.
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15. International Product Life Cycle (IPLC) Theory
Introduction
Growth
Maturity
Decline
Production Location
Market Location
Competitive Factors
Production Technology

16. Porter’s Diamond- International Competitiveness of Nations

17. Diamond of National Advantage
The Diamond of National Competitive Advantage
This Figure provides more details on each factor that makes up the diamond of national advantage. Keep in mind though, that the existence of all four factors does not guarantee that an industry will develop, nor is it necessary given globalization. For example, today, because capital and managers are internationally mobile, it may not be necessary to depend on domestic factor conditions. Similarly, thanks to freer trade and advances in transportation, local related and supporting industries are not as important.
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18. International Competitiveness of Nations (Michael Porter 1990)
It is a departure from the previous trade theories. Most trade theories are from a country perspective but it is the companies that make decisions about trade.
Porter argues that the dynamic interplay of the four factors that determine international competitiveness are:
- Demand Conditions
- Factor Conditions
- Related and Supporting Industries
- Firm Structure and Rivalry.
Other two factors that also influence the competitiveness of nations are Chance and Government.

19. Back to the questions we begun this chapter with-Trade Pattern Theories
How much does a country trade?
Depends on the size of the country, larger economies trade more
What products does a country trade?
Factor proportion theory (Heckscher-Ohlin) explains that
With whom do countries trade?
Country Similarity Theory
Geography/proximity also influences

20. Trade and Factor Mobility-1
Trade, Production and Investment move simultaneously, we need a comprehensive explanation instead of a piecemeal theory.
Factor mobility/movements alter factor endowments, can be substantial for some countries, and insignificant for others
The lowest costs occur when trade and production factors are both mobile
What is the relationship between trade and factor mobility? In general, if free trade is coupled with the free moving factors of production, the most efficient resource allocation should occur.
The most abundant factors should move to areas of scarcity.
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21. Trade and Factor Mobility-2
Relationship among land, labor, and capital movements will continue to evolve
International division of labor will continue to reshape the global specialization and trade patterns
Displacement of jobs will continue to be a source of conflict
International labor migration can be a source conflict as demographics change: brain drain, inward vs. outward remittances
What is the relationship between trade and factor mobility? In general, if free trade is coupled with the free moving factors of production, the most efficient resource allocation should occur.
The most abundant factors should move to areas of scarcity.
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22. What Does A Country Trade?
Worldwide Trade by Major Sectors
This Figure shows the changing composition of world trade. Most new products are developed in industrialized countries.
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23. Chapter 5: Discussion Question
1. Question can be asked to explain one or more theories of trade. For example…
Explain Porter’s Diamond of International Competitiveness of Nations.
Elaborate the trade theories of Smith, Ricardo and Heckscher-Ohlin and distinguish their differences.
Explain International Product Life Cycle Theory (IPLC).
2. Discuss the evolving pattern and future of “trade and factor mobility” in a globalized world.

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