2. 3 Theories of International Trade and Investment
This chapter covers:
Why goods are traded internationally
Arguments for imposing trade restrictions
Kings of import restrictions
Weakness of GNP/capita as economic indicator
Characteristics of developing nations
Theories of foreign direct investment
Theories of International
Trade and Investment
International Business
by Ball, McCulloch, Frantz,
Geringer, and Minor
McGraw-Hill/Irwin
Copyright © The McGraw-Hill Companies, Inc. All rights reserved.

3. Chapter Objectives Understand the theories of international trade.
Comprehend the arguments of imposing trade restrictions.
Explain the two basic kinds of import restrictions.
Appreciate the relevance of the changing status of tariff and non tariff barriers.
Recognize the weaknesses of GNP/capita as an economic indicator.
Understand the new definition of economic development.
Understand why governments change from import substitution to export promotion.
Explain some of the theories of foreign direct investment.
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4. International Trade Theory
Mercantilism
Believed nation’s welfare was in accumulation of stock of precious metals.
Trade surplus created by import restrictions and government subsidies to exporters.
Mercantilist era ended in 1700s.
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5. Modern Day Mercantilism
Economic Nationalism
Industrial policy based on state intervention
France nationalized key industries and banks to use the power of the state as
Stockholder and financier
Customer and marketer to revitalize the nation’s base
In 1986, little growth and high unemployment led government to reverse “mercantilist” policy
Japan called “fortress of mercantilism” by some
Nearly impenetrable market
Effort to maintain a cheap yen
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6. Theory of Absolute Advantage
“The capacity of one nation to produce more of a good with the same amount of input than another country.”
Adam Smith claimed that market forces, not government controls should determine the direction, volume, and composition of international trade.
Each nation should specialize in producing goods it could produce most efficiently
In absolute advantage, both nations would gain from trade.
Assumptions
Perfect competition and no transportation costs in a world of two countries and two products.
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7. Theory of Comparative Advantage
“A nation having absolute disadvantages in the production of two goods compared to another nation,
has a comparative advantage in producing the good in which its absolute disadvantage is less.”
Theory of comparative advantage demonstrated by Ricardo in 1817.
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8. Production Possibility Frontiers
The following two graphs illustrate Chinese and U.S. production possibility frontiers using constant cost for simplicity.
These curves, in the absence of trade, also illustrate the possible combinations of goods for consumption.
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9. Offshoring Service Jobs to India
Approximately 1 Billion people
Comparative advantage in production of goods or services that require large amounts of labor
Citizens speak English
Low labor costs due to large workforce
Internet and telephone communications much less expensive
Industries offshoring include software engineering, telemarketing, banking, medical services, claims processing, IT jobs, financial services, insurance
Jobs created overseas generate jobs at home
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10. Heckscher-Ohlin Theory of Factor Endowment
States that international and interregional differences in production costs occur because of differences in the supply of production factors. Therefore,
India should export labor intensive goods.
Germany, with relatively more capital than labor should specialize in capital intensive products.
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Assumptions
The price of factors depend only on the factor endowment.
Not a perfect market
Legislated wages and benefits
Tax credits
Given technology is universally available.
Always a lag between intro of new technology and world application

11. Leontief Paradox
Study in 1953 by economist Wassily Leontief disputed the usefulness of the Heckscher-Ohlin Theory as a predictor of the direction of trade.
Found that the U.S., one of the most capital-intensive countries in the world, was exporting labor intensive products.
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12. Effect of Money on Trade
Exchange Rate
The price of one country’s currency stated in terms of the other.
Influence of Exchange Rates
European companies pressured to incraese prices of exports to maintain Euro profits
Currency devaluation
Lowering of a country’s currency in terms of other currencies.
Example is tourism and currency rates in Mexico during 1980s

13. Newer Explanations of the Direction of Trade
Economies of Scale and the Experience Curve
As output increases cost per unit decreases
Larger and more efficient equipment
Volume discounts
Fixed cost allocation
Drop in learning curve
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First Mover Theory
Gain market share
Discourage foreign entrants
The Linder Theory of Overlapping Demand
Customers’ tastes determined by income levels
Trade greater between nations with similar per capital incomes

14. International Product Life Cycle (IPLC)
Four stages of the IPLC in the U.S.
1) U.S. exports
2) Foreign production begins
3) Foreign competition in export markets
4) Import competition in the U.S
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15. Stages of the International Product Life Cycle
Exports
May be only manufacturer of new product
Overseas customers learn of product, export market develops
Foreign production
Export volume grows
Production technology becomes stable
Reduced costs for transportation
Exports diminish
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Foreign competition
Foreign manufacturers gain experience
Compete in export markets
Import competition
Foreign producers obtain economies of scale
Compete in quality and undersell domestic company in domestic market

16. International Technology Life Cycle
Initial Stage
Development of new technology in an industrialized country
Subsequently exported to other developed countries
Increasing cost of labor make it no longer profitable to use in developed nation
Technology exported to developing nation
Technology produced abroad for domestic consumption
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17. Porter’s Competitive Advantage of Nations
Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage.
Demand conditions
Factor conditions
Related and supporting industries
Firm strategy, structure, rivalry
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18. Porter’s Competitive Advantage of Nations
Demand Conditions
Nature of domestic demand.
If customers are demanding, firms will produce high-quality and innovative products gaining competitive advantage
Factor Conditions
Level and consumption of factors of production
Lack of natural endowments has caused nations to invest in the creation of advanced factors
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Related and supporting industries
Suppliers and industry support services tend to form a cluster in a given location
Firm Strategy, Structure, Rivalry
Extent of domestic competition,
The existence of barriers to entry
The firm’s management style and organization.

19. Trade Restrictions Arguments for National Defense
Certain industries need protection
Imports may not be available during wartime
Prevent valuable technologies from being used to strengthen competition, especially militarily
Sanctions to Punish Offending Nations
Inflict economic damage to encourage to modify behavior
Protect Infant or Dying Industry
In the long run will have a comparative advantage
Meant to be temporary for emerging industry or to protect jobs of dying industry
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20. Trade Restrictions Arguments for
Protect Domestic Jobs from Cheap Foreign Labor
Productivity per worker greater in developed countries
Fails to consider cost of other factors of production
Scientific Tariff or Fair Competition
Bring cost of imported goods up to domestically produced goods to prevent unfair advantage
Retaliation
Import restrictions placed by another country may result in similar restrictions by domestic government
EU ban on hormone treated U.S. beef
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21. Other Reasons for Retaliation
Dumping is the selling of a product abroad for less than
The average cost of production in the exporting nation
The market price in the exporting nation
The price to third countries
Result of
Excess production
Cyclical or seasonal factors
Attempt to force domestic producers out of business
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22. Sanctions Justified
Dumping for which sanctions are considered justified
Social dumping
Lower labor costs and poorer working conditions
Environmental dumping
Lax environmental standards
Financial services dumping
Low requirements for bank capital/asset ratios
Cultural dumping
Cultural barriers aid local firms
Tax dumping
Differences in corporate tax rates or special breaks
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23. Other Reasons for Retaliation
Subsidies
Government provides to domestic firm to encourage exports or protect from imports
Can be
Cash payment
Government participation in ownership
Low-cost loans
Preferential tax treatment
Countervailing Duties
Set by importing nation to offset effects of subsidy
Equal to the subsidy amount
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24. Types of Restrictions - Tariffs
Ad Valorem
Percentage of invoice value
Specific
Fixed sum of money per unit
Compound duty
Combination of the above
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Official Prices
Minimum import duty regardless of invoice price
Variable Levy
Calculated daily based on world market price
Lower Duties for Local Input
Encourages some local production

25. Types of Restrictions - Nontariff
Quantitative
Quotas
Voluntary Export Restraints
Orderly Marketing Arrangements
Nonquantitative Nontariff
Direct government participation in trade
Customs and other administrative procedures
Government and private standards
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26. Levels of Economic Development
Developed
Classification for all industrialized nations, which are mostly technologically developed.
Developing
Classification for world’s lower income nations, which are less technically developed.
Newly Industrialzing Countries (NICs)
Fast-growing, middle-income or higher economies
Heavy concentration of foreign investment
Exported large quantities of manufactured goods, including high-tech products
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27. Levels of Economic Development
Newly Industrialized Economies (NIEs)
Primarily used to refer to the four tigers
Taiwan, Hong Kong, Singapore, South Korea
IMF combines NIEs with Industrialized Nations to form “advanced economies
Emerging Market Economies
Chile, Malaysia, China, Thailand, Indonesia
Transition Countries or Eastern Europe
Former communist countries
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28. The World Bank Classification System
Based on GNP/capita
Low income ($735 or less)
Lower middle income ($736 - $2935)
Upper middle income ($2,936 - $9,075)
High income ($9,076 or more)
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29. GNP/Capita as an Indicator
Concerns
GNP/Capital data does not include Underground Economy
Undeclared legal production
Production of illegal goods and services
Concealed income – barter
Underground Economy larger if
Higher level of taxation
Oppressive government red tape
Currency conversion
Local currency converted to the dollar by using exchange rate
Conversions do not reflect domestic purchasing powers of currencies, must use purchasing power parity (PPP)
World Bank uses Atlas methodology
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30. Characteristics of Developing Nations
GNP/capital less than $9,075
Unequal distribution of income
Technological dualism
Regional dualism
Majority of population working in agricultural sector
Disguised unemployment or underemployment
High population growth
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High rate of illiteracy and insufficient educational facilities
Widespread malnutrition and health problems
Political instability
High dependence on a few products
Inhospitable topography
Low savings rates and inadequate banking facilities

31. Human Needs Approach to Economic Development
Defines economic development as the reduction of poverty, unemployment, and inequality in the distribution of income.
Less illiteracy, less malnutrition, less disease and early death, shift from agricultural to industrial production
Human Development Index (HDI) based on
A long and healthy life
Ability to acquire knowledge
Access to resources for a decent standard of living
Measured by life expectancy, adult literacy, and GDP/capita adjusted for PPP
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32. Development Theory No generally accepted theory
Economists concentrating on
Population growth
Income distribution
Unemployment
Transfer of technology
Role of government
Investment in human capital
The education of people
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33. Contemporary Theories of FDI
Monopolistic Advantage Theory
FDI occurs largely in oligopolistic industries
Product and Factor Market Imperfections
FDI typically from companies with heavy product research and marketing efforts
International Product Life Cycle
FDI normal state in life of a product
Other Theories
Follow-the-leader theory
Cross investment
Internalization theory
Theory of International production
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34. Current U.S. Trade Sanctions
Balkans
Burma (Myanmar)
Cuba
Diamond Trading
Iran
Iraq
Liberia
Source:
Libya
Narcotics Trafficking
Nonproliferation
North Korea
Sudan
Syria
Terrorists
Zimbabwe

35. Export Screening Guidelines
Screening Elements
Element 1: Denied Persons Screen Element 2: Product Classification/License Determination Screen Element 3: Diversion Risk Screen Element 4: Sensitive Nuclear End-Uses/End-Users Screen Element 5: Missile End-Use/End-Users Screen Element 6: Chemical and Biological Weapons End-Uses/End-Users Screen Element 7: Antiboycott Screen Element 8: Informed Letter/Entity List Screen
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36. Department of Commerce Transshipment Country Export Control Initiative (TECI)
TECI is a multi-faceted, cooperative initiative that seeks to strengthen the trade compliance and export control systems of those countries and companies that constitute global transshipment hubs. By working to strengthen those systems, the DOC seeks to enhance security and confidence in international trade flows.
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37. GDP Growth
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38. AIDS Crisis
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39. Antidumping Measures
The United States maintains 54 of its outstanding 288 antidumping measures against products from China.
In 2003, new cases against China were initiated at the brisk pace of one per month. These actions hit consumable products like honey, apple juice concentrate, mushrooms, and pencils, as well as raw material inputs like creatine monohydrate, polyvinyl alcohol, barium carbonate and ferrovanadium.
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