International Business 9 e By Charles W L

Chapter 6 International Trade Theory

Why Is Free Trade Beneficial? Ø Free trade - a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country Øtrade theory shows why it is beneficial for a country to engage in international trade even for products it is able to produce for itself 6 -3

Why Is Free Trade Beneficial? Ø International trade allows a country Øto specialize in the manufacture and export of products and services that it can produce efficiently Øimport products and services that can be produced more efficiently in other countries Ølimits on imports may be beneficial to producers, but not beneficial for consumers 6 -4

What Is Mercantilism? Ø Mercantilism (mid-16 th century) suggests that it is in a country’s best interest to maintain a trade surplus -to export more than it imports Øadvocates government intervention to achieve a surplus in the balance of trade Ø Mercantilism views trade as a zero-sum game Øone in which a gain by one country results in a loss by another 6 -5

What Is Smith’s Theory Of Absolute Advantage? Ø Adam Smith (1776) argued that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it Øcountries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for goods produced by other countries 6 -6

What Is Ricardo’s Theory Of Comparative Advantage? Ø David Ricardo asked what happens when one country has an absolute advantage in the production of all goods Ø The theory of comparative advantage (1817) countries should specialize in the production of those goods they produce most efficiently and buy goods that they produce less efficiently from other countries Øeven if this means buying goods from other countries that they could produce more efficiently at home Ø Trade is a positive sum game 6 -7

What Is The Heckscher-Ohlin Theory? Ø Eli Heckscher (1919) and Bertil Ohlin (1933) comparative advantage arises from differences in national factor endowments Øthe more abundant a factor, the lower its cost Ø Heckscher and Ohlin predict that countries will Øexport goods that make intensive use of locally abundant factors Øimport goods that make intensive use of factors that are locally scarce 6 -8

Does The Heckscher-Ohlin Theory Hold? Ø Wassily Leontief (1953) theorized that since the U. S. was relatively abundant in capital compared to other nations, the U. S. would be an exporter of capital intensive goods and an importer of labor-intensive goods. ØHowever, he found that U. S. exports were less capital intensive than U. S. imports Ø Since this result was at variance with the predictions of trade theory, it became known as the Leontief Paradox 6 -9

What Is The Product Life Cycle Theory? Ø The product life-cycle theory - as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade Ø proposed by Ray Vernon in the mid-1960 s Ø Globalization and integration of the world economy has made this theory less valid today Ø theory is ethnocentric Ø production today is dispersed globally Ø products today are introduced in multiple markets simultaneously 6 -10

What Is New Trade Theory? Ø New trade theory suggests that the ability of firms to gain economies of scale (unit cost reductions associated with a large scale of output) can have important implications for international trade Ø Countries may specialize in the production and export of particular products because in certain industries, the world market can only support a limited number of firms Ø new trade theory emerged in the 1980 s Ø Paul Krugman won the Nobel prize for his work in 2008 6 -11

What Are The Implications Of New Trade Theory For Nations? Ø Nations may benefit from trade even when they do not differ in resource endowments or technology Ø a country may dominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good Ø Governments should consider strategic trade policies that nurture and protect firms and industries where first mover advantages and economies of scale are important 6 -12

What Is Porter’s Diamond Of Competitive Advantage? Ø Michael Porter (1990) tried to explain why a nation achieves international success in a particular industry Ø Porter identified four attributes that promote or impede the creation of competitive advantage 1. 2. 3. 4. Factor endowments Demand conditions Relating and supporting industries Firm strategy, structure, and rivalry 6 -13

What Is Porter’s Diamond Of Competitive Advantage? Determinants of National Competitive Advantage: Porter’s Diamond 6 -14

Does Porter’s Theory Hold? Ø Government policy can Ø affect demand through product standards Ø influence rivalry through regulation and antitrust laws Ø impact the availability of highly educated workers and advanced transportation infrastructure. Ø The four attributes, government policy, and chance work as a reinforcing system, complementing each other and in combination creating the conditions appropriate for competitive advantage Ø So far, Porter’s theory has not been sufficiently tested to know how well it holds up 6 -15

What Are The Implications Of Trade Theory For Managers? 1. Location implications - a firm should disperse its various productive activities to those countries where they can be performed most efficiently 2. First-mover implications - a first-mover advantage can help a firm dominate global trade in that product 3. Policy implications - firms should work to encourage governmental policies that support free trade 6 -16

What Is The Balance Of Payments? Ø A country’s balance of payments accounts keep track of the payments to and receipts from other countries for a particular time period 1. The current account records transactions of goods, services, and income, receipts and payments Ø current account deficit Ø current account surplus 2. The capital account records one time changes in the stock of assets 3. The financial account records transactions that involve the purchase or sale of assets 6 -17