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International Trade Theory

Mercantilism

The principal assertion of mercantilism was that gold and silver were the mainstays of national wealth and essential to vigorous commerce. At that time, gold and silver were the currency of trade between countries; a country could earn gold and silver by exporting goods. By the same token, there were outflows of gold and silver while a country was importing. The main principle of mercantilism was a country would maintain a trade surplus, to export more than it imported.

Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. They saw no virtue in a large volume of trade. Rather, they recommended policies to maximize exports and minimize imports. To achieve this, imports were limited by tariff, and exports were subsidized.

The flaw with mercantilism was that it viewed trade as a zero-sum game; that is a game in which one can gain at the cost of anothers loss. The following scenario will depict the flaw

Let us assume England had a balance of trade surplus with France, the resulting inflow of gold and silver would swell the domestic money supply and generate inflation in England. In France, however, the outflow of gold and silver would have the opposite effect. Frances money supply would contract, and its prices will fall. This change in relative prices between France and England would encourage the French to buy fewer English goods as they were becoming more expensive, and the English to buy more French goods as they were becoming cheaper. The result would be deterioration in the English balance of trade and an improvement in Frances trade balance, until the English trade surplus was eliminated. Hence, in the long run, no country could sustain a surplus in the trade balance and so mercantilism doctrine is dead. Absolute Advantage

According to Adam Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries. Smiths basic argument is that a country should never produce goods at home that it can buy at a lower cost from other countries. Smith demonstrated that, by specializing in the production of goods in which each has an absolute advantage, both countries benefit by engaging in trade.

Let us analyze the below case

International Trade Theory


Comparative Advantage

According to Ricardos theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces more efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself. Cocoa Rice Domestic Exchange Ghana 10 13.33 1:1.33 South Korea 40 20 2:1 International Exchange 1:4 1:1.5 The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. Let us assume that total resource available is 200 units Production without Trade: If there is no trade, suppose the resources are being utilized in equal amount for the production of both goods by both countries. Cocoa Rice Ghana 10 7.5 South Korea 2.5 5 Total 12.5 12.5 Production with Specialization: According to the theory of comparative analysis,

South Korea will go for specialization in producing rice as it has less comparative disadvantage compared to Ghana, and for the opposite reason Ghana will go for specialization in producing cocoa. Cocoa Rice Ghana 15 3.75 South Korea

0 10 Total 15 13.75

International Trade Theory


Consumption after Ghana Trades 4 units of Cocoa for 4 units of South Korean Rice: Cocoa Rice Ghana 11 7.75 South Korea 4 6 Total 15 13.75 Increase in Consumption after Trade: Cocoa Rice Ghana 1 0.25 South Korea 1.5 1 Assumptions for the Comparative Advantage Doctrine

In this doctrine only two countries and two goods are assumed. In the real world,

there are many countries and many goods.

The transportation costs are not considered here. The prices of resources are assumed to be same in the same countries. It is assumed that the resources can move freely from one production to another

within a country.

In this doctrine, constant return of scale is considered. It is assumed that each country has a fixed stock of resources and that free trade The effect of trade on income distribution within a country is not considered here.

does not change the efficiency with which a country uses its resources. Extension of the Ricardian Model Immobile Resources

Resources do not always move easily from one economic activity to another. The process creates friction and human suffering too. While the theory predicts that the benefits of free trade outweigh the costs by a significant margin, this is of cold comfort to those who bear the costs. Accordingly, political opposition to the adoption of a free trade regime typically comes from those whose jobs are most at risk.

The pain caused by the movement toward a free trade regime is a short time phenomenon, while the gains from trade once the transition has been made are both significant and enduring.

International Trade Theory


Diminishing Returns

Diminishing returns to specialization occurs when more units of resources are required to produce each additional unit. Diminishing return implies a convex PPF rather than the straight line.

It is more realistic to assume diminishing returns for two reasons. First, not all resources are of the same quality. As a country tries to increase its output of a certain good, it is increasingly likely to draw on more marginal resources whose productivity is not as great as those initially employed. The result is that it requires even more resources to produce an equal increase in output. A second reason for diminishing returns is that different goods use resources in different proportions.

Diminishing returns show that it is not feasible for a country to specialize to the degree suggested by the simple Ricardian model outlined earlier. Diminishing returns to specialization suggest that the gains from specialization are likely to be exhausted before specialization is complete. In reality, most countries do not specialize but, instead, produce a range of goods. However, the theory predicts that it is worthwhile to specialize until that point where the resulting gains from trade are outweighed by diminishing returns. Dynamic Effects of Economic Growth Free trade might increase a countrys stock of resources as increased supplies of labor and capital from abroad become available for use within the country.

Free trade might also increase the efficiency with which a country uses its resources. Gains in the efficiency of resource utilization could arise from a number of factors. Economies of large scale production might become available as trade expands the size of total market available for domestic firms. Trade might make better technology from abroad available, better technology can increase productivity of resources. Opening an economy for foreign competition might stimulate producers to look for ways to increase their efficiency. The Samuelson Critique

The Samuelson model suggests that when a rich country enters into free trade with a poor country, the lower prices that the rich country consumers pay for goods imported from the poor country may not be enough to produce a net gain for the rich country economy if the dynamic effect of free trade is to lower the real wage rates in the rich country.

International Trade Theory


Samuelson concedes that free trade has historically benefited rich countries. Also he notes that introducing protectionist measures to guard against the theoretical possibility may harm the rich country in the future may produce a situation that is worse than the disease they are trying to prevent.

Some economists note that as a practical matter developing nations are unlikely to be able to upgrade the skill level of their workforce rapidly enough to give rise to the situation in Samuelson model. In other words, they will quickly run into diminishing returns. Link between Trade and Growth

Countries that adopt a more open stance toward international trade enjoy higher growth rates than those who close their economies to trade. Higher growth rate will raise income levels and living standards. For every 10% increase in the importance of international trade in an economy, average income level will rise by at least 5%. Heckscher Ohlin Theory

Heckscher and Ohlin argues that comparative advantage arises not prom the productivity, but from the differences in national factor endowments. By factor endowments they mean the extent to which a country is endowed with resources. The more abundant a factor, the lower its cost.

The Heckscher Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce.

Relative, not absolute, endowments are important; a country may have larger absolute amounts of land and labor than another country, but be relatively abundant in one of them. A key assumption in this theory is that technologies are the same across countries. The Leontief Paradox

Since US is relatively abundant in capital compared to other nations, US would be an exporter of capital intensive good and an exporter of labor intensive goods; as Heckscher Ohlin theory suggests. But in reality it is opposite, which is called the Leontief Paradox.

The probable reason behind this is US has a special advantage in producing new products made with innovative technologies. Such product may be less capital intensive than products whose technology has had time to mature and become suitable for mass

International Trade Theory


production. Thus US may be exporting goods that heavily use skilled labor and innovative entrepreneurship. Product Life Cycle Theory

Raymond Vernon argued that most new products were initially produced in US. Apparently, the pioneering firms believed that it was better to keep production facilities close to the market and to the firms center of decision making, given the uncertainty and risks inherent in introducing new products. Also, the demand for most new products tends to be based on non-price factors. Consequently, firms can charge relatively high prices for new products, which obviate the need to look for low cost production sites in other countries.

Vernon went on to argue that early in the life cycle of a typical new product, while demand is starting to grow rapidly in US, demand in other advanced countries is limited to the high income groups. The limited initial demand in other advanced countries does not make it worthwhile for the firms in those countries to produce the new product, but it needs some exports from US.

Over time demand for the new product grows in other advanced countries and it becomes worthwhile for foreign producers to begin producing for their home markets. In addition, US firms might set up production facilities in those advanced countries where demand is growing. Consequently, production within other advanced countries begins to limit the potential for exports from US.

As the market in US and other advanced countries matures, the product becomes more standardized, and price becomes the main competitive weapon. As this occurs, cost considerations start to play a greater role in the competitive process. Producers based in advanced countries where labor costs are lower than in US might now be able to export to US. If cost pressure becomes intense, the process might not stop here. The cycle by which

US lost its advantage to other advanced countries might be repeated once more, as developing countries begin to acquire a production advantage over advanced countries. Thus, the locus of global production initially switched from US to other advanced countries, and later to the developing countries.

International Trade Theory


The New Trade Theory

The new trade theory suggests that nations may benefit from trade even when they do not differ in factor endowments or technology. Trade allows a nation to specialize in the production of certain products, attaining scale of economies and lowering the cost of production. Economies of scale are unit cost reduction associated with large volume of output. Economies of scale have a number of sources, including the ability to spread fixed cost over a large volume, and the ability of large producers to utilize specialized resources. New trade theory makes two important points

Through its impact on economies of scale, trade can increase the variety of goods In those industries when the output required to attain economies of scale represents

available to consumers and decrease the average costs of those goods.

a significant proportion of total world demand, the global market may only be able to support a small number of enterprises. Thus, world trade in certain products may be dominated by countries whose firms were first movers in their production. Increasing Product Variety and Reducing Costs

In the era of free trade, individual national markets are combined into a larger world market. As the size of market expands due to trade, individual firms may be able to better attain economies of scale. The implication according to the new trade theory, is that each nation may be able to specialize in producing a narrower range of products than it would in the absence of trade, yet by buying goods from other countries, each nation can simultaneously increase the variety of goods available to its consumers and lower the costs of those goods thus trade offers an opportunity for mutual gain even when countries do not differ in their resource endowments or technology.

Trade is mutually beneficial because it allows for the specialization of production, the realization of scale of economies, the production of a greater variety of products, and lower prices. Economies of Scale, First Mover Advantages, and the Pattern of Trade

The trade pattern we observe in the world economy may be the result of economies of scale and first mover advantage. First mover advantages are the economic and strategic advantages that accrue to early entrants into an economy. The ability to capture scale economies ahead of later entrants, and thus benefit from a lower cost structure, is an important first mover advantage.

nternational

Trade Theory

The new trade theory argues that for those products where economies of scale are significant and represent a substantial proportion of world demand, the first movers in an industry can gain a scale based cost advantage that later entrants find almost impossible to match. Thus the trade pattern we observe for such products may reflect the first mover advantage. Countries may dominate in the export of certain goods because economies of scale are important in their production and because firms located in those countries are the first to capture scale economies, giving them a first mover advantage. National Competitive Advantage: Porters Diamond Classical theories of international trade propose that comparative advantage resides in the factor endowments that a country may be fortunate enough to inherit. Factor endowments include land, natural resources, labor, and the size of the local population. Michael E. Porter argued that a nation can create new advanced factor endowments such as skilled labor, a strong technology and knowledge base, government support, and culture. Porter used a diamond shaped diagram as the basis of a framework to illustrate the determinants of national advantage. This diamond represents the national playing field that countries establish for their industries.

International Trade Theory


The new trade theory argues that for those products where economies of scale are significant and represent a substantial proportion of world demand, the first movers in an industry can gain a scale based cost advantage that later entrants find almost impossible to match. Thus the trade pattern we observe for such products may reflect

the first mover advantage. Countries may dominate in the export of certain goods because economies of scale are important in their production and because firms located in those countries are the first to capture scale economies, giving them a first mover advantage. National Competitive Advantage: Porters Diamond

Classical theories of international trade propose that comparative advantage resides in the factor endowments that a country may be fortunate enough to inherit. Factor endowments include land, natural resources, labor, and the size of the local population. Michael E. Porter argued that a nation can create new advanced factor endowments such as skilled labor, a strong technology and knowledge base, government support, and culture. Porter used a diamond shaped diagram as the basis of a framework to illustrate the determinants of national advantage. This diamond represents the national playing field that countries establish for their industries.

Firm,strategy,structure and rivalry. Chance Factor Conditions Related and Supporting Government Demand Conditions Industries

International Trade Theory


The individual points on the diamond and the diamond as a whole affect four ingredients that lead to a national comparative advantage. These ingredients are:

The availability of resources and skills Information that firms use to decide which opportunities to pursue with those The goals of individuals in companies The pressure on companies to innovate and invest A country creates its own important factors such as skilled resources and The stock of factors at a given time is less important than the extent that they are Local disadvantages in factors of production force innovation. Adverse conditions

resources and skills I. Factor Conditions technological base. upgraded and deployed. force firms to develop new methods, and this innovation often leads to a national competitive advantage. II. Demand Conditions

When the market for a particular product is larger locally than in foreign markets, the A more demanding local market leads to national advantage. A strong, trend-setting local market helps local firms anticipate global trends. When local supporting industries are competitive, firms enjoy more cost effective and This effect is strengthened when the suppliers themselves are strong global

local firms devote more attention to that product than do foreign firms, leading to a competitive advantage when the local firms begin exporting the product.

III. Related and Supporting Industries innovative inputs.

competitors. IV. Firm Strategy, Structure, and Rivalry

Local conditions affect firm strategy. For example, German companies tend to be

hierarchical. Italian companies tend to be smaller and are run more like extended families. Such strategy and structure helps to determine in which types of industries a nation's firms will excel.

In Porters Five Forces model, low rivalry made an industry attractive. While at a

single point in time a firm prefers less rivalry, over the long run more local rivalry is

International

Trade Theory better since it puts pressure on firms to innovate and improve. In fact, high local rivalry results in less global rivalry. Local rivalry forces firms to move beyond basic advantages that the home country may enjoy, such as low factor costs. The Diamond as a System The effect of one point depends on the others. For example, factor disadvantages will not lead firms to innovate unless there is sufficient rivalry. The diamond also is a self-reinforcing system. For example, a high level of rivalry often leads to the formation of unique specialized factors. Government's Role Encourage companies to raise their performance, for example by enforcing strict product standards. Stimulate early demand for advanced products. Focus on specialized factor creation. Stimulate local rivalry by limiting direct cooperation and enforcing antitrust regulations. Chances Influencing Competitive Advantage

Acts of pure invention; Major technological discontinuities (e.g. biotechnology, microelectronics); Discontinuities in input costs such as the oil crisis; Significant shifts in world financial markets or exchange rates ; Surges of world or regional demand; Political decision by foreign governments; and Wars. Environment Economic Environment Markets require buying power as well as people. The economic environment consists of factors that affect consumer purchasing power and spending patterns. Marketers should he aware of the following predominant economic trends. Income Distribution and Changes in Purchasing Power Global upheavals in technology and communications over the 1990s brought about a shift in the balance of economic power from the West towards the East. Official statistics suggest that, by 2010, purchasing power income per head in countries like Singapore and South Korea will exceed that of the United States. Economic growth projections suggest that Europe will drop down the economic rankings. Assuming annual growth in western Europe and the United States of 2.5 per cent, and 6 per cent in Asia as a whole, the share of world grows domestic product (GDP) taken by Asian developing countries, including China and India, could rise to 28 per cent in 2010 from 18 per cent in 1990. Western Europe's share will fall to 17 per cent from 22 per cent, while the United States will drop to 18 per cent from 23 per cent. Although there has been a narrowing of the wealth and living standards gap between the developed western and rising Asian countries in recent decades, the uncertain economic

climate in the Asian economies has important implications for international marketers. They must determine how changing incomes affect purchasing power and how they translate into marketing threats and opportunities for the firm. Where consumer purchasing power is reduced as in countries experiencing economic collapse or in an economic recession,value-far-mo ney becomes a key purchasing criterion. Marketers must pursue value-based marketing to capture and retain price-conscious customers during lean economic times, unlike boom periods when consumers become literally addicted to personal consumption rather than offering high quality at a high price, or lesser quality at very low prices, marketers have to look for ways to offer the more financially cautious buyers greater value - just the right combination of product quality and good service at a fair price. Consumers with the greatest purchasing power are likely to belong to the higher socioeconomic groups, whose rising incomes mean that their spending patterns are less susceptible to economic downturns than lower-income groups. So, marketers must determine a population's incomedistribution. Theupper economic group of a society become primary targets for expensive luxury goods, themi ddle income groups are more careful about spending, but can usually afford some luxuries sometimes, while thelowe
Environment

group will afford only basic food, clothing and shelter needs. In some countries, an underclass exists people permanently living on state welfare and/or below the poverty line - which has little purchasing power, often struggling to make even the most basic purchases. Changing Consumer Spending Patterns

Generally, the total expenditures made by households tend to vary for essential categories of goods and services, with food, housing and transportation often using up most household income. Marketers also want to identify how spending patterns of consumers at different income levels vary. Some of these differences were noted over a century ago by Ernst Engel, who studied how people shifted their spending as their income rose. He found that as family income rises, the percentage spent on food declines, the percentage spent on housing remains constant (except for such utilities as gas. electricity and public services, which decrease), and both the percentage spent on other categories and that devoted to savings increase. Engel's laws have generally been supported by later studies. Changes in major economic variables such as income, cost of living,

interest rates, and savings

and borrowing patterns have a large impact on the market-place. Companies watch these variables by using economic forecasting. Businesses do not have to be wiped out by an economic downturn or caught short in a boom. With adequate warning, they can take advantage of chances in the economic environment. Political Environment Marketing decisions are strongly affected by developments in the political environment. The political environment consists of laws, government agencies and pressure groups that influence and limit various organizations and individuals in a given society. Legislation Regulating Business Even the most liberal advocates of free-market economies agree that the system works best with at least some regulation. Well-conceived regulation can encourage competition and ensure fair markets for goods and services. Thus governments develop public policy to guide commerce - sets of laws and regulations that limit business for the good of society as a whole. Almost every marketing activity is subject to a wide range of laws and regulations. Understanding the public policy implications of a particular marketing activity is not a simple matter. Environment First, there are many laws created at different levels: for example, in the EU, business operators are subject to European Commission, individual member state and specific local regulations; in the USA, laws are created at the federal, state and local levels, and these regulations often overlap. Second, the regulations are constantly changing - what was allowed last year may now be prohibited. In the single European market, deregulation and ongoing moves towards harmonization are expected to take time, creating a state of flux, which challenges and confuses both domestic and international marketers. They must therefore work hard to keep up with these changes in the regulations and their interpretations.

In many developed economies, legislation affecting business has increased steadily over the years. This legislation has been enacted for a number of reasons. The first is to protect companies from each other. Although business executives may praise competition, they sometimes try to neutralize it when it threatens them. So laws are passed to define and prevent unfair competition. Anti-trust agencies and monopolies and mergers commissions exist to enforce these laws. The second purpose of government regulation is toprotect consumers from unfair business practices. Some firms, if left alone would make shoddy products, tell lies in their advertising and deceive consumers through their packaging and pricing. Unfair business practices have been defined and are enforced by various agencies. The third purpose of government regulation isto protect the interests of society against unrestrained business behavior. Profitable business activity does not always create a better quality of life. Regulation arises to ensure that firms take responsibility for the social costs of their production or products. International marketers should additionally be aware of regional, country and local laws that affect their international marketing activity. Growth of Public Interest Groups The number and power of public interest groups have increased during the past two decades. The role of public interest groups is as watchdogs on consumer interests and lifted consumerism into a powerful social force. Consumerism has spilled over to countries in W estern Europe and other developed market economies such as Australia. Hundreds of

other consumer interest groups, private and governmental, operate at all levels - regional, national, state/county and local levels. Other groups that marketers need to consider are

Environment

those seeking to protect the environment and to advance the rights of various groups such as women, children, ethnic minorities, senior citizens and the handicapped. Increased Emphasis on Ethics and Socially Responsible

Written regulations cannot possibly cover all potential marketing abuses, and existing laws are often difficult to enforce. However, beyond written laws and regulations, business is also governed by social codes and rules of professional ethics. Enlightened companies encourage their managers to look beyond what the regulatory system allows and simply to 'do the right thing'. These socially responsible firms actively seek out ways to protect the long-run interests of their consumers and the environment. Increased concerns about the environment have created fresh interest in the issues of ethics and social responsibility. Almost every aspect of marketing involves such issues. Unfortunately, because these issues usually involve conflicting interests, well-meaning people can disagree honestly about the right course of action in a particular situation. Thus many industrial and professional trade associations have suggested codes of ethics, and many companies are now developing policies and guidelines to deal with complex social responsibility issues.
Cultural Environment

The cultural environment is made up of institutions and other forces that affect society's basic values, perceptions, preferences and behaviors. A classic definition is provided by Sir Edward Taylor: Culture is that complex whole which includes knowledge, belief, art, morals, law, custom, and any other capabilities and habits acquired by individuals as members of society. It is commonly agreed that a culture must have three characteristics: 1. It is learned, that is people over time transmit the culture of their group from generation to generation. 2. It is interrelated, that is, one part of the culture is deeply connected with another part, such as religion with marriage, or business with social status. 3. It is shared, that is, the tenets of the culture are accepted by most members of the group.

Another characteristic of culture is it does not stand still, but slowly, over time, changes. This change is partly in response to environmental needs and partly through the influence of outside forces. From the marketers point of view, one way of gaining cultural understanding is to examine the following cultural elements within a country.
Environment

Material Life: Material life refers to economics, that is, what people do to drive their

livelihood. The tools, knowledge, techniques, methods, and processes that a culture utilizes to produce goods and services, as well as their distribution and consumption, are all part of material life. Thus, two essential parts of material life are knowledge and economics.

The material life of any given society will fall on a continuum between traditional and industrialized poles. That position indicates a societys overall way of life and can be analyzed to determine opportunities for the marketers. Social Interactions: Social interactions establish the roles that play in a society and their authority/responsibility patterns. These roles and patterns are supported by societys institutional framework, which includes, for example, education and marriage.

Social roles are also established by culture. For example, a woman can be a wife, a mother, a community leader, and/or an employee. What role is preferred in different situations is culture-bound. Most Swiss women consider household work as their primary role. For this reason, they resent modern gadgets and machines.

Behavior also emerges from culture in the form of conventions, rituals, and practices on different occasions such as festivals, marriages, informal get-togethers, and times of grief or religious celebration.

The authority of the aged, the teacher, the religious leader in many societies is derived from the culture. The educational system, the social settings, customs and traditions prescribe roles and patterns for individuals and groups.

With reference to marketing, social interactions influence family decision making and buying behavior and define the scope of personal influence and opinion. In Latin America and Asia the extended family is considered the most basic and stable unit of social organization. It is the center of all economic, political, social, and religious life, providing companionship, protection, and a common set of values with specially prescribed means for fulfilling them. In contrast, the nuclear family is the focus of social organization in the US.

Language: Language as part of culture consists not only the spoken word, but also symbolic communication of time, space, things, friendships, and agreements. Nonverbal communication occurs through gestures, expressions, and other body movements.

The many different languages of the world do not literally translate from one to another, and understanding the symbolic and physical aspects of different cultures communication is even more difficult to achieve.
Environment

In addition, meanings differ within the same language used in different places. The English language differs so much from one English speaking country to another that sometimes the same word means something entirely opposite in a different culture. Table the report in the US means postponement; in England it means bring the matter to the forefront.

Language differences can affect all sorts of business dealings, contracts, negotiations, advertising, and labeling. Symbolic communication poses some cross-cultural dangers, too. To be on time for an appointment is an accepted norm in the US. Whereas in many countries, like Bangladesh, 11 AM means about that time, not precise.

Greetings vary from culture to culture, encompassing the handshake, kiss, hug, and placing hands in praying position. Lack of awareness concerning a countrys accepted form of greetings can lead to awkward encounters and sometimes offended feelings. Aesthetics: Aesthetics include the art, drama, music, folkways, and architecture

endemic to a society. These aspects of a society convey its concept of beauty and modes of expression. The aesthetic values of a society show in the design, colors, expressions, symbols, movements, emotions, and postures valued and preferred in a particular culture. These attributes have an impact on the design and promotion of different products.

Likewise, space, and the way that a person occupies it, communicates something about social position in the terms of each culture. A large office on the top floor of building in US means that the person occupying that

office is important in an organizational hierarchy. Such a conclusion elsewhere would not always be right. Japanese executives usually share an office.

In the US worldly possessions and material things are often used as symbols of success. However, in many countries, it may not be true. Particularly in the Islamic countries, an emphasis on material possessions is frowned upon. Religion and Faith: Religion influences a cultures outlook on life, its meaning and

concept. In general, the religion practiced in a society influences the emphasis placed on material life, which in turn affects the attitudes toward owning and using goods and services. Religious traditions may even prohibit the use of certain goods and services altogether. Religion also influences male-female roles, as well as societal institutions and customs such as marriage and funeral rites. Religion affects patterns of living in various other

Environment ways. It establishes authority relationships, an individual duties and responsibilities both in childhood and as an adult, and the sanctity of different acts such as hygiene. In general, organized religion and faith inevitably motivate people and their customs in numerous ways. The impact of religion is continuous and profound. Consequently, international marketers must be sensitive to the religious principles of each host country. Pride and Prejudice: Cultural pride and prejudice make many nations reject foreign ideas and imported products. But the reverse also occurs; a perception of greatness attributes to another culture may lead to the eager acceptance of things reflecting that culture. For example, the Japanese are proud of their culture and economic achievement and prefer to buy Japanese manufactures. Yet the words Made in USA marked on a product communicate quality and sophistication to them. Ethics and More: The concept of what is right and what is wrong is based on culture. To be straightforward and openly honest are considered morally right in the US; even if feelings are hurt. In Latin cultures people avoid direct statements that would embarrass or make another uncomfortable.

The differences in mannerisms between the Japanese and the Koreans illustrate this point. The Japanese are formal and reserved; the Koreans are informal and outgoing. A Korean saleswoman puts her hand on a customers shoulder as she walks him to the door; a Korean executive invites a business acquaintance home to meet the family. Such acts of familiarity would be very unusual in Japan What Is International Trade? International trade is the exchange of goods and services between countries. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events. Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at your local mall. A decrease in the cost of labor, on the other hand, would result in you having to pay less for your new shoes. Trading globally gives consumers and countries the opportunity to be exposed to goods and services not available in their own countries. Almost every kind of product can be found on the international market: food, clothes, spare parts, oil, jewelry, wine, stocks, currencies and water. Services are also traded: tourism, banking, consulting and transportation. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country's current account in the balance of payments. (For more on this, see the articles Increased Efficiency of Trading Globally Global trade allows wealthy countries to use their resources - whether labor, technology or capital - more efficiently. Because countries are endowed with different assets and natural resources (land, labor, capital and technology), some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain the item by trading with another country that can. This is known as specialization in international trade. Let's take a simple example. Country A and Country B both produce cotton sweaters and wine. Country A produces 10 sweaters and six bottles of wine a year while Country B produces six sweaters and 10 bottles of wine a year. Both can produce a total of 16 units. Country A, however, takes three hours to produce the 10 sweaters and two hours to produce the six bottles of wine (total of five hours). Country B, on the other hand, takes

one hour to produce 10 sweaters and three hours to produce six bottles of wine (total of four hours). But these two countries realize that they could produce more by focusing on those products with which they have a comparative advantage. Country A then begins to produce only wine and Country B produces only cotton sweaters. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products. We can see then that for both countries, the opportunity cost of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both sweaters and wine is 20 units of both products (after trading). Specialization reduces their opportunity cost and therefore maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease, thus giving an advantage to the end consumer as well. Note that, in the example above, Country B could produce both wine and cotton more efficiently than Country A (less time). This is called an absolute advantage, and Country B may have it because of a higher level of technology. However, according to international trade theory, even if a country has an absolute advantage over another, it can still benefit from specialization. (For a review of some of these economic concepts, see the Economics Basics tutorial.) Other Possible Benefits of Trading Globally International trade not only results in increased efficiency but also allows countries to participate in a global economy, encouraging the opportunity of foreign direct investment (FDI), which is the amount of money that individuals invest into foreign companies and other assets. In theory, economies can therefore grow more efficiently and can more easily become competitive economic participants. For the receiving government, FDI is a means by which foreign currency and expertise can enter the country. These raise employment levels and, theoretically, lead to a growth in the gross domestic product. For the investor, FDI offers company expansion and growth, which means higher revenues. Free Trade vs. Protectionism As with other theories, there are opposing views. International trade has two contrasting views regarding the level of control placed on trade: free trade and protectionism. Free trade is the simpler of the two theories: a laissez-faire approach, with no restrictions on trade. The main idea is that supply and demand factors, operating on a global scale, will ensure that production happens efficiently. Therefore, nothing needs to be done to protect or promote trade and growth because market forces will do so automatically. In contrast, protectionism holds that regulation of international trade is important to ensure that markets function properly. Advocates of this theory believe that market

inefficiencies may hamper the benefits of international trade and they aim to guide the market accordingly. Protectionism exists in many different forms, but the most common are tariffs, subsidies and quotas. These strategies attempt to correct any inefficiency in the international market. Conclusion As it opens up the opportunity for specialization and therefore more efficient use of resources, international trade has potential to maximize a country's capacity to produce and acquire goods. Opponents of global free trade have argued, however, that international trade still allows for inefficiencies that leave developing nations compromised. What is certain is that the global economy is in a state of continual change and, as it develops, so too must all of its participants

International Trade Theories


July 18, 2010 Leave a comment Go to comments 1 Votes Mercantilism is an economic theory, considered to be a form of economic nationalism that holds that the prosperity of a nation is dependent upon its supply of capital, and that the global volume of international 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). Principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Countries should produce those goods in which they have absolute advantage. The law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party. It is the ability to produce a product most efficiently given all the other products that could be produced. Abilities are compared and if other countries are efficient in production of some goods you should not produce that rather switch to other product. Assume that no difference in currency value and factor of production are movable. The HeckscherOhlin theorem: "A capital-abundant country will export the capitalintensive good, while the labor-abundant country will export the labor-intensive good."

The product life-cycle theory suggests early in a products 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. New Trade Theory (NTT) is a collection of economic models in international trade which focuses on the role of increasing economies of scale and network effects (words of mouth). The Diamond model of Michael Porter for the Competitive Advantage of Nations offers a model that can help understand the competitive position of a nation in global competition. This model can also be used for other major geographic regions. These interlinked advanced factors for Competitive Advantage for countries or regions in Porters Diamond framework are: 1. Firm Strategy, Structure and Rivalry (The world is dominated by dynamic conditions, and it is direct competition that impels firms to work for increases in productivity and innovation) 2. Demand Conditions (The more demanding the customers in an economy, the greater the pressure facing firms to constantly improve their competitiveness via innovative products, through high quality, etc) 3. Related Supporting Industries (Spatial proximity of upstream or downstream industries facilitates the exchange of information and promotes a continuous exchange of ideas and innovations) 4. Factor Conditions (Contrary to conventional wisdom, Porter argues that the "key" factors of production (or specialized factors) are created, not inherited. Specialized factors of production are skilled labor, capital and infrastructure. Factor Endowment is commonly understood as the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing. Instruments of Trade Policy: 1) Tariffs 2) Subsidies 3) Import Quotas & voluntary export restraints 4) Local content requirement 5) administrative policies 6) Anti-dumping policies Foreign direct investment (FDI) refers to long term participation by country A into country B. It usually involves participation in management, joint-venture, transfer of technology and "know-how". There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow.

Horizontal FDI is FDI in the same industry abroad as that in which a firm operates at home. Vertical FDI is FDI in associated industries in the chain of vertical integration. Factors for FDI: 1) Transportation Cost 2) Market Imperfection 3) Strategic Behavior 4) Product Life Cycle 5) Location Advantage Radical View: MNEs are coming to just extract the profits from the host country and they wont return anything. Keep the developing or under-developed countries as they are. Free Market View: MNEs should produce in other countries to balance the production. Pragmatic Nationalism: There are some benefits & cost for both counties. Ads by Google

Theories Of International Trade And Investment Presentation Transcript


1. International Business Strategy, Management & the New Realities by Cavusgil, Knight and Riesenberger Chapter 4 Theories of International Trade and Investment 2. Learning Objectives o Theories of international trade and investment o Why nations trade o How nations enhance their competitive advantage: contemporary theories o Why and how firms internationalize o How firms gain and sustain international competitive advantage 3. Foundation Concepts o Comparative advantage Superior features of a country that provide it with unique benefits in global competition derived from either national endowments or deliberate national policies o Competitive advantage Distinctive assets or competencies of a firm derived from cost, size, or innovation strengths that are difficult for competitors to replicate or imitate 4. Perspectives of the Nation and the Firm o Comparative advantage o Is the concept that helps answer the question of all nations can gain and sustain national economic superiority o Competitive advantage

Is the concept that helps explain how individual firms can gain and sustain distinctive competence vis--vis competitors 5. Examples of National Comparative Advantage o China is a low labor cost production base o Indias Bangalore region offers a critical mass of IT workers o Irelands repositioning enabled a sophisticated service economy o Dubai, a previously obscure Emirate, has been transformed into a knowledge-based economy 6. Examples of Firm Competitive Advantage o Dells prowess in global supply chain management o Nokias design and technology leadership in telecommunications o Samsungs leadership in flat-panel TV o Herman Millers design leadership o in office furniture o (e.g., Aeron chairs) 7. 8. Why Nations Trade: Classical Theories o Mercantilism : the belief that national prosperity is the result of a positive balance of trade maximize exports and minimize imports o Absolute advantage principle : a country should produce only those products in which it has absolute advantage or can produce using fewer resources than another country 9. 10. Why Nations Trade: Classical Theories o Comparative advantage principle : it is beneficial for two countries to trade even if one has absolute advantage in the production of all products; what matters is not the absolute cost of production but the relative efficiency with which it can produce the product o By specializing in what they produce best and trade for the rest, countries can use scarce resources more efficiently 11. 12. Limitations of Early Trade Theories o Do not take into account the cost of international transportation o Tariffs and import restrictions can distort trade flows o Scale economies can bring about additional efficiencies o When governments selectively target certain industries for strategic investment, this may cause trade patterns contrary to theoretical explanations o Today, countries can access needed low-cost capital on global markets o Some services do not lend themselves to cross-border trade 13. Classical Theories: Factor Proportions Theory o 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
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Leontief paradox suggested that countries can be successful in the export of products that require a less abundant resource (e.g., the U.S. with its labor-intensive exports) o The Leontief paradox implies that international trade is complex and cannot be fully explained by a single theory, e.g., the abundance of a certain production input 14. Classical Theories: International Product Cycle Theory o International product cycle theory : each product and its associated manufacturing technologies go through three stages of evolution: introduction, growth, and maturity o In the introduction stage, the inventor country enjoys a monopoly both in manufacturing and exports o As the products manufacturing becomes more standard, other countries will enter the global marketplace o When the product reaches maturity, the original innovator country will become a net importer of the product o Applicability to the contemporary global economy: Today, the cycle from innovation to maturity is much shorter making it harder for the innovator country to sustain its lead in a particular product 15. How Nations Enhance Competitive Advantage o The contemporary view suggests that governments can proactively implement policies to enhance a nations competitive advantage, beyond the natural endowments the country possesses o Governments can create national economic advantage by: stimulating innovation, targeting industries for development, providing low-cost capital, and through other incentives 16. 17. Michael Porters Diamond Model: Sources of National Competitive Advantage o Firm strategy, structure, and rivalry the presence of strong competitors at home serves as a national competitive advantage o Factor conditions labor, natural resources, capital, technology, entrepreneurship, and know how o Demand conditions at home the strengths and sophistication of customer demand o Related and supporting industries availability of clusters of suppliers and complementary firms with distinctive competences 18. 19. Industrial Clusters o A concentration of suppliers and supporting firms from the same industry located within the same geographic area o Examples include: the Silicon Valley, fashion cluster in northern Italy, pharma cluster in Switzerland, footwear industry in Pusan, South Korea, and the IT industry in Bangalore, India o Industrial clusters can serve as an export platform for individual nations 20. National Industrial Policy
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Proactive economic development plan implemented by the public sector to nurture or support promising industry sectors with potential for regional or global dominance. Public sector initiatives can include: o Tax incentives o Monetary and fiscal policies o Rigorous educational systems o Investment in national infrastructure o Strong legal and regulatory systems 21. National Industrial Policy: Ireland as an Example o Beginning in the 1980s, the Irish government implemented a series of probusiness policies to build strong economic sectors. The Irish Miracle resulted from: o Fiscal, monetary, and tax consolidation o Partnership with the industry and unions o Emphasis on high-value adding industries such as pharma, biotechnology, and IT o Membership in the European Union; subsidies and investment received from the EU o Investment in education 22. 23. New Trade Theory o The argument that economies of scale are an important factor in some industries for superior international performance even without any clear comparative advantage possessed by the nation. Some industries succeed best as their volume of production increases. o For example, the commercial aircraft industry has very high fixed costs that necessitate high-volume sales to achieve profitability. 24. Why and How Firms Internationalize o The internationalization process model of the firm suggests a gradual, evolutionary path to internationalization o The slow and incremental nature of internationalization by the firm results from the uncertainty and uneasiness that managers have about crossborder transactions o A predictable pattern of internationalization may include the following stages: domestic focus, pre-export stage, experimental involvement, active involvement, and committed involvement 25. 26. Born Global Firms and International Entrepreneurship o The slow, gradual internationalization predicted by the process model is no longer practical or realistic in todays fast-paced, interconnected economy o Today many firms, even those that are young or without much experience, take bold steps to internationalize o Indicative of this trend is the emergence of Born Global companies young, entrepreneurial firms that take on internationalization early in their evolution and leapfrog into global markets
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27. How Firms can Gain and Sustain International Competitive Advantage o Since the MNE has traditionally been the major player in international business, many scholars have offered explanations of what makes these firms pursue, and succeed in, internationalization o FDI has been the principal strategy used by MNEs in international expansion; therefore, earlier theoretical explanations relate to motives for, and patterns of, foreign direct investment 28. 29. 30. FDI Based Explanations: Monopolistic Advantage Theory o Suggests that FDI is preferred by MNEs 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 o Key sources of monopolistic advantage include proprietary knowledge, patents, unique know-how and skills, and sole ownership of other assets 31. 32. FDI Based Explanations: Internalization Theory o Explains the process by which firms acquire and retain one or more valuechain activities inside the firm retaining control over foreign operations and avoiding the disadvantages of dealing with external partners o In contrast to arms-length foreign market entry strategies (such as exporting and licensing) which imply developing contractual relationships with external business partners, FDI implies control and ownership of resources 33. FDI Based Explanations: Dunnings Eclectic Paradigm o Three conditions determine whether or not a company will internalize via FDI: o Ownership-specific advantages knowledge, skills, capabilities, relationships, or physical assets that form the basis for the firms competitive advantage o Location-specific advantages advantages associated with the country in which the MNE is invested, including natural resources, skilled or low cost labor, and inexpensive capital o Internalization advantages control derived from internalizing foreignbased manufacturing, distribution, or other value chain activities 34. Non-FDI Based Explanations: International Collaborative Ventures o While FDI-based internationalization is still common, beginning in the 1980s firms have increasingly utilized non-equity, flexible collaborative ventures in international market entry. o A collaborative venture is a form of cooperation between two or more firms. Through collaboration, a firm can gain access to foreign partners know-how, capital, distribution channels, and marketing assets, and overcome government imposed obstacles. o In an international collaborative venture partners share this risk of their joint efforts and pool resources and capabilities to create synergy. 35. Two Types of International Collaborative Ventures

Equity-based joint ventures result in the formation of a new legal entity. In contrast to the wholly-owned FDI, the firm collaborates with local partner(s) to reduce risk and commitment of capital. Project-based alliances do not require equity commitment from the partners but simply a willingness to cooperate in R&D, manufacturing, design, or any other value-adding activity. Since project-based alliances have a narrowly defined scope of activities and timeline, they provide greater flexibility to the firm than equity-based ventures.

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