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International

Business
Fourth Edition
International Trade Theory
4-3

Chapter Focus

Explain why it is beneficial for a country to engage


in international trade.

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4-4

Chapter Focus

Explain why it is beneficial for a country to engage


in international trade.
Explain the pattern of international trade
observed in the world economy.

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4-6

The Impact of Trade Policies


Ghana Korea
1970 1970
GNP/capita GNP/per capita
$250 $260
1992
1992
GNP/per capita
GNP/per capita
$6790
$450
GNP Growth/year
GNP Growth/year
9%
1.5%
Shift from non-comparative
Shift from productive uses advantage uses (agriculture) to
(cocoa) to unproductive uses productive uses (labor-intensive
(subsistence agriculture). manufacturing).

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4-7

An Overview of Trade Theory

Free Trade occurs when 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.

The Benefits of Trade allow a country to


specialize in the manufacture and export of
products that can be produced most efficiently in
that country.

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4-8

Mercantilism: mid-16th century


A nations wealth depends on accumulated treasure
Gold and silver are the currency of trade.
Theory says you should have a trade surplus.
Maximize exports
through subsidies.
Minimize imports through tariffs
and quotas.
Flaw: zero-sum game.

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4-10

Theory of Absolute Advantage


Adam Smith: Wealth of Nations (1776).

Capability of one country to produce more of a


product with the same amount of input than
another country.
Produce only goods where you are most efficient,
trade for those where you are not efficient.
Assumes there is an absolute advantage balance
among nations, e.g., Ghana/cocoa.

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4-9

The Theory of Absolute Advantage


and the Gains from Trade
Resources Required to Produce 1 Ton of Cocoa and Rice
Cocoa Rice
Ghana 10 20
S. Korea 40 10
Production and Consumption without Trade
Ghana 10.0 5.0
S. Korea 2.5 10.0
Total production 12.5 15.0
Production with Specialization
Ghana 20 0
S. Korea 0 20
Total production 20 20
Consumption after Ghana Trades 6T of Cocoa for 6TSouth Korean Rice
Ghana 14.0 6.0
S. Korea 6.0 14.0
Increase in Consumption as a Result of Specialization and Trade
Ghana 4.0 1.0
S. Korea 3.5 4.0 Table 4.1
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4-13
Theory of Comparative Advantage
David Ricardo: Principles of Political Economy (1817).

Should trade even if country is more efficient in the


production than its trading partner.

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4-11

Comparative Advantage and the Gains from Trade


Resources Required to Produce 1 Ton of Cocoa and Rice
Cocoa Rice
Ghana 10 13.33
S. Korea 40 20
Production and Consumption without Trade
Ghana 10.0 7.5
S. Korea 2.5 5.0
Total production 12.5 12.5
Production with Specialization
Ghana 15 3.75
S. Korea 0.0 10.0
Total production 15 13.75
Consumption after Ghana Trades 4T of Cocoa for 4TSouth Korean Rice
Ghana 11 7.75
S. Korea 4 6
Increase in Consumption as a Result of Specialization and Trade
Ghana 1.0 0.25
S. Korea 1.5 1.0 Table 4.2

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4-16

Extensions of the Ricardian Model

Immobile resources:
Resources do not always move easily from one
economic activity to another.
Diminishing returns:
More a country produces, at some point, will require
more resources (diminishing returns to specialization).
Different goods use resources in different
proportions.
However:
Free trade might increase a countrys stock of
resources (as labor and capital arrives from abroad),
and
Increase the efficiency of resource utilization.

McGraw-Hill/Irwin 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.


4-20

Heckscher (1919)-Olin (1933) Theory

Labor is not the only Factor of production. We


need to account for land, capital, and
technology.

McGraw-Hill/Irwin 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.


4-20

Heckscher (1919)-Olin (1933) Theory

Factor endowments: extent to which a country


is endowed with such resources as land, labor,
and capital.
Export goods that intensively use factor
endowments which are locally abundant.
Corollary: import goods made from
locally scarce factors.

McGraw-Hill/Irwin 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.


4-20

Heckscher (1919)-Olin (1933) Theory

Patterns of trade are determined by


differences in factor endowments - not
productivity.
Remember, focus on relative advantage, not
absolute advantage.

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4-21

The Leontief Paradox, 1953

Disputes Heckscher-Olin in some instances.


Factor endowments can be impacted by
government policy - minimum wage.
US tends to export labor-intensive products, but
is regarded as a capital intensive country.

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4-23

Product Life-Cycle Theory


(Raymond Vernon, 1966)
Article in the Quarterly Journal of Economics.
As products mature, both location of sales and optimal
production changes.
Affects the direction and flow of imports and exports.
Globalization and integration of the economy makes this
theory less valid.

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4-25

The New Trade Theory


Began to be recognized in the 1970s.
Deals with the returns on specialization where
substantial economies of scale are present.
Specialization increases output, ability to enhance
economies of scale increase.
In addition to economies of scale, learning effects also
exist.
Learning effects are cost savings that come from
learning by doing.

McGraw-Hill/Irwin 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.


4-26

Application of the New Trade Theory

Typically, requires industries with high, fixed


costs.
World demand will support few competitors.
Competitors may emerge because they got
there first.
First-mover advantage.
Some argue that it generates government
intervention and strategic trade policy.

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4-27

First-Mover Advantage
Economies of scale may preclude new entrants.
Role of the government.

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4-28

Porters Diamond
(Harvard Business School, 1990)

The Competitive Advantage of Nations.


Looked at 100 industries in 10 nations.
Thought existing theories didnt go far enough.
Question: Why does a nation achieve international
success in a particular industry?

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4-22

Determinants of National
Competitive Advantage
Factor endowments:nations position in factors of
production such as skilled labor or infrastructure necessary
to compete in a given industry.
Demand conditions:the nature of home demand for the
industrys product or service.
Related and supporting industries:the presence or absence
in a nation of supplier industries or related industries that
are nationally competitive.
Firm strategy, structure and rivalry:the conditions in
the nation governing how companies are created,
organized, and managed and the nature of domestic
rivalry.

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4-30

Porters Diamond
Determinants of National Competitive Advantage

Firm Strategy,
Structure and
Rivalry

Factor Endowments Demand Conditions

Related and
Supporting
Figure 4.6
Industries

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4-31

The Diamond

Success occurs where these attributes exist.


More/greater the attribute, the higher chance of
success.
The diamond is mutually reinforcing.

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4-32
Determinants of
National Competitive Advantage

Chance
Company Strategy,
Structure,
and Rivalry

Two external
factors that Factor Demand
influence the Conditions Conditions
four
determinants.
Related
and Supporting
Industries
Government

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4-33

Factor Endowments
Taken from Heckscher-Olin
Basic factors:
natural resources
climate
location
demographics
Advanced factors:
communications
skilled labor
research
technology

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4-39

Evaluating Porters Theory

If Porter is right, we would expect his model to


predict the pattern of international trade that we
observe in the real world. Countries should be
exporting products from those industries where all
four components of the diamond are favorable, while
importing in those areas where the components are
not favorable.

McGraw-Hill/Irwin 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.