New trade theories

Lecture 8
Modern Firm-Based Trade
Theories

• Product Life Cycle Theory

• New trade theory
• Porter’s National Competitive
Advantage
PRODUCT LIFE CYCLE THEORY

• Raymond Vernon 1966

Vernon’s Product Life Cycle Theory differs

from previous trade theories because it puts
less emphasis on
 comparative cost doctrine and more
upon the timing of innovation
the effects of scale economies
the roles of ignorance and uncertainty
in influencing trade patterns
• Product Life Cycle Theory of Trade
(PLC) Raymond Vernon—The
production location for many
products moves from one country to
another depending on the stage in
the product’s life cycle.

4 stages in a product life cycle

• 1. INTRODUCTION
• 2. GROWTH
• 3.MATURITY
• 4 DECLINE
Product life cycle theory
Stage in product life cycle
Stage 1: Introduction : Innovation of a
product with some exports
Stage 2 Growth: Production in innovating
country and other industrial countries due
to increase in sales, more competition.
Stage 3 Maturity- product standardization
Production in multiple countries
Stage 4 Decline –Production in developing
countries, Innovating country becoming
net importer.
 New trade theory
• In 1980s Paul krugman
• It stress that in some cases countries specialize in
production and export of particular product not
because of difference in factor endowments but
because in certain industries world market can
support only limited number of industries.
• Specialization due to
• Economies of scale
• First movers advantage: chemical industry,
computer software, tire industry.
• Learning effects-comes by learning by doing,
learns by repetition.
Example :commercial aerospace dominated
by two firms: Boeing and airbus

• Boeing spends $5 billion to

develop its Boeing 777.
• If Boeing makes 199
Boeing 777 then fixed cost
=$5billion/100=$50 million
• Variable cost per aircraft-
$80 million
• Total cost of each aircraft-
$50
million+$80million=$130
million
• If it makes 500 aircraft:
• Total cost=$90 million
MICHAEL PORTER…Originator of the
THEORY OF NATIONAL COMPETITIVE
ADVANTAGE

• Michael Porter’s
Theory of National
Competitive
Advantage/Porter’s
Diamond published in
1990 was based on a
study of 100 firms in
10 developed nations

• Porter questions how

Switzerland and Japan
could become success
stories without
assumed
prerequisites.
 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

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

Factor conditions
Factor endowments can be divided into two parts:
1)Basic factors-
• Natural resources
• climate,
• Location
• Demographics
2)Advanced factors-
• Communication
• Infrastructure
• Skilled labor
• Research facilities
• Technological know-how
 Advanced factors are product of investment by individuals.
Companies, government
Demand conditions
These include :
• The size and growth rate of the home demand;
• The ways through which domestic demand is
internationalized and pulls a nation’s products
and services abroad.
Firm strategy, structure, and
rivalry
These include:
1. Different nations are chartericed by different management
idelogies
2. The ways in which firms are managed and choose to
compete;
3. The goals that companies seek to attain as well as the
motivations of their employees and managers;
4. The amount of domestic rivalry and the creation and
persistence of competitive advantage in the respective
industry .
Related and supporting
industries
These include:

• The presence of internationally competitive supplier

industries that create advantages in downstream
industries through efficient , early , or rapid access to
cost-effective inputs.
• Internationally competitive related industries that can
coordinate and share activities in the value chain when
competing or those that involve complementary
products.
The role of chance
Chance events can nullify the advantages of some
competitors and bring about a shift in overall competitive
position because of developments such as:

3. new inventions and innovations

5. significant shifts in world financial markets or

exchange rates;
6. discontinuities in input costs such as oil shocks
The role of government
Government can i nfluence all 4 of the major determinants
through actions such as:

3. SUBSIDIES
4. EDUCATION POLICIES;
5. THE REGULATION OR DEREGULATION OF
CAPITAL MARKETS;
6. THE ESTABLISHMENT OF LOCAL PRODUCT
STANDARDS AND REGULATIONS;
7. THE PURCHASE OF GOODS AND SERVICE;
8. TAX LAWS;
9. ANTITRUST REGULATION.
Question

• WHICH THEORIES OF
INTERNATIONAL TRADE PREDICTS
THE RISE OF INDIAN SOFTWARE
INDUSTRIES?
Implications for Business
• Location implications:makes sense to disperse
production activities to countries where they can
be performed most efficiently.
• First-mover implications:It pays to invest
substantial financial resources in building a first-
mover, or early-mover, advantage.
• Policy implications:promoting free trade is
generally in the best interests of the home-
country, although not always in the best
interests of the firm. Even though, many
firms promote open markets.