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International Production
International Trade can be defined as the exchange of goods and services across borders. Free Trade refers to 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.(Hill,1998 pp123). Adam Smith (1776) argued that the invisible hand of the market mechanism should determine what a country need to import or export and not the Government .
Countries can import goods for which they are relatively inefficient producer.
Specialisation often results in economies of scale and an increased in world output.
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How to achieve trade surplus? Maximise export and minimise import Through Government Intervention ,i.e. by: Subsidising export and Limiting imports by imposing tariffs and quotas.
Viewed trade as zerosum game in which a gain by one country results in a loss by another.
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A country has absolute advantage in the production of a product when it is more efficient than any other country producing it.
Both countries gain from trade even if one of them is more efficient than the other in producing everything.
Assumptions: Only two countries and two goods in real world there
are many countries and many goods. Zero transportation costs. Resources move freely from production of one good to another within a country, but not across countries. Price of resources in different countries are constant. Fixed stocks of resources.
Principle- A country should: Specialize in the production of goods that make intensive use of factors that are locally abundant, and then export those goods.
Import goods that make intensive use of factors that are locally scarce. International Business Management 10
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The limited demand in other advances countries does not make it feasible for firms in those countries to start production. They would rather satisfy the needs by exports from the USA.
Over time demand for the new product starts to grow in the other advanced countries to such an extent that it becomes viable for foreign producers to start producing the products for their home markets.
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Substantial economies of scale result in increasing returns i.e. as output increases ability to realise economies of scale increases and cost per unit eventually falls. Due to the presence of substantial economies of scale, world demand will support a few firms in many countries. The economic and strategic advantage of the firm act as barriers to entry.
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Countries may export certain products simply because they have one firm that was an early entrant in the industry (Firstmover advantage). For example, Boeing Aircrafts. First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. Therefore, Government may subsidize the firm at period of entry and growth. However, this theory is in contravention to the idea of free trade.
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Demand Conditions
M.E Porter (1990), The Competitive Advantage of Nations, Harvard Business Review
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Hymer (1960) distinguishes direct investment from portfolio investment by arguing that the former gives the firm control over the business activities abroad where as the latter does not.
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The underlying principle of Hymers doctoral thesis is the demarcation between FDI and portfolio investment.
Hymer notes that international production occurs as a result of: The firms intention to grow further thus enhancing its market position. The existence of market imperfection
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Foreign Market
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The factors that lead to the location of production abroad; The location where the production of new product is likely begin; The consequences resulting from the flow of FDI; and The location where new ideas and technology for new products are likely to originate.
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The product is exported to nations most similar to the US in demand patterns and standard of living.
In the final stage of the product life cycle, Vernon argues that as products become more and more standardised, it will eventually require high capital intensity and unskilled labour. The firm may relocate its production facilities to lower cost producing countries. International Business Management 35
Later in 1979, Vernon came up with a critical review of his previous analysis with more focus on the changing macro environment in Europe.
He noted that changes in the macro economic environment have challenged the application of his initial theory which was relevant in the 1960s. For instance, changes in Europe between 1970 and 1979 have gradually closed up the gap between Europe and USA. (differences in standard of living, cost of labour, size of markets and consumer tastes between the two countries have significantly reduced).
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Moreover, the technological leadership enjoyed by the US in the 50s and early 60s gave way to a more balanced technological competition between the US, Europe and Japan.
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Dunnings (1977) eclectic framework is considered as the complete theory of international production as it corrected certain omissions in the earlier theories. Dunnings approach of internationalisation attempted to analyse the why, where and when decisions in terms of ownership, locational and internalisation (OLI) advantages.
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For instance, technological capabilities of a firm which are the result of internal learning processes involving trial and error, are primary sources of a firms competitive (or ownership, in the OLI paradigm) advantage (Dunning, 1993).
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The objective of the research was to determine the relationship between a country's net foreign direct investment and its level of economic development
The Investment Development Path (IDP) theory: establishes a dynamic and positive relationship between the countrys level of inward and outward foreign investment and the level of industrialisation and
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Countries progress in terms of the countrys locationspecific advantage which gradually upgrade the domestic firms ownership specific advantage.
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Country
1. Weak Local Demand 2. Inadequate Infrastructure Limit Countrys attractiveness to foreign investors 1. Government initiates basic infrastructure. 2. Local Demand grows. 3. FDI takes place Net Investment position is negative
Local Firms
Local Firms lack ownership specific advantage to invest abroad. Ownership specific advantage of domestic firms are weak and limits outward investment.
2nd Stage
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Country
Decrease in the rate of growth of inward investment flows due to growing competitiveness of local firms.
Local Firms
Domestic firms increase outward investment due to improvement of ownership specific advantage.
Countrys net outward investment position is still negative but is on an upward trend
4th Stage 5th Stage Outward FDI stock exceeds inward FDI stocks Net Investment position will improve further.
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Main objective is to maximise the benefits of the joint internalisation of interrelated activities.
Examples: Alliance between BMW and Rolls Royce- Production of engine for the aero engine market. Sony- Ericsson
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3. More innovative ideas and fault free products as a result of continuous improvement and transfer of technology.
4. Better position to extend the Product Life Cycle.
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5.
Ability to bring together complementary skills and assets that neither company could easily develop on its own.
To gain access to new markets of distribution channels. Benefit from economies of scale.
6. 7.
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