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International Business

Part Three
Theories and Institutions: Trade
and Investment
Chapter Six
International Trade and Factor
Mobility Theory

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Chapter Objectives
• To understand theories of international trade
• To explain how global efficiency can be
improved through free trade
• To identify factors affecting national trade
patterns
• To explain why a country’s export capabilities
are dynamic
• To understand why production factors
• To explain the relationship between foreign trade
and international factor mobility
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International Operations and
Economic Connections

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Laissez-Faire versus Interventionist
Approaches to Exports & Imports
• Interventionist:
 Mercantilism
 Neomercantilism
• Free-trade theories:
 Absolute advantage
 Comparative advantage

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Theories of Trade Patterns
• Explaining trade patterns:
 Country size
 Factor proportions
 Country similarity
• Trade competitiveness:
 Product life cycle theory
 Porter diamond

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What the major trade theories Do
and Don’t discuss

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Mercantilist Theory
• Mercantilist theory proposed that a country
should try to achieve a favorable balance
of trade (export more than it imports)
• Neomercantilist policy also seeks a
favorable balance of trade, but its purpose
is to achieve some social or political
objective

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Theory of Absolute Advantage
• Suggests specialization through free trade
because consumers will be better off if they
can buy foreign-made products that are
priced more cheaply than domestic ones
• A country may produce goods more
efficiently because of a natural advantage or
because of an acquired advantage

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Theory of Comparative Advantage

• Also proposes specialization through free


trade because it says that total global
output can increase even if one country
has an absolute advantage in the
production of all products

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Theories of Specialization
• Both absolute and comparative advantage
theories are based on specialization
• Assumptions policymakers question:
 full employment
 economic efficiency
 division of gains
 transport costs
 statics and dynamics
 services
 production networks
 mobility

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Trade Pattern Theories
• How much a country will depend on trade
if it follows a free trade policy
• What types of products countries will
export and import
• With which partners countries will primarily
trade

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Theory Of Country Size
• Countries with large land areas are apt to
have varied climates and natural resources
• They are generally more self-sufficient than
smaller countries are
• Large countries’ production and market
centers are more likely to be located at a
greater distance from other countries, raising
the transport costs of foreign trade

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Factor-Proportions Theory
• A country’s relative endowments of land,
labor, and capital will determine the
relative costs of these factors
• Factor costs will determine which goods
the country can produce most efficiently

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Worldwide trade of major
manufactured goods

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Country-similarity Theory
• Most trade today occurs among high-income
countries because they share similar market
segments and because they produce and
consume so much more than emerging
economies
• Much of the pattern of two-way trading partners
may be explained by cultural similarity between
the countries, political and economic
agreements, and by the distance between them

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Product Life Cycle (PLC) Theory
• Companies will manufacture products first
in the countries in which they were
researched and developed, almost always
developed countries
• Over the product’s life cycle, production
will shift to foreign locations, especially to
developing economies as the product
reaches the stages of maturity and decline

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Life Cycle of the International
Product

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The Porter Diamond
• Four conditions as important for
competitive superiority:
 demand conditions
 factor conditions
 related and supporting industries
 firm strategy, structure, and rivalry

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Limitations of the Porter Diamond
Theory
• Production factors and finished goods are
only partially mobile internationally
• The cost and feasibility of transferring
production factors rather than exporting
finished goods internationally will
determine which alternative is better

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The Relationship
between Trade and Factor Mobility
• Capital and labor move internationally to
gain more income and flee adverse
political situations
• Although international mobility of
production factors may be a substitute for
trade, the mobility may stimulate trade
through sales of components, equipment,
and complementary products

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