TBS983 :International Trade

Theory

Lecture
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:4
Neo-Classical-Trade Theory
Charles

Hill
Chapter 6

UOWD
Autumn Semester 2014

Dr. Gwendolyn Rodrigues

TheProductLifeCycleTheory

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Vernon(mid-1960s)proposedtheproduct lifecycle theory-as products mature boththe

locationofsalesandtheoptimalproduction
locationwill change affecting the flow and
direction of trade
thewealth and size of the U.S. market gavea
strongincentive to U.S. firms todevelop new
products
Intheearly stages of a products life cycle
demand may grow in the U.S.,butdemand in
other advanced countries is limited tohighincomegroups
itisnot worthwhile for firms inthosecountries
tostart producing the new product,butit
doesnecessitate some exports from the U.S.
tothosecountries

The Product
Life Cycle
Theory

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TheProductLifeCycleTheory
Overtime,demandforthenew product
starts to grow in other advanced
countriesmaking it worthwhile for
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foreign producers to begin producing for

their home markets

U.S. firms mightalso set up production

facilitiesinthoseadvanced countries
wheredemand is growing limiting the

exports from the U.S.

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Asthemarket in the U.S. and other advanced

nations matures, theproduct becomesmore
standardized,andprice becomes the

main competitive weapon

TheProductLifeCycleTheory
Producersbasedinadvanced

countries

wherelabor costs are lower than the

United States mightnowbeabletoexport

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the U.S.

to

Ifcost pressures become intense,

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developing countries begin to

acquire a production advantage

over

advanced countries

TheUnitedStatesswitchesfrom
beinganexporter of the product to
animporter of the product asproduction
becomesmoreconcentrated in lowercost foreign locations

Evaluating The Product Life Cycle Theory

Whiletheproductlifecycletheory accurately

explains what has happened for products

like photocopiers andanumberofotherhigh
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technologyproductsdevelopedintheUSinthe1960sand
1970s,theincreasingglobalization andintegration
of the world economyhasmadethistheory less valid in
today'sworld
today,manynewproductsareinitiallyintroducedin

Japan or Europe,orare introduced

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simultaneously in the U.S., Japan, and

Europe
productionmayalsobedispersed to those locations
where it is most favorable

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PortersDiamond

Porter(1990)triedtoexplainwhy

a nation
achieves international success in
aparticularindustry

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Porteridentified four attributeshecallsthe

diamondthatpromote orimpedethe
creationofcompetitiveadvantage

1. Factor endowments
2. Demand conditions
3. Related and supporting industries
4. Firm strategy, structure, and rivalry
Inaddition,Porteridentifiedtwoadditionalvariables

(chance

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and government)that

can influence thediamondinimportantways

PortersDiamond
Figure5.6:DeterminantsofNationalCompetitiveAdvantage:Porters
Diamond
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Factor Endowments

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Anation'spositioninfactor endowments
(factorsofproduction)canleadtocompetitive
advantage
Thesefactorscanbeeither:
BASIC :natural resources, climate,

location)or;

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skilled labor,
infrastructure,
technological know-how

ADVANCED:

initial
advantage thatisthen reinforced

Basicfactorscanprovidean

and extended by investment in

advanced factors

Demand Conditions
Demand conditions -thenature
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home demand for an industrys

product or service

influencethedevelopment of capabilities
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Sophisticated and demanding

customers pressure firms to be :
(i)more competitive and to
(ii) produce high quality,
(iii) innovative products

of

Related and Supporting Industries

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Relatedandsupportingindustries -the
presencesupplier industries andrelated
industries thatareinternationally competitive
investingintheseindustriescanspill over and
contribute to success in other
industries
Successfulindustriestendtobegrouped in clusters in
countrieswhichthenprompts knowledge flows
between firms
havingworld class manufacturers ofsemiconductorprocessingequipmentcanleadto(and
bearesultofhaving)acompetitive semi-

conductor industry

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Example:Biomedical/Biotechnical
Support
Industries:
ScientificR&D
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Suppliers
:

Laboratory
apparatus
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andfurniture
Mfg
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Driver Industries:
PharmaceuticalsandMedicinesMfg
MedicalInstruments/
Equipment/SuppliesMfg

Infrastructure:
Waste
management
andtransport

Customers:
Healthand
personal
carestores;
Doctors
offices;
Hospitals

Firm Strategy, Structure, and Rivalry

Firm strategy, structure, and rivalry -the
conditions in the nation governing how companies
are created,organized,andmanaged,

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andthenature of domestic rivalry

nationsarecharacterizedbydifferent

management ideologies which

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influence the ability of firms to build

national competitive advantage

Thereisastrong association between

vigorous domestic rivalry andthe

creation and persistence of competitive

advantageinanindustry
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PortersDiamond
CompetitiveAdvantageforCountries

Beans
Beeror Brands?
Fashion
Consumer
Apparel
Electronics

Firm Strategy, Structure and Rivalry

Multiple
cooperatives
Large,
diverse
brewers
Innovative
Strong
firms
designers
Diverse
growing strategies
Complex
positioning
Competitive
Competitive
styles
features

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Factor Conditions

Demand Conditions

Skilled yeast
farmers
Hops,
barley,
Fabric
Components
suppliers
Knowledgeable
acceptance
Fashion
Design Engineers
designers
Regional system
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Brewers

Socialbuyers
Stylistic
Innovative
buyers
Fashion
Knowledgeable
conscious
Selective
Knowledgeable

Related and Supporting Industries

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Specialty
Media suppliers
retailing
Transportation
Advertising
industry infrastructure
Promotional
Retail
infrastructure
Media
Agricultural
supports
Hospitality
infrastructure

Howwouldyourevisethisstrategytoonesupporting
firmsstrongindevelopingcoffeebrands?

Evaluating Porters Theory

Porter-thefour attributes of the diamond

together with government policy, and chance

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workasareinforcing

system,
complementing each other andin

combination creatingtheconditions appropriate for

competitive advantage
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Government policy can

affect demand throughproductstandards
influence rivalry throughregulationandantitrust

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laws

impact the availability ofhighly educated

workersandadvanced transportation infrastructure

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Evaluating Porters Theory

Question:IsPorterright?
Answer:
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IfPorteriscorrect,hismodelshouldpredict

the pattern

of international trade intherealworld

Countries should export products fromindustries

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wherethediamondisfavorable
Countriesshould import products fromareaswhere
thediamond is not favorable

So,fartherehasbeenlittle
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theory

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empirical testing of the

An Economies of Scale
Model of Trade
Eveniftwo
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nations are

identical inevery respect,

thereisstill a basis for
mutually beneficial trade
basedoneconomies

of scale
The firm is producing
under increasing returns
conditions

An Economies of Scale Model of Trade

Increasing Returns to Scale

The production situation where output
grows proportionately more than
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the increase in inputs or factors

of production.
For example doubling all inputs

more than doubles output

i.e. due to:
(i)division of labour
(ii)Specialisation
(iii)more productive machinery
(iv)labour productivity

An Economies of Scale
Model of Trade
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Wheneach nation specialises

intheproductionofone
commodity,
Thecombined total world output of
both commodities willbegreater

than without specialisation

WhenEconomies of Scale
arepresent
With trade then each nation

shares these gains

Aneconomyofscale
modeloftrade
Mutuallybeneficialtradecan
bebasedonincreasing
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returns to scale

Iftwonationsareassumed
tobeidentical in every
respect,
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frontier &
a single indifference
map willrepresentboth
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nations
Increasing returns to scale
resultinproduction
frontiers that are convex
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An Economies of
Scale Model of Trade

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Economies of Scale resultinidenticaland

convex production frontiers and
indifference map.Autarkyequilibriumrelative commodity price intwonationsis
identicalandgivenbyPA.
With trade, Nation1 could specialise completely in the production of

commodity X and produce at point B.

Nation 2 would then specialise completely in the production of

commodity Y and produce at point B

By exchanging 60X for 60Y with each other , each nation would end
up consuming at point E on indifference
curve II, thus gaining 20X and 20Y.

An Economies of Scale
Model of Trade
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ECONOMIESofSCALEissimilartothehypothesis
advancedbyLinder 1961 thatanationexportsthose
manufacturedproductsforwhichalargedomestic
marketexists
AdditionallyRemember:
1. Outsourcing-Afirmspurchase of parts &
components abroad,ratherthanitselfproducing
themathome,inordertokeep costs down in

the global economy.

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2. International Economies of Scale -Theincreased

productivity resultingfromthefirms integration

of its entire system of manufacturing

operations around the world. i.e Ford Fiesta

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Motor produced in UK, Transmission in

France, Clutches in Spain & final assembly in
Germany

ImplicationsforManagers
Question:Whataretheimplicationsofinternational
tradetheoryforinternationalbusinesses?
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Answer:
Thereareatleast three main
implications forinternational
businesses

1. Locationimplications
2. First-moverimplications
3. Policyimplications

Location

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Differentcountrieshaveadvantagesindifferent
productiveactivities
differences influence afirmsdecisionabout

wheretolocateproductive
activities
shoulddisperseits
productiveactivitiestothosecountries

afirm
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where they can be performed most efficiently

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First-Mover Advantages andGovernment Policy

Firmsthatestablisha first-mover advantage inthe
productionofa new product maylaterdominate
globaltradeinthatproduct
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afirmcaninvest resources intryingtobuild

first-moveradvantages, even if it
means losses for a few years beforeaventure
becomes profitable

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Governmentpoliciesonfreetradeor
protectingdomesticindustriescansignificantly
impact global competitiveness

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businessesshouldencouragefree

tradepolicies
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