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INTERNATIONAL TRADE

THEORIES
Introduction to Global Business
BUS 1067
1.INTRODUCTION
• Since 1990s we have seen a great shift
towards greater free trade.
• The process resulted in the global flow of
goods and services which, in turn, has led to
competitive environment in which
international businesses work.
TRADE THEORY OVERVIEW

• FREE TRADE

- situation when the government does not


attempt to influence (via quotas\duties) what
its citizens can buy from another country, or
what they can produce and sell to another
country.
FREE TRADE
BENEFITS: DRAWBACKS:

• The country benefit from • If the imported goods are


trade by exchanging the cheaper than the ones
products it produces at low produced at home, local
cost for the products it industries may close down
and the number of working
cannot produce at all places will reduce.
Eg: fish into oranges. • Therefore, countries
introduce limits on imports
Thus the country may become to support domestic
a leader in a certain industry. producers (though not
domestic consumers).
WHAT INFLUENCES INTERNATIONAL
TRADE?
• Climate
(Eg: Brazil exports coffee)
• Natural resources
(Eg: Saudi Arabia exports oil)
• Proportions of land, labour and capital needed for
producing specific goods compared with the ones
available in the country
(Eg: Switzerland exports watches)
• Some industries that enter the market first build a
competitive advantage that is difficult to challenge
(Eg: the USA dominates in the commercial jet aircraft
export “Boeing”)
2. MERCANTILISM THEORY
(mid-16th century, England )
• Mercantilism

an economic philosophy advocating that


countries should simultaneously encourage
exports (by subsidizing exports) and discourage
imports (by introducing tariffs and quotas)
MERCANTILISM THEORY
• Gold and silver-the basics of national wealth.
As the wealth increases, so does the country’s
national wealth and prestige.
• Trade was seen as zero-sum game : a situation in
which a gain by one country results in a loss by
another
• The theory has proved its inefficiency and is considered
dead today as Trade is seen as positive –sum game (all
countries benefit even if one more than another),
though the trade strategy for many countries today is
to boost exports and limit imports.
3. ABSOLUTE ADVANTAGE THEORY
(1776, Adam Smith)
• A country has absolute advantage in the
production of a product when it is more efficient
than any other country at producing it.
• Eg:
Canada has an absolute advantage in raw
materials from silver to timber. *
England of the 18th century had an absolute
advantage in textile production while France in
wine industry.
ABSOLUTE ADVANTAGE THEORY

• According to Smith, countries should specialize


only on the production of goods for which they
have an absolute advantage and trade them for
goods produced by other countries (never
produce goods at home if they can be bought
cheaper from other countries).
Thus both countries will benefit from trade.
• What are the benefits and drawbacks of this
theory?
4. COMPARATIVE ADVANTAGE THEORY
(1817, David Ricardo)
-What will happen if one country has absolute
advantage in the production of all goods?
• Smith theory: No benefits for such a country
from international trade.
• Ricardo’s theory: The country should
specialize on the goods it produces more
efficiently (comparative advantage in the
production of such goods and services) and
buy less efficient goods from other countries.
COMPARATIVE ADVANTAGE THEORY
• This theory is based on unrestricted free
trade: trade is a positive-sum game in which
all countries that participate realize economic
gains.
• The supporters of free trade rely on Ricardo’s
theory today.
Why can’t the theories of Smith’s and
Ricardo’s be ideal?
• -there are many countries and many goods in the
world (not just 2 for trade)
• -there are transportation costs b\n the countries (not
considered by both theories)
• - what about exchange rates (there are differences in
the price of resources)?
• - the resources do not move freely from the
production of one good to another within a country
• - the amount of resources necessary for the
production of the good cannot be stable all the time:
it can increase or decrease
5. HECKSCHER-OHLIN THEORY
(1919, 1933)
• Countries will export those goods that make
intensive use of factors that are locally
abundant, while importing goods that make
intensive use of factors that are locally scarce
(international trade issues we observe in the
world economy today)
HECKSCHER-OHLIN THEORY
• Theory Appeal: a
country may have large absolute amounts of land and labour than
another country, but be relatively abundant in one of them.
• Eg:
Canada has abundant land, growing population, export from fish to
minerals.
• China excels in the import of labour-intensive industries: textiles and
footwear (so China has abundant low-cost labour).
• The USA lacks abundant low-cost labour but is also a primary
importer of these goods.

• The theory is widely used in theory but not in practice as it predicts


the real world international patterns very poorly.
5. THE LEONTIEF PARADOX
(1953, Wassily Leontief)
• Basing on Ohlin’s theory he postulated that
since the USA was relatively abundant in
capital compared to other nations, it would be
an exporter of capital-intensive goods and an
importer of labour –intensive goods.

BUT THE USA EXPORTS WERE LESS CAPITAL


INTENSIVE THAN ITS IMPORTS.
THE LEONTIEF PARADOX
• ? It may be because the USA has a special
advantage in producing new products of
goods made with innovative technologies.
Such products are less capital intensive and
are suitable for mass production.
• Thus the USA exports skilled-labour and
innovative goods (computer software) and
imports heavy manufacturing products that
use a large amount of capital.
6. THE PRODUCT LIFE-CYCLE THEORY
(mid-1960s, Raymond Vernon)
• The theory is based on the fact that for the most
of the 20th century a large proportion of the
world new products were developed by USA
firms and sold first for the US market
(automobiles, TV sets, cameras, computers).
• HOW?
Wealth and size of the US market gave US firms a
strong incentive to develop new consumer
products, and the high cost of US labour gave the
US firms the incentive to develop cost-saving
innovations.
THE PRODUCT LIFE-CYCLE THEORY
• As soon as new demands appear, a new product
appears at the market for American potential
users.
• At the same time other countries do not need
this product in a great number. But with the time
the demand in it grows, and other countries start
producing it for their own markets.
• Only at this stage the price becomes competitive
and global production switches to other countries
(Thailand).
THE PRODUCT LIFE-CYCLE THEORY

• Theory Appeal: today a lot of new products


are introduced simultaneously in the USA,
Japan, and Europe.
7. THE NEW TRADE THEORY
• Economies of scale – cost advantages associated
with large scale production.
• Eg: Microsoft spreads the fixed costs of
developing new versions of its Windows
operating system, which runs to about $5bln, over
the 250 mln personal computers upon which each
new system is installed.
• Eg: Automobile companies produce a high volume
of autos from an assembly line where each
employee has a specialized task.
THE NEW TRADE THEORY
• Theory Issues
-increase in the variety of goods available to
consumers
-decrease in the average cost of the goods available
to consumers
- in the industries with a significant proportion of
total world demand the global market may support
a small number of enterprises, so the world trade
in certain products may be dominated by the
countries that were the first in the production.
8. NATIONAL COMPETITIVE ADVANTAGE THEORY:
PORTER’S DIAMOND
(1990, Michael Porter, Harvard Business School)

• Why do some nations succeed and others fail


in the international competition?
• Why does Switzerland excel in
pharmaceuticals? (better than Britain)
• Why do Germany and the USA do well in
chemical industries? (better than Spain)
PORTER’S DIAMOND

Firm
strategy, Demand
structure, conditions
rivalry

Related and
Factor
supporting
endowments
industries
PORTER’S DIAMOND
• Firm strategy, structure, rivalry – conditions managing domestic
rivalry, the way companies are organized.
• Demand conditions – the nature of home demand for the product
• Related and supporting industries – presence/absence of supplier
industries that are internationally competitive
• Factor endowments – skilled labour or infrastructure necessary to
compete in a given industry

2 more additional variables: Chance Events and Government.


• Chance Events – reshape industry and provide opportunities
(eg: major innovations)
• Government – the policies can either improve or worsen national
advantage
(eg: government investment in education)
KEY POINTS
• Absolute advantage, comparative advantage,
constant return to specialization, economies
of scale, free trade, mercantilism, positive-
sum game, zero-sum game