Chapter

International Trade Theory

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Trade theory-overview


Free Trade occurs when 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 The Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country
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Trade theory-overview
The Pattern of International Trade displays patterns that are easy to understand (Saudi Arabia/oil or Brazil/Sugar). Others are not so easy to understand (Japan and cars, Finland/telecom, Israel/ Optics)  The history of Trade Theory and government involvement presents a mixed case for the role of government in promoting exports and limiting imports  Later theories appear to make a case for limited involvement McGraw-Hill/Irwin

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Mercantilism: mid-16th century



A nations wealth depends on accumulated treasure



Gold and silver are the currency of trade Maximize export through subsidies. Minimize imports through tariffs and quotas

Theory says you should have a trade surplus.

 

Flaw: zero-sum game

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Mercantilism-zero-sum game


David Hume in 1752 pointed out that:

  

Increased exports leads to inflation and higher prices, Increased imports lead to lower prices Gold Standard created too much wealth

Result: Country A sells less because of high prices and Country B sells more because of lower prices In the long run, no one can keep a trade surplus

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Theory of absolute advantage



 

Adam Smith: Wealth of Nations (1776) argued:  Capability of one country to produce more of a product with the same amount of input than another country can vary  A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient Trade between countries is, therefore, beneficial Assumes there is an absolute balance among nations
 

Example: Ghana and Korea Each has 200 units of resources

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Theory of absolute advantage

Fig 4.1

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Absolute advantage and the gains from trade table 5.1

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Theory of comparative advantage



David Ricardo: Principles of Political Economy (1817).

  

Extends free trade argument Efficiency of resource utilization leads to more productivity. Should import even if country is more efficient in the products production than country from which it is buying. Look to see how much more efficient. If only comparatively efficient, than import.

Makes better use of resources  Trade is a positive-sum game McGraw-Hill/Irwin


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Theory of comparative advantage (5.2)

Fig 4.2

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Comparative advantage and the gains from trade

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Simple extensions of the Ricardian model



Immobile resources:  Resources do not always move easily from one economic activity to another Diminishing returns:  Diminishing returns to specialization suggests that after some point, the more units of a good the country produces, the greater the additional resources required to produce an additional item  Different goods use resources in different proportions
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Simple extensions of the Ricardian model



Free trade (open economies):



 

Free trade might increase a countrys stock of resources (as labor and capital arrives from abroad) Increase the efficiency of resource utilization PPF is non-linear and there are diminishing returns

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PPF under diminishing returns

Fig 4.3

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Influence of free trade on PPF

Fig 4.4

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Heckscher (1919)-Olin (1933) Theory



Export goods that intensively use factor endowments which are locally abundant  Corollary: import goods made from locally scarce factors


Note: Factor endowments can be impacted by government policy - minimum wage

 

Patterns of trade are determined by differences in factor endowments - not productivity Remember, focus on relative advantage, not absolute advantage
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Leontiefs Paradox Contrary to H-O-S predictions, US was exporting Labor-intensive products as measured by I-O US was importing Capital intensive products: WHY? US labor quality Trade constraints

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Product life-cycle Theory- R. Vernon,(1966)



As products mature, both location of sales and optimal production changes Affects the direction and flow of imports and exports Globalization and integration of the economy makes this theory less valid

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Product life cycle theory

Fig 4.5

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New trade theory

In industries with high fixed costs: Autos, TVs, FPDs, Chemicals, Pharma Specialization increases output, and the ability to enhance economies of scale increases learning effects are high. These are cost savings that come from learning by doing

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New trade theory-applications



Typically, requires industries with high, fixed costs



World demand will support few competitors

Competitors may emerge because of First-mover advantage

 

Economies of scale may preclude new entrants Role of the government becomes significant

Some argue that it generates government intervention and strategic trade policy Sunrise-sunset industries
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Theory of national competitive advantage

 

The theory attempts to analyze the reasons for a nations success in a particular industry Porter studied 100 industries in 10 nations


postulated determinants of competitive advantage of a nation were based on four major attributes
endowments  Demand conditions  Related and supporting industries  Firm strategy, structure and rivalry
 Factor

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Porters diamond
  

Success occurs where these attributes exist. More/greater the attribute, the higher chance of success The diamond is mutually reinforcing
Fig 4.6

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Factor endowments


 

Factor endowments:- A nations position in factors of production such as skilled labor or infrastructure necessary to compete in a given industry Basic factor endowments Advanced factor endowments Acquired Advantages. Japan in electronics, US in Pharma, Italy in fashion, India in software.
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Basic factor endowments



Basic factors: Factors present in a country

   

Natural resources Climate Geographic location Demographics

While basic factors can provide an initial advantage they must be supported by advanced factors to maintain success
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Advanced factor endowments

Advanced factors: Are the result of investment by people, companies, government and are more likely to lead to competitive advantage  If a country has no basic factors, it must invest in advanced factors


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Advanced factor endowments

    

communications skilled labor research Technology education

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Demand conditions


Demand:  creates capabilities  creates sophisticated and demanding consumers Demand impacts quality and innovation
    

Japanese electronmics French/italian fashion US Golf and sports Govt purchasing; military Homeland Security

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Related and supporting industries

 

Creates clusters of supporting industries that are internationally competitive Boeing in Wichita, Hollywood, Bollywood, Nashville, Route 128, Wall Street, Silicon Glen in Scotland, Hi-Tech cluster in Herziliya, Israel, Banking, trade and logistics in Dubai, Dulles Access Road, I-270 Maryland tech corrider. Must also meet requirements of other parts of the Diamond
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Firm Strategy, Structure and Rivalry

Long term corporate vision is a determinant of success: Five competitive forces Management ideology and structure of the firm can either help or hurt you Presence of domestic rivalry improves a companys competitiveness by adding pressure to innovate. Japanese Auto Industry.

  

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Firm Strategy, Structure, Rivalry

Five forces influence industry competition 1) Potential entrants (entry barriers?) 2) Bargaining power with suppliers 3) Bargaining power with buyers 4) Intra-industry competition 5) Threat of substitute products or services (rail vs water) Ex: Apple, Satellite radio, Amazon, long distance tele, Disney-Pixar, Beverages, Netflix(Vitamin h2o vs Gatorade, Disruptive technologies)

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Determinants of Competitive Advantage in nations

Chance
Company Strategy, Structure, and Rivalry
Fig 4.8

Two external factors that influence the four determinants.

Factor Conditions

Demand Conditions

Related and Supporting Industries

Government

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Chance and Government

South Africa, Russia, North Korea, Burma, Philippines, Saudi Arabia, Mexico, Afghanistan, Iran, Iraq, China, etc

All countries have a legacy that moderates their Present competitiveness: it may be the result of colonization (British, French, Portuguese), Culture (religion), Location Natural Endowments, Immigration (israel) and so on

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World Competitiveness Yearbook (2008)

1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16) McGraw-Hill/Irwin International Business, 5/e17) USA Singapore Hong Kong Switzerland Luxembourg Denmark Australia Canada Sweden Netherlands Norway Ireland Taiwan Austria Finland Germany China

From IMD in Switzerland.. Are you comparing Apple to Apples?

http://www.imd.ch/news/2008-WCY-Rankings.cfm

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Porters Theory-predictions


Porters theory should predict the pattern of international trade that we observe in the real world. Italian footwear, Hollywood movies, French fashion, German steel, Korean Ships, Japanese cars and electronics, Indian Software, Chinese Apparel Countries should be exporting products from those industries where all four components of the diamond are favorable, while importing in those areas where the components are not favorable Public Policy Implications: Developing Countries???

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