InternationalBusiness

9eByCharlesW.L.HillMcGraw-Hill/IrwinCopyright?2013byTheMcGraw-HillCompanies,Inc.Allrightsreserved.Chapter6InternationalTradeTheoryWhyIsFreeTradeBeneficial?Freetrade-asituationwhereagovernmentdoesnotattempttoinfluencethroughquotasordutieswhatitscitizenscanbuyfromanothercountryorwhattheycanproduceandselltoanothercountryTradetheoryshowswhyitisbeneficialforacountrytoengageininternationaltradeevenforproductsitisabletoproduceforitselfWhyIsFreeTradeBeneficial?Internationaltradeallowsacountrytospecializeinthemanufactureandexportofproductsandservicesthatitcanproduceefficientlyimportproductsandservicesthatcanbeproducedmoreefficientlyinothercountrieslimitsonimportsmaybebeneficialtoproducers,butnotbeneficialforconsumersWhyDoCertain

PatternsOfTradeExist?

SomepatternsoftradearefairlyeasytoexplainitisobviouswhySaudiArabiaexportsoil,Ghanaexportscocoa,andBrazilexportscoffeeBut,whydoesSwitzerlandexportchemicals,pharmaceuticals,watches,andjewelry?WhydoesJapanexportautomobiles,consumerelectronics,andmachinetools?WhatRoleDoes

GovernmentHaveInTrade?ThemercantilistphilosophymakesacrudecaseforgovernmentinvolvementinpromotingexportsandlimitingimportsSmith,Ricardo,andHeckscher-OhlinpromoteunrestrictedfreetradeNewtradetheoryandPorter’stheoryofnationalcompetitiveadvantagejustifylimitedandselectivegovernmentinterventiontosupportthedevelopmentofcertainexport-orientedindustriesWhatIsMercantilism?Mercantilism(mid-16thcentury)suggeststhatitisinacountry’sbestinteresttomaintainatradesurplus-toexportmorethanitimportsadvocatesgovernmentinterventiontoachieveasurplusinthebalanceoftradeMercantilismviewstradeasazero-sumgame-oneinwhichagainbyonecountryresultsinalossbyanotherWhatIsSmith’sTheory

OfAbsoluteAdvantage?AdamSmith(1776)arguedthatacountryhasanabsoluteadvantageintheproductionofaproductwhenitismoreefficientthananyothercountryinproducingitcountriesshouldspecializeintheproductionofgoodsforwhichtheyhaveanabsoluteadvantageandthentradethesegoodsforgoodsproducedbyothercountriesHowDoesTheTheory

OfAbsoluteAdvantageWork?Assumethattwocountries,GhanaandSouthKorea,bothhave200unitsofresourcesthatcouldeitherbeusedtoproducericeorcocoaInGhana,ittakes10unitsofresourcestoproduceonetonofcocoaand20unitsofresourcestoproduceonetonofriceGhanacouldproduce20tonsofcocoaandnorice,10tonsofriceandnococoa,orsomecombinationofriceandcocoabetweenthetwoextremesHowDoesTheTheory

OfAbsoluteAdvantageWork?InSouthKoreaittakes40unitsofresourcestoproduceonetonofcocoaand10resourcestoproduceonetonofriceSouthKoreacouldproduce5tonsofcocoaandnorice,20tonsofriceandnococoa,orsomecombinationinbetweenHowDoesTheTheory

OfAbsoluteAdvantageWork?WithouttradeGhanawouldproduce10tonsofcocoaand5tonsofriceSouthKoreawouldproduce10tonsofriceand2.5tonsofcocoaWithspecializationandtradeGhanawouldproduce20tonsofcocoaSouthKoreawouldproduce20tonsofriceGhanacouldtrade6tonsofcocoatoSouthKoreafor6tonsofriceHowDoesTheTheory

OfAbsoluteAdvantageWork?AftertradeGhanawouldhave14tonsofcocoaleft,and6tonsofriceSouthKoreawouldhave14tonsofriceleftand6tonsofcocoaIfeachcountryspecializesintheproductionofthegoodinwhichithasanabsoluteadvantageandtradesfortheother,bothcountriesgaintradeisapositivesumgameHowDoesTheTheory

OfAbsoluteAdvantageWork?AbsoluteAdvantageandtheGainsfromTrade

WhatIsRicardo’sTheory

OfComparativeAdvantage?DavidRicardoaskedwhathappenswhenonecountryhasanabsoluteadvantageintheproductionofallgoodsThetheoryofcomparativeadvantage(1817)-countriesshouldspecializeintheproductionofthosegoodstheyproducemostefficientlyandbuygoodsthattheyproducelessefficientlyfromothercountriesevenifthismeansbuyinggoodsfromothercountriesthattheycouldproducemoreefficientlyathomeHowDoesTheTheoryOfComparativeAdvantageWork?AssumeGhanaismoreefficientintheproductionofbothcocoaandriceInGhana,ittakes10resourcestoproduceonetonofcocoa,and131/3resourcestoproduceonetonofriceSo,Ghanacouldproduce20tonsofcocoaandnorice,15tonsofriceandnococoa,orsomecombinationofthetwoHowDoesTheTheoryOfComparativeAdvantageWork?InSouthKorea,ittakes40resourcestoproduceonetonofcocoaand20resourcestoproduceonetonofriceSo,SouthKoreacouldproduce5tonsofcocoaandnorice,10tonsofriceandnococoa,orsomecombinationofthetwoHowDoesTheTheoryOfComparativeAdvantageWork?WithtradeGhanacouldexport4tonsofcocoatoSouthKoreainexchangefor4tonsofriceGhanawillstillhave11tonsofcocoa,and4additionaltonsofriceSouthKoreastillhas6tonsofriceand4tonsofcocoaifeachcountryspecializesintheproductionofthegoodinwhichithasacomparativeadvantageandtradesfortheother,bothcountriesgainHowDoesTheTheoryOfComparativeAdvantageWork?Comparativeadvantagetheoryprovidesastrongrationaleforencouragingfreetrade

totaloutputishigherbothcountriesbenefitTradeisapositivesumgameHowDoesTheTheoryOfComparativeAdvantageWork?ComparativeAdvantageandtheGainsfromTradeIsUnrestrictedFreeTrade

AlwaysBeneficial?Unrestrictedfreetradeisbeneficial,butthegainsmaynotbeasgreatasthesimplemodelofcomparativeadvantagewouldsuggestimmobileresourcesdiminishingreturnsdynamiceffectsandeconomicgrowththeSamuelsoncritiqueBut,openingacountrytotradecouldincreaseacountry'sstockofresourcesasincreasedsuppliesbecomeavailablefromabroadtheefficiencyofresourceutilizationandsofreeupresourcesforotheruseseconomicgrowthCouldARichCountryBe

WorseOffWithFreeTrade?

PaulSamuelson-thedynamicgainsfromtrademaynotalwaysbebeneficialfreetrademayultimatelyresultinlowerwagesintherichcountryTheabilitytooffshoreservicesjobsthatweretraditionallynotinternationallymobilemayhavetheeffectofamassinwardmigrationintotheUnitedStates,wherewageswouldthenfallbut,protectionistmeasurescouldcreateamoreharmfulsituationthanfreetradeWhatIsThe

Heckscher-OhlinTheory?

EliHeckscher(1919)andBertilOhlin(1933)-comparativeadvantagearisesfromdifferencesinnationalfactorendowments

theextenttowhichacountryisendowedwithresourceslikeland,labor,andcapitalThemoreabundantafactor,theloweritscostWhatIsThe

Heckscher-OhlinTheory?

ThepatternoftradeisdeterminedbyfactorendowmentsHeckscherandOhlinpredictthatcountrieswillexportgoodsthatmakeintensiveuseoflocallyabundantfactorsimportgoodsthatmakeintensiveuseoffactorsthatarelocallyscarceDoesTheHeckscher-Ohlin

TheoryHold?WassilyLeontief(1953)theorizedthatsincetheU.S.wasrelativelyabundantincapitalcomparedtoothernations,theU.S.wouldbeanexporterofcapitalintensivegoodsandanimporteroflabor-intensivegoods.However,hefoundthatU.S.exportswerelesscapitalintensivethanU.S.importsSincethisresultwasatvariancewiththepredictionsoftradetheory,itbecameknownastheLeontiefParadoxWhatIsThe

ProductLifeCycleTheory?Theproductlife-cycletheory

-asproductsmatureboththelocationofsalesandtheoptimalproductionlocationwillchangeaffectingtheflowanddirectionoftradeproposedbyRayVernoninthemid-1960sAtthistimemostoftheworld’snewproductsweredevelopedbyU.S.firmsandsoldfirstintheU.S.WhatIsThe

ProductLifeCycleTheory?Accordingtotheproductlife-cycletheory

thesizeandwealthoftheU.S.marketgaveU.S.firmsastrongincentivetodevelopnewproductsinitially,theproductwouldbeproducedandsoldintheU.S.asdemandgrewinotherdevelopedcountries,U.S.firmswouldbegintoexportdemandforthenewproductwouldgrowinotheradvancedcountriesovertimemakingitworthwhileforforeignproducerstobeginproducingfortheirhomemarketsWhatIsThe

ProductLifeCycleTheory?U.S.firmsmightsetupproductionfacilitiesinadvancedcountrieswithgrowingdemand,limitingexportsfromtheU.S.AsthemarketintheU.S.andotheradvancednationsmatured,theproductwouldbecomemorestandardized,andpricewouldbethemaincompetitiveweaponWhatIsThe

ProductLifeCycleTheory?ProducersbasedinadvancedcountrieswherelaborcostswerelowerthantheUnitedStatesmightnowbeabletoexporttotheUnitedStatesIfcostpressureswereintense,developingcountrieswouldacquireaproductionadvantageoveradvancedcountriesProductionbecameconcentratedinlower-costforeignlocations,andtheU.S.becameanimporteroftheproductWhatIsThe

ProductLifeCycleTheory?TheProductLifeCycleTheoryDoesTheProductLife

CycleTheoryHold?TheproductlifecycletheoryaccuratelyexplainswhathashappenedforproductslikephotocopiersandanumberofotherhightechnologyproductsdevelopedintheUnitedStatesinthe1960sand1970smatureindustriesleavetheU.S.forlowcostassemblylocationsDoesTheProductLife

CycleTheoryHold?But,theglobalizationandintegrationoftheworldeconomyhasmadethistheorylessvalidtodaythetheoryisethnocentricproductiontodayisdispersedgloballyproductstodayareintroducedinmultiplemarketssimultaneouslyWhatIsNewTradeTheory?Newtradetheorysuggeststhattheabilityoffirmstogaineconomiesofscale(unitcostreductionsassociatedwithalargescaleofoutput)canhaveimportantimplicationsforinternationaltradeCountriesmayspecializeintheproductionandexportofparticularproductsbecauseincertainindustries,theworldmarketcanonlysupportalimitednumberoffirmsnewtradetheoryemergedinthe1980sPaulKrugmanwontheNobelprizeforhisworkin2008

WhatIsNewTradeTheory?Throughitsimpactoneconomiesofscale,tradecanincreasethevarietyofgoodsavailabletoconsumersanddecreasetheaveragecostofthosegoodswithouttrade,nationsmightnotbeabletoproducethoseproductswhereeconomiesofscaleareimportantwithtrade,marketsarelargeenoughtosupporttheproductionnecessarytoachieveeconomiesofscaleso,tradeismutuallybeneficialbecauseitallowsforthespecializationofproduction,therealizationofscaleeconomies,andtheproductionofagreatervarietyofproductsatlowerpricesWhatIsNewTradeTheory?Inthoseindustrieswhenoutputrequiredtoattaineconomiesofscalerepresentsasignificantproportionoftotalworlddemand,theglobalmarketmayonlybeabletosupportasmallnumberofenterprises

firstmoveradvantages-theeconomicandstrategicadvantagesthataccruetoearlyentrantsintoanindustryeconomiesofscalefirstmoverscangainascalebasedcostadvantagethatlaterentrantsfinddifficulttomatchWhatAreTheImplicationsOf

NewTradeTheoryForNations?

NationsmaybenefitfromtradeevenwhentheydonotdifferinresourceendowmentsortechnologyacountrymaydominateintheexportofagoodsimplybecauseitwasluckyenoughtohaveoneormorefirmsamongthefirsttoproducethatgoodGovernmentsshouldconsiderstrategictradepoliciesthatnurtureandprotectfirmsandindustrieswherefirstmoveradvantagesandeconomiesofscaleareimportantWhatIsPorter’sDiamondOfCompetitiveAdvantage?MichaelPorter(1990)triedtoexplainwhyanationachievesinternationalsuccessinaparticularindustryidentifiedfourattributesthatpromoteorimpedethecreationofcompetitiveadvantageFactorendowments-anation’spositioninfactorsofproductionnecessarytocompeteinagivenindustrycanleadtocompetitiveadvantagecanbeeitherbasic(naturalresources,climate,location)oradvanced(skilledlabor,infrastructure,technologicalknow-how)WhatIsPorter’sDiamondOfCompetitiveAdvantage?Demandconditions-thenatureofhomedemandfortheindustry’sproductorserviceinfluencesthedevelopmentofcapabilitiessophisticatedanddemandingcustomerspressurefirmstobecompetitiveRelatingandsupportingindustries-thepresenceorabsenceofsupplierindustriesandrelatedindustriesthatareinternationallycompetitivecanspilloverandcontributetootherindustriessuccessfulindustriestendtobegroupedinclustersincountriesWhatIsPorter’sDiamondOfCompetitiveAdvantage?Firmstrategy,structure,andrivalry-theconditionsgoverninghowcompaniesarecreated,organized,andmanaged,andthenatureofdomesticrivalrydifferentmanagementideologiesaffectthedevelopmentofnationalcompetitiveadvantagevigorousdomesticrivalrycreatespressurestoinnovate,toimprovequality,toreducecosts,andtoinvestinupgradingadvancedfeaturesWhatIsPorter’sDiamondOfCompetitiveAdvantage?DeterminantsofNationalCompetitiveAdvantage:Porter’sDiamondDoesPorter’sTheoryHold?Governmentpolicycanaffectdemandthroughproductstandardsinfluencerivalrythroughregulationandantitrustlawsimpacttheavailabilityofhighlyeducatedworkersandadvancedtransportationinfrastructure.Thefourattributes,governmentpolicy,andchanceworkasareinforcingsystem,complementingeachotherandincombinationcreatingtheconditionsappropriateforcompetitiveadvantageSofar,Porter’stheoryhasnotbeensufficientlytestedtoknowhowwellitholdsupWhatAreTheImplicationsOfTradeTheoryForManagers?Locationimplications-afirmshoulddisperseitsvariousproductiveactivitiestothosecountrieswheretheycanbeperformedmostefficientlyfirmsthatdonotmaybeatacompetitivedisadvantageFirst-moverimplications-afirst-moveradvantagecan