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Chapter 6

InternationalTrade Theory

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6-2

Why Is Free Trade Beneficial?

Free trade - a situation where agovernment does not attempt to influencethrough quotas or duties what its citizenscan buy from another country or what theycan produce and sell to another country

Trade theory shows why it is beneficial fora country to engage in international trade

even for products it is able to produce foritself

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6-3

Why Is Free Trade Beneficial?

International trade allows a countryto specialize in the manufacture and export of

products and services that it can produceefficiently

import products and services that can beproduced more efficiently in other countries

limits on imports may be beneficial toproducers, but not beneficial for consumers

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6-4

Why Do Certain

Patterns Of Trade Exist?Some patterns of trade are fairly easy to

explain

it is obvious why Saudi Arabia exports oil,

Ghana exports cocoa, and Brazil exportscoffee

But, why does Switzerland exportchemicals, pharmaceuticals, watches, and

jewelry?

Why does Japan export automobiles,consumer electronics, and machine tools?

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6-5

What Role Does

Government Have In Trade?The mercantilist philosophy makes a crude case

for government involvement in promoting

exports and limiting imports

Smith, Ricardo, and Heckscher-Ohlin promoteunrestricted free trade

New trade theory and Porters theory of national

competitive advantage justify limited and

selective government intervention to support the

development of certain export-oriented

industries

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What Is Mercantilism?

Mercantilism (mid-16th century) suggeststhat it is in a countrys best interest tomaintain a trade surplus -to export more

than it importsadvocates government intervention to achieve

a surplus in the balance of trade

Mercantilism views trade as a zero-sumgame - one in which a gain by one countryresults in a loss by another

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What Is Smiths Theory

Of Absolute Advantage?

Adam Smith (1776) argued that a country

has an absolute advantage in the

production of a product when it is more

efficient than any other country inproducing it

countries should specialize in the production

of goods for which they have an absoluteadvantage and then trade these goods for

goods produced by other countries

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How Does The Theory

Of Absolute Advantage Work?

If each country specializes in theproduction of the good in which it has anabsolute advantage and trades for theother, both countries gaintrade is a positive sum game

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What Is Ricardos Theory

Of Comparative Advantage?

David Ricardo asked what happens when onecountry has an absolute advantage in theproduction of all goods

The theory ofcomparative advantage (1817) -countries should specialize in the production ofthose goods they produce most efficiently andbuy goods that they produce less efficiently fromother countries

even if this means buying goods from othercountries that they could produce moreefficiently at home

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How Does The Theory Of

Comparative Advantage Work?

If each country specializes in theproduction of the good in which it has acomparative advantage and trades for the

other, both countries gain

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How Does The Theory Of

Comparative Advantage Work?

Comparative advantage theory provides astrong rationale for encouraging free trade

total output is higher

both countries benefit

Trade is a positive sum game

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Is Unrestricted Free Trade

Always Beneficial? Unrestricted free trade is beneficial, but the gains may

not be as great as the simple model of comparativeadvantage would suggest immobile resources

diminishing returns dynamic effects and economic growth

the Samuelson critique

But, opening a country to trade could increase a country's stock of resources as increased supplies become

available from abroad the efficiency of resource utilization and so free up resources for

other uses

economic growth

ld h

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Could A Rich Country Be

Worse Off With Free Trade?Paul Samuelson - the dynamic gains from trade

may not always be beneficial

free trade may ultimately result in lower

wages in the rich countryThe ability to offshore services jobs that were

traditionally not internationally mobile may havethe effect of a mass inward migration into the

United States, where wages would then fallbut, protectionist measures could create a

more harmful situation than free trade

h h

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What Is The

Heckscher-Ohlin Theory?Eli Heckscher (1919) and Bertil Ohlin

(1933) - comparative advantage arises

from differences in national factor

endowments

the extent to which a country is endowed with

resources like land, labor, and capital

The more abundant a factor, the lower itscost

Wh I Th

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What Is The

Heckscher-Ohlin Theory?The pattern of trade is determined by

factor endowments

Heckscher and Ohlin predict that countries

will

export goods that make intensive use of

locally abundant factors

import goods that make intensive use offactors that are locally scarce

D Th H k h Ohli

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Does The Heckscher-Ohlin

Theory Hold?

Wassily Leontief (1953) theorized that since theU.S. was relatively abundant in capital comparedto other nations, the U.S. would be an exporterof capital intensive goods and an importer oflabor-intensive goods.

However, he found that U.S. exports wereless capital intensive than U.S. imports

Since this result was at variance with thepredictions of trade theory, it became known asthe Leontief Paradox

Wh I Th

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What Is The

Product Life Cycle Theory?

The product life-cycle theory- as products

mature both the location of sales and the

optimal production location will change

affecting the flow and direction of trade

proposed by Ray Vernon in the mid-1960s

At this time most of the worlds new products were

developed by U.S. firms and sold first in the U.S.

Wh I Th

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What Is The


According to the product life-cycle theory

the size and wealth of the U.S. market gave U.S.

firms a strong incentive to develop new products

initially, the product would be produced and sold inthe U.S.

as demand grew in other developed countries, U.S.

firms would begin to export

demand for the new product would grow in otheradvanced countries over time making it worthwhile for

foreign producers to begin producing for their home

markets

Wh I Th

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What Is The


U.S. firms might set up production facilitiesin advanced countries with growingdemand, limiting exports from the U.S.

As the market in the U.S. and otheradvanced nations matured, the productwould become more standardized, andprice would be the main competitive

weapon

Wh I Th

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What Is The

Product Life Cycle Theory?Producers based in advanced countries where

labor costs were lower than the United Statesmight now be able to export to the United States

If cost pressures were intense, developing

countries would acquire a production advantageover advanced countries

Production became concentrated in lower-costforeign locations, and the U.S. became an

importer of the product

Wh I Th

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What Is The

Product Life Cycle Theory?The Product Life Cycle Theory

D Th P d t Lif

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Does The Product Life

Cycle Theory Hold?

The product life cycle theory accurately explainswhat has happened for products likephotocopiers and a number of other hightechnology products developed in the UnitedStates in the 1960s and 1970s

mature industries leave the U.S. for low costassembly locations

D Th P d t Lif

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Does The Product Life

Cycle Theory Hold?

But, the globalization and integration of theworld economy has made this theory lessvalid today

the theory is ethnocentricproduction today is dispersed globally

products today are introduced in multiplemarkets simultaneously

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6-24

What Is New Trade Theory?

New trade theory suggests that the ability offirms to gain economies of scale (unit costreductions associated with a large scale ofoutput) can have important implications for

international trade Countries may specialize in the production and

export of particular products because in certainindustries, the world market can only support alimited number of firms

new trade theory emerged in the 1980s

Paul Krugman won the Nobel prize for hiswork in 2008

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6-25


1. Through its impact on economies of scale, tradecan increase the variety of goods available toconsumers and decrease the average cost ofthose goods

without trade, nations might not be able to producethose products where economies of scale areimportant

with trade, markets are large enough to support theproduction necessary to achieve economies of scale

so, trade is mutually beneficial because it allows forthe specialization of production, the realization ofscale economies, and the production of a greatervariety of products at lower prices

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2. In those industries when output required toattain economies of scale represents asignificant proportion of total world demand,the global market may only be able to support

a small number of enterprises first mover advantages - the economic and

strategic advantages that accrue to earlyentrants into an industry

economies of scale first movers can gain a scale based costadvantage that later entrants find difficult tomatch

Wh t A Th I li ti Of

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6-27

What Are The Implications Of

New Trade Theory For Nations?Nations may benefit from trade even when they

do not differ in resource endowments or

technology

a country may dominate in the export of a goodsimply because it was lucky enough to have one or

more firms among the first to produce that good

Governments should consider strategic trade

policies that nurture and protect firms andindustries where first mover advantages and

economies of scale are important

Wh t I P t Di d Of

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6-28

What Is Porters Diamond Of

Competitive Advantage? Michael Porter (1990) tried to explain why a

nation achieves international success in aparticular industry

identified four attributes that promote or

impede the creation of competitiveadvantage

1. Factor endowments - a nations position infactors of production necessary to compete in

a given industry can lead to competitive advantage can be either basic (natural resources, climate,

location) or advanced (skilled labor, infrastructure,technological know-how)


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Competitive Advantage?2. Demand conditions - the nature of home

demand for the industrys product or service influences the development of capabilities

sophisticated and demanding customers pressure

firms to be competitive3. Relating and supporting industries - the

presence or absence of supplier industries andrelated industries that are internationallycompetitive can spill over and contribute to other industries

successful industries tend to be grouped in clustersin countries


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What Is Porter s Diamond Of

Competitive Advantage?

4. Firm strategy, structure, and rivalry - theconditions governing how companies arecreated, organized, and managed, and thenature of domestic rivalry different management ideologies affect the

development of national competitive advantage

vigorous domestic rivalry creates pressures toinnovate, to improve quality, to reduce costs, and to

invest in upgrading advanced features


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What Is Porter s Diamond Of

Competitive Advantage?Determinants of National Competitive Advantage: Porters Diamond

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Does Porters Theory Hold?

Government policy canaffect demand through product standards

influence rivalry through regulation and antitrust laws

impact the availability of highly educated workers and

advanced transportation infrastructure.The four attributes, government policy, and

chance work as a reinforcing system,complementing each other and in combinationcreating the conditions appropriate forcompetitive advantage

So far, Porters theory has not been sufficientlytested to know how well it holds up


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Trade Theory For Managers?

1. Location implications - a firm should disperse itsvarious productive activities to those countries wherethey can be performed most efficiently

firms that do not may be at a competitive

disadvantage2. First-mover implications - a first-mover advantage can

help a firm dominate global trade in that product

3. Policy implications - firms should work to encouragegovernmental policies that support free trade

want policies that have a favorable impact on eachcomponent of the diamond

What Is The

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What Is The

Balance Of Payments? A countrys balance of payments accounts

keep track of the payments to and receiptsfrom other countries for a particular time period

double entry bookkeeping

sum of the current account balance, thecapital account and the financial accountshould be zero

What Is The

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What Is The

Balance Of Payments? There are three main accounts1. The current account records transactions of goods,

services, and income, receipts and payments

current account deficit - a country imports morethan it exports

current account surplus a country exports morethan it imports

2. The capital account records one time changes in thestock of assets

3. The financial account records transactions that involvethe purchase or sale of assets

net change in U.S. assets owned abroad

foreign owned assets in the U.S.

What Is The

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What Is The

Balance Of Payments?United States Balance of Payments Accounts, 2010

Is A Current

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Is A Current

Account Deficit Bad?Question:Does current account deficit in the

United States matter?

A current account deficit implies a net debtor

so, a persistent deficit could limit future

economic growthBut, even though capital is flowing out of the

U.S. as payments to foreigners, much of it flowsback in as investments in assets

Yet, suppose foreigners stop buying U.S. assetsand sell their dollars for another currency

a dollar crisis could occur

Documents

2000 Chp 6 Intl Trade