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7/28/2019 Unit 1 5 Trade TheoriesS
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INTERNATIONAL BUSINESS
MANAGEMENT
4/1/2013 a.velsamy, sona school of management 1
TRADE THEORIES
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Learning objectives
To understand and evaluate several trade
theories.
To assess the implications of trade theories on
international business.
Explain the pattern of international trade
observed in the world economy.
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# The case of US Information Technology
manufacturing.
# Countrys economy may gain if its citizens buy
certain products from other country -
international trade allows a country to specializein manufacturing and export of products that
can be produced most efficiently, while
importing products that can be produced moreefficiently in other countries.
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The pattern of international trade
Ghana exports cocoa, Brazil exports coffee, Saudi
arabia exports oil, china exports crawfish
But why does japan export automobiles, consumer
electronics. Why swiss export chemicals,
pharmaceuticals, jewelry and watches.
Intervention of govt. policies.
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INTERNATIONAL TRADE THEORIES
Mercantilism 16th & 17th century simultaneously to encourage export, discourage
imports ( Zero sum game)
1776, Theory of Absolute advantage by Adam smiths explained unrestricted free trade
is beneficial to country
Theory of comparative advantage by 19th century economist David Ricardo, - through
his book Principles of Political economy in 1817
Eli Heckscher (1919) & Bertil ohlin(1933) , - HeckscherOhlin theory
1966, Product life-cycle theory by Raymond Vermon
1970, New trade theory by Paul Krugman of the Massachusetts institute of technology
Economies of Scale, First-Mover advantages
1990, Theory of national competitive advantage by Michael Porter of HBS
1953, The Leontief paradox
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Mercantilism: mid-16th century
A nations wealth depends on accumulatedtreasure
Gold and silver are the currency of trade.
Theory says you should have a trade surplus. Maximize exports through subsidies.
Minimize imports through tariffs and quotas.
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 higherprices
Increased imports lead to lower prices
Result: Country A sells less because of highprices 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).
Capability of one country to produce more of a
product with the same amount of input than
another country. Produce only goods where you are most
efficient, trade for those where you are not
efficient. Assumes there is an
absolute advantage balance among nations,
e.g., Ghana/cocoa.
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The Theory of Absolute Advantage
Rice
Cocoa
G
0 5 10 15 20
5
10
1
5
20
A
BK
G
K
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The Theory of Absolute Advantage and the
Gains from Trade
Production and Consumption without Trade (equal resource for both crops
S. Korea 2.5 10.0
Total production 20 20
S. Korea 6.0 14.0
Resources Required to Produce 1 Ton of Cocoa and RiceCocoa Rice
Ghana 10 20S. Korea 40 10
Ghana 10.0 5.0
Total production 12.5 15.0Production with Specialization
Ghana 20 0S. Korea 0 20
Consumption after Ghana Trades 6T of Cocoa for 6TSouth Korean RiceGhana 14.0 6.0
Increase in Consumption as a Result of Specialization and Trade
Ghana 4.0 1.0
S. Korea 3.5 4.0
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Theory of Comparative Advantage
David Ricardo: Principles of Political Economy
(1817).
Should trade even if country is more efficient
in the production than its trading partner.
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The Theory of Comparative Advantage
3.75 7.5
2.5
0 5 10 15 20
5
10
15
20
Coc
oa
Rice
G
C
A
K
KB
G
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Comparative Advantage and the Gains from Trade
S. Korea 40 20
S. Korea 2.5 5.0
S. Korea 0.0 10.0
S. Korea 4 6
Resources Required to Produce 1 Ton of Cocoa and Rice
Ghana 10 13.33
Production and Consumption without Trade
Ghana 10.0 7.5
Total production 12.5 12.5Production with Specialization
Ghana 15 3.75
Total production 15 13.75Consumption after Ghana Trades 4T of Cocoa for 4TSouth Korean Rice
Ghana 11 7.75
Increase in Consumption as a Result of Specialization and Trade
Ghana 1.0 0.25
S. Korea 1.5 1.0
Cocoa Rice
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Extensions of the Ricardian Model
Immobile resources: Resources do not always move easily from one economic
activity to another.
Diminishing returns:
More a country produces, at some point, will require moreresources (diminishing returns to specialization).
Different goods use resources in different proportions.
Dynamic effects and economic growth :
However:
Free trade might increase a countrys stock of resources (aslabor and capital arrives from abroad), and
Increase the efficiency of resource utilization.
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Ghanas PPF under Diminishing Returns
Cocoa
Rice
G
G
0
Figure 4.3
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The Influence of Free Trade on the PPF
Figure 4.4
Cocoa
Rice
G
PPF2
0
PPF1
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THE SAMUELSON CRITIQUE
Rich country, US enter into free trade agreement with a poor
country, China rapidly improves its productivity dynamicgain for China Samuelson model suggests that the lower
prices that US consumers pay for goods imported from
china, may not be enough to produce a net gain for the US
economy
Samuelson is concerned about the ability to send offshore
service jobs that traditionally were not internationally mobile,
such as software debugging, call center jobs, accounting
jobs and even medical diagnosis of MRI scans.
Samuelson concedes that free trade has historically
benefitted rich countries introducing protectionist measure
will harm US
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A Link Between Trade and Growth
Sachs and Warner: 1970 to 1990 study
Open economy developing countries grew 4.49%/year.
Closed economy developing countries grew 0.69%/year.
Open economy developed countries grew 2.29%/year.Closed economy developed countries grew 0.74%/year.
Frankel and Romer:On average, a one percentage point increase in
the ratio of a countrys trade to its GDP increases
income/person by at least 0.5%. For every 10%
increase in the importance of international trade
in an economy, average income levels will rise by
at least 5%.
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Heckscher (1919)-Olin (1933) Theory
Patterns of trade are determined by differences in factor
endowments - not productivity.
Remember, focus on relative advantage, notabsoluteadvantage.
Labor is not the only Factor of production. We need to
account for land, capital, and technology.
Factor endowments: extent to which a country is endowed
with such resources as land, labor, and capital.
Export goods that intensively use factor endowments which
are locally abundant.
(Corollary: import goods made from locally scarce factors.)
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The Leontief Paradox, 1953
Disputes Heckscher-Olin in some instances.
Factor endowments can be impacted by
government policy - minimum wage.
US tends to export labor-intensive products,
but is regarded as a capital intensive country.
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Product Life-Cycle Theory
(Raymond Vernon, 1966)
Article in the Quarterly Journal of Economics.
As products mature, both location of sales and optimalproduction 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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The International Product Life Cycle:
Innovating Firms Country
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The International Product Life Cycle: Other
Industrialized Countries
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The International Product Life Cycle: Less
Developed Countries
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The Product Life-Cycle Theory
production
consumptionExports
160140120100
806040200
United States
Other Advanced Countries
Developing Countries
Stages of Production Development
New Product Standardized ProductMaturing Product
Imports
Imports
Exports
Exports
Imports
16014012010080
6040200
16014012010080
6040200
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The New Trade Theory
Began to be recognized in the 1970s.
Deals with the returns on specialization where
substantial economies of scale are present. Specialization increases output, ability to
enhance economies of scale increase.
In addition to economies of scale, learning effects
also exist.
Learning effects are cost savings that come
from learning by doing.
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Application of the New Trade Theory
Typically, requires industries with high, fixed
costs.
World demand will support few competitors.
Competitors may emerge because they got
there first.
First-mover advantage.
Some argue that it generates government
intervention and strategic trade policy.
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First-Mover Advantage
Economies of scale may preclude new
entrants.
Role of the government.
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Porters Diamond
(Harvard Business School, 1990)
The Competitive Advantage of Nations.
Looked at 100 industries in 10 nations.
Thought existing theories didnt go far enough.
Question: Why does a nation achieve
international success in a particular industry?
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Determinants of National Competitive
Advantage
Factor endowments: nations position in factors ofproduction such as skilled labor or infrastructure necessaryto compete in a given industry.
Demand conditions: the nature of home demand for theindustrys product or service.
Related and supporting industries: the presence or absencein a nation of supplier industries or related industries that
are nationally competitive. Firm strategy, structure and rivalry: the conditions in the
nation governing how companies are created, organized,and managed and the nature of domestic rivalry.
P t Di d
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Porters DiamondDeterminants of National Competitive Advantage
CHANCE
GOVERNMENT
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The Diamond
Success occurs where these attributes exist.
More/greater the attribute, the higher chance ofsuccess.
The diamond is mutually reinforcing.
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Factor Endowments
Taken from Heckscher-Olin Basic factors:
natural resources
climate
location
demographics
Advanced factors:
communications skilled labor
research
technology
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Advanced Factor Endowments
More likely to lead to competitiveadvantage.
Are the result of investment by
people, companies, government.
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Relationship of Basic to Advanced Factors
Basic can provide an initial advantage. Must be supported by advanced factors to
maintain success.
No basics, then must invest in advancedfactors.
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Demand Conditions
Demand creates the capabilities.
Look for sophisticated and
demanding consumers. impacts quality and innovation.
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Related and Supporting Industries
Creates clusters of supporting industries that are
internationally competitive.
Must also meet requirements of other parts of the
Diamond.
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Firm Strategy, Structure and Rivalry
Management ideology can either help or hurtyou.
Presence of domestic rivalry improves a
companys competitiveness.
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Evaluating Porters Theory
If Porter is right, we would expect his model topredict the pattern of international trade that we
observe in the real world. Countries should be
exporting products from those industries where
all four components of the diamond arefavorable, while importing in those areas where
the components are not favorable.
Too soon to tell.
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Implications for Business Location implications: makes sense to disperse
production activities to countries where they can be
performed most efficiently.
First-mover implications: Itpays to invest substantial
financial resources in building a first-mover, orearly-mover, advantage.
Policy implications: promoting free trade is
generally in the best interests of the home-country,
although not always in the best interests of the firm.
Even though, many firms promote open markets.
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Theories of
International TradeCountry-Based Theories Country is unit of analysis
Emerged prior to WWII
Developed by economists
Explain interindustry trade Include
Mercantilism
Absolute advantage
Comparative advantage
Relative factorendowments
Firm-Based Theories
Firm is unit of analysis
Emerged after WWII
Developed by business school
professors Explain intraindustry trade
Include
Country similarity theory
Product life cycle
Global strategic rivalry National competitive
advantage
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Stay tuned