International bussiness the challenge of global competition 11e chapter 03

Absolute Advantage Terms of Trade Ratio of International Prices Gains from Specialization and Trade... Theory of Comparative Advantage• Comparative Advantage – A nation having absolute d

Theories of International Trade

and Investment

McGraw-Hill/Irwin

International Business, 11/e Copyright © 2008 The McGraw-Hill Companies, Inc All rights reserved.

chapter three

Learning Objectives

 Explain the theories that attempt to explain

why certain goods are traded internationally

 Discuss the arguments for imposing trade

restrictions

 Explain two basic kinds of import restrictions:

International Trade Theory

• Mercantilism

– Economic philosophy based on belief that

• (1) a nation’s wealth depends on accumulated

treasure, usually gold, and

• (2) to increase wealth, government policies

should promote exports and discourage imports

Theory of Absolute Advantage

• Absolute advantage

– Theory that a nation has absolute

advantage when it can produce a larger

amount of a good or service for the same

amount of inputs as can another country or

– When it can produce the same amount of a

good or service using fewer inputs than

could another country

Absolute Advantage

Each Country Specializes

Example

Absolute Advantage

Terms of Trade (Ratio of International Prices)

Gains from Specialization and Trade

Theory of Comparative Advantage

• Comparative Advantage

– A nation having absolute disadvantages in

the production of two goods with respect to

another nation has a comparative or relative advantage in the production of the good in

which its absolute disadvantage is less

Comparative Advantage

Terms of Trade – at a rate of ¾ bolt of cloth for 1 ton of soybeans

Terms of Trade – at a rate of 1 bolt of cloth for 1 ton of soybeans

Gains from Specialization and Trade

Comparative Advantage

• Production Possibility Frontiers (figure 3.1)

Figure 3.1

Heckscher-Ohlin Theory of Factor

Endowment

• Factor Endowment

– Heckscher-Ohlin theory that countries

export products requiring large amounts of

their abundant production factors and import products requiring large amounts of their

scarce production factors

Heckscher-Ohlin Theory of Factor

Endowment

• Leontief Paradox

– The United States, one of the most capital-intensive

countries in the world, was exporting relatively

labor-intensive products in exchange for relatively

capital-intensive products

• Differences in Taste

– A demand-side construct that is always difficult to

deal with in economic theory

How Can Money Change The

Direction of Trade?

Example

Exchange Rate – the price of one currency stated in terms of another currency

Some Newer Explanations For The

Direction Of Trade

• Linder Theory of Overlapping Demand

– Customers’ tastes are strongly affected by

income levels; therefore a nation’s income per capita level determines the kinds of

goods they will demand

Some Newer Explanations For The

Direction Of Trade

• International Product Life Cycle (IPLC)

– Explains why a product that begins as

export eventually becomes import (figure 3.2)

• U.S exports

• Foreign production begins

• Foreign competition in export market

• Import competition in the United States

Figure 3.2 International Product Life

Cycle

Some Newer Explanations For The

Direction Of Trade

• Technology Life Cycle

– Production technology application of IPLC

• Economies of Scale and Experience Curve

– As a plant gets larger and output increase, the

average cost of producing each unit of output decreases

– As firms produce more products, they learn ways to

improve production efficiency

Some Newer Explanations For The

Direction Of Trade

• Imperfect Competition

– Economies of scale with the existence of

differentiated products Paul Krugman

• First-Mover Theory

– Pattern of trade in goods subject to scale

economies may be determined by historical

Some Newer Explanations For The

Direction Of Trade

• National Competitive Advantage from Regional

Clusters: Porter’s Diamond Model (figure 3.3)

– National Competitiveness: a nation’s relative ability

to design, produce, distribute, or service products while earning increasing returns on resources

• Demand conditions

• Factor Conditions

• Related and supporting industries

• Firm strategy, structure, and rivalry

Figure 3.3 Variable Impacting Competitive

Advantage: Porter’s Diamond

Trade Restrictions: Arguments For

• National Defense

• Sanctions to Punish Offending Nations

• Protect Infant (or Dying) Industry

• Protect Domestic Jobs from Cheap Foreign

Labor

• Scientific Tariff or Fair Competition

Trade Restrictions

• Retaliation

– Dumping: selling a product abroad for less

than the cost of production, the price in the

home market, or the price to third countries

• Social dumping

• Environmental dumping

• Financial services dumping

Trade Restrictions

– Subsidies: Financial contributions, provided

directly or indirectly by a government, which confer a benefit; include grants, preferential

tax treatment, and government assumption

of normal business expenses (figure 3.4)

– Countervailing duties: Additional import

taxes levied on imports that have benefited

from export subsidies

Figure 3.4 Value of OECD Member

Farm Subsidies

Tariff Barriers

• Tariff

– Taxes on imported goods for the purpose of raising

their price to reduce competition for local producers

or stimulate local production

• Ad Valorem Duty

– An import duty levied as a percentage of the invoice

value of imported goods

• Specific Duty

– A fixed sum levied on a physical unit of an imported

good

– An import duty set at the difference between

world market prices and local

Nontariff Barriers

• Nontariff barriers (NTBs)

– All forms of discrimination against imports

other than import duties

• Quantitative

– Quotas: numerical limits placed on specific

classes of imports

– Voluntary export restraints (VERs): Export

quotas imposed by exporting nation

Nontariff Barriers

• Orderly Marketing Arrangements

– Formal agreements between exporting and

importing countries that stipulate the import

or export quotas each nation will have for a

good

• Nonquantitative Nontariff Barriers

– Direct government participation in trade

– Customs and other administrative

From Multinational to Globally

Integrated Manufacturing Systems

• Close least efficient plants, and supply their

markets with imports from other subsidiaries

• Change multidomestic manufacturing system

to globally integrated system in which each

plant performs the activities at which it is most

efficient

International Investment Theories

• Monopolistic Advantage Theory

Theory that FDI is made by firms in oligopolistic

industries possessing technical and other advantages

over indigenous firms

• Product and Factor Market Imperfections

Superior knowledge leads to differentiated products,

and they lead to firm control on price and advantage

over indigenous firm (Hymer and Caves)

•

International Investment Theories

• Follow The Leader

• Cross Investment

– Foreign direct investment by oligopolistic firms in

each other’s home countries as a defense measure

• Internalization Theory

– An extension of the market imperfection theory: to

obtain a higher return on its investment, a firm will

transfer its superior knowledge to a foreign

subsidiary rather than sell it in the open market

International Investment Theories

• Dynamic Capabilities

– Theory that for a firm to successfully invest

overseas, it must have ownership of unique

knowledge or resources and the ability to

dynamically create and exploit these capabilities

• Dunning’s Eclectic Theory Of International

Production

– Theory that for a firm to invest overseas, it must

have three kinds of advantages: ownership-specific,