© 2001 prentice hall5-1 international business by daniels and radebaugh chapter 5 international...

© 2001 Prentice Hall 5-1

International Businessby

Daniels and Radebaugh

Chapter 5International TradeTheory


ObjectivesTo explain trade theoriesTo discuss how global efficiency can be increased through free

tradeTo introduce prescriptions for altering trade patternsTo explore how business decisions influence international

trade


Companies’ International Operations Link Countries Economically

OBJECTIVES

STRATEGY

MEANS OF OPERATING• Importing and exporting goods and services (trade)• Transferring production factors, such as labor and capital, internationally

Country BCountry A


IntroductionTrade in goods and services is one means by which countries

are linked economicallyTypes of trade theories

• Descriptive—deal with natural order of trade– examine and explain trade patterns under laissez-

faire conditions• Prescriptive—concerned with government interference in

the free movement of goods and services– considers governments’ affect on the amount,

composition, and direction of trade• Both types of theories

– provide insights about markets for exports and potentially successful export products

– help companies determine where to locate production facilities


MercantilismFoundation of economic thought from 1500—1800

• Intended to benefit colonial powers– colonies supplied commodities to the mother country– mother country tried to run trade surpluses with their

own colonies• A country’s wealth determined by its holding of treasure,

usually gold• Countries should export more than they import

– favorable balance of trade– governments imposed restrictions on imports– governments subsidized many products that could

not otherwise compete in domestic or export markets• Mercantilism faded after 1800

Neomercantilism—attempt to achieve favorable trade balances to achieve social or political objectives


Absolute AdvantageAdam Smith—different countries produce some goods more

efficiently than other countries• Free trade increases global efficiency• Each country will specialize in products that give it a

competitive advantage– labor becomes more skilled by repeating tasks– no time lost switching from production of one kind to

production of another kind– long production runs provide incentives for

development of more effective work methods• Natural advantage—stems from climatic conditions,

access to certain natural resources, or availability of certain labor forces

• Acquired advantage— based on technology and skill development

– product technology – process technology


Production Possibilities with Absolute AdvantageASSUMPTIONS for Sri Lanka1. 100 units of resources available2. 10 units to produce a ton of wheat3. 4 units to produce a ton of tea4. Uses half of total resources per product when there is no foreign trade

ASSUMPTIONS for United States1. 100 units of resources available2. 5 units to produce a ton of wheat3. 20 units to produce a ton of tea4. Uses half of total resources per product when there is no foreign trade

PRODUCTION Tea Wheat (tons) (tons)

Without Trade: Sri Lanka (point A) 12.5 5 U.S. (point B) 2.5 10 Total 15.0 15

With Trade: Sri Lanka (point C) 25 0 U.S. (point D) 0 20 Total 25 20

U.S. production possibilities

10Quantity of Wheat (tons)

0 5 15 20 25

5

10

15

20

25

Qu

anti

ty o

f T

ea (

ton

s)

A

B

C

D

Sri Lankan production possibilities


Comparative AdvantageDavid Ricardo—gains from trade will occur even in a country

that has absolute advantage in all products because the country must give up less-efficient output to produce more-efficient output

Country should specialize in products it can make most efficiently, even if other countries can make the product more efficiently

Theory accepted by most economists• Theory is influential in promoting policies for freer trade


Production Possibilities with Comparative AdvantageASSUMPTIONS for Sri Lanka

1. 100 units of resources available

2. 10 units to produce a ton of wheat

3. 10 units to produce a ton of tea

4. Uses half of total resources per product

when there is no foreign trade

PRODUCTION Tea Wheat (tons) (tons)

Without Trade: Sri Lanka (point A) 5 5 U.S. (point B) 10 12.5 Total 15 17.5

With Trade (increasingtea production): Sri Lanka (point C) 10 0 U.S. (point D) 6 17.5 Total 16 17.5

ASSUMPTIONS for United States

1. 100 units of resources available

2. 4 units to produce a ton of wheat

3. 5 units to produce a ton of tea

4. Uses half of total resources per product

when there is no foreign trade

10Quantity of Wheat (tons)

0 5 15 20 25

5

10

15

20

25

Qu

anti

ty o

f T

ea (

ton

s)C

D E

U.S. production possibilities

A

B

Sri Lankan production possibilities

With Trade (increasingtea production): Sri Lanka (point C) 10 0 U.S. (point E) 5 18.75 Total 15 18.75


Assumptions and Limitations of Theories of SpecializationBoth absolute and comparative advantage theories are based

on specialization• Countries should trade output based on their own

specialization for the output from other countries specialization

Full employment— not valid assumptionEconomic efficiency objective—countries’ goals may not be

limited to economic efficiencyDivision of gains—if trading partner is perceived to be gaining

too large a share of benefits, other partner may forgo absolute gains to prevent relative losses

Two countries, two commodities—original two-country, two-product logic applies to more complex situations

Transport costs—may negate advantages of tradingSize of economy and production scales—longer production

runs, less production abroad


Factor-Proportion TheoryEli Heckscher and Bertil Ohlin—relative factor costs lead

countries to excel in the production and export of products that used their abundant, and therefore cheaper, production factors

Land-labor relationship—in countries in which there are many people relative to the amount of land, land price is very high because it’s in demand

• Land costs and technology dictate what types of industries choose to locate in a country

Labor-capital relationship— production factors, especially labor, are not as homogeneous as assumed

• Labor skills vary within and among countries due to differences in training and education

– led to international specialization by task to produce a given product

Technological complexities—the same product can be produced by different methods (labor or capital)


Product Life Cycle Theory of Trade (PLC)Raymond Vernon—the production location for many products

moves from one country to another depending on the stage in the product’s life cycle

Stage 1: Introduction• Innovation, production, and sales in same country

– new products developed in response to nearby observed need and markets for them

– early production occurs in domestic location• Location and importance of technology

– most new technology that results in new products and production methods originates in industrial countries

• Exports and labor– export small part of production– production process likely to be labor intensive– capital machinery for large-scale production develops

later in industrialized countries


Product Life Cycle Theory of Trade (cont.)Stage 2: Growth

• Increases in exports by the innovating country• More competition• Increased capital intensity

– growing sales offer incentives to companies to develop process technology

• Some foreign productionStage 3: Maturity

• Decline in exports from the innovating country• More product standardization• More capital intensity• Increased competitiveness of price• Production start-ups in emerging countries

Stage 4: Decline• Production increased in emerging economies• Innovating country becoming net importer


Product Life Cycle Theory of Trade (cont.)Verification and limitations of plc theory

• High transportation costs limit export opportunities, regardless of the life cycle stage

• Shifts in production site do not change for many types of products

– innovating country maintains its export ability throughout the life cycle

» products with very short life cycles» luxury products for which cost is not a concern

for the consumer» products used to promote differentiation strategy» products requiring specialized technical labor to

evolve• MNEs increasingly introduce new products at home and

abroad simultaneously


Country-Similarity TheoryEconomic similarity of industrial countries

• Most of the world’s trade occurs among countries that have similar characteristics

– country similarity theory—once a company has developed a new product to serve needs in a local market, it will turn to markets it sees as most similar to those at home

– most trade takes place among industrial countries because:

» growing importance of acquired advantage as opposed to natural advantage

» markets in industrial countries can support products and their variations

» importance of industrial markets due to their size» incomes are high and people buy more

• Few emerging countries trade with each other


World Trade by Major Product Category asPercentage of Total World Trade for Selected Years

1980 1990 1998

100

80

60

40

20

0

Per

cent

age

53.9

27.7

14.7

3.7

70.7

14.2

12.3

2.8

62.8

7.9

8.6

20.7

Commercial services

Manufactured products

Mining products

Agricultural products


Country-Similarity Theory (cont.)Similarity of location

• Distances among countries accounts for many world trade relationships

• Methods to overcome distance disadvantages are difficult to maintain

Cultural similarity• Importers and exporters find it easier to do business in a

country perceived as being similar• Historic colonial relationships explain much of

international tradeSimilarity of political and economic interests

• Political relationships and economic agreements among countries may discourage or encourage trade between them or their companies

• Military conflicts disrupt trade patterns• Political animosity may interfere with trading channels


Degree of DependenceIndependence—complete economic independence

• Country has no reliance on other countries for goods, services, or technologies

• Price of independence is having to do without goods that cannot be produced domestically

• Hinders country’s ability to borrow and adapt existing technologies

Interdependence— trade based on mutual need• Neither trading partner is likely to cut off supplies or

markets for fear of retaliation• Governments may be pressured to sustain trade

Dependence—developing countries rely heavily on:• The sale of one commodity for export earnings

– 25 % of emerging countries sell one commodity• One country as supplier or customer• Industrialized countries


Strategic Trade PolicyGovernmental role and influence in affecting the acquired

advantage of production within their borders• Alter conditions for industries in general

– change conditions that affect factor proportions, efficiency, and innovation

• Target conditions for a specific industry– typically results in no more than small payoffs

» hard to identify and target appropriate industries» too many countries identify the same industry,

leading to excessive competition» relative conditions change, causing relative

capabilities to change as well– have been a few notable government successes in

targeting a specific industry


The Porter DiamondIndicates four important conditions for competitive superiority

• Demand conditions—observation of need or demand– usually in home country– production started near the observed market

• Factor conditions— availability and terms for acquiring them

• Related and supporting industries—existence of infrastructure

• Firm strategy, structure, and rivalry– influenced by other three conditions

Existence of the four favorable conditions does not guarantee that an industry will develop in a locale

Absence of one of the four conditions from a country may not inhibit companies from becoming globally competitive


Determinants of Global Competitive Advantage:The Porter Diamond

DemandConditions

FactorConditions

Related andSupportingIndustries

Firm Strategy,Structure, and

Rivalry


Companies’ Role in TradeMost trade theories based on a national perspective

• Decisions to trade are usually made by companiesStrategic advantages of exports

• Use of excess capacity—companies leverage their competencies by using them abroad

• Cost reduction– experience curve effect—cost reductions stemming

from increased output• Freater profitability—may have higher profit margins in

foreign markets• Risk spreading—counterbalance business cycles in

different countriesStrategic advantages of imports

• Procurement of supplies abroad may lower costs• Foreign products complement existing products• Reduces dependence on single suppliers

© 2001 prentice hall5-1 international business by daniels and radebaugh chapter 5 international...

Documents

trade patterns

trade surpluses

introduction trade

direction of trade

natural order of trade

foreign trade assumptions

prentice hall5

favorable trade balances