Chapter 6:
International
Trade and
Investment
Theory
International Business
Griffin & Pustay
6-1
Chapter Objectives
 Why should we study Trade Theories?
 Types of Trade Theories
 Overview of International Investment
 International Investment theory
 Factors influencing investments
6-2
International Trade
 Trade: voluntary exchange of goods, services,
assets, or money between one person or
organization and another.
 International trade: trade between residents of
two countries.
6-3
Significance of Trade Theories
 Governments use these theories when they design
policies they hope will benefit their industries and
citizens.
 Managers use them to identify the promising
markets and profitable internationalization
strategies.
6-4
Trade Theories
 Classical Country-Based Trade
Theories
 Modern Firm-Based Trade Theories
6-5
Classical Country-Based Trade
Theories
 Developed in sixteenth century, focused on the
individual country in examining pattern of export
and import.
 These theories are particularly useful for
describing trade in commodities , which are
standardized, undifferentiated goods, that are
typically bought on the basis of price rather than
brand name.
6-6
Contd.
Classical Country-Based Trade
Theories
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6-7
Mercantilism
Absolute Advantage
Comparative Advantage
Relative Factor Endowments
Contd.
Mercantilism
 A country’s wealth is measured by its holdings of
gold and silver
 A country’s goal should be to enlarge holdings of
gold and silver by
– Promoting exports
– Discouraging imports
6-8
Contd.
Disadvantages of Mercantilism
 Weakens the country because it robs individuals
of the ability
– To trade freely
– To benefit from voluntary exchanges
 Forces countries to produce products it would
otherwise not in order to minimize imports
6-9
Absolute Advantage
 Proposed by Adam Smith.
 Export those goods and services for which a
country is more productive than other countries
 Import those goods and services for which other
countries are more productive than it is
6-10
The Theory of Absolute Advantage: An
Example
OUTPUT PER HOUR OF LABOR
France
Japan
6-11
Wine
2
1
Clock
radios
3
5
Comparative Advantage
 Developed by David Ricardo in 1817.
 Produce and export those goods and services for
which it is relatively more productive than other
countries
 Import those goods and services for which other
countries are relatively more productive than it is
6-12
The Theory of Comparative Advantage:
An Example
OUTPUT PER HOUR OF LABOR
France
Japan
6-13
Wine
4
1
Clock
radios
6
5
Relative Factor Endowments
 Heckscher-Ohlin Theory
 What determines the products for which a
country will have a comparative advantage?
– Factor endowments vary among countries
– Goods differ according to the types of factors
that are used to produce them
6-14
Relative Factor Endowments
 A country will have a comparative advantage in
producing products that intensively use resources
(factors of production) it has in abundance
– China: labor
– Saudi Arabia: oil
– Argentina: wheat
6-15
Modern Firm-Based Trade Theories
 Firm based were developed after World War II
and are used to describe trade patterns of
differentiated goods, for which brand name is an
important component of the customer’s purchase
decision.
6-16
Modern Firm-Based Trade Theories
 Country Similarity Theory
 Product Life Cycle Theory
 Global Strategic Rivalry Theory
 Porter’s National Competitive
Advantage
6-17
Country Similarity Theory
 Country similarity theory is particularly useful in
explaining trade in differentiated goods for which
brand names and product reputation play an
important role in consumer decision making.
 Explains the phenomenon of intraindustry trade
– Trade between two countries of goods produced by the
same industry
• Japan exports Toyotas to Germany
• Germany exports BMWs to Japan
6-18
Country Similarity Theory
 Trade results from similarities of preferences among
consumers in countries that are at the same stage of
economic development
 Most trade in manufactured goods should be between
countries with similar per capita incomes.
 Firms initially manufacture goods to satisfy the domestic
market. As they explore exporting opportunities, they
discover that the most promising foreign markets are in
countries where consumer preferences resembles to their
own domestic market.
6-19
Product Life Cycle Theory
 Product life cycle theory, which originated in the
marketing field to describe the evolution of
marketing strategies as a product matures.
 This theory states that location of production of
certain kinds of products shifts as they go through
their stages of life cycle, which consists of– New product
– Maturing product
– Standardized product
6-20
Product Life Cycle Theory
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6-21
New Product Stage:
Innovation in response to observed needs in the domestic
market.
Limited export by the innovating country.
Maturing Product stage:
Demand for the product expands dramatically as
consumers recognize its value.
So, increase in production to satisfy both domestic and
foreign market.
Domestic and foreign competition begins to emerge.
Product Life Cycle Theory
Standardized Product Stage:
 The market for the product stabilizes.
 Firms are pressured to lower their manufacturing
costs as much as possible by shifting to countries
where labour costs are lower.
 Product begins to be imported in the innovative
country.
6-22
Global Strategic Rivalry Theory
 Firms struggle to develop sustainable competitive
advantage
 Advantage provides ability to dominate global
marketplace
 Focus: strategic decisions firms use to compete
internationally
6-23
Global Strategic Rivalry Theory
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6-24
Owning intellectual property rights
Investing in research and development
Achieving economies of scale or scope
Exploiting the experience curve
Porter’s National
Competitive Advantage
 Success in trade comes from the interaction of
four country and firm specific elements
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–
–
–
6-25
Factor conditions
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry
Porter’s Diamond of
National Competitive Advantage
Firm Strategy,
Structure,
and Rivalry
Factor
Conditions
Demand
Conditions
Related and
Supporting
Industries
6-26
Theories of
International Trade
Country-Based Theories
 Country is unit of analysis
 Emerged prior to WWII
 Developed by economists
 Explain interindustry trade
 Include
– Mercantilism
– Absolute advantage
– Comparative advantage
– Relative factor endowments
6-27
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
International Investment Theories
 Ownership Advantages
 Internalization
 Dunning’s Eclectic Theory
6-28
Ownership Advantages
 A firm owning a valuable asset that
creates a competitive advantage
domestically can use that advantage to
penetrate foreign markets through FDI
 Why FDI and not other methods?
6-29
Internalization Theory
 FDI is more likely to occur when
transaction costs with a second firm are
high
 Transaction costs: costs associated
with negotiating, monitoring, and
enforcing a contract
6-30
Dunning’s Eclectic Theory
 FDI reflects both international business
activity and business activity internal
to the firm
 3 conditions for FDI
– Ownership advantage
– Location advantage
– Internalization advantage
6-31