International
Trade and
Investment
Theory
1
OBJECTIVES
• Understand the motivation for international trade
• Summarize and discuss the differences among the
classical country-based theories of international
trade
• Use the modern firm-based theories of
international trade to describe global strategies
adopted by businesses
2
OBJECTIVES CONTINUED
• Describe and categorize the different forms
of international investment
• Explain the reasons for foreign direct
investment
• Summarize how supply, demand, and
political factors influence foreign direct
investment
3
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
4
Sources of the World’s Merchandise
Exports, 2001
37%
40%
European Union
United States
Japan
Canada
Other countries
4%
7%
12%
5
The largest
component of the
annual $1.5 trillion
trade in
international
services is
travel and tourism
6
Classical Country-Based Trade
Theories
•
•
•
•
•
Mercantilism
Absolute Advantage
Comparative Advantage
Comparative Advantage with Money
Relative Factor Endowments
7
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
8
Modern Mercantilism
• Neomercantilists or protectionists
– American Federation of Labor-Congress of
Industrial Organizations
– Textile manufacturers
– Steel companies
– Sugar growers
– Peanut farmers
9
Disadvantages of Mercantilism
• Confuses the acquisition of treasure with the
acquisition of wealth
• 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
10
Absolute Advantage
• 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
11
Table 6.1 The Theory of Absolute
Advantage: An Example
OUTPUT PER HOUR OF LABOR
Wine
2 France
1 Japan
Clock radios
3
5
12
Absolute Advantage’s Flaw
• What happens to trade if one country has
an absolute advantage in both products?
• No trade would occur
13
Comparative Advantage
• 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
14
Differences between Comparative
and Absolute Advantage
• Absolute versus relative productivity
differences
• Comparative advantage incorporates the
concept of opportunity cost
– Value of what is given up to get the good
15
The Theory of Comparative
Advantage: An Example
OUTPUT PER HOUR OF LABOR
France
Japan
Wine
4
1
Clock radios
6
5
16
Comparative Advantage with
Money
• One is better off specializing in what one
does relatively best
• Produce and export those goods and
services one is relatively best able to produce
• Buy other goods and services from people
who are better at producing them
17
The Theory of Comparative
Advantage with Money:
An Example
Cost of Goods in France
Cost of Goods in Japan
French Made Japanese Made French Made Japanese Made
Wine
€3
€8
¥375
¥1,000
Clock Radios
€3
€1.6
¥250
¥200
18
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
19
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
20
U.S. Imports and Exports, 1947:
The Leontief Paradox
21
Modern Firm-Based Trade
Theories
•
•
•
•
Country Similarity Theory
Product Life Cycle Theory
Global Strategic Rivalry Theory
Porter’s National Competitive Advantage
22
Growth of Firm-Based Theories
• Growing importance of MNCs
• Inability of the country-based theories to
explain and predict the existence and
growth of intraindustry trade
• Failure of Leontief and others to
empirically validate country-based
Heckscher-Ohlin Theory
23
Firm-Based Trade Theories
• Incorporate additional factors into explanations
of trade flows
–
–
–
–
Quality
Technology
Brand names
Customer quality
24
Country Similarity Theory
• 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
25
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
26
Product Life Cycle Theory
• Describes the evolution of marketing
strategies
• Stages
– New product
– Maturing product
– Standardized product
27
The International Product Life Cycle:
Innovating Firm’s Country
28
The International Product Life Cycle:
Other Industrialized Countries
29
Figure 6.4 The International Product Life
Cycle: Less Developed Countries
30
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
31
Sustaining Competitive
Advantage
•
•
•
•
Owning intellectual property rights
Investing in research and development
Achieving economies of scale or scope
Exploiting the experience curve
32
Porter’s National
Competitive Advantage
• Success in trade comes from the
interaction of four country and firm
specific elements
–
–
–
–
Factor conditions
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry
33
Porter’s Diamond of
National Competitive Advantage
Firm Strategy,
Structure,
and Rivalry
Factor
Conditions
Demand
Conditions
Related and
Supporting
Industries
34
The intense
competitiveness
of Japanese
market forces
manufacturers
to continually
develop and
fine-tune new
products
35
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
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
36
Types of International
Investments
• Does the investor seek an active
management role in the firm r merely a
return from a passive investment?
– Foreign Direct Investment
– Portfolio Investment
37
Stock of Foreign Direct
Investment, by recipient
38
Sources of FDI for the U.S.,
end of 2002
United Kingdom
283.3
France
170.6
Netherlands
154.8
Japan
152.
Germany
137.0
Switzerland
113.2
Canada
92.0
Luxembourg
34.3
Bermuda, Bahamas, Caribbean islands
32.5
Other European countries
All other countries
Total
113.3
65.0
1,348.0
39
Destinations of FDI for the U.S., end
of 2002
United Kingdom
255.4
Canada
152.5
Netherlands
145.5
Bermuda, Bahamas, Caribbean islands
98.1
Switzerland
70.1
Japan
65.7
Germany
64.7
Mexico
58.1
France
44.0
Other European countries
217.2
All other countries
349.7
Total
1,521.0
40
International Investment
Theories
• Ownership Advantages
• Internalization
• Dunning’s Eclectic Theory
41
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?
42
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
43
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
44
Factors Affecting
the FDI Decision
Supply Factors
Demand Factors
Political Factors
Production costs
Customer access
Avoidance of trade
barriers
Logistics
Marketing advantages
Economic development
incentives
Resource availability
Exploitation of
competitive advantages
Access to technology
Customer mobility
45
Ikea
aggressively
exports its
furniture to
other
countries
46