07/05/2014
INTERNATIONAL BUSINESS
ENVIRONMENT
Topic 2
International
Trade Theories
WHY STUDY INTERNATIONAL TRADE THEORIES?
Common knowledge base for
Academics – Managers – Policy-makers
Helps understand business
internationalisation drivers
Legitimates the role of
business in society and policymakers' decisions
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(why – where – how)
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KEY INTERNATIONAL TRADE THEORIES
(Neo-) Mercantilism
Modern (firm-based)
theories
Vernon's product life-cycle
New trade theory
Country similarity, Country size,
gravity model
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Traditional (countrybased) theories
Absolute advantage
Comparative advantage
Factor proportion
Eclectic theories
National competitiveness
diamond
Internalisation theory
Eclectic (OLI) paradigm
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MERCANTILISM
 Original XVII th century mercantilists, such as
John Law, a Scots financier, believed that a
country's economic prosperity and political
power came from its stocks of precious metals.
 To maximise these stocks they argued against
free trade, favouring protectionist policies
designed to minimise imports and maximise
exports, creating a trade surplus that could be
used to acquire more precious metal
http: / / w w w. e c o no m i s t. c o m/ re s e a rc h/ Ec o no m ic s /a l p ha be t ic . c f m? le tte r
= M # me rc a nt i lis m
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VARIOUS FORMS OF MERCANTILISM
Commercialism
(export
promotion)
Colbertism
(import
substitution)
Bullionism
(gold
accumulation)
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MERCANTILISM TODAY
Neo-mercantilism is a term used to describe a policy regime which
encourages exports, discourages imports, controls capital movement
and centralises currency decisions in the hands of a central government
The objectives of neo-mercantilist policies are to:
(1) Increase the level of foreign currency deposits and bonds held by
central banks and monetary authorities (foreign exchange reserves)
(2) Support growth in GDP and employment at home.
Adapted from: http://www.project-syndicate.org/print/mercantilism-reconsidered
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ECONOMICS OF NEO-MERCANTILISM
National income accounts
Balance of payments
Y = C + I + G + EX – IM
Current account + (financial
account) = 0
A country running a trade surplus
earns more income from exports
than it spends on imports
A country running a trade surplus is
a creditor to the world and can
increase its reserve assets
Net foreign wealth is increasing
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AN ASIAN MODEL?
The growth champions of the past few decades – Japan in the 1950s
and 1960s, South Korea from the 1960s to the 1980s, and China
since the early 1980s – have all had activist governments
collaborating closely with large business. All aggressively promoted
investment and exports while discouraging (or remaining agnostic
about) imports.
China's pursuit of a high-saving, large-trade-surplus economy in
recent years embodies mercantilist teachings.
http://www.europeanceo.com/news/commentaries//article672.html
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THE CHINESE CASE
2011,
Md USD
PPP
Y
C
I
G
X
M
CHN 11300 3902 5490 1484 3230 2938
USA 14991 10729 2236 2594 2094 2662
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X-M
C/Y
I/Y
G/Y
X+M/2Y
CHN
292
0,35
0,49
0,13
0,27
USA
-568
0,72
0,15
0,17
0,16
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GOVERNMENT-BUSINESS ISSUES
Business organisations must take into account
governments' involvement in supporting exports and
limiting imports
Macroenomic policies
Microeconomic policies
Fiscal – Monetary policies
Foreign exchange policy
Industrial policy – Education and
infrastructure – Public procurement –
Market regulation
Trade policy
Export promotion – Import restriction
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FOOD FOR THOUGHT …
"Hymns to export are only stupidity and lies.
They assume not to be aware of the futility of any distinction
between domestic and international trade."
Jacques Rueff, L'Ordre Social, 1981
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MERCANTILISM DEFICIENCIES
Promotes exports and savings at the expense of domestic demand /
living standards
Renders the domestic economy dependent on trade partners' business
cycle
"Beggar-thy-neighbour" strategy …
Carried-out at the expense of trade partners, likely to turn into
trade war
Generating imbalances between creditors and debtors, likely to
result in economic crisis
Leading to global depression if applied by all players
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MERCANTILISM DEFICIENCIES
(RE MINDE R)
Y=C+I+G+X–M
→ X – M = Y – (C + G + I)
→ X – M = (Y – (C + G)) – I
X–M=S–I
X>M ↔ S>I
C: Household consumption
I: Business investment
S: Savings
T: taxes
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G: Government spending
EX: Exports
IM: Imports
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ASSIGNMENT – GERMANY
Germany is sometimes called a mercantilist country (see below).
Please explain and discuss.
The text argues that Germany's trade surplus is a problem for the
Eurozone ... and Germany itself. Please explain and discuss.
"Euro membership has encouraged Germany into a costly mercantilist strategy
at the expense of its people and the productivity of the economy".
Martin Wolf, Financial Times
http://www.ft.com/intl/cms/s/0/1e2f2cd0-064e-11e2-bd29-00144feabdc0.html#axzz2znVp8kP7
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FOOD FOR THOUGHT …
"An international economics course should drive home to
students the point that international trade is not about
competition, it is about mutually beneficial exchange.
Even more fundamentally, we should be able to teach
students that imports, not exports, are the purpose of
trade. That is, what a country gains from trade is the
ability to import what it wants.
Exports are not an objective in and of themselves: the
need to export is a burden that the country must bear
because its import suppliers are crass enough to
demand payment".
Paul KRUGMAN, Pop Internationalism
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ABSOLUTE / COMPARATIVE ADVANTAGE
Absolute advantage refers
to the ability of a person or
a country to produce a
particular good at a lower
absolute cost than another.
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Comparative advantage
refers to the ability of a
country to produce a
particular good at a lower
marginal or opportunity
cost than another country.
The net benefits of such an
outcome are called gains
from trade.
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ABSOLUTE / COMPARATIVE ADVANTAGE
(CW HILL)
❶
❷
(+2.5)
200 units of resources available per country
Absolute advantage
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(+1.25)
Comparative advantage
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COMPARATIVE ADVANTAGE: GRAPH
Cocoa
15
❷
❶
10
❶
2,5
South Korea
❷
3,75
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5
7,5
10
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Ghana
Rice
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THE FACTOR PROPORTION THEORY
For Eli Heckscher and Bertil Ohlin, comparative advantage
arises from differences in relative national factor
endowments – the extent to which a country is endowed with
resources like labour and capital
The Heckscher-Ohlin-Samuelson (H-O-S) model predicts that
countries will export goods that make intensive use of those
factors that are locally abundant, while importing goods that
make intensive use of factors that are locally scarce
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COMPARING FACTOR ENDOWMENTS
US
Mexico
Labour
300 units
120 units
Capital
100 units
20 units
The US is the relatively capital abundant country
Mexican capital-labor ratio: KMex / LMex is 20/120 or 1/6
U.S. capital-labor ratio: KUS / LUS is 100/300 or 1/3
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LEONTIEF'S PARADOX
An analysis carried-out in 1947 concluded that the US exported labourintensive commodities and imported capital-intensive commodities
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GOVERNMENT / BUSINESS ISSUES
Governments should promote free trade to let
the domestic economy gain from its
comparative advantages
DIFFERENT COUNTRIES HAVE ADVANTAGES IN
DIFFERENT PRODUCTIVE ACTIVITIES
Firms that fail to do this, may be at a
competitive disadvantage
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Firms should disperse their various
productive activities across countries
taking these advantages into account
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QUESTIONING TRADITIONAL THEORIES
Assumes mobility of production factors within each
country and no mobility between countries (no FDI)
Static model, does not explain changes in comparative
advantage or long-term effect of specialisation
Does not explain intra-industry trade or trade between
similar countries
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THE PRODUCT LIFE-CYCLE THEORY
According to Raymond Vernon's
product life-cycle theory, both the
location of sales and the optimal
production location will change as
products mature, affecting the flow
and direction of trade, as well as
foreign direct investment


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THE NEW TRADE THEORY
…
Tries to explain why trade is growing fastest
between industrial countries


…
With similar economies and endowments of
the factors of production
Trading similar goods (intra-industry trade)
Considers



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(P. KRUGMAN )
Markets of imperfect competition (oligopolies)
Movement of capital (foreign direct
investment)
Business and government strategies (session 3)
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ECONOMIES OF SCALE …
… Are the reduction in average production costs arising from a larger
output
Fixed costs are
spread over a large
output
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Production facilities
are used more
intensively
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Bargaining power
with suppliers is
increased
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THE CASE OF TRANSPORT
The first wave of globalization in the 19th century increased trade based
on comparative advantage. Countries exchanged what they could not
produce themselves. So Europe traded machinery for Central American
bananas, or for South Asian spices.
th
But in the 20 century, transportation costs fell so much that even trade
in similar goods or in parts and components made economic sense.
But these costs have not fallen equally everywhere. Economies of scale in
transportation, such as giant container ships plying the seas on lucrative
routes between Northeast Asia and North America, imply that lower costs
will increase trade, which will further lower costs.
http://www.imf.org/external/pubs/ft/fandd/2008/12/deichmann.htm
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IMPERFECT COMPETITION MARKETS
CAPITAL INTENSIVE INDUSTRIES
Research & Development
Marketing
Firm 1

Sunk costs / Economies of scale
Economies of learning
A
Lower prices
Technological leadership
Access to resources
Consumer's switching cost
1st mover advantage
 Barriers to entry
OLIGOPOLISTIC MARKETS
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
Firm 2
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BUSINESS INTERNATIONALISATION
Capital intensive industries
Oligopolistic markets
Product
differentiation
INTERNATIONALISATION
Strategic trade
policies
Economies of scale
Economies of learning
First-mover advantage
 Global dominant position
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THE EXAMPLE OF SOFTWARE
Software development is characterized by substantial economies of
scale. The fixed costs of producing software, including applications, is
very high. By contrast, marginal costs are very low.
Moreover, the costs of developing software are "sunk" -- once
expended to develop software, resources so devoted cannot be used
for another purpose.
The result of economies of scale and sunk costs is that application
developers seek to sell as many copies of their applications as
possible. […]
The [negative] experiences of IBM and Apple, Microsoft's most
significant operating system rivals in the mid- and late 1990s, confirm
the strength of [such a] barrier to entry.
http://www.albion.com/microsoft/findings-8.html
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GOVERNMENT/BUSINESS ISSUES
Governments should enforce strategic trade
policies to help domestic firms achieve first
mover advantages.
In capital intensive industries that can only support a few
competitors, firms that establish a first-mover advantage may
dominate global trade
Firms will try to match each others’
moves as a way of keeping each other
in check (multipoint competition)
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What one firm does has an immediate
effect on its competitors, forcing them
to take similar actions (herd / mimetic
behavior)
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GAINS FROM TRADE
Country 1
Country 2
A
B
A
B
C
D
C
D
A
B
A
B
C
D
C
D
Country 3
Country 4
Country 1
Country 2
A
B
C
D
Country 3
Country 4
With trade:
Static gains: lower prices due to tariff cuts
Dynamic gains: lower prices due to economies
of scale, competitive pressure and specialization
 Innovation, broader range of products
Homogeneous standards
http://www.codart.nl/news/439/
Without trade:
Small and monopolistic domestic markets
No economies of scale
 Limited range of products, high prices
Different national standards
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STATIC GAINS FROM TRADE
P
S
E*
P*
Domestic
price
s1
P1
d1
World
price
Trade creation (imports)
qs
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D
q*
Q
qd
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NEW TRADE vs. COUNTRY SIZE THEORY
The size of the domestic market influences global competitive
advantage
Larger countries are more self-sufficient and therefore less
dependent on international trade than smaller ones
2011
Ireland
Belgium
Netherlands
France
Germany
Japan
China
United States
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GDP
189
427
714
2,306
3,308
4,385
11,300
14,991
X
199
360
593
622
1,711
668
3,230
2,094
M
158
355
528
687
1,521
708
2,938
2,662
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(X+M) / (2*GDP)
0.94
0.84
0.79
0.28
0.49
0.16
0.27
0.16
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EXAMPLES OF OPENNESS RATIOS
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THE NATIONAL COMPETITIVENESS FRAMEWORK
M. Porter's thesis is that national competitive advantage is not dependent on
factor endowment alone, but on various (country- and industry-based)
factors that interact with each other to create conditions where innovation
and improved competitiveness occurs
Firms' competitive
advantages
National comparative
advantages
National
competitive
advantages
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THE COMPETITIVENESS DIAMOND
Firm strategy,
structure and
rivalry
Gov't
policies
National
competitive
advantage
Factor
endowments
Demand
conditions
Chance
Related and
supporting
industries
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FACTOR ENDOWMENTS
BASIC FACTORS
ADVANCED FACTORS
Labour
Skilled labour
Capital
Infrastructure
Location, climate
Technological know-how
Land and natural resources
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DEMAND CONDITIONS
Demand conditions refer to the nature of home-market demand for
specific products and services.
The strength and sophistication of demand pressures firms to
innovate more quickly and produce better products.
Japan is a densely populated, hot,
and humid country with very
demanding consumers. These
conditions led Japan to become
one of the leading producers of
superior, compact air conditioners.
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STRATEGIC RIVALRY
The presence of strong competitors in a nation helps create and
maintain national competitive advantage, putting firms under
constant pressure to innovate
Japan has the world’s most competitive consumer
electronics industry, with major players like
Nintendo, NEC, Sharp, and Sony producing
semiconductors, computers, video games, and liquid
crystal displays.
Vigorous competitive rivalry puts these firms under
continual pressure to innovate and improve.
See: http://www.techaction.org/the-japans-consumer-electronics-industry
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RELATED AND SUPPORTING INDUSTRIES
It refers to the presence of clusters of suppliers, competitors, and
complementary firms that excel in particular industries.
↓
The resulting business environment is highly supportive for the
founding of particular types of firms.
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THE ROLE OF GOVERNMENTS
Governments should promote the development of a national
competitive advantage through proactive national industrial policy
Investment in
education
Stable businessfriendly legal
system
Investment in
infrastructure
Tax incentives
Support to
development
of high valueadding
industries
Low interest
loans
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TRADE vs. FOREIGN DIRECT INVESTMENT
H-O-S model
New trade theory
Foreign direct investment
(export of capital) will
prevail over exports in case
of …
High transportation
costs
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Actual or threatened
trade barriers
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TRADE vs. FOREIGN DIRECT INVESTMENT
(CTD)
Eclectic theories
International trade and
foreign direct investment
are combined
Market seeking
Resource seeking
Natural resources, workforce,
technology, brand
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CASE STUDY – LOGITECH
1. What particular limitations of international trade
theories does Logitech's case highlight?
2. How can international trade theories nonetheless be
used to explain Logitech's internationalization and the
configuration of its international operations?
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THE INTERNATIONAL VALUE CHAIN/NETWORK
The value chain describes the categories of activities within an organisation which, together,
create a product or service.
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THE INTERNATIONAL VALUE CHAIN/NETWORK
(CTD)
The value network is the set of inter-organisational links and relationships that are necessary to create a
product or service.
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THE INTERNATIONAL VALUE CHAIN/NETWORK
51
(CTD)
International firms will exploit specific advantages
in various locations in order to optimise their value
chain / network
Global sourcing
Purchasing components and services
from the most appropriate suppliers
around the world
Foreign direct investment
Investing directly in new facilities to
produce and/or market in a foreign
country
The firm's ability to coordinate activities in different locations is a distinctive capability that
will contribute to its global competitiveness
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EXAMPLE: DELL'S INTERNATIONAL VALUE CHAIN
http://www.youtube.com/watch?v=owQzo82ac_M
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