TOPIC 3: INTERNATIONAL TRADE AND INVESTMENT THEORY Prepared By : Miss Noorsyalina Nordin INTERNATIONAL BUSINESS BUS 3233
TOPIC OUTLINE: After studying this topic, student should be able to : 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 business Describe and categorize the different form of international investment Summarize how supply, demand and political factor influence foreign direct investment
3.1 International Trade And The World Economy Trade Definition :voluntary exchange of goods, services, assets, or money between one person or organization and another International trade Definition: trade between residents of two countries
3.2 Classical Country and Modern Firm-Based Trade Theories Mercantilism Absolute Advantage Comparative Advantage Comparative Advantage with Money Relative Factor Endowments
3.2.1 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 Neomercantilists or protectionists American Federation of LaborCongress of Industrial Organizations Textile manufacturers Steel companies Sugar growers Peanut farmers
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
3.2.2 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 Table 3.2.2 The Theory of Absolute Advantage: An Example Absolute Advantage’s Flaw What happens to trade if one country has an absolute advantage in both products? No trade would occur
ABSOLUTE ADVANTAGE (EXPLANATION) In France 1 hour of labor can produce either 2 bottles of wine or 3 clock radios. In Japan, 1 hour of labor can produce either 1 bottle of wine or 5 clock radio France has absolute advantage in the production of wine 1 hour of labor produces 2 bottles in France but only 1 in Japan Japan has absolute advantage in the production of clock radio If Japan and France are able to trade with each other, both will be better off
3.2.3 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 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
3.2.3 Comparative Advantage EXPLANATION Table 3.2.3 (a)The Theory of Comparative Advantage: An Example Based absolute advantage no trade will occur In comparative advantage, trade still can be make among the country Actually, France is 4 times ( 4÷1) better than Japan in wine production Only 1.2 times (6÷5) better in clock production In this theory : France should export wine to Japan Japan should export clock radio to France 1 bottle of wine will sell for 1.5 (6÷4) clock radio in France and 5 clock radio (5÷1) in Japan Let say, Japan trade 2 clock radio = 1 bottle of wine France can get 2 clock radio if sell 1 bottle of wine but if without trade they just only get 1.5 clock radio in increased production In Japan, only sell 2 clock radio to get 1 bottle of wine, but if without trade Japan must to give up 5 clock radios to get 1 more bottle of wine
COMPARATIVE ADVANTAGE WITH MONEY (EXPLANATION) Wine = Japanese made =€8 (¥1,000) Clock Radios = Japanese made=€1.6 (¥200) 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 Table 3.2.4The Theory of Comparative Advantage with Money: An Example
COMPARATIVE ADVANTAGE WITH MONEY (EXPLANATION) Wine = Japanese made =€8 (¥1,000) Clock Radios = Japanese made =€1.6 (¥200) Let say in France, the buyer want to buy clock radio if France made =€2 however Japanese made= € 1.6 So, they should buy from Japan because it cheaper than France made Let say in Japan, the buyer want to buy wine, the cost if in Japan, they have to pay= ¥1,000 however France made =¥375 So, better Japanese buy from French Table 3.2.4The Theory of Comparative Advantage with Money: An Example
3.2.5 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 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
Modern Firm-Based Trade Theories Country Similarity Theory Product Life Cycle Theory Global Strategic Rivalry Theory Porter’s National Competitive Advantage
Growth of Firm-Based Theories Growing importance of MNCs Inability of the countrybased 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 Firm-Based Trade Theories Incorporate additional factors into explanations of trade flows Quality Technology Brand names Customer quality
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 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
Product Life Cycle Theory Describes the evolution of marketing strategies Stages New product Maturing product Standardized product Figure 1: The International Product Life Cycle: Innovating Firm’s Country
Product Life Cycle Theory (cont..) Figure 2 :The International Product Life Cycle: Other Industrialized Countries Figure 3 The International Product Life Cycle: Less Developed Countries
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 Sustaining Competitive Advantage 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 Factor conditions Demand conditions Related and supporting industries Firm strategy, structure, and rivalry Figure 6.5 Porter’s Diamond of National Competitive Advantage The intense competitiveness of Japanese market forces manufacturers to continually develop and fine-tune new products
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
3.3 Types of International Investments Does the investor seek an active management role in the firm are merely a return from a passive investment? Foreign Direct Investment Portfolio Investment International Investment Theories Ownership Advantages Internalization Dunning’s Eclectic Theory
International Investment Theories 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? 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
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 Table 6.5 Factors Affecting the FDI Decision Ikea aggressively exports its furniture to other countries