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INTERNATIONAL BUSINESS

Chapter 5 : International Trade :

5.1 Theories of International Trade

5.2 International Trading Environment

5.3 Cross-National Cooperation and Agreements

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5.1 Theories of International Trade :

Countries wrestle with the question of what, how

much and with whom their country should import and

export Various theories of international trade provide

insights about favorable location for exports as well as

potentially successful export products


CH. 5 : INTERNATIONAL TRADE


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In absence of government trade restrictions, given

products are exported from lower cost to higher cost

production locations. Therefore these theories also

help companies determine where to locate theirproduction facilities

Trade restrictions may diminish export capabilities

and cause companies to locate some production in the

restricting countries


5.1 : THEORIES OF INTERNATIONAL TRADE


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5.1 Theories of International Trade :

5.1.1 Interventionist theories

5.1.2 Free trade theories

5.1.3 Trade pattern theories

5.1.4 The statics and dynamics of trade




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5.1.1 Interventionist theories :

These theories prescribe government intervention in

international trade




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5.1.1 Interventionist theories (contd.) :

5.1.1.1 Mercantilism

5.1.1.2 Neo-mercantilism




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5.1.1.1 Mercantilism :

According to Mercantilism trade theory, a countrys

wealth is measured by its holding oftreasure, i.e.gold. This theory formed the foundation of economic

thought from about year 1500 to 1800

According to this theory, countries should export

more than they import and if successful, should

receive gold from countries that run deficit




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Mercantilism


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5.1.1.1 Mercantilism (contd.) :

Mercantilism flourished because of :

Government policies

The concept ofBalance of Trade




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Mercantilism flourished because of (contd.) :

Government policies :

To export more than they imported, governments

imposed restrictions on most imports and subsidisedproduction of products that could otherwise not

compete in domestic or export markets

European colonial powers used their colonial

possessions to support this trade objective. Colonies

supplied many commodities that the colonising

country might otherwise purchase from other country




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Government policies (contd.) :

Colonial powers sought to run trade surpluses with

their colonies as an additional way to obtain revenue

Colonial powers not only monopolised colonial tradebut also prevented the colonies from engaging in

manufacturing

The colonies had to export lass value added raw

materials and import more value added manufactured

products




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Mercantilism flourished because of (contd.) :

The concept ofBalance of Trade :

Balance of trade is the difference between export and

import of the country In the mercantilist period, the deficit in Balance of

trade was made-up by a transfer of gold. Today it is

made-up by holding the deficit countrys currency or

investments denominated in that currency. In effect,

the surplus country is granting credit to the deficit

country




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5.1.1.2 Neo-mercantilism :

Recently emerged term neo-mercantilism refers to the

approach of countries that try to achieve favorableBalance of trade in an attempt to achieve some social

or political objective

A country may try to achieve full employment by

setting economic policies that encourage its

companies to produce in excess of the demand at

home, to send the surplus abroad




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5.1.2 Free trade theories :

Why countries need to trade at all? Many countries,

following mercantilist policy did try to become as self-

sufficient as possible through local production ofgoods and services

Some countries take a more lenient approach,

because they believe that government programs lead

to inefficiency. Therefore they allow market forces to

determine trading relations between the countries




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5.1.2 Free trade theories (contd.) :

Free trade theories hold that the nations should

neither artificially limit imports nor promote exports.

Consumers would buy those products that best servetheir needs, thereby determining which producers

survive in the market

Free trade theories imply specialisation, i.e. nations

producing something for domestic consumption andexport, while using the export earning to buy import

products and services produced abroad




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5.1.2.1 Absolute advantage theory

5.1.2.2 Comparative advantage theory




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5.1.2.1 Absolute advantage theory :

In 1776Adam Smith questioned the mercantilists

assumptions and proposed that the real wealth of acountry consists of the goods and services available to

its citizens




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Adam

Smith


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5.1.2.1 Absolute advantage theory (contd.) :

The theory ofabsolute advantage developed by Smith

holds that different countries produce some goods

more efficiently than other countries. Thus globalefficiency can increase through free trade

Based on this theory,Adam Smith questioned why the

citizens of any country should have to buy

domestically produced goods, when they could buythose goods more cheaply from abroad




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Adam Smith reasoned that if trade were unrestricted,

each country would specialise in those products that

gave it a competitive advantage Each countrys resources would shift to the efficient

industries, because the country could not compete in

the inefficient ones




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Through specialisation, countries would increase their

efficiency, because of following reasons :

Labour could become more skilled by repeating thesame tasks

Labour would not loose time in switching from the

production of one kind of product to another

Long production runs would provide incentives for the

development of more effective working methods




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A country could then use its excess specialised

production to buy more imports than it could have

otherwise produced As perAdam Smith, marketplace would decide what

products a country should specialise

A countrys advantage would be either natural or

acquired




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Natural advantage :

A country may have a natural advantage in producing a

product because of : Climatic conditions

Access to certain natural resources

Availability of certain labour forces




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Natural advantage (contd.) :

The more the two countries climates differ, the more

likely they will favour trade with one another

Soil and topography are important determinants ofthe types of products a country can produce most

efficiently




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Natural advantage (contd.) :

Variations among countries in natural advantages also

help explain in what countries certain manufactured

or processed products might be best produced By processing an agricultural commodity or natural

resource prior to exporting, companies can reduce

transportation costs




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Acquired advantage :

Worlds trade today is more in services and

manufactured goods than in agricultural goods andnatural resources

Countries that produce manufactured goods and

services competitively have an acquired advantage,

usually in eitherproductorprocess technology




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Acquired advantage (contd.) :

An advantage ofproduct technologyenables a country

to produce a unique product or one that is easily

distinguished from those of competitors An advantage inprocess technologyis a countrys

ability to produce a homogeneous product (i.e. one

not easily distinguished from that of competitors)

more efficiently




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Acquired advantage (contd.) :

Acquired advantage through technology has created

new products, displaced old ones and altered trading

partner relationships Companies have developed new uses for old products

Products have been at least partially displaced by

substitutes

Technology can overcome natural disadvantages




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Demonstration ofAbsolute advantage theory :

Two countries, namely USA and Brazil produce two

commodities, namely wheat and coffee Cost of production is defined in terms of the resources

needed to produce either wheat or coffee




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Demonstration ofAbsolute advantage theory (contd.) :

Assumptions :

Brazil and USA are the only existing countries

Each has the same amount of resources to produceeither wheat or coffee, say 100 units

Brazil takes 4 units of resources to produce a ton of

coffee and 10 units per ton of wheat USA takes 20 units per ton of coffee and 5 units per

ton of wheat




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Brazil takes fewer resources to produce a ton, hence

its more efficient than USA in coffee production

USA is more efficient than Brazil in wheat production




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25

12.5

5

5 10 20

US production possibilities

Brazil production possibilities

Qty. of

Wheat(M.T.)

Qty. of

Coffee

(M.T.)

0

2.5


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If there is no foreign trade between the two countries

and if both the countries devote half of their

resources to producing coffee and wheat, then Brazilcan produce 12.5 tons of coffee and 5 tons of wheat

The USA can produce 2.5 tons of coffee and 10 tons of

wheat

Without trade, their combined production is 15 tons

of coffee and 15 tons of tons of wheat




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Specialisation increases the production of both the

commodities, from 15 to 25 tons of coffee and from

15 to 20 tons of wheat Thus by trading, global efficiency is optimised and the

two countries can have more of the two commodities,

than they would without trade




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5.1.2.2 Comparative advantage theory :

In 1817 David Ricardo examined the question what

happens when one country can produce all productsat an absolute advantage? and developed the theory

of comparative advantage




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5.1.2.2 Comparative advantage theory :

In 1817 David Ricardo examined the question what

happens when one country can produce all productsat an absolute advantage? and developed the theory

of comparative advantage




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5.1.2.2 Comparative advantage theory (contd.) :

The theory ofcomparative advantage says that the

global efficiency gains may still result from trade, if a

country specialises in those products that it canproduce more efficiently than other products,

regardless of whether other countries can produce

those same products even more efficiently



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A country gains, if it concentrates its resources on

producing the commodities it can produce most

efficiently. It then trades some of these commoditiesfor those commodities it has relinquished



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Demonstration ofComparative advantage theory :

Two countries, namely USA and Brazil produce two

commodities, namely wheat and coffee Cost of production is defined in terms of the resources

needed to produce either wheat or coffee




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Demonstration ofComparative advantage theory(contd.) :

Assumptions :

Brazil and USA are the only existing countries Each has the same amount of resources to produce

either wheat or coffee, say 100 units

Brazil takes 10 units of resources to produce a ton ofcoffee or wheat

USA takes 5 units of resources to produce a ton of

coffee and 4 units to produce a ton of wheatDecember 14, 2011 (c) Shantanu Jahagirdar (Mob.: 988 1313 325)



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USA is more efficient in producing both wheat and

coffee than Brazil. Thus USA has an absoluteadvantage in production of both the products




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10

6

5

5 10 12.5 2517.5 18.25

US production possibilities

Brazil production possibilities

Qty. of

Wheat(M.T.)

Qty. of

Coffee(M.T.)

0


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If there is no foreign trade between the two countries

and if both the countries devote half of theirresources to producing coffee and wheat, then Brazil

can produce 5 tons of coffee and 5 tons of wheat

The USA can produce 10 tons of coffee and 12.5 tons

of wheat

Without trade, their combined production is 15 tons

of coffee and 17.5 tons of tons of wheat




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Although USA has an absolute advantage in

production of both coffee and wheat, it has acomparative advantage only in production of wheat.

This is because its advantage in wheat production is

comparatively greater than its advantage in coffee

production




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By using the same amount of resources, USA can

produce 2.5 times as much wheat as Brazil, but onlytwice as much coffee

Through trading, the combined production of coffee

and wheat within the two countries can be increased

as follows




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If the combined production of wheat is unchanged

(from when there was no trade), USA could produceall 17.5 tons of what by using 70 units of resources .

The remaining 30 units of USAs resources could be

used for producing 6 tons of coffee

The combined wheat production has stayed at 17.5tons, but the coffee production has increased from 15

to 16 tons




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If the combined coffee production is unchanged from

the time before trade, Brazil could use all its resourcesto produce 10 tons of coffee. USA could produce the

remaining 5 tons of coffee by using 25 units of

resources . The remaining 75 units of USAs resources

could be used to produce 18.75 tons of wheat Without sacrificing any of the coffee available before

trade, wheat production has increased from 17.5 to

18.75 tonsDecember 14, 2011 (c) Shantanu Jahagirdar (Mob.: 988 1313 325)



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Assumptions and limitations ofFree trade theories :

Both absolute advantage theory and comparative

advantage theory are based on specialisation They hold that output will increase through

specialisation and that countries will be best off by

trading the output from their own specialisation for

the output from other countries specialisation




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Assumptions and limitations ofFree trade theories(contd.) :

Absolute advantage theory and comparative

advantage theory make assumptions, which may notbe always valid




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Full employment

Economic efficiency Division of gains

Two countries, two commodities

Transport costs Statics and dynamics

Services




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Production networks

Mobility




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Full employment :

Both the theories assume that the resources are fullyemployed

When countries have many unemployed or unused

resources, they may seek to restrict imports, to

employ or use the idle resources




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Economic efficiency :

Countries often pursue objectives other than outputefficiency

They may avoid over-specialisation because of the

vulnerability created by changes in technology and by

price fluctuations




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Division of gains :

Although specialisation brings potential benefits to allcountries that trade, how do countries divide

increased output? If both the countries receive some

share of the increased output, both will be better off

economically, through specialisation and trade




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Division of gains (contd.) :

However many governments are concerned with

absolute economic growth as well as relative to their

trading partners. If they perceive a trading partner isgaining too large a share of benefits, they may forgo

absolute gains for themselves so as to prevent relative

losses




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Two countries, two commodities :

For simplicity sake, both Smith and Ricardo assumed asimple world composed of only two countries and two

commodities

Although the simplification is unrealistic, it does not

diminish the usefulness of either theory




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Transport costs :

If it costs more to transport the goods than is savedthrough specialisation, the advantages of trade are

negated

As long as the diversion of resources reduces output

by less than what the two countries gain fromspecialisation, there are still gains from trade




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Statics and dynamics :

The two theories address countries advantages bylooking at them statically, i.e. at one point in time

However the relative conditions that give countries

advantages or disadvantages in the production of

given products are dynamic, i.e. constantly changing

It should not be assumed that the future advantages

will remain same as they are today




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Services :

The two theories deal with products rather thanservices. However increasing portion of world trade is

in services. Resources must go in into producing

services as well




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Production networks :

Both theories deal with trading one product foranother. However increasingly we see division of

work within a companys value chain network

Company's activities take place in those countries

where there is an absolute or comparative advantagefor their production




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Mobility :

The two theories assume that resources can movedomestically from the production of one good to

another, and at no cost. This assumption may not be

completely valid




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Mobility (contd.) :

The theories also assume that resources can not move

internationally, however they do. However resources

are more mobile domestically than they areinternationally

The movement of resources such as labour and capital

are clearly an alternative to trade




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5.1.3 Trade pattern theories :

Trade pattern theories deal with following issues :

How much a country will depend on trade if it follows

a free market policy? What type of products country will export and import?

With which partner countries will the country trade?



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5.1.3 Trade pattern theories (contd.) :

5.1.3.1 Theory of country size

5.1.3.2 Factors proportions theory

5.1.3.3 Country similarity theory

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5.1.3.1 Theory of country size :

The theory ofcountry size holds that large countries

usually depend less on trade than small countries Countries with large land areas are apt to have varied

climates and an assortment of natural resources,

making them more self-sufficient than smaller

countries



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5.1.3.1 Theory of country size (contd.) :

Transport cost in international trade affects large and

small countries differently. Normally the farther the

distance, the higher the transport cost Distance also creates indirect costs of tying up

inventory for longer period and of adding to the

uncertainty and unreliability of timely delivery

Among countries that border each other, the smallercountry tends to depend more on trade than the

larger country, because of transportation costs



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5.1.3.1 Theory of country size (contd.) :

Size of the economy :

Although land area is the most obvious way of

measuring a countrys size, countries can also becompared on the basis of economic size

Worlds top 10 exporters and importers are all

developed countries, except for China. These 10

countries account for over half the worlds exports

and imports



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Size of the economy (contd.) :

The top 10 exporters and importers of the world

produce so much that they have more to sell, both

domestically and internationally Also, because they produce so much, income are high

and people buy more from both domestic and foreign

sources

At the same time, there is little trade of developingcountries with other developing countries



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5.1.3.2 Factors proportions theory :

This theory helps us explain what types of products

result from natural and acquired advantages Eli Heckscherand Bertil Ohlin developedfactors

proportions theory, which is based on countries

production factors, namely land, labour and capital

(i.e. funds for investment in plant and equipment)



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5.1.3.2 Factors proportions theory (contd.) :

The theory says that the differences in countries;

endowments of labour, compared to their

endowments of land or capital explain differences inthe cost of production factors

For example, if labour was abundant in a country in

comparison to land and capital, then labour costs

would be low relative to land and capital costs



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The relative factor costs would lead countries to excel

in the production and export of products that used

their abundant (and hence cheaper) productionfactors



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People and land :

In countries where there are many people relative to

the amount of land, regardless of climate and soilcondition, they can not excel in production of goods

requiring large amounts of land



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Manufacturing locations :

In countries with limited land, the most successful

industries are those in which technology permits theuse of a minimum amount of land, relative to the

number of people employed



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Capital, labour rates and specialisation :

In countries where little capital is available for

investment and where the amount of investment perworker is low, companies find cheaper labour rates

and export competitiveness in products that require

large amounts of labour relative to capital



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Capital, labour rates and specialisation (contd.) :

Export from high income countries embody a higher

proportion of professionals (such as scientists and

engineers) than in low income economies exports.

Therefore these rich countries are using above

abundant production factors to maintain their lead in

exports

Exports of low income economies on the other handshows a high intensity of less skilled labour



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Capital, labour rates and specialisation (contd.) :

The variation in labour skills among countries has led

to more international specialisation by task to

produce a given product

A company may locate its R&D activities and

management functions primarily in countries with a

highly educated population and may locate its

production work in countries where less skilled andless expensive workers may be employed



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Process technology :

Factor proportions analysis becomes more

complicated when the same product can be producedby different methods, such as labour or capital. Thus

production technology helps explain where products

are made

Hence the optimum location of production dependson comparing the cost in each location based on the

type of production that minimises costs there



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Process technology (contd.) :

Large economies are more likely to produce goods

that use technologies requiring long production runs

because these countries develop industries to serve

their large domestic markets, which in turn tend to be

competitive in export markets

Companies however may locate long production runs

in small countries if they expect few barriers in othercountries to export if their products



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Process technology (contd.) :

In industries where long production runs are

important for gaining competitive advantages,

companies tend to locate their production in few

countries, using these locations as sources of exports

to other countries

Where long production runs are less important, a

greater prevalence of multiple production units isfound scattered around the world, so as to minimise

transportation cost involved in exporting



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Process technology (contd.) : Technologically intensive company from a small nation

may have a more compelling need to sell abroad than

would a company with a large domestic market



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5.1.3.2 Factors proportions theory (contd.) :Product technology :

Manufacturing depends on acquired advantage,

largely technology, which in turn depends on largenumber of highly educated people (like scientists,

engineers, etc.) and a large amount of capital to invest

in research and development

Developed countries have abundance of abovefeatures, hence they originate most new products and

account for most manufacturing output and trade



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Product technology (contd.) : Developing countries depend much more on

production of primary products and hence they

depend more on natural advantage



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5.1.3 Trade pattern theories (contd.) :5.1.3.3 Country similarity theory :

Most trade takes place among developed countries

Country similarity theorysays that once a companyhas developed a new product in response to observed

market conditions in its home market, it turns to

markets it sees as most similar to those at home



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5.1.3.3 Country similarity theory (contd.) :Specialisation and acquired advantage :

Markets in developed countries can support the

development and sale, both of new products andvariations of existing ones. Trade occurs because

countries specialise to gain acquired advantage, e.g.

by apportioning their research efforts more strongly

to some sectors than to others



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5 1 THEORIES OF INTERNATIONAL TRADE


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Specialisation and acquired advantage (contd.) : Developing countries also have gained advantages

through specialisation, whereby they concentrate

successfully on a very narrow product segments



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5.1.3.3 Country similarity theory (contd.) :Product differentiation :

Trade also occurs because companies differentiate

products, thus creating two way trade in similarproducts

Different companies from different countries develop

product variations that appeal to different consumers



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5.1.3.3 Country similarity theory (contd.) :The effect of cultural similarity :

Cultural similarity also helps explain much of the

direction of trade. Importers and exporters find iteasier to do business in a country they perceive as

being culturally similar to their home country, because

they speak a common language

Historic colonial relationships explain much of thetrade between specific high income and low income

economies



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The effect of cultural similarity (contd.) : Importers and exporters find it easier to continue

business ties than to develop new distribution

arrangements in countries where they are less

experienced



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5.1.3.3 Country similarity theory (contd.) :The effects of political relationships and economic

agreements :

Political relationships and economic agreementsamong countries may discourage or encourage trade

between them

Agreement among many European countries to

remove all trade barriers with each other has caused agreater share of the countries total trade to be

conducted within the group



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5.1.3.3 Country similarity theory (contd.) :The effects of distance :

Greater distances usually means higher transportation

costs Why does a country buy more from one country than

from another? The geographic distance between two

countries accounts for many of the world trade

relationships



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5.1.3.3 Country similarity theory (contd.) :Overcoming distance :

Transport cost is not the only factor in trade partner

choice Disadvantage in freight costs can be countered in a

limited manner. However these methods are difficult

to maintain



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5.1.4 The statics and dynamics of trade : These theories help explain how countries develop,

maintain and lose their competitive advantages



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5.1.4 The statics and dynamics of trade :5.1.4.1 Product Life Cycle (PLC) theory

5.1.4.2 The Porter diamond

5.1.4.3 Factor mobility theory



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The statics and dynamics of trade (contd.) :5.1.4.1 Product Life Cycle (PLC) theory :

The international product life cycle (PLC) theory of

trade states that the location of production of certainkinds of products shift as they go through four stages

of their life cycles, namely introduction, growth,

maturity and decline



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5.1.4.1 Product Life Cycle (PLC) theory (contd.) :Changes over the cycle :

Companies develop new products primarily because

there is an observed need and market for themnearby

Almost all new technology that results in new

products and production methods originates in

developed countries. They have most of the resourcesto develop new products and most of the income to

buy them



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5.1.4.1 Product Life Cycle (PLC) theory (contd.) :Introduction :

Once a company has created a new product, the early

production stage, called the introductory stagegenerally occurs in a domestic location, so the

company can obtain rapid market feedback as well as

save on transport costs

At this stage, export markets are small and mainly toother developed countries, because more customers

in these countries can afford the new products



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5.1.4.1 Product Life Cycle (PLC) theory (contd.) :Growth :

As sales grow, competitors enter the market

During the growth stage, demand may justifyproducing in some foreign countries (usually

developed ones) to reduce transport charges

At this stage, sales are likely to stay almost entirely in

the countries producing the product



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Growth (contd.) : The original producing country will increase its

exports in this stage, but loose certain key export

markets in which local production commences



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5.1.4.1 Product Life Cycle (PLC) theory (contd.) :Maturity :

In maturity stage, worldwide demand begins to level

off, although it may be growing in some countries anddeclining in others

There often is a shakeout of producers such that

product models become highly standardised, making

cost an important competitive weapon Longer production runs reduce per unit cost, thus

creating more demand in developing economiesDecember 14, 2011 (c) Shantanu Jahagirdar (Mob.: 988 1313 325)


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Maturity (contd.) : Because markets and technologies are widespread,

the innovating country no longer commands a

production advantage

Producers have incentives to shift production to

developing economies where they can employ less

skilled and less expensive labour efficiently for

standardised and capital intensive production Exports decrease from innovating country as foreign

production displaces it



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5.1.4.1 Product Life Cycle (PLC) theory (contd.) :Decline :

As product moves into the decline stage, those factors

occurring during the maturity stage continue toevolve. The market in developed countries decline

more rapidly than those in developing economies, as

affluent customers demand ever-newer products



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Decline (contd.) : Market and cost factors dictate that almost all

production is in developing economies, which export

to the declining or small niche markets in developed

countries

Thus the country in which the innovation first

emerged and exported from, then becomes importer



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5.1.4.1 Product Life Cycle (PLC) theory (contd.) :Verification and limitations of PLC theory :

The PLC theory holds that the location of production

facilities that serve world markets shifts as productsmove through their life cycle

However if transport costs are very high, then there is

little opportunity for export sales, regardless of the

stage in the life cycle



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Verification and limitations of PLC theory (contd.) :For following products, shifts in production location do

not usually take place. The innovating country may

maintain its export ability throughout the products

life cycle

Products with extremely short life cycle

Luxury products

A company using differentiation strategy for theproducts

Products that require specialised technical labourDecember 14, 2011 (c) Shantanu Jahagirdar (Mob.: 988 1313 325)


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Verification and limitations of PLC theory (contd.) :Products with extremely short life cycle :

Because of very rapid innovations, products that have

extremely short life cycle, makes it impossible toachieve cost reductions, by moving production from

one country to another



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Verification and limitations of PLC theory (contd.) :Luxury products :

For luxury products, cost is of little concern to the

customer. Production in a developing country maymake the product seem less luxurious than it really is



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Verification and limitations of PLC theory (contd.) :A company using differentiation strategy for the products

:

Through advertising, a company can usedifferentiation strategy for its products, to maintain

consumer demand, without competing on the basis of

price



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Verification and limitations of PLC theory (contd.) :Products that require specialised technical labour :

Some products require specialised technical labour to

evolve into next generation. Such products maintaintheir dominance in the world market, by continuing to

operate from developed countries



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Verification and limitations of PLC theory (contd.) : There is an increased tendency on the part of MNEs to

introduce new products at home and abroad almost

simultaneously, regardless of the product type

Instead of merely observing needs within their

domestic markets, companies develop products and

services for observable market segments that

transcend national borders. In doing so, theyeliminate delays as a product is diffused from one

country to another



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Verification and limitations of PLC theory (contd.) : They choose an initial production location that will

minimise costs for serving markets in multiple

countries. This production location may or may not

be in the innovating companys home market



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The statics and dynamics of trade (contd.) :5.1.4.2 The Porter diamond :

The Porter diamond theory shows following four

conditions as important for competitive superiority : Demand conditions

Factor conditions

Related and supporting industries

Firm strategy, structure and rivalry



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The Porter diamond



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Michael

Porter

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5.1.4.2 The Porter diamond (contd.) : The theory is useful for understanding how and where

globally competitive companies develop and sustain

themselves

Usually all four conditions need to be favourable for

an industry within a country to attain global

supremacy


5 O S O O

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5.1.4.2 The Porter diamond (contd.) :Demand conditions :

Both PLC theory and country similarity theory show

that the new products or industries usually arise from

companies observation of need or demand, which is

usually in their home country

Companies then start-up production near the observed

market


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5.1.4.2 The Porter diamond (contd.) :Factor conditions :

Natural advantage in most production factors such as

skilled labour, capital, technology (or equipment) need

to be available in a country on favourable terms


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5.1.4.2 The Porter diamond (contd.) :Related and supporting industries :

The existence of nearby related and supporting

industries need to be favourable


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5.1.4.2 The Porter diamond (contd.) :Firm strategy, structure and rivalry :

The combination of earlier three conditions influences

companies decisions to initiate production of a certain

product in a given country

The ability of the companies to develop and sustain a

competitive advantage requires favourable

circumstances for the fourth condition, namely thefirms strategy, structure and rivalry


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Firm strategy, structure and rivalry (contd.) : The ability of the companies to develop and sustain a

competitive advantage requires favourable

circumstances for the fourth condition, namely the

firms strategy, structure and rivalry

Rivalry becomes intense as companies try to serve

increasingly sophisticated consumers


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Firm strategy, structure and rivalry (contd.) : This forces breakthroughs in both product and process

technology, which gives producers advantage over

foreign producers and enable them to gain larger

global share of exports


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5.1.4.2 The Porter diamond (contd.) :Limitations of the Porter diamond theory :

The existence of the four favourable conditions does

not guarantee that an industry will develop in a given

location

The increased ability of companies to attain market

information, production factors and supplies from

abroad


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Limitations of the Porter diamond theory (contd.) :The absence of any of the four conditions from the

diamond domestically may not inhibit companies and

industries from becoming globally competitive

Observations of foreign or foreign plus domestic,

rather than just domestic demand conditions have

spurred much of the recent growth in Asian exports

Companies and countries are not dependent entirelyon domestic factor conditions, because capital and

managers are now internationally mobile


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Limitations of the Porter diamond theory (contd.) : If related and supporting industries are not available

locally, materials and components are now more easily

brought in from abroad, because of advancements in

transportation and the relaxation of import restrictions

Companies react not only to domestic rivals, but also

to foreign based rivals, they compete with at home

and abroad


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The statics and dynamics of trade (contd.) :5.1.4.3 Factor mobility theory :

Factor mobility means movement of capital,

technology and people across the border

Factor conditions in a country change in both quantity

and quality, therefore the relative capabilities of

countries also change. The change may come about

because of internal circumstances


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5.1.4.3 Factor mobility theory (contd.) :Thefactor mobilitytheory of trade patterns focuses on

the following reasons :

Why production factors move?

The effects of such movement on transforming factor

endowments

The effect of international factor mobility (especially

people) on world trade


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5.1.4.3 Factor mobility theory (contd.) :Why production factors move?:

Capital

People Economic motives

Political motives


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Why production factors move? (contd.) :Capital :

Capital, especially short-term capital, is the most

internationally mobile production factor

Companies and private investors primarily transfer

capital because of differences in expected return,

after accounting for risk

Political and economic conditions affect investorsperception of risk and where they prefer to put their

capitalDecember 14, 2011 (c) Shantanu Jahagirdar (Mob.: 988 1313 325)

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Why production factors move? (contd.) :People :

People are also internationally mobile, but less so

than capital

Unlike funds that can be cheaply transferred by wire,

people must usually incur high transportation costs, to

work in another country

If people move legally, they must get immigrationdocuments and most countries give them sparingly


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People (contd.) : Migrating people may have to learn another language

and adjust to different culture away from their

families and friends, who serve as their customary

support groups

Of the people who go abroad for work, some move

permanently and some move temporarily


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Why production factors move? (contd.) :Economic motives :

People, whether professionals or unskilled workers,

largely work in another country for economic reasons


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Why production factors move? (contd.) :Political motives :

People also move for political reasons, e.g. because of

persecution or war dangers, in which case they are

known as refugees. However once they are refugees,

they usually become part of the labour pool where

they live




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Political motives (contd.) : Sometimes it is difficult to distinguish between

economic and political motives for international

mobility, because poor economic conditions often

parallel poor political conditions




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5.1.4.3 Factor mobility theory (contd.) :Effects of factor movements :

Neither international capital nor population mobility

is a new occurrence

Many immigrants bring human capital with them,

thus adding to the base of skills that enables the

countries to be newly competitive in an array of

products they might otherwise have imported




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Effects of factor movements (contd.) : These countries receive foreign capital to develop

infrastructure and natural resources, which further

alters their competitive structures and international

trade




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5.1.4.3 Factor mobility theory (contd.) :What happens when people move?

People movements are substantial for many countries

and insignificant for other

The US is currently an example of a country whose

recent immigration is largely concentrated at he high

and low end of human skills

Although labour and capital are different productionfactors, they are intertwined




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What happens when people move? (contd.) : Countries lose potentially productive resources, when

educated people leave, a situation known as a brain

drain, but they may gain from the foreign earnings on

those factors



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Remittance flows todeveloping countries in

2007 (US $ mn.)
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What happens when people move? (contd.) : Countries receiving productive human resources also

incur cost of social services and for acculturating

people to a new language and culture




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What happens when people move? (contd.) : The unskilled workers who take jobs that native born

workers dont want, have children who eventually

enter the workforce. If these children are also

unskilled, the country is perpetuating a long-termclass ofhave-nots. If these children become skilled,

then there is a need to bring in even more unskilled

workers from abroad




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5.1.4.3 Factor mobility theory (contd.) :Relationship between trade and factor mobility :

Factor movement is an alternative to trade that may

or may not be a more efficient allocator of resources

Free trade, when coupled with freedom of factor

mobility internationally usually results in the most

efficient allocation of resources




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5.1.4.3 Factor mobility theory (contd.) :Substitution :

When the factors proportions vary widely among

countries, pressure exists for the most abundant

factors to move to countries with greater scarcity,

where they can command a better return

If finished goods and production factors were both

free to move internationally, the competitive cost oftransferring goods and factors would determine the

location of production




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Substitution (contd.) : As is true of trade, there are restrictions on factor

movement that make them only partially mobile

internationally




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5.1.4.3 Factor mobility theory (contd.) :Complementarity :

Factor movements may substitute or stimulate trade

When companies invest abroad, the investmentsoften stimulate exports from their home countries

About a third of world exports is among controlled

entities, such as from parent to subsidiary, subsidiary

to parent and subsidiary to subsidiary of the samecompany




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Complementarity (contd.) : Domestic operating units may export materials and

components to their foreign facilities, for use in a

finished product

A foreign facility may produce part of the product

line, while serving as sales agent for exports of its

parents complementary products

1st chapter int'l. bus. sibm

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