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Theories of InternationalTheories of InternationalTrade and InvestmentTrade and Investment
International Businessby Ball, McCulloch, Frantz,
Geringer, and Minor McGraw-Hill/Irwin Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.
This chapter covers:
•Why goods are traded internationally
•Arguments for imposing trade restrictions
•Kings of import restrictions
•Weakness of GNP/capita as economic indicator
•Characteristics of developing nations
•Theories of foreign direct investment
Chapter ObjectivesChapter Objectives
Understand the theories of international trade.Comprehend the arguments of imposing trade
restrictions. Explain the two basic kinds of import restrictions.Appreciate the relevance of the changing status of tariff
and non tariff barriers.Recognize the weaknesses of GNP/capita as an economic
indicator.Understand the new definition of economic development.Understand why governments change from import
substitution to export promotion. Explain some of the theories of foreign direct
investment.
3-2
International Trade TheoryInternational Trade Theory
Mercantilism Believed nation’s
welfare was in accumulation of stock of precious metals.
Trade surplus created by import restrictions and government subsidies to exporters.
Mercantilist era ended in 1700s.
3-3
Modern Day MercantilismModern Day Mercantilism
Economic Nationalism Industrial policy based on state intervention France nationalized key industries and banks
to use the power of the state as Stockholder and financier Customer and marketer to revitalize the
nation’s base In 1986, little growth and high unemployment
led government to reverse “mercantilist” policy Japan called “fortress of mercantilism” by
some Nearly impenetrable market Effort to maintain a cheap yen
3-4
Theory of Absolute AdvantageTheory of Absolute Advantage
“The capacity of one nation to produce more of a good with the same amount of input than another country.”
Adam Smith claimed that market forces, not government controls should determine the direction, volume, and composition of international trade.
Each nation should specialize in producing goods it could produce most efficiently
In absolute advantage, both nations would gain from trade.
Assumptions Perfect competition and no transportation costs in a
world of two countries and two products.3-5
Theory of Comparative AdvantageTheory of Comparative Advantage
“A nation having absolute disadvantages in the production of two goods compared to another nation, has a comparative
advantage in producing the good in which its absolute disadvantage is less.”
Theory of comparative advantage demonstrated by Ricardo in 1817.
3-6
Production Possibility FrontiersProduction Possibility Frontiers
The following two graphs illustrate Chinese and U.S. production possibility frontiers using constant cost for simplicity.
These curves, in the absence of trade, also illustrate the possible combinations of goods for consumption.
3-7
Offshoring Service Jobs to IndiaOffshoring Service Jobs to India
Approximately 1 Billion people Comparative advantage in production of goods
or services that require large amounts of labor Citizens speak English Low labor costs due to large workforce Internet and telephone communications much
less expensive Industries offshoring include software
engineering, telemarketing, banking, medical services, claims processing, IT jobs, financial services, insurance
Jobs created overseas generate jobs at home3-8
Heckscher-Ohlin Theory of Factor Heckscher-Ohlin Theory of Factor EndowmentEndowment
States that international and interregional differences in production costs occur because of differences in the supply of production factors. Therefore,
India should export labor intensive goods.
Germany, with relatively more capital than labor should specialize in capital intensive products.
3-9
Assumptions The price of factors
depend only on the factor endowment. Not a perfect market Legislated wages and
benefits Tax credits
Given technology is universally available. Always a lag between
intro of new technology and world application
Leontief ParadoxLeontief Paradox
Study in 1953 by economist Wassily Leontief disputed the usefulness of the Heckscher-Ohlin Theory as a predictor of the direction of trade.
Found that the U.S., one of the most capital-intensive countries in the world, was exporting labor intensive products.
3-10
Effect of Money on TradeEffect of Money on Trade
Exchange Rate The price of one country’s currency stated
in terms of the other. Influence of Exchange Rates
European companies pressured to incraese prices of exports to maintain Euro profits
Currency devaluation Lowering of a country’s currency in terms of
other currencies. Example is tourism and currency rates in
Mexico during 1980s
Newer Explanations of the Direction of Newer Explanations of the Direction of TradeTrade
Economies of Scale and the Experience Curve
As output increases cost per unit decreases
Larger and more efficient equipment
Volume discounts
Fixed cost allocation
Drop in learning curve
3-12
First Mover Theory Gain market share Discourage foreign
entrants
The Linder Theory of Overlapping Demand Customers’ tastes
determined by income levels
Trade greater between nations with similar per capital incomes
International Product Life Cycle (IPLC)International Product Life Cycle (IPLC)
Four stages of the IPLC in the U.S.1) U.S. exports2) Foreign production begins3) Foreign competition in export markets4) Import competition in the U.S3-13
Stages of the International Product Life Stages of the International Product Life CycleCycle
Exports May be only
manufacturer of new product
Overseas customers learn of product, export market develops
Foreign production Export volume grows Production technology
becomes stable Reduced costs for
transportation Exports diminish
3-14
Foreign competition Foreign
manufacturers gain experience
Compete in export markets
Import competition Foreign producers
obtain economies of scale
Compete in quality and undersell domestic company in domestic market
International Technology Life CycleInternational Technology Life Cycle
Initial Stage Development of new technology in an
industrialized country Subsequently exported to other developed
countries Increasing cost of labor make it no longer
profitable to use in developed nation Technology exported to developing nation Technology produced abroad for domestic
consumption
3-15
Porter’s Competitive Advantage of Porter’s Competitive Advantage of NationsNations
Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage. Demand conditions Factor conditions Related and
supporting industries Firm strategy,
structure, rivalry3-16
Porter’s Competitive Advantage of Porter’s Competitive Advantage of NationsNations
Demand Conditions Nature of domestic
demand. If customers are
demanding, firms will produce high-quality and innovative products gaining competitive advantage
Factor Conditions Level and consumption of
factors of production Lack of natural
endowments has caused nations to invest in the creation of advanced factors
3-17
Related and supporting industries Suppliers and industry
support services tend to form a cluster in a given location
Firm Strategy, Structure, Rivalry Extent of domestic
competition, The existence of
barriers to entry The firm’s
management style and organization.
Trade RestrictionsTrade Restrictions
Arguments for National Defense
Certain industries need protection Imports may not be available during wartime Prevent valuable technologies from being used to
strengthen competition, especially militarily Sanctions to Punish Offending Nations
Inflict economic damage to encourage to modify behavior
Protect Infant or Dying Industry In the long run will have a comparative advantage Meant to be temporary for emerging industry or to
protect jobs of dying industry3-18
Trade RestrictionsTrade Restrictions
Arguments for Protect Domestic Jobs from Cheap Foreign Labor
Productivity per worker greater in developed countries
Fails to consider cost of other factors of production
Scientific Tariff or Fair Competition Bring cost of imported goods up to domestically
produced goods to prevent unfair advantage Retaliation
Import restrictions placed by another country may result in similar restrictions by domestic government EU ban on hormone treated U.S. beef
3-19
Other Reasons for RetaliationOther Reasons for Retaliation Dumping is the selling of a
product abroad for less than The average cost of
production in the exporting nation
The market price in the exporting nation
The price to third countries
Result of Excess production Cyclical or seasonal
factors Attempt to force domestic
producers out of business3-20
Sanctions JustifiedSanctions Justified
Dumping for which sanctions are considered justified Social dumping
Lower labor costs and poorer working conditions Environmental dumping
Lax environmental standards Financial services dumping
Low requirements for bank capital/asset ratios Cultural dumping
Cultural barriers aid local firms Tax dumping
Differences in corporate tax rates or special breaks3-21
Other Reasons for RetaliationOther Reasons for Retaliation
Subsidies Government provides to domestic firm to encourage
exports or protect from imports Can be
Cash payment Government participation in ownership Low-cost loans Preferential tax treatment
Countervailing Duties Set by importing nation to offset effects of subsidy Equal to the subsidy amount
3-22
Types of Restrictions - TariffsTypes of Restrictions - Tariffs
Ad Valorem Percentage of
invoice value Specific
Fixed sum of money per unit
Compound duty Combination of
the above
3-23
Official Prices Minimum import
duty regardless of invoice price
Variable Levy Calculated daily
based on world market price
Lower Duties for Local Input
Encourages some local production
Types of Restrictions - NontariffTypes of Restrictions - Nontariff
Quantitative Quotas Voluntary Export
Restraints Orderly Marketing
Arrangements Nonquantitative
Nontariff Direct government
participation in trade Customs and other
administrative procedures
Government and private standards3-24
Levels of Economic DevelopmentLevels of Economic Development
Developed Classification for all industrialized nations,
which are mostly technologically developed. Developing
Classification for world’s lower income nations, which are less technically developed.
Newly Industrialzing Countries (NICs) Fast-growing, middle-income or higher
economies Heavy concentration of foreign investment Exported large quantities of manufactured
goods, including high-tech products3-25
Levels of Economic DevelopmentLevels of Economic Development
Newly Industrialized Economies (NIEs) Primarily used to refer to the four tigers
Taiwan, Hong Kong, Singapore, South Korea IMF combines NIEs with Industrialized
Nations to form “advanced economies Emerging Market Economies
Chile, Malaysia, China, Thailand, Indonesia Transition Countries or Eastern Europe
Former communist countries
3-26
The World Bank Classification SystemThe World Bank Classification System
Based on GNP/capita
Low income ($735 or less)
Lower middle income ($736 - $2935)
Upper middle income ($2,936 - $9,075)
High income ($9,076 or more)
3-27
GNP/Capita as an IndicatorGNP/Capita as an Indicator Concerns
GNP/Capital data does not include Underground Economy Undeclared legal production Production of illegal goods and services Concealed income – barter Underground Economy larger if
Higher level of taxation Oppressive government red tape
Currency conversion Local currency converted to the dollar by using
exchange rate Conversions do not reflect domestic purchasing powers
of currencies, must use purchasing power parity (PPP) World Bank uses Atlas methodology
3-28
Characteristics of Developing NationsCharacteristics of Developing Nations
GNP/capital less than $9,075
Unequal distribution of income
Technological dualism Regional dualism Majority of population
working in agricultural sector
Disguised unemployment or underemployment
High population growth
3-29
High rate of illiteracy and insufficient educational facilities
Widespread malnutrition and health problems
Political instability High dependence on a
few products Inhospitable topography Low savings rates and
inadequate banking facilities
Human Needs Approach to Economic Human Needs Approach to Economic DevelopmentDevelopment
Defines economic development as the reduction of poverty, unemployment, and inequality in the distribution of income. Less illiteracy, less malnutrition, less disease and
early death, shift from agricultural to industrial production
Human Development Index (HDI) based on A long and healthy life Ability to acquire knowledge Access to resources for a decent standard of living Measured by life expectancy, adult literacy, and
GDP/capita adjusted for PPP3-30
Development TheoryDevelopment Theory
No generally accepted theory
Economists concentrating on Population growth Income distribution Unemployment Transfer of technology Role of government Investment in human
capital The education of
people3-31
Contemporary Theories of FDIContemporary Theories of FDI
Monopolistic Advantage Theory FDI occurs largely in oligopolistic industries
Product and Factor Market Imperfections FDI typically from companies with heavy
product research and marketing efforts International Product Life Cycle
FDI normal state in life of a productOther Theories
Follow-the-leader theory Cross investment Internalization theory Theory of International production
3-32
Current U.S. Trade SanctionsCurrent U.S. Trade Sanctions
Balkans Burma (Myanmar) Cuba Diamond Trading Iran Iraq Liberia
Source: www.treas.gov
Libya Narcotics
Trafficking Nonproliferation North Korea Sudan Syria Terrorists Zimbabwe
Export Screening GuidelinesExport Screening Guidelines
Screening ElementsElement 1: Denied Persons ScreenElement 2: Product Classification/License Determination ScreenElement 3: Diversion Risk ScreenElement 4: Sensitive Nuclear End-Uses/End-Users ScreenElement 5: Missile End-Use/End-Users ScreenElement 6: Chemical and Biological Weapons End-Uses/End-Users ScreenElement 7: Antiboycott ScreenElement 8: Informed Letter/Entity List Screen
Source: www.bxa.doc.gov
Department of CommerceDepartment of CommerceTransshipment Country Export Control Initiative Transshipment Country Export Control Initiative
(TECI)(TECI)
TECI is a multi-faceted, cooperative initiative that seeks to strengthen the trade compliance and export control systems of those countries and companies that constitute global transshipment hubs. By working to strengthen those systems, the DOC seeks to enhance security and confidence in international trade flows.
Source: www.bxa.doc.gov
GDP GrowthGDP Growth
Source: www.globalpolicy.org
AIDS CrisisAIDS Crisis
Source: www.globalpolicy.org
Antidumping MeasuresAntidumping Measures
The United States maintains 54 of its outstanding 288 antidumping measures against products from China.
In 2003, new cases against China were initiated at the brisk pace of one per month. These actions hit consumable products like honey, apple juice concentrate, mushrooms, and pencils, as well as raw material inputs like creatine monohydrate, polyvinyl alcohol, barium carbonate and ferrovanadium.
Source: www.freetrade.org