MIB, BBA 2010 1

WK3 Agenda• Hot topic: – News?– Facebook, Lecture PPT– Change the date for this week Wednesday class to

Friday June 18, 2010 morning.– No class last week of July

• FDI Decision Homework• Trade Theory Discovery• PBS Video and script, US-China Tire Trade• Government Intervention Homework

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Trade Theory Discovery

• What are the major products exporting from these countries (Saudi Arabia, Thailand, Brazil, Norway, China, and the US.)?

• Any explanation?• Hecsksher-Ohlin Theory• Countries will export goods that make intensive use

of those factors that are locally abundant.• Countries will import goods that make intensive use

of factors that are locally scarce.• How would you explain Thai international marriage?

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Trade Theory Discovery

• How can you explain this chart?

• Product Life Cycle Theory

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Trade Theory Discovery• Raymond Vernon PLC Theory• Initially produced and sold in the

US. as demand grow in other developed countries, U.S. firms will begin to export.

• Overtime, demand would grow in other advanced countries making it worthwhile for foreign producers to begin producing in their home market.

• Once the products become more standard and price are competitive. Then the low cost foreign location would switch to be exporters.

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Trade Theory Discovery• How do we gain trade surplus?• When will we get trade deficit?• Examples?• Mercantilism

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Origami Trade Theory• In 10 minutes• Divide the students into 4 groups.• 2 groups fold the airplanes• 2 groups fold the elephants• Report your output on the board.

Time:10 minutes

Products Thailand US

Labor Airplane A1:amount of airplane produced A2

Elephant E1:amount of elephant produced E2

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Origami Trade Theory• Absolute Advantage– Division of labor– Specialization. Do what you’re good at then

combine later.– If one country has absolute advantage for all

products, should it produces all products?– Impossible

• Comparative Advantage– Opportunity Cost

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Trade Theory Discovery

• What do these three universities(Ramkamhang, Sukothai, and Ratjabhat) have in common?

• What are their differences? Differentiation?• New trade theory– Economies of scale are significant!– First mover advantage can gain a scale base cost

advantage that later entrants find it difficult to match.• Is this theory conflict with our sufficient economy เศรษฐกิ�จพอเพ�ยง?

• How can we combine both ways?

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Trade Theory Discovery• What’s the success factors

for a business in a particular industry?

• Michael Porter tried to explain why nation achieve international success in a particular industry.

• Four attributes that promote or impede the creation of competitive advantage:

Demand Condition

Factor Endowments

Firm Strategy, Structure, and

Rivalry

Related and Supporting Industries

MIB, BBA 2010 10

US-China Tire Trade Tensions

• What’s the story about?• What’s the rationale for government

intervention?• What are other intervention tools that the

government can use?• Why Chinese companies don’t do like

Bridgestone?

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Government Intervention Homework

• In group of 4 or 5.• Find 2 articles that are related to the

government intervention.• Your report should explain:– Statement of the problem.– Reasons for fixing the problem.– How did the government try to fix the problem?– What are the effects to all parties involved?• Local producers, consumers, foreign producers, etc.

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WK3.2 Agenda

• Hot topics: Thaicom, Seminar & Porter’s Diamond

• Student Lecture• Mind map & Homework

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Overview of Free Trade Theory

Free Trade : a situation that the government does not attempt to influence through quotas or duties what its citizen can buy from another country or what they can produce and sell to another country

How can we create a win-win situation?Eastern-How do you divide the inheritance?Western-How can we win the Olympic game?Hybrid-Have fun together?

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The Benefit of Trade• Smith, Ricardo, and Heckscher-Ohlin show why it is

beneficial for a country to engage in international trade.

• International Trade allows a country: – To specialize in the manufacture and export of products

that it can produce efficiently.– Import products that can be produced more efficiently in

other countries.– How much the Quad countries accounted for exporting the

world’s merchandise?

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Trade Theory and Government Policy

Mercantilism: government promoting export and discouraging

import

Neo-mercantilist?

Smith, Ricardo, and Heckscher-Ohlin:

government promote unrestricted free trade

New Trade Theory and Porter’s Diamond: government justify

limited and selective government

intervention to support certain development of certain export oriented

industry

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Mercantilism• Mercantilism: 16th century

economic philosophy: a country should promote exports and discourage imports—maintain trade surplus.

• Mercantilism advocate government intervention to achieve a surplus in the balance of trade.

• It views trade as a zero sum game—one country gain, another country loss.

• Disadvantages include: short term, retaliation, not all available products, balance cycle(But for how long? In reality, it’s not just two countries.)

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Absolute Advantage• Adam Smith: The Wealth of

Nations: countries differ in their ability to produce goods efficiently.

• A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.

• SpecializeTrade

• From our discovery game,What country has an absolute advantage in producing airplane? Elephant?

10 Minutes, 3 workers per group

Thailand US.

20 23

4 3

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Absolute Advantage• Without trade: each country

could enjoy the products only what they can produce.

• If each country specialize in what it has an absolute advantage and trade for the other product (assuming the same production rate as before)– The US. would produce 46

airplanes.– Thailand would produce 8

elephants.– The result is a positive sum game

with more total products to enjoy. Will it be lower price and better quality?

• When we free up our labor work, do you see the possible problem of shifting industry?

• What if a country has an absolute advantage in the productions of all goods? Should it still trade?

10 Minutes, 3 workers per group

Thailand US.

20 23

4 3

10 Minutes, 3 workers per group

Thailand US.

0 46

8 0

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Comparative Advantage• Ricardo Comparative Advantage:

– Countries should specialize in the goods that they produce most efficiently.

– Countries should buy goods that they produce less efficiently from other countries, even if they can produce more efficiently than other countries.

– Opportunity cost: brain surgeon with cleaning lady, manager with subordinates (save time)

– Without trade: Thailand production rate is 1 elephant to 5 planes, and 1 elephant to 4 planes for American.

– Opportunity cost for American to make an elephant is 4 planes which is less than the opportunity cost of Thailand 5 planes. Therefore, America has a comparative advantage in making an elephant.

– If they trade 1 elephant for 4.5 planes, American gain more planes than by making it domestically(4).

– Thailand also gain because use only 4.5 planes to get 1 elephant instead of making 5 planes domestically to get an elephant.

• Is it worth trading?-Transportation cost-Currency exchange rate-Reality has more than 2 countries and 2 products.-Switching cost

10 Minutes, 3 workers per group

Thailand US.After training

20 24

4 6

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Extensions of the Ricardian Model vs. Samuelson Critique

• Resources do not always move freely from one economic activity to another, and job losses may occur i.e. shift textile to software

• Unrestricted Free trade is beneficial, because of the diminishing returns, the gain may not be as great as the simple model would suggest.

• Do you know the difference in solving diminishing return between the East and the West?

• Opening a country to trade:– Might increase a country stock of

resources: more supplies from abroad– Might increase resource utilization,

and free up resources for other uses– Might increase economic growth

• Paul Samuelson argues that dynamic gain from trade may not always be beneficial “20% cheaper at Wal-Mart does not necessarily make up for the wage losses”.

• The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the U.S. where wages would then fall.

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Heckscher-Ohlin Theory• What determines the products for which a country will have a

comparative advantage?

• Eli Hecksher and Bertil Ohlin argued that comparative advantage arises from differences in national factor endowment (land, labor, and capital).

• Hecksher-Ohlin theory 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.

• Leontief Paradox

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Product Life Cycle Theory• Raymond Vernon PLC Theory• Initially produced and sold in the US. as

demand grow in other developed countries, U.S. firms will begin to export.

• Overtime, demand would grow in other advanced countries making it worthwhile for foreign producers to begin producing in their home market.

• Once the products become more standard and price are competitive. Then the low cost foreign location would switch to be exporters.

• Good explanation for electronic production during the 70s such as photocopies and camera.

• Less valid these days due to globalization.

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New Trade Theory• New trade theory suggest that the ability of firms to gain economies

of scale (avg. cost decrease as the number of units produce increase) can have important implication on international trade. i.e. Microsoft

• New trade theory suggest that:– Economy of scale not only decrease the average cost but also increase the

variety of those goods: without trade, the variety of goods and the scale of productions are limit by the size of the market. For example, Aj Supapak&BBA students@UBU. If we trade with Ramkamhang, Aj Supapak&BBA students plus Aj Ramkamheng and the long distance learning students. Then grade all the students together. More teacher and students variety with economies of scale students. Will you do that when you become the instructors?

– First mover advantage: First mover advantage can gain a scale base cost advantage that later entrants find it difficult to match i.e. Boeing and Airbus, AIS, DTAC, and Truemove.

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Implication of New Trade Theory

• Nations may benefit from trade even no difference in resource endowment and technology.

• A country may dominate in the export of the goods because they are lucky to be the first mover.

• While this is at variance with Heckscher-Ohlin theory, it does not contradict comparative advantage (identify a source of comparative advantage).

• Government should use trade policy that nurture and protect firms and industries where first mover advantages and economies of scale are important

• Proton Malaysian car vs. Thai Took Took, Detroit Hub

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National Competitive Advantage: Porter’s Diamond

• Michael Porter tried to explain why nation achieve international success in a particular industry.

• Four attributes that promote or impede the creation of competitive advantage:

Demand Condition

Factor Endowments

Firm Strategy, Structure, and

Rivalry

Related and Supporting Industries

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Factor Endowments• Factor endowment: a

nation’s position in factors of production necessary to compete in a given industry.

• A nation’s position in factors of production can lead to competitive advantage.

• Factors-Basic: natural resources, climate, location-Advanced: skilled labor, infrastructure, tech know-how

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Demand Conditions

• Refers to the nature of home demand for the industry’s product or service.

• The home demand influences the development of capabilities.

• Sophisticated and demanding customers pressure firms to be competitive.

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Relating and Supporting Industries• Relating and supporting industries: presence of

suppliers or related industries that are internationally competitive.

• The benefit of investments in advanced factors that are internationally competitive can spill over into an industry– Better communication, exchange of cost-saving ideas,

inventions with those suppliers.– Competition among these suppliers leads to lower prices,

higher quality products, and technical innovations in the market.

• Successful industries tends to be group in clusters in countries i.e. silicon valley

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Firm Strategy, Structure, and Rivalry

Firm strategy, structure, and rivalry: condition governing how companies are created, organized, and managed and the

nature of domestic rivalry.

Management ideology affect the development of national competitive advantage: -German, and Japanese engineer CEO emphasis on quality improvement-US. financial CEO want short term return on investment

Domestic rivalry create: -pressure to innovate-improve quality-reduce cost-invest in upgrading advanced featuresExamples: different strategies of car manufacturers.

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Evaluating Porter’s Theory

• What can the government do in each component?

• Do we need all four components to be successful?

• Uniden, Thai Sanitary Ware

Demand Condition: product

standard, campaign

Factor Endowments:

educated workers, infrastructure, transportation

Firm Strategy, Structure, and

Rivalry: law and regulations such as antitrust law and

tax policy

Related and Supporting Industries:

national strategic cluster plan

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Implications for Managers

What can you do?Location: most efficient for each activity First mover (especially with economies

of scale and oligopoly business) Firm Policy: red, blue, or white ocean

How can the government help?

Any mechanism distortion?

New Trade Theory, Porter’s

Competitive Advantage

Smith, Ricardo, and Heckscher-Ohlin

Mercantilism

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Mind Map Summary

Theory MNE Government

Mercantilism:

Absolute Advantage:

Comparative Advantage:

Hecksher-Olin:

Product Life Cycle:

New Trade:

Porter’s Competitive Advantage:

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The Political Economy

• Free Trade: government do not attempt to restrict what its citizens can buy from or sell to another country

• Fair Trade: managed trade, or government actively intervene to ensure that domestic firms exports receive an equitable share of foreign market and that imports are controlled to minimize losses (domestic jobs, market share, etc.)

• Why do government intervene in trade?• What are their tools?• Will there be a problem with the intervention?

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Rationale For Government

Economic rationale-Prevent unemployment-Protect infant industry: Proton, -Russian Lada, Brazil auto industry-Promote industrialization-Improve position relative to other countries

Non-economic rationale-Maintain essential industries (defense, aerospace)-Deal with unfriendly countries: Iraq, Cuba-Maintain sphere of influence-Preserve national identity: French music, Chinese movie

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Instruments of Trade Policy

--Specific Tax-Ad valorem Tariffs-Combination

Tariffs-Subsidies -Import quotas-Voluntary export restraints (VERs)-Local content requirements-Administrative policies-Antidumping duties

Non Tariffs Barriers

-Sanitary and Phytosanitary Measures: product origin, hygien

-Technical barriers to trade: protect consumer: label

-Environmental Measures: 3R, animal protection, forest certification

Non Tariffs Measures

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Tariffs• Tariffs: a tax levied on imports or

exports (cost of the product ↑)– Specific tariffs: levied as a fixed

charge for each unit of a good imported i.e. $3/barrel of oil,

– Ad valorem tariffs: levied as a proportion of the value of the imported good (% of the market value of the imported good)

– Tariffs increase government revenue, provide protection to domestic producers against foreign competitors by increasing the cost of imported goods and force consumers to pay more

– Tariffs are pro-producers, anti-consumer, and reduce the overall efficiency of the world economy

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Subsidies• Subsidies: a government payment to a

domestic producer i.e. cash grant, low interest loans, tax breaks

• Consumers typically absorb the costs of subsidies (Consumers pay tax=>Subsidies)

• Subsidies help domestic producers in two ways:– Help them compete against low cost

foreign imports– Help them gain export markets i.e.

Japan tied-aid package to reduce the risk of nonpayment for oversea sales: export telecommunication by aiding loan for railway or electric power projects

– Reality?– Price never goes down.

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Import Quotas and Voluntary Export Restraints

• Import quota: a direct restriction on the quantity of some good that may be imported into a country

• Tariffs rate quota: a hybrid of quota and tariff where a lower tariff is applied to imports within the quota than those over the quota i.e. sugar sales in the U.S.

• Voluntary export restraints: quotas on trade impose by the exporting country, typically at the request of the importing country’s government i.e. US-Japan auto industry

• A quota rent: the extra profit that producers make when supply is artificially limited by an import quota=> Japanese car in the US during the 80s

• Import quotas and VERs benefit domestic producers by limiting import competition, but they raise the prices of imported goods.

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Local Content Requirements

• Local content requirement: a requirement that some fraction of a good be produced domestically i.e. Buy America Act 51%, import license, Thai auto local content in 2000, German Beer local water content.

• What’s the effect of this policy?• Local content requirement benefit domestic

producers, but consumers face higher prices.• Encourage FDI instead of exporting.

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Administrative Policies

• Administrative policies: bureaucratic rules designed to make it difficult for imports to enter a country i.e. Fed Ex in Japan, Mexican Customs delays at the border.

• These policies hurt consumers by denying access to possibly superior foreign products.

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Antidumping Policies

• Dumping: selling goods in a foreign market below their costs of production or fair market value

• Dumping enables firms to unload excess production in foreign markets

• Dumping as a predatory behavior: producers using profit from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising price and earning substantial profits

• Antidumping policies or countervailing duties are designed to punish foreign firms that engage in dumping and protect domestic producers from unfair foreign competition i.e. U.S. Canadian softwood industry, EU and Korean semiconductor

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Summary

Government Rationale and instruments

How will the policy affect

your business?

How to prevent or solve your

problem?

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Implication for Managers

• Trade barriers and firm strategy: Firm should consider relocation to produce in that country when – Trade barriers raise the cost of exporting– VERs may limit a firm ability to sell in that country

(Japan auto industry and its suppliers; although higher cost in the U.S.)

– To conform to local requirement.• Policy implications: lobby for free trade, ask for

government protection (but be careful with trade retaliation and inefficiency).