why study international trade theories? · why study international trade theories? ... ppp y c i g...

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Topic 2

International

Trade Theories

INTERNATIONAL BUSINESS ENVIRONMENT

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WHY STUDY INTERNATIONAL TRADE THEORIES?

International Business Environment – JG DITTER

Common knowledge base forAcademics – Managers – Policy-makers

Helps understand business internationalisation drivers

(why – where – how)Legitimates the role of business in society and policy-

makers' decisions

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International Business Environment – JG DITTER 3

KEY INTERNATIONAL TRADE THEORIES

Traditional (country-based) theoriesAbsolute advantage

Comparative advantage

Factor proportion

Eclectic theoriesNational competitiveness diamond

Internalisation theory

Eclectic (OLI) paradigm

(Neo-) Mercantilism

Modern (firm-based) theoriesVernon's product life-cycle

New trade theory

Country similarity, Country size, gravity model

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MERCANTILISM

Original XVII th century mercantilists, such as John Law, a Scots financier, believed that a country's economic prosperity and political power came from its stocks of precious metals.

To maximise these stocks they argued against free trade, favouring protectionist policies designed to minimise imports and maximise exports, creating a trade surplus that could be used to acquire more precious metal

http://www. econom i st .com/res ea rc h/Eco nom ics/a l pha be t ic .c fm? le tte r

=M#mercant i l is m

International Business Environment – JG DITTER 407/05/2014

http://www.economist.com/research/Economics/alphabetic.cfm?letter=M

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VARIOUS FORMS OF MERCANTILISM


Bullionism(gold

accumulation)

Colbertism(import

substitution)

Commercialism(export

promotion)

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MERCANTILISM TODAY


Neo-mercantilism is a term used to describe a policy regime which encourages exports, discourages imports, controls capital movement

and centralises currency decisions in the hands of a central government

The objectives of neo-mercantilist policies are to:

(1) Increase the level of foreign currency deposits and bonds held by central banks and monetary authorities (foreign exchange reserves)

(2) Support growth in GDP and employment at home.

Adapted from: http://www.project-syndicate.org/print/mercantilism-reconsidered

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http://www.project-syndicate.org/print/mercantilism-reconsidered

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ECONOMICS OF NEO-MERCANTILISM


National income accounts

Y = C + I + G + EX – IM

A country running a trade surplus earns more income from exports

than it spends on imports

Balance of payments

Current account + (financial account) = 0

A country running a trade surplus is a creditor to the world and can

increase its reserve assets

Net foreign wealth is increasing

AN ASIAN MODEL?


The growth champions of the past few decades – Japan in the 1950s and 1960s, South Korea from the 1960s to the 1980s, and China

since the early 1980s – have all had activist governments collaborating closely with large business. All aggressively promoted investment and exports while discouraging (or remaining agnostic

about) imports.

China's pursuit of a high-saving, large-trade-surplus economy in recent years embodies mercantilist teachings.

http://www.europeanceo.com/news/commentaries//article672.html

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http://www.europeanceo.com/news/commentaries/article672.html

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THE CHINESE CASE

2011, Md USD

PPPY C I G X M

CHN 11300 3902 5490 1484 3230 2938

USA 14991 10729 2236 2594 2094 2662

X-M C/Y I/Y G/Y X+M/2Y

CHN 292 0,35 0,49 0,13 0,27

USA -568 0,72 0,15 0,17 0,16

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GOVERNMENT-BUSINESS ISSUES

Business organisations must take into account governments' involvement in supporting exports and

limiting imports

Microeconomic policiesIndustrial policy – Education and

infrastructure – Public procurement –Market regulation

Macroenomic policiesFiscal – Monetary policiesForeign exchange policy

Trade policyExport promotion – Import restriction

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FOOD FOR THOUGHT …

"Hymns to export are only stupidity and lies.

They assume not to be aware of the futility of any distinction

between domestic and international trade."

Jacques Rueff, L'Ordre Social, 1981

MERCANTILISM DEFICIENCIES


"Beggar-thy-neighbour" strategy …

Carried-out at the expense of trade partners, likely to turn into

trade war

Generating imbalances between creditors and debtors, likely to

result in economic crisis

Leading to global depression if applied by all players

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Promotes exports and savings at the expense of domestic demand /

living standards

Renders the domestic economy dependent on trade partners' business

cycle

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MERCANTILISM DEFICIENCIES (REMINDER)

Y = C + I + G + X – M

→ X – M = Y – (C + G + I)→ X – M = (Y – (C + G)) – I

X – M = S – I

X > M ↔ S > I

C: Household consumption G: Government spendingI: Business investment EX: ExportsS: Savings IM: ImportsT: taxes

Germany is sometimes called a mercantil ist country (see below). Please explain and discuss.

The text argues that Germany's trade surplus is a problem for the Eurozone ... and Germany itself. Please explain and discuss.


ASSIGNMENT – GERMANY

"Euro membership has encouraged Germany into a costly mercantilist strategy at the expense of its people and the productivity of the economy".

Martin Wolf, Financial Timeshttp://www.ft.com/intl/cms/s/0/1e2f2cd0-064e-11e2-bd29-00144feabdc0.html#axzz2znVp8kP7

http://www.ft.com/intl/cms/s/0/1e2f2cd0-064e-11e2-bd29-00144feabdc0.html#axzz2znVp8kP7

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FOOD FOR THOUGHT …


"An international economics course should drive home to

students the point that international trade is not about

competition, it is about mutually beneficial exchange.

Even more fundamentally, we should be able to teach

students that imports, not exports, are the purpose of

trade. That is, what a country gains from trade is the

ability to import what it wants.

Exports are not an objective in and of themselves: the

need to export is a burden that the country must bear

because its import suppliers are crass enough to

demand payment".

Paul KRUGMAN, Pop Internationalism

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ABSOLUTE / COMPARATIVE ADVANTAGE


Absolute advantage refers to the ability of a person or a country to produce a particular good at a lower absolute cost than another.

Comparative advantage refers to the ability of a country to produce a particular good at a lower marginal or opportunity cost than another country.

The net benefits of such an outcome are called gains from trade.

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ABSOLUTE / COMPARATIVE ADVANTAGE ( C W H I L L )

Absolute advantage Comparative advantage200 units of resources available per country

(+2.5) (+1.25)

❶

❷

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COMPARATIVE ADVANTAGE: GRAPH

Cocoa

Rice

GhanaSouth Korea

10

2,5

❶

❷

❶

❷

5 7,5 10

15

3,7507/05/2014

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THE FACTOR PROPORTION THEORY

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For Eli Heckscher and Bertil Ohlin, comparative advantage arises from differences in relative national factor

endowments – the extent to which a country is endowed with resources like labour and capital

The Heckscher-Ohlin-Samuelson (H-O-S) model predicts that countries will export goods that make intensive use of those factors that are locally abundant, while importing goods that

make intensive use of factors that are locally scarce

COMPARING FACTOR ENDOWMENTS


US Mexico

Labour 300 units 120 units

Capital 100 units 20 units

The US is the relatively capital abundant country

Mexican capital-labor ratio: KMex / LMex is 20/120 or 1/6 U.S. capital-labor ratio: KUS / LUS is 100/300 or 1/3

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http://www.feline207.fr/photos/2399.jpg

http://www.feline207.fr/photos/2399.jpg

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LEONTIEF'S PARADOX

An analysis carried-out in 1947 concluded that the US exported labour-intensive commodities and imported capital-intensive commodities

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GOVERNMENT / BUSINESS ISSUES

DIFFERENT COUNTRIES HAVE ADVANTAGES IN DIFFERENT PRODUCTIVE ACTIVITIES

Firms should disperse their various productive activities across countries taking these advantages into accountFirms that fail to do this, may be at a

competitive disadvantage

Governments should promote free trade to let the domestic economy gain from its

comparative advantages

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QUESTIONING TRADITIONAL THEORIES


Assumes mobility of production factors within each country and no mobility between countries (no FDI)

Static model, does not explain changes in comparative advantage or long-term effect of specialisation

Does not explain intra-industry trade or trade between similar countries

According to Raymond Vernon's product life-cycle theory, both the

location of sales and the optimal production location will change as

products mature, affecting the flow and direction of trade, as well as

foreign direct investment


THE PRODUCT LIFE-CYCLE THEORY

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THE NEW TRADE THEORY (P. KRUGMAN)

… Tries to explain why trade is growing fastest between industrial countries

With similar economies and endowments of the factors of production

Trading similar goods (intra-industry trade)

… Considers

Markets of imperfect competition (oligopolies)

Movement of capital (foreign direct investment)

Business and government strategies (session 3)



ECONOMIES OF SCALE …

… Are the reduction in average production costs arising from a larger output

Fixed costs are spread over a large

output

Production facilities are used more

intensively

Bargaining power with suppliers is

increased

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http://www.investopedia.com/video/play/what-is-economies-of-scale/

http://www.investopedia.com/video/play/what-is-economies-of-scale/

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THE CASE OF TRANSPORT


The first wave of globalization in the 19th century increased trade based on comparative advantage. Countries exchanged what they could not

produce themselves. So Europe traded machinery for Central American bananas, or for South Asian spices.

But in the 20th century, transportation costs fell so much that even trade in similar goods or in parts and components made economic sense.

But these costs have not fallen equally everywhere. Economies of scale in transportation, such as giant container ships plying the seas on lucrative

routes between Northeast Asia and North America, imply that lower costs will increase trade, which will further lower costs.

http://www.imf.org/external/pubs/ft/fandd/2008/12/deichmann.htm

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IMPERFECT COMPETITION MARKETS

A

Firm 1

Firm 2

Lower pricesTechnological leadership

Access to resourcesConsumer's switching cost

Research & DevelopmentMarketing

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CAPITAL INTENSIVE INDUSTRIES

Sunk costs / Economies of scaleEconomies of learning

1st mover advantage Barriers to entry

OLIGOPOLISTIC MARKETS

http://www.imf.org/external/pubs/ft/fandd/2008/12/deichmann.htm

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BUSINESS INTERNATIONALISATION

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Capital intensive industriesOligopolistic markets

INTERNATIONALISATION

Economies of scale

Economies of learning

First-mover advantage

Global dominant position

Strategic trade policies

Product differentiation


THE EXAMPLE OF SOFTWARE

Software development is characterized by substantial economies of scale. The fixed costs of producing software, including applications, is

very high. By contrast, marginal costs are very low.

Moreover, the costs of developing software are "sunk" -- once expended to develop software, resources so devoted cannot be used

for another purpose.

The result of economies of scale and sunk costs is that application developers seek to sell as many copies of their applications as

possible. […]

The [negative] experiences of IBM and Apple, Microsoft's most significant operating system rivals in the mid- and late 1990s, confirm

the strength of [such a] barrier to entry.

http://www.albion.com/microsoft/findings-8.html

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http://www.albion.com/microsoft/findings-8.html

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GOVERNMENT/BUSINESS ISSUES

In capital intensive industries that can only support a few competitors, firms that establish a first-mover advantage may

dominate global trade

What one firm does has an immediate effect on its competitors, forcing them to take similar actions (herd / mimetic

behavior)Firms will try to match each others’

moves as a way of keeping each other in check (multipoint competition)

Governments should enforce strategic trade policies to help domestic firms achieve first

mover advantages.

GAINS FROM TRADE


A

C

B

D

A

C

B

D

A

C

B

D

A

C

B

D

A B

C D

Without trade:Small and monopolistic domestic marketsNo economies of scale Limited range of products, high pricesDifferent national standards

With trade:Static gains: lower prices due to tariff cuts

Dynamic gains: lower prices due to economies of scale, competitive pressure and specialization

Innovation, broader range of productsHomogeneous standards

Country 1

Country 3

Country 2

Country 4

Country 1

Country 3

Country 2

Country 4

http://www.codart.nl/news/439/

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http://www.codart.nl/news/439/

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STATIC GAINS FROM TRADE

d1

qd

P1Worldprice

Q

s1

qs

Trade creation (imports) D

S

P*Domesticprice

P

E*

q*

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The size of the domestic market influences global competitive advantage

Larger countries are more self-sufficient and therefore less dependent on international trade than smaller ones


NEW TRADE vs. COUNTRY SIZE THEORY

2011 GDP X M (X+M) / (2*GDP)Ireland 189 199 158 0.94Belgium 427 360 355 0.84Netherlands 714 593 528 0.79France 2,306 622 687 0.28Germany 3,308 1,711 1,521 0.49Japan 4,385 668 708 0.16China 11,300 3,230 2,938 0.27United States 14,991 2,094 2,662 0.16

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EXAMPLES OF OPENNESS RATIOS

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THE NATIONAL COMPETITIVENESS FRAMEWORK

National competitive advantages

Firms' competitive advantages

National comparative advantages

M. Porter's thesis is that national competitive advantage is not dependent on factor endowment alone, but on various (country- and industry-based)

factors that interact with each other to create conditions where innovation and improved competitiveness occurs

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Firm strategy, structure and

rivalry

Demand conditions

Related and supporting industries

Factor endowments


THE COMPETITIVENESS DIAMOND

ChanceGov't

policies

National competitive advantage

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BASIC FACTORS

Labour

Capital

Location, climate

Land and natural resources

ADVANCED FACTORS

Skilled labour

Infrastructure

Technological know-how


FACTOR ENDOWMENTS

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DEMAND CONDITIONS

Demand conditions refer to the nature of home-market demand for specific products and services.

The strength and sophistication of demand pressures firms to innovate more quickly and produce better products.

Japan is a densely populated, hot,

and humid country with very

demanding consumers. These

conditions led Japan to become

one of the leading producers of

superior, compact air conditioners.

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STRATEGIC RIVALRY

The presence of strong competitors in a nation helps create and maintain national competitive advantage, putting firms under

constant pressure to innovate

Japan has the world’s most competitive consumer

electronics industry, with major players like

Nintendo, NEC, Sharp, and Sony producing

semiconductors, computers, video games, and liquid

crystal displays.

Vigorous competitive rivalry puts these firms under

continual pressure to innovate and improve.

See: http://www.techaction.org/the-japans-consumer-electronics-industry

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http://www.techaction.org/the-japans-consumer-electronics-industry

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RELATED AND SUPPORTING INDUSTRIES

It refers to the presence of clusters of suppliers, competitors, and complementary firms that excel in particular industries.

↓

The resulting business environment is highly supportive for the founding of particular types of firms.

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THE ROLE OF GOVERNMENTS

Governments should promote the development of a national competitive advantage through proactive national industrial policy

Support to development of high value-

adding industries

Tax incentives

Investment in education

Stable business-friendly legal

system

Investment in infrastructure

Low interest loans

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TRADE vs. FOREIGN DIRECT INVESTMENT

Foreign direct investment (export of capital) will

prevail over exports in case of …

Actual or threatened trade barriers

High transportation costs


H-O-S modelNew trade theory

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TRADE vs. FOREIGN DIRECT INVESTMENT (CTD)

International trade and foreign direct investment

are combined

Resource seekingNatural resources, workforce,

technology, brand

Market seeking


Eclectic theories

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1. What particular limitations of international trade theories does Logitech's case highlight?

2. How can international trade theories nonetheless be used to explain Logitech's internationalization and the configuration of its international operations?

CASE STUDY – LOGITECH


07/05/2014 International Business Development - JG DITTER 50

THE INTERNATIONAL VALUE CHAIN/NETWORK

The value chain describes the categories of activities within an organisation which, together, create a product or service.

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THE INTERNATIONAL VALUE CHAIN/NETWORK (CTD)

The value network is the set of inter-organisational links and relationships that are necessary to create a product or service.

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International firms will exploit specific advantages in various locations in order to optimise their value

chain / network

Foreign direct investmentInvesting directly in new facilities to produce and/or market in a foreign

country

Global sourcingPurchasing components and services from the most appropriate suppliers

around the world


THE INTERNATIONAL VALUE CHAIN/NETWORK ( C T D )

The firm's ability to coordinate activities in different locations is a distinctive capability that will contribute to its global competitiveness

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EXAMPLE: DELL'S INTERNATIONAL VALUE CHAIN

http://www.youtube.com/watch?v=owQzo82ac_M

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http://www.youtube.com/watch?v=owQzo82ac_M

Dell Notebook Global Value Chain.mp4

Dell Notebook Global Value Chain.mp4

why study international trade theories? · why study international trade theories? ... ppp y c i g...

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