part three theories and institutions: trade and investment international business

1. PART THREETHEORIES AND INSTITUTIONS: TRADE AND INVESTMENTInternational Business Chapter Six International Trade and Factor Mobility Theory

2. 2 Chapter Objectives Theoretically why should countries trade? How can global efficiency increase through free trade? What factors affect countries� trade patterns? Why are countries� export capabilities dynamic? Why do labor and capital move internationally? What is the relationship between foreign trade and international factor mobility?

3. Why should countries trade?

4. 4 Trade Theory Trade theory helps managers answer three critical questions: What products should be imported and exported? How much should be traded? With whom should they trade?

5. 5 Merchantilism: Old School Trade Theory Two t MERCHANTILISM: 1500-1800 policy who�s goal was to help the country amass as much gold/treasure as it could at the expense of it�s trading partner (I.e. their colony). Subsidized domestic markets to Export > Imports limited by trade restrictions Force colonies to trade cheap raw materials for more expensive finished goods. NEOMERCHANTILISM: The more recent trade policy strategy of countries who�s goal is to achieve a social or political objectives using a favorable balance of trade. Full employment by exporting surplus with trade partner Maintain political influence by exporting needed goods/services at a cheaper rate.

6. 6 Merchantilism vs. Neomerchantilism Two different trade policies: MERCHANTILISM: 1500-1800 policy who�s goal was to help the country amass as much gold/treasure as it could at the expense of it�s trading partner (I.e. their colony). Subsidized domestic markets to Export > Imports limited by trade restrictions Force colonies to trade cheap raw materials for more expensive finished goods. NEOMERCHANTILISM: The more recent trade policy strategy of countries who�s goal is to achieve a social or political objectives using a favorable balance of trade. Full employment by exporting surplus with trade partner Maintain political influence by exporting needed goods/services at a cheaper rate.

7. Costa Rica Question: What did trade during Merchantilism? What did it trade during neomerchantilism?

8. 8 Costa Rica Answer: 1800-1960 exported coffee and bananas. 1960-Present exported seeds, pharmaceuticals, electronics and ecotourism.

9. 9 Companies� International Operations Link Countries Economically

10. How can countries benefit from free trade?

11. 11 Free Trade Theories � The theories of absolute and comparative advantage argue that economies benefit when they specialization and trade. � Free trade argues that nations shouldn�t artificially limit imports nor artificially promote exports. � The invisible hand of the market determines which competitors survive, as customers buy those products that best serve their needs.

12. 12 Adam Smith�s Theory of Absolute Advantage A country can maximize its own economic well being by specializing in the production of those goods and services that it produces more efficiently than any other nation and enhance global efficiency through its participation in free trade. Smith reasoned that: � workers become more skilled by repeating the same tasks � workers do not lose time in switching from the production of one kind of product to another � longer production runs provide greater incentives for the development of more effective working methods

13. 13 Natural vs. Acquired Advantages A natural advantage may exist because of: -given climatic conditions -access to particular resources -the availability of labor, etc. An acquired advantage may exist because of: -superior skills -better technology -greater capital assets, etc. Q: What are Costa Rica�s natural and acquired advantages?

14. Complete Worksheet Learning in Trade: How Absolute & Comparative Advantage Work.

15. How can global efficiency increase through free trade?

16. 16 Ricardo�s Theory of Comparative Advantage A country can maximize its own economic well-being by specializing in the production of those goods and services it can produce relatively efficiently and enhance global efficiency via its participation in free trade. Ricardo also reasoned that: � a country can have both absolute and comparative advantage in producing a given product. � Countries, like people, should concentrate on producing what it has the greater advantage in to make the greatest profit.

17. 17 Assumptions and Limitations of the Free Trade Theories The theories of absolute and comparative advantage both make assumptions that may not be entirely valid. Full employment of resources Exclusive pursuit of economic efficiency objectives Equitable division of gains from specialization Only two countries and two commodities Exclusion of transport costs A static rather than a dynamic view Exclusion of services Unrestricted factor mobility

18. What factors affect What we trade? Who we trade with?

19. 19 The Size Factor (it counts) Large countries are more independent due to: Varied climates and greater assortment of natural resources. Higher transportation costs for exported and imported products.

20. 20 Top 10 Exporting and Importing Nations all have �big� economies Exporting Importing Rank Nation ($US Bil.) % Rank Nation ($US Bil.) % 1 Germany (748.3) 10.0 1 U.S.A. (1303.1) 16.8 2 U.S.A (723.8) 9.6 2 Germany (601.7) 7.7 3 Japan (471.8) 6.3 3 China (413.1) 5.3 4 China (437.9) 5.8 4 U.K. (390.8) 5.0 5 France (386.7) 5.2 5 France (390.5) 5.0 6 U.K. (304.6) 4.1 6 Japan (382.9) 4.9 7 Neth. (294.1) 3.9 7 Italy (290.8) 3.7 8 Italy (292.1) 3.9 8 Neth. (262.8) 3.4 9 Canada (272.7) 3.6 9 Canada (245.0) 3.2 10 Belgium (255.3) 3.4 10 Belgium (235.4) 3.0 Total 55.8 Total 53.0 Source: International Trade Statistics, 2004 (Geneva: World Trade Organization), p.19.

21. 21 What are the factors of production? Land Labor Capital

22. 22 Factor Proportions Theory Differences in the type and abundance of a country�s land, labor, and capital results in a differences in the cost of production. In theory each country will . . . Utilize relatively abundant/cheaper production factors rather than scarce/expensive factors. This theory also applies to acquired advantages like technology or highly skilled labor.

23. 23 Country Similarity Theory New products for the home market are likely to be sold to similar foreign markets first because of cultural similarity similarity political/economic interests economic similarity (industrialized, developed, developing) While neighboring countries typically enjoy lower transportation costs they may not have enough similarity to promote trade.

24. Why are countries� export capabilities dynamic? How do countries develop, maintain, and possibly lose their competitive advantages?

25. 25 Product Life Cycle (PLC) Theory The optimal location for the production of certain types of goods and services shifts over time as they pass through the stages of: (i) introduction, (ii) growth, (iii) maturity, and (iv) decline. Exceptions to the typical pattern of the PLC would include: � products that have very short life cycles � luxury goods and services � products that require specialized labor � products that are differentiated from competitive offerings � products for which transportation costs are relatively high During the decline stage, a product is often imported by the country where it was initially developed; however, the importing firm may or may not be the innovating firm.

26. 26 Product Life Cycle Characteristics Stage Intro. Growth Maturity Decline PRODUCTION Innovating Innovating Industrial, Developing LOCATION(S) country other ind�l developing countries MARKET Innovating Industrial Industrial + Developing LOCATIONS + other ind�l countries developing countries COMPETITIVE Uniqueness Rising comp. Price compe- Declining FACTORS & demand tition demand PRODUCTION Short prod�n Capital input Economies Rationali- TECHNNOLOGY runs increases of scale zation

27. 27 Product�s Life Cycle of Cell Phones Think about which type of country developed telecom? Which markets could afford it? How did new telecom firms affect price/product? How long will it take to make an iPhone knock-off?

28. 28 Porter�s Diamond of National Competitive Advantage [1990] The Porter Diamond theorizes that national competitive advantage is embedded in four variables: � Domestic demand conditions � Conditions of the factors of production � Competing and supporting industries � firm strategy, structure, and rivalry Note: Variables can be affected by luck and government.

29. Why do labor and capital move internationally?

30. 30 Factor Mobility Capital, especially short-term capital, is the most mobile factor of all. It moves wherever investors expect a return. Interest rates Direct investments Lower operating costs Response to government incentives. Foreign aid or loans NGO�s donations Individuals remit $ to help families People transfer in order to work abroad, either on a temporary or on a permanent basis. 2% of people migrate to another country for work. �Brain drain� when educated citizens leave a country.

31. 31 What Would You Do? If you were Western Europe, Japan or U.S. would you encourage FDI in your country or export trade? What if you were advising Brazil, Russia, India or China?

32. What is the relationship between foreign trade and international factor mobility?

33. 33 The relationship between trade and factor mobility. Substitution: If a country can�t trade or import a factor, they might be motivated to come up with a domestic alternative or substitute. Complementarity: If a country does trade or import a factor mobility it might be motivated to trade for complementary equipment, components, and/or products. Immigrants bring skills that increase countries comparative advantage. The resulting increase in income can be used for infrastructure and increase trade.

34. 34 Testing the Trade and Factor Mobility Theory How much cheaper is Mexico�s labor per bushel? How much cheaper is U.S. capital per bushel? If neither labor or production factors can move (left) how much is a bushel in Mexico? Or the U.S.? If trade restrictions are lifted (right) where would tomatoes be produced? With whose factors? After transportation costs, what would the cost of tomatoes be in the U.S.?

35. 35 Drawing Conclusions Theoretically why should countries trade? Achieve social, political or economic objectives How can global efficiency increase through free trade? Absolute & Comparative Advantage What factors affect countries� trade patterns? Size, factor proportion, similarity Why are countries� export capabilities dynamic? Product Life Cycle, Porter Diamond�s Theory Why do labor and capital move internationally? Factor mobility theory What is the relationship between foreign trade and international factor mobility? countries import or develop substitute or complimentary goods/services as a result of trade and factor mobility

36. 36 Closing Case: LUK Oil What theories of trade help to explain Russia�s position as an oil exporter?

37. 37 How do global political and economic conditions affect world markets & prices of oil? OPEC makes supply uncertain Chinese industrialization increases demand. Political unrest in Venezuela and war in Iraq makes supply from competition uncertain.

38. 38 Discuss the following statement as it applies to Russia & LUKOil. �Regardless of the advantages a country may gain by trading, international trade will begin only if companies within that country have competitive advantages that enable them to be viable traders - and they must foresee profits in exporting and importing�

39. 39 4. In LUKoil�s situation, what is the relationship between factor mobility & exports? Oil production process are capital-intensive and require highly-specialized equipment manned by highly-skilled labor. Investment capital, and labor goes where production is most efficient at making a profit. LUKoil serves customers around the world, therefore they keep reserves around the world. In other words, mobile.

40. 40 5. Compare role of Costa Rican and Russian govt. in the use of trade to meet economic objectives. Costa Rica Developed acquired skills in targeted industries. Transform economy from exporting natural resources to high-tech manufactured products. Russia Exploited demand for their surplus of natural resources Transformed state-owned business to competitive privately owned enterprise.