Global Dimensions of Business Mark McKenna BUS 1875, Fall 2008 Charles H. Hill, International Business: Competing in

1. Global Dimensions of Business Mark McKenna BUS 187(5), Fall 2008 Charles H. Hill, International Business: Competing in the Global Marketplace, 7th ed. (New York: McGraw-Hill/Irwin, 2009) Adapted from PowerPoint slides prepared for the text by Veronica Horton

2. WEEK 5 (Sept. 22) INTERNATIONAL Trade Theory Hill, Chapter 5

3. Learning Objectives Understand why nations trade with each other Be familiar with the different theories explaining trade flows between nations Understand why many economists believe that unrestricted free trade benefits all parties Be familiar with arguments in favor of government playing a proactive role in promoting national competitiveness Understand the implications of international trade theory for business

4. Patterns of International Trade Can you explain why � Saudi Arabia is a leading exporter of oil? Brazil is a leading exporter of coffee? Switzerland is a leading exporter of chemicals? Japan is a leading exporter of automobiles? This is what trade theory seeks to explain Observed patterns of international trade, The benefits of more open trade regimes, and The role of government regulation

5. Free Trade Theory What is free trade? Trade is free when governments do not influence, through quotas or duties, what citizens can buy from or what they can produce and sell to another country Why is free trade beneficial? Individuals, groups, and countries benefit when they specialize in the manufacture and export of products and services that they are able to produce most efficiently, and import products and services that can be more efficiently produced by others

6. The Ecuadorian Rose Industry History Rose industry started 20 years ago; today Ecuador is the fourth largest producer of roses in the world Factor endowments Intense sunlight, fertile volcanic soil, an equatorial location, and high altitude are ideal growing conditions Underemployed women in these high altitude regions provide a ready supply of low-cost labor Issues Environmental and worker safety concerns Certification programs identify responsible growers

7. Mercantilism Key features Aim of trade is to increase a nation�s wealth Increase exports through subsidies and limit imports through tariffs and quotas Equates economic/political power with trade surplus Critique (David Hume, 1752) Exports increase while imports decrease money supply, leading to inflation or deflation and higher or lower prices As a result, there can be no permanent trade surplus Country A has a positive trade balance with Country B The price of Country A�s exports go up in Country B The price of imports from Country B go down in Country A Consumers respond and the trade balance is reversed

8. Theory of Absolute Advantage In mercantilism, trade is a �zero-sum� game Adam Smith (Wealth of Nations, 1776) argued that trade is a �positive-sum� game Because countries vary in their output for a given input Trade is mutually beneficial if countries export where they are the most efficient producer and import where they aren�t

9. Theory of Comparative Advantage What about countries that have no absolute advantages, or countries that are the most efficient producers for all goods, should they engage in trade? David Ricardo (Principles of Political Economy, 1817) extended Smith�s free trade argument to address this question: Efficient resource utilization leads to greater productivity What is important, therefore, is relative efficiency (or comparative advantage) rather than absolute advantage Countries should export products they produce most efficiently, and import products they produce less efficiently (even if they are the more efficient producer of that product)

10. Figure 5.2, p. 173Figure 5.2, p. 173

11. Qualifications And Assumptions only two countries and two goods zero transportation costs similar prices and values fixed stocks of resources (200 units each) resources are mobile between goods within countries, but not across borders constant returns to scale/specialization no effects on income distribution within countries

12. Extensions Of The Ricardian Model Model may exaggerate gains from trade Resources do not always move freely from one economic activity to another, leading to job losses or limiting overall productive capacity Returns to specialization may not be constant Model may not capture the dynamic effects of trade Imported resources can augment a country's existing stock Trade may increase the efficiency with which a country is able to make use of its existing resources Samuelson�s critique Free trade may not be beneficial to all if increased labor competition serves to suppress wages

13. Related Theories of Trade  Heckscher-Ohlin Theory Stresses factor endowments rather than productivity The Leontief Paradox US exports less capital intensive than US imports Differences in technology lead to differences in productivity Product Life-Cycle Theory In the first phase, innovators keep production close to home where it can be monitored and controlled As external demand grows production shifts overseas Once product as been �commoditized� production shifts to lowest-cost producers in the development world

14. New Trade Theory Shifts theory away from a pure free trade approach Identifies advantages of economies of scale Countries benefit from trade even if there are no significant comparative advantages Provides a greater variety of goods available at lower cost Recognizes �first-mover� advantages In some industries, world demand can support only a few competitors Once early movers established, difficulties in achieving economies of scale may preclude new entrants Role of the government becomes significant in assisting firms to gain first-mover advantages

15. Theory of National Competitive Advantage Theory focuses on why nation�s (and regions within nations) becomes centers for a particular industry (fashion in Italy; computer in Silicon Valley) Michael Porter identified for attributes of competitive regions/nations Factor endowments (basic and advanced) Demand conditions (consumer/customer pressure) Related and supporting industries (investing in advanced factors of production) Firm strategy, structure and rivalry (emphasis on long-term growth and innovation)

16. Porter�s Diamond Figure 5.6, p. 188Figure 5.6, p. 188

17. Implications for Business Location Locate production activities in those countries where they can be performed most efficiently First-mover advantages Invest up-front to capture first-mover advantages Government policy Free trade is almost always in the best interests of the home country and consumers It is not always in the best interests of individual firms (what is good for GM may not always �good for America�) Restricting free trade benefits producers but hurts consumers, including other businesses (e.g. LCDs and steel)