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International Business

International Business. Chapter Six International Trade and Factor Mobility Theory. International Trade Theory. Why nations (or companies in a nation) trade? What factors determine trade? How much and with whom should a nation trade? Trade theories are as follows. Mercantilism

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International Business

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  1. International Business Chapter Six International Trade and Factor Mobility Theory

  2. International Trade Theory • Why nations (or companies in a nation) trade? What factors determine trade? How much and with whom should a nation trade? • Trade theories are as follows. • Mercantilism • Adam Smith’s Absolute Advantage • Ricardo’s Comparative Advantage • Heckscher-Ohlin’s Theory of Factor Proportion • International Product Life Cycle (IPLC) • Porter’s Diamond and International Competitiveness of Nations

  3. Mercantilism • Initial trade theory that formed the foundation of economic thought from 1500 – 1800 • The mercantilists believed that the way for nations to become rich and powerful was to have a favorable balance of trade. • They advocated strict government control of all economic activity and preached economic nationalism. • Neomercantilism preaches export surplus to achieve a country’s social and political objective. It supports colonialism—it is alright to have colonies to generate trade surplus.

  4. Theory of Absolute Advantage (Adam Smith, 1776) • Believed that countries are at different levels in terms of trade because of natural or acquired advantage. Resource base, country size, technology or resource efficiencies (as absolute advantages) is the basis (or reason) for trade. • A country can (i) 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 (ii) enhance global efficiency through its participation in free trade. • Advocated that market forces, and not the government, should determine the direction, volume, and composition of international trade.

  5. Theory of Comparative Advantage(David Ricardo, 1817) • A country can (i) maximize its own economic well-being by specializing in the production of those goods and services it can produce relatively efficiently and (ii) enhance global efficiency via its participation in free trade. Relative or comparative efficiency is the main issue. • Comparative advantage stems from the relative efficiency of one nation over another. A country will produce and export those goods and services in which it has comparative advantage. • Free trade will foster global efficiency. Global gains will be made if a country specializes in products it produces more efficiently than other products.

  6. Theory of Factor Proportion (Eli Heckscher, 1919 and Bertil Ohlin, 1933) • Differences in a country’s relative endowments of land, labor, and capital explain differences in the cost of production factors. A country will produce and export those goods and services in which it is relatively better endowed. • The comparative advantage in relative prices and factor inputs would be the basis for trade.Given this, a capital abundant country will have comparative advantage in capital-intensive goods and will export those for labor-intensive goods.

  7. Assumptions of Trade Theories The trade theories make assumptions that are questionable • 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

  8. Introduction Growth Maturity Decline Production Location Market Location Competitive Factors Production Technology International Product Life Cycle (IPLC) Theory

  9. International Product Life Cycle (IPLC) Theory

  10. Porter’s Diamond- International Competitiveness of Nations

  11. International Competitiveness of Nations(Michael Porter 1990) • It is a departure from the previous trade theories. Most trade theories are from a country perspective but it is the companies that make decisions about trade. Porter argues that the dynamic interplay of the four factors that determine international competitiveness are: - Demand Conditions - Factor Conditions - Related and Supporting Industries - Firm Structure and Rivalry. • Other two factors that also influence the competitiveness of nations are Chance and Government.

  12. Back to the questions we begun this chapter with-Trade Pattern Theories • Why nations trade? • How much does a country trade? • Depends on….size of the country/economy • What types of products does country trade? • Factor proportion theory (Heckscher-Ohlin) • With whom do countries trade? • Country-similarity theory • Influence of geography/proximity • Can we live in a world without trade?

  13. Chapter 6: Discussion Question Question can be asked to explain one or more theories of trade. The distinction between them should also be explained. For example… • Explain Porter’s Diamiond of International Competitiveness of Nations. • Elaborate the trade theories of Smith, Ricardo and Heckscher-Ohlin and distinguish their differences. • Explain International Product Life Cycle Theory (IPLC).

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