Int’l Bus Strategy Lecture 3: The Global Business Environment

1. Int’l Bus StrategyLecture 3:The Global Business Environment

2. Learning Objectives • Understanding the historical evolution of the international trade theories • Understanding the politics and economics underlying the international business environment

3. Through 1700s 1776, Smith 1817, Ricardo 1920s 1966, Vernon 1980s 1990s International Trade Theory • Introduction and illustrations • Theories of international trade • Mercantilism • Absolute Advantage • Comparative Advantage • Heckscher-Ohlin Theory • Product Life Cycle Theory • New Trade Theory • Porter’s Diamond  Ram Mudambi, Temple University, 2001

4. Definitions • Output per capita = GDP divided by population • Standard of living depends on (among other things) the evolution of output per capita. • Purchasing powerparity (PPP) = adjustment when comparing output figures across countries. • The Penn World Tables

5. Large-scale ocean-borne Trade Industrial revolution Technology A Growth History of the World Output per capita

6. 1st British African colony to win independence and richest country in Sub-Saharan Africa - 1957 • Relatively good infrastructure • Education, judicial institutions • Developed resources – cocoa, gold • Nkrumah espoused pan-African socialism • High tariffs, anti-exporting policy

7. Outward oriented, but not a totally free market economy • 1950s – import substitution; education, infrastructure • 1960s – heavy govt. intervention • 1970s – H-C-I period • 1980s – gradual reduction of quotas and subsidies

8. The Impact of Trade Policies • Ghana • 1970 • GNP/capita • $250 • 1997 • GNP/per capita • $370 • GNP Growth/year • 1.5% (1997) • Shift from comparative advantage uses (cocoa) to non-comparative advantage uses (subsistence agriculture). • Korea • 1970 • GNP/per capita • $260 • 1997 • GNP/per capita • $10,550 • GNP Growth/year • 5.1% (1997) • Shift from non-comparative advantage uses (agriculture) to comparative advantage uses (labor-intensive manufacturing).

9. Brazil • 1970 • GNP/per capita • $1,145 • 1997 • GNP/per capita • $4,720 • GNP Growth/year • 1.1% (1997) • Blanket policies for the entire economy • Policy characterized by crisis management The Impact of Trade Policies • Korea • 1970 • GNP/per capita • $260 • 1997 • GNP/per capita • $10,550 • GNP Growth/year • 5.1% (1997) • Specific policies for export sector. • Strategic policy continuity

10. Growth in Modern Times

11. An Overview of Trade Theory • Free Tradeoccurs when a government does not attempt to influence, through quotas or duties, what its citizens can buy from another country or what they can produce and sell to another country. • The Benefits of Tradeallow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country. • Some patterns of international trade are easy to understand (Saudi Arabia / oil or Mexico / labor intensive goods). Others are not so easy to understand (Japan / cars).

12. Mercantilism: mid-16th century • A nation’s wealth depends on accumulated internationally valued assets - gold and silver • To maximize its wealth, a nation should • Maximize exports through subsidies. • Minimize imports through tariffs and quotas. Trade is a “Zero-sum game”  Implement ‘beggar thy neighbor’ policies

13. Theory of Absolute Advantage • Adam Smith: Wealth of Nations (1776). • Production efficiencies vary across countries. • Produce only goods where you are most efficient, trade for those where you are not efficient. • Trade between countries is, therefore, beneficial. • Ghana / cocoa.

14. Theory of Comparative Advantage • David Ricardo: Principles of Political Economy (1817). • Countries specialize in products where they have the largest comparative advantage. • Implication: Trade can be beneficial even between countries where one has an absolute advantage in ALL goods.

15. Production point = Consumption point PPF2 The Production Possibility Frontier* PPF1 Cocoa *Diminishing returns mean that the PPF is curved 0 Rice

16. Production point Consumption point Export Import The Influence of Free Trade on the PPF PPF2 Cocoa PPF1 0 Rice

17. Japan, China Is the mercantilist theory still valid? • A qualified Yes. • Equate political power with economic power and economic power with a trade surplus.

18. Product Life-Cycle Theory(Raymond Vernon, 1966) • Article in the Quarterly Journal of Economics. • As products mature, both location of sales and optimal production changes. • Affects the direction and flow of imports and exports. • Globalization and integration of the economy makes this theory less valid.

19. International Product Trade Cycle Model production High Income Countries Exports Imports consumption Quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Medium Income Countries Exports Imports 1 2 3 7 4 5 6 8 9 10 11 12 13 14 15 Low Income Countries Exports Imports Time 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 New Product Maturing Product Standardized Product Stages of Production Development

20. The New Trade Theory • Typically, in industries with high fixed costs, world demand will support few competitors • Competitors may emerge because “they got there first” – first mover advantages • economies of scale and experience curve effects • Some argue that it creates a role for govt. intervention and strategic trade policy

21. Founded 1915 by William Boeing Largest commercial airplane manufacturer Over 9,000 commercial jetliners in service First-Mover Advantage

22. Government-supported entry Established 1967 Western Europe buying 25% of aircraft ,but selling only 10%. France, Germany, Great Britain, Spain, Italy By 2002: 4,632 orders - 3,127 deliveries

23. Boeing vs. Airbus Net plane orders

24. Porter’s Diamond • The Competitive Advantage of Nations. • Looked at 100 industries in 10 nations. • Thought existing theories didn’t go far enough. • Question: “Why does a nation achieve international success in a particular industry?”

25. Economies of scale • Discerning customers • Creation and organization of firms • Antitrust Firm Strategy, Structure and Rivalry Factor Endowments Demand Conditions Key items: • Skilled labor • Technology Porter’s DiamondDeterminants of National Competitive Advantage Related and Supporting Industries

26. Chance Company Strategy, Structure, and Rivalry Two external factors that influence the four determinants. Factor Conditions Demand Conditions Related and Supporting Industries Government Policy and Luck

27. New Trade Theory vs. the Diamond • New trade theory provides a role for government in supporting ‘national champions’ • Porter’s diamond argues that such support is counter-productive • Airbus seems to provide evidence for New Trade theory • The computer industry seems to provide evidence for Porter’s diamond • Groupe Bull (France), Siemens (Germany), Olivetti (Italy), ICL (The UK) World Trade

28. The Political Economy of Trade • The role of politics in trade policy • Trade wars • Policy tools through which political factors impact international trade • Instruments of trade policy

29. EU-US and GMO • 1989 - EU bars growth hormone treated beef. • US exports decline form $231m in 1988 to $98m in 1994. US exports of GM corn targeted in 1998. • With other countries, US files complaint to WTO. • 1998 - WTO Panel declares ban to be illegal. • EU reluctant to comply and appeals, but loses the appeal. • 1999 - US threatens to raise tariffs on hundreds of EU products. • 2005 - WTO rules in favor of US again, allowing punitive tariffs of hundreds of millions of euros

30. Beef Pork Sausages Corned Beef Roquefort Cheese Chocolate Products Mustards Chewing Gum Soups and Broths Truffles Mineral Water Cut Flowers Yarn Electric Hair Clippers Motorcycles and Mopeds US Targets EU

31. Trade Policy and Politics • Protecting jobs and industries: • emerging industries. • Increasing exports. • National security. • Retaliation. • International product domination: • New trade theory and subsidies.

32. Instruments of Trade Policy • Tariffs • Subsidies • Quotas and voluntary export restraints (VERs) • Local content requirements (LCRs) • Anti-dumping policies • Administrative policies

33. Instruments of Trade PolicyTariffs • Tariffs - oldest form of trade policy • Specific • ad valorem • Good for government • Good for producers • But reduces efficiency • Bad for consumers

34. Instruments of Trade PolicySubsidies • A payment to a domestic producer. • Cash grants • low-interest loans • tax breaks • government equity participation in the company • Airbus • Subsidy revenues generated from taxes.

35. Instruments of TradePolicy ImportQuotas and Voluntary Export Restraints (VERs) • Import Quota: • Restriction on the quantity of some good imported into a country. • Voluntary Export Restraint (VER): • Quota on trade imposed by exporting country, typically at the request of the importing country.

36. Instruments of Trade PolicyLocal Content Requirements - LCRs • Requires some specific fraction of a good to be produced domestically. • Percent of component parts. • Percent of the value of the good. • Initially used by developing countries to help shift from assembly to production of goods. • Developed countries (US) beginning to implement. • For component part manufacturer, LCR acts the same as an import quota. • Benefits producers, not consumers.

37. Instruments of Trade Policy Anti-dumping Policies • Defined variously as: • Selling goods in a foreign market below production costs. • Selling goods in a foreign market below fair market value. • Result of: • Unloading excess production. • Predatory behavior. • Remedy: seek imposition of tariffs.

38. Dumping: GATT and the U.S. • GATT:Sale of an imported product at ‘less than fair value’ and causes ‘material injury to a domestic industry’. • US: An unfair trade practice that results in injury, destruction, or the prevention of the establishment of an American industry.

39. Instruments of Trade PolicyAdministrative Policies • Bureaucratic rules designed to make it difficult for imports to enter a country. • Japanese ‘masters’ in imposing rules. • Unit inspections • Tulip bulbs • Cars

40. Summary • Both theory and practice indicate that international trade and engaging with the world economy have enormous wealth creating potential • Industries are internationally mobile and generally this mobility creates efficiency • National politics has a powerful influence on trade policies and generally leads to the erection of trade barriers of various kinds • These barriers generally create inefficiencies