Dynamics of International Trade: Theories and Practices

1. To learn how differing types of political system function, in terms of governmental processes, societies and business interactions. • To gain a critical appreciation of democracy’s progress in differing national environments. • To assess political risk, both internally and internationally. • To appreciate the nature and significance of diverse national legal systems, as well as their interactions with both regional and international legal frame-works • To assess legal risk for international managers, including both national and international implications. Chapter 6 International Trade and Regional Integration Learning Objectives

2. Aims of the lecture To gain an overview of the changing pattern of trade as it impacts on international business To understand and apply key theories of international trade, gaining insight into current trends To identify the tools of government trade policy and how they are exercised in practice To take a critical perspective on the changing role of the WTO and multilateral trade agreements To examine the extent to which regional and bilateral trade agreements are affecting trade and impacting on international business strategy

3. Trade in the national economy • Trade may be in goods (merchandise trade) or services (commercial services trade). • Merchandise trade may be: agricultural products, fuels and mining products, or manufactured goods. • Increasing trade is linked with economic growth. Countries which have surged ahead include those who are… • rich in natural resources • leaders in low-cost mass-manufacturing Balance of payments: a trade deficit indicates an excess of imports over exports; strong exporters enjoy trade surplus.

4. Why Nations Trade? Absolute versus comparative advantage 1. The theory of absolute advantage 2. The theory of comparative advantage The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication AnInquiry into the Nature and Causes of the Wealth of Nationsin which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nation’s import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves. While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchanges.

5. Why Nations Trade? Absolute versus comparative advantage 1. The theory of absolute advantage 2. The theory of comparative advantage Perhaps the most important contribution of David Ricardo (1772 –1823) The English political economist was the law of comparative advantage, a fundamental argument in favor of free trade among countries and of specialization among individuals. He argued that there is mutual benefit from trade (or exchange) even if one party (e.g. resource-rich country, highly-skilled artisan) is more productive in every possible area than its trading counterpart (e.g. resource-poor country, unskilled laborer), as long as each concentrates on the activities where it has a relative productivity advantage.

6. Examples of absolute advantage Party A can produce 5 widgets per hour with 3 employees. Party B can produce 10 widgets per hour with 3 employees. If wages are same for both parties, then Party B has an absolute advantage over Party A because Party B can produce twice as many widgets as Party A can with the same number of employees. Country A can produce 1000 parts per hour with 200 workers. Country B can produce 2500 parts per hour with 200 workers. Country C can produce 10000 parts per hour with 200 workers. If labor and material costs are same then Country C has absolute advantage over both Country B and Country A because it can produce the most parts per hour at the same cost as other nations. Country B has an absolute advantage over Country A because it can produce more parts per hour with the same number of employees. Country A has no absolute advantage because it can't produce more goods than either Country B or Country C given the same input.

7. Business, government and social impacts of trade

8. Patterns of global trade • Major industrialized countries – the triad of US, Japan and Europe - have dominated trade in the post-war era, but this pattern is breaking down. • Developing and transition economies have increased their shares of world trade. Notable performers: • The rise of export-oriented manufacturing, e.g. China. • The growing importance of resource-rich exporting countries, such as those in the Middle East. • The least-developed countries, concentrated in sub-Saharan Africa, have fallen behind.

9. The world’s leading merchandise exporting countries Germany US Japan China Source: WTO (2007) International Trade Statistics, www.wto.org

10. Figure 6.3:Long-term trends in merchandise exports Source:WTO (2007) International Trade Statistics, www.wto.org

11. Shares of world merchandise exports ($11,783 billion), 2006 Note: Developing/transition countries = South and Central America, Mexico, Commonwealth of Independent States (CIS), Africa, Middle East and the developing countries of Asia Source: WTO (2007) International Trade Statistics 2007, www.wto.org

12. Trade theories • Comparative advantage: a country should specialize in producing the goods in which it has the greatest relative advantage in terms of productive inputs. • Factor endowment theory: Every country has factor endowments – of labour, land, capital & natural resources. Those that are scarce command a high price, but… • where trade takes place, the high rewards of the scarce factor will diminish, whereas the rewards of the abundant factor will rise. • Product life cycle theory: as consumer products become standardized over their lifetime, production shifts away from high-cost locations to low-cost locations.

13. Figure 6.5:The Heckscher-Ohlin-Samuelson theory

14. Newer trade theories • Take account of recent trends: • Intra-industry trade • Globalized production – breaks down production into different steps in the value chain. Benefits from economies of scale. • Global competition – • First-mover advantages, by which early entrants in a market gain a lead which later entrants struggle to make up. • Oligopoly, whereby a few large firms dominate. • Monopolistic competition, whereby many producers compete in a product class on the basis of product differentiation.

15. National competitiveness • Porter’s theory of national competitive advantage, the diamond model: • Factor conditions • Demand conditions • Related and supporting industries • Firm strategy, structure and rivalry • Relative competitiveness of countries – quantitative and qualitative aspects. Some of the criteria: • Economic performance, institutions, health, education

16. Firm stra-tegy, structureand rivalry Factorconditions Demandconditions Related andsupportingindustries

17. Firm stra-tegy, structureand rivalry Factorconditions Demandconditions Related andsupportingindustries

18. Sources: WEF (2007) Global Competitiveness Report 2007–8, www.wef.org; IMD (2007) World Competitiveness Yearbook (Lausanne: IMD) Figure 6.6:National competitiveness rankings

19. Government trade policies • Government considerations in designing trade policy: • National security • Strategic needs • Domestic employment • Cultural goods • Consumer protection • Policies may vary between free trade and protectionism, whereby governments attempt to support domestic producers.

20. Figure 6.7:Tools of government trade policy

21. Import tariffs Import quotas Non-tariff barriers Health and safety rules Local content rules Importingcountry Exportingcountry Export tariffs Voluntary export restraints Subsidies to domestic producers Subsidies to exporters Government incentives to export-oriented industries

22. Import tariffs Import quotas Non-tariff barriers Health and safety rules Local content rules Importingcountry Export tariffs Subsidies to exporters Voluntary export restraints Subsidies to domestic producers Government incentives to export-oriented industries Exportingcountry

23. Figure 6.8:Financial support for agricultural producers, 2005 Source: OECD (2006) Producer Support Index, http://www.oecd.org

24. WTO and multilateral agreements • WTO seeks to liberalize trade through multilateral agreements. • GATT legacy included the most-favoured nation principle(MFN): A country’s trade terms for all members are equivalent to the most preferential. • WTO’s dispute resolution procedure is used to resolve trade disputes between member countries. • Doha Round of WTO, dating from 2001, aimed to be a ‘development’ round, liberalizing trade in agricultural products, which would benefit the least-developed countries. • However, breakdown in 2008 indicated gap in perspective between the developed and developing countries.

25. Implications of the growth in bilateral agreements • Bilateral agreementsare growing in number. • They cover investment as well as trade. • They are outside the WTO framework, often including onerous conditions on the weaker country, which the WTO framework would not permit. • The multiplication of bilateral agreements has resulted in a ‘spaghetti bowl’ effect for international business. • The export-processing zone (EPZ)gets round complex trading rules, but export zones do not necessarily benefit the wider economy.

26. Regional integration • Regional trade agreements (RTAs)– seek to liberalize trade among members. • The world’s regions vary in levels of intra-regional trade. • Nafta (the US, Canada and Mexico) has facilitated tariff-free exports into the US, benefiting US consumers. But a backlash has developed, accusing NAFTA of exporting US jobs. • Asian economic integration has been limited – Asean members vary in levels of economic development and goals; Apec is a large group of diverse countries, which aspire to trade liberalization.

27. European integration • The European Free Trade Area (Efta) preceded the EU and its members have extensive ties with the EU. • The European Union (EU) is the world’s most highly integrated regional grouping. • Constitutional reform hinged on a new constitutional treaty, but was set back by ‘no’ votes in some countries which held referendums. • The eurozone has facilitated cross-border trade and investment.

28. Figure 6.9: Share of intra-regional trade flows in each region’s total merchandise exports, 2006 Source: WTO (2007) International Trade Statistics, www.wto.org

29. Asia Middle East Africa CIS Europe South & Central America N. America 0% 20% 40% 60% 80% Share of intra-regional trade flows in 2006, as % of the region’s total merchandise exports

30. Figure 6.10:Levels of regional economic integration

31. Figure 6.11:Merchandise exports of Mercosur countries by destination, 2006 Source: WTO (2007) International Trade Statistics, www.wto.org

35. Figure 6.12:Merchandise exports of Nafta countries by destination, 2006

36. Figure 6.13:EU trade among member states and with major non-EU trading partners, 2006 Source: WTO (2007) International Trade Statistics, www.wto.org

37. Figure 6.14: Africa’s regional exports by region, 2006 Source: WTO (2007) International Trade Statistics, www.wto.org

38. Conclusions • Trade ties generate wealth for countries and businesses, and satisfy consumer needs for products and services. • Emerging countries are now gaining on the established developed countries in their share of world trade. • Governments have at their disposal a number of policy tools, such as tariffs and quotas, which promote national objectives. • The WTO has fostered multilateral trade liberalization, but has encountered protectionist resistance among members. • Regional trade agreements have aimed to liberalize intra-regional trade, benefiting businesses and consumers. However, national interests remain a strong force. • For international business, complex bilateral and regional frameworks create challenges.