Understanding Global Markets

1. Understanding Global Markets

2. The Role of Global Trade • Absolute Advantage (Adam Smith) • Comparative Advantage (David Ricardo) • Factor Proportions (Eli Heckscher und Bertil Ohlin) • International Product Cycle (Raymond Vernon) • Human skills/technology view • Income preference similarity (Lindner) • Economies of Scale (Paul Krugman) • Political Economy Models • Competitive Advantage of Nations (Michael Porter) • Phelps‘ Economic Dynamism

3. 2-2 1. Who Has What Absolute Advantage?

4. 2. Comparative Advantage Trade between two countries is beneficial even if one of the countries is inferior in producing all products as long as the degree of inferiority is not exactly the same for all products.

5. 3. Factor Proportions Theory “Production raises capital to the same level of importance as labor.” Eli Heckscher und Bertil Ohlin Countries that are relatively labor abundant (capital abundant) export labor intensive (capital intensive) goods and import capital intensive (labor intensive) goods. The factor proportions theory could not always be verified empirically. (Leontief Paradox)

6. 4. Human skills – technology view Essentially treats skilled labor (education, human capital) as a factor of production. Countries with a well-educated population have a comparative advantage producing innovative or technologically complex products.

7. 5. International Product Cycle Development of New Product in Developed Countries Product is Sold in Domestic Market and DCs As Product Matures, Export to LDCs Transfer of Knowledge As Maufacturing Process is increasingly Standardized, Production in LDCs Re-export to DCs

8. 5. International Product Cycle (Cont.) U.S. Invented Technology 9 0% Phonographs 1% 9 0% Color TVs 1 0% 1 9 7 0 4 0% Audiotape Recorders 0% N O W 1 0% Videotape Recorders 1% 9 9% Machine Tools 3 5% Telephones 9 9% 2 5% 8 9% Semiconductors 6 4% 9 8% Computers 7 4% 0 20 40 60 80 100

9. 2-3 5. International Product Cycle (Cont.) Advanced countries Exports Imports Quantity 1 5 10 15 Time NewProduct MaturingProduct StandardizedProduct Stages of production development Consumption Production Exhibit 2.1

10. 5. International Product Cycle (Cont.) Developing countries Exports Quantity Imports 1 5 10 15 Time NewProduct MaturingProduct StandardizedProduct Stages of production development Consumption Production

11. 5. International Product Cycle (Cont.) Less developed countries Exports Quantity Imports 1 5 10 15 Time NewProduct MaturingProduct StandardizedProduct Stages of production development Consumption Production

12. 5. International Product Cycle (Cont.) Usually, new products are invented in developed countries in order to satisfy the home market. As production increases above the home market demands, the country starts to export. As the production know-how gets more widespread these countries develop their own manufacturing capabilities. As low-cost production in these less developed countries gets under way, they start to export back to the original country.

13. 6. Income preference similarity (Lindner) Countries become skilled at producing products meeting desires of the domestic market • Devised to explain trade within developed world

14. 7. Economies of Scale Economies of scale lower production cost, lead to imperfect competition and potentially drive international trade.

15. 7. Economies of Scale (cont.) •Internal Economies of Scale Increasing production output lowers cost, which allows lower prices. Lower prices increase demand and production output. Eventually, company could monopolize industry, which explains intra industry trade. •External Economies of Scale Increasing size of an industry leads to a decrease of production cost for firms in that industry

16. 8. Political Economy Models Models try to explain and predict the economic development of countries Modernization Theory: Introduction of western technology and institutions will spur growth and trade. Popular model in 60ies and 70ies. Naïve assumptions influence U.S. foreign policy Vietnam, Korea, Iraq) Dependency Theory Developed by Latin American Economists, stating that LDCs will never be able to compete successfully with DCs. Nationalization and governmental control are only remedies.

17. 8. Political Economy Models (cont.) World Systems Similar to Dependency theory, it is assumed that DCs exploit LDCs because DCs control most markets and technologies. New Institutional Economics Transaction cost (the cost of an economic transaction) must be lowered in order to have prosperity. Corruption is important reason for high transaction costs.

18. 9. Competitive Advantage of Nations “National prosperity is created, not inherited. A nation’s competitiveness depends on the capacity of its industry to innovate and upgrade.Companies gain advantage against the world’s best competitors because of pressure and challenge. They benefit from having strong domestic rivals, aggressive home based suppliers, and demanding local customers” Michael Porter

19. 9. Competitive Advantage of Nations (cont.) Firm strategy, structure and rivalry Factorconditions Demandconditions Related and supporting industries

20. 9. Competitive Advantage of Nations (cont.) Competitive Advantage of Clusters • Clusters are geographic concentrations of interconnected • companies and institutions in a particular field. • - Clusters increase competition and cooperation • Clusters increase communication between companies and employees. Clusters decrease transaction cost by establishing trust. • Clusters increase productivity. Clusters offer access to skilled labor, local suppliers, and public institutions • Clusters offer a high potential for innovation. Companies in clusters are close to competition, customers, and public institutions. Employees might feel peer pressure.

21. Competitive Advantage of Clusters Strategic Implications: Choosing location not only based on input cost. Consideration of Potential for Innovation is a critical factor for long term success.

22. 10. Phelps‘ Economic Dynamism National prosperity depends on the dynamism of a nation's economic model. The economic dynamism of a country reflects its rate of commercially successful innovations. “The level of dynamism is a matter of how fertile the country is in coming up with innovative ideas having prospects of profitability, how adept it is at identifying and nourishing the ideas with the best prospects, and how prepared it is in evaluating and trying out the new products and methods that are launched onto the market” Edmund Phelps

23. 10. Phelps‘ Economic Dynamism (cont.) Economic Dynamism Economic Institutions - financial sector - consumer sector - education - governmental interventions - laws (labor, bankruptcy, tax, etc.) Economic Culture - values - norms - attitudes