Download Comparative Advantage

UNIT II
Theories of International Trade and Investment
GLOBALIZATION

IMF
defines
globalization
as,
“the
growing
economic
interdependence of countries worldwide through increasing volume
and variety of cross border transactions in goods and services and
of international capital flows and also through the more rapid and
widespread diffusion of technology”
COMPONENTS OF GLOBALISATION
Globalization of
Markets
Globalization of
Production
Globalization of
Investment
Globalization of
Technology
GLOBALIZATION OF MARKETS

Globalization of markets refers to the process of integrating and
merging of the distinct world markets into a single market

EXAMPLE: Coca-Cola, Pepsi, McDonald’s burgers, Levis Jeans
etc.,
FEATURES:

Size of the company need not be too large

Distinction of national markets still prevail

Most of the foreign markets are markets for non-consumer goods
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REASONS FOR GLOBALIZATION OF MARKETS

Large scale industrialization enabled mass production

Risk reduction by diversification

Increase profits and achieve goals

Adverse business environment in home country

Demand for their products in foreign markets

Failure of domestic companies to cater the needs of customers
GLOBALIZATION OF PRODUCTION

Globalization of production is locating the manufacturing facilities in a
number of locations around the globe. EXAMPLE: Jet airlines Boeing 777 and
Swan opticals
REASONS:

Impositions of imports by the foreign country

Availability of high quality raw materials and components

Availability of inputs at low cost

Skilled human resource at low cost

Liberal labour laws

To reduce cost of transport

To cater to varying tastes of customers
GLOBALIZATION OF PRODUCTION

Globalization of investment refers to investment of capital by a global company
in any part of the world.
REASONS:

Increase in volume of global trade

Limitations of exporting and importing

Liberalization

Avoid restrictions
GLOBALIZATION OF TECHNOLOGY

Latest technology and distinctive competencies

Technological collaboration

Usage of technology by paying royalty
GLOBALIZATION
ADVANTAGES









Free flow of capital, technology
Industrialization
Production facilities throughout the
world
Increase in production and
consumption
Lower prices and high quality
Jobs and Incomes
Higher standard of living
Balanced Human development
Welfare and prosperity
DISADVANTAGES

Kills domestic business

Exploits human resource

Unemployment and
underemployment

Widening gap between rich and poor

Transfer of natural resources

National sovereignty at stake

Commercial and political colonialism
INTERNATIONAL BUSINESS
ENVIRONMENT
EXTERNAL
INTERNAL
Organisational
Organisational
Structure
Structure
Production
Finance
Marketing
External Micro
Environment
Shareholders
Creditors
HR
R&D
External Macro
Environment
Bankers &
Financial
Institutions
Competitors
Suppliers
Market &
Intermediary
Customers
Social
&Cultural
Factors
Technological
Factors
Economic
International
Factors
Versatile Business School, Egmore,
ChennaiFactors
- 600 008
Natural
Political
INTRODUCTION TO GATT

There were many barrier for free trade were laid down to support
the government expenditure

After II world war several international measures were undertaken
to liberalize trade and payment between nations

International
monetary
funds
and
international
bank
for
reconstruction and development were set up

International trade organization to deal with international trade
was sought to be set up

GATT (general agreement for trade and tariff)was set to liberalize
the trade and reduce the tariff amount
GATT







The General Agreement on Tariffs and Trade (GATT) was
originally created by the Bretton Woods Conference as part of
a larger plan for economic recovery after World War II.
The GATT’s main purpose was to reduce barriers to
international trade.
This was achieved through the reduction of tariff barriers,
quantitative restrictions and subsidies on trade through a
series of different agreements.
The GATT was an agreement, not an organization.
Originally, the GATT was supposed to become a full
international organization like the World Bank or IMF called
the International Trade Organization
The agreement was not ratified, so the GATT remained
simply an agreement.
The functions of the GATT have been replaced by the World
Trade Organization.

GATT trade rounds

Geneva Round – 1947
The first round’s duration was 7
months. 23 countries took part in the round. The main focus
was Tariffs Signing of GATT, 45,000 tariff concessions
affecting $10 billion of trade.

Annecy Round – 1949 The second round took place in 1949
in Annecy, France. 13 countries took part in the round. The
main focus of the talks was more tariff reductions.

Torquay Round – 1951 The third round occurred in
Torquay, England in 1950. 38 countries took part in the
round. 8,700 tariff concessions were made totaling the
remaining amount of tariffs to ¾ of the tariffs which were in
effect in 1948.

Geneva Round - 1955-1956 The fourth round returned to
Geneva in 1955 and lasted until May 1956. Twenty-six
countries took part in the round. $2.5 billion in tariffs were
eliminated or reduced.

Dillon Round - 1960-1962 The fifth round occurred once
more in Geneva and lasted from 1960-1962. The talks were
named after U.S. Treasury Secretary and former Under
Secretary of State, Douglas Dillion, who first proposed the
talks. 26 countries took part in the round. Along with
reducing over $4.9 billion in tariffs, it also yielded discussion
relating to the creation of the European Economic Community
(EEC).

Kennedy - 1964 The sixth round’s duration was 37
months. 62 countries took part in the round and the
main focus was Tariffs, Anti-dumping. Its achievement
was Tariff concessions worth $40 billion of world trade

Tokyo Round -
1973-1979 Reduced tariffs and
established new regulations aimed at controlling the
proliferation of non-tariff barriers and voluntary export
restrictions. 102 countries took part in the round.
Concessions were made on $190 billion worth.

Uruguay Round - 1986-1994 The Uruguay Round
began in 1986. It was the most ambitious round to date,
hoping to expand the competence of the GATT to
important new areas such as service, capital, intellectual
property, textiles, and agriculture. 123 countries took
part in the round. The Uruguay Round was also the first
set
of
multilateral
trade
negotiations
developing countries had played an active role
in
which
OBJECTIVES OF GATT

To raise standard of living

To ensure full employment and a large and steadily
growing volume of real income and effective demand

To develop the full use of the resource of the world

To expand production and international trade
ACTIVITIES OF GATT
Tariff bargaining
 Bargaining on non- tariff trade barriers
 Elimination of quantum restriction
 Settlement of disputes between contracting parties

WORLD TRADE ORGANIZATION

WTO was established on January 1, 1995

WTO is the embodiment of the Uruguay Round results
and the successor to GATT

Government became member of the WTO on its first day

As of December 2000 there are 142 members of the WTO
and 34 countries have an observer status

28 members are there in waiting list
FUNCTIONS OF WTO
Administering and implementing the multilateral and
plurilateral trade agreements which together make up
WTO
 Acting as a forum for multilateral trade negotiation
 Seeking to resolve trade disputes
 Overseeing national trade policies
 Cooperating with other international institution
involved in global policy making

DIFFERENCE BETWEEN GATT AND WTO

It is a set of rules and multilateral
agreement

It was designed with an attempt to

It is a permanent institution

It is established to serve its own purpose

Its activities are full and permanent

Its
establish International Trade Organization

It was applied on a provisional basis

Its
rules
are
applicable
to
trade
GATT
was
originally
in
a
multilateral
were added at a later stage
Its disputes settlement system was not
faster and automatic
applicable
to
trade
in
trade in related aspects of intellectual
property
instrument, but plurilateral agreement

are
merchandise and trade in services and
merchandise goods

rules

Its agreements are almost multilateral

Its disputes settlement systems is fast and
automatic
CLASSICAL COUNTRY-BASED TRADE
THEORIES
Mercantilism
 Absolute Advantage
 Comparative Advantage
 Comparative Advantage with Money
 Relative Factor Endowments

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FOUNDATION CONCEPTS
Comparative advantage
Superior features of a country that provide it
with unique benefits in global competition –
derived from either national endowments or
deliberate national policies
Competitive advantage
Distinctive assets or competencies of a firm –
derived from cost, size, or innovation strengths
that are difficult for competitors to replicate or
imitate
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MERCANTILISM
A country’s wealth is measured by its holdings of
gold and silver
 A country’s goal should be to enlarge holdings of
gold and silver by

Promoting exports
 Discouraging imports

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EXAMPLES OF NATIONAL COMPARATIVE ADVANTAGE
 Abundant,
low-cost labor in China
 Mass of IT workers in India
 Huge reserves of bauxite in Australia
 Abundant agricultural land in the USA
 Oil in Saudi Arabia
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EXAMPLES OF FIRM COMPETITIVE ADVANTAGE
Dell’s prowess (ability) in global supply chain
management
 Procter & Gamble’s skill in marketing
 Samsung’s leadership in flat-panel TV
 Apple’s design leadership in cell phones and personal
music players

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MODERN MERCANTILISM

Neomercantilists or protectionists





American Federation of Labor-Congress of Industrial
Organizations
Textile manufacturers
Steel companies
Sugar growers
Peanut farmers
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WHY NATIONS TRADE: CLASSICAL THEORIES
Mercantilism: the belief that national
prosperity is the result of a positive balance of
trade – maximize exports and minimize imports
 Absolute advantage principle: a country
should produce only those products in which it
has absolute advantage or can produce using
fewer resources than another country

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ABSOLUTE ADVANTAGE
Export those goods and services for which a
country is more productive than other countries
 Import those goods and services for which other
countries are more productive than it is

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One ton of
Cloth
Wheat
--------------------------------------------France
30
40
Germany
100
20
---------------------------------------------Example of Absolute Advantage (labor cost in
days of production for one ton)
DISADVANTAGES OF MERCANTILISM
 Confuses
the acquisition of treasure
with the acquisition of wealth
 Weakens the country because it robs
individuals of the ability
To trade freely
 To benefit from voluntary exchanges

 Forces
countries to produce products it
would otherwise not in order to
minimize imports
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WHY NATIONS TRADE: CLASSICAL THEORIES

Comparative advantage principle: it is
beneficial for two countries to trade even if one
has absolute advantage in the production of all
products; what matters is not the absolute cost of
production but the relative efficiency with which
it can produce the product.
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One ton of
Cloth
Wheat
--------------------------------------------France
30
40
Germany
10
20
---------------------------------------------Example of Comparative Advantage (labor cost
in days of production for one ton)
CLASSICAL THEORIES: FACTOR PROPORTIONS THEORY
Factor proportions (endowments) theory:
each country should produce and export products
that intensively use relatively abundant factors
of production, and import goods that intensively
use relatively scarce factors of production
 Examples:

China and labor
 USA and pharmaceuticals
 Canada and electric power

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RELATIVE FACTOR ENDOWMENTS_2

A country will have a comparative advantage in
producing products that intensively use resources
(factors of production) it has in abundance
China: labor
 Saudi Arabia: oil
 Argentina: wheat

6-36
MODERN FIRM-BASED TRADE THEORIES
Country Similarity Theory
 Product Life Cycle Theory
 Global Strategic Rivalry Theory
 Porter’s National Competitive Advantage

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FIRM-BASED TRADE THEORIES

Incorporate additional factors into explanations of
trade flows
Quality
 Technology
 Brand names
 Customer quality

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GROWTH OF FIRM-BASED THEORIES
Growing importance of MNCs
 Inability of the country-based theories to explain and
predict the existence and growth of intraindustry
trade
 Failure of Leontief and others to empirically validate
country-based Heckscher-Ohlin Theory

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FIRM-BASED TRADE THEORIES

Incorporate additional factors into explanations
of trade flows
Quality
 Technology
 Brand names
 Customer quality

6-40
COUNTRY SIMILARITY THEORY

Explains the phenomenon of intraindustry trade

Trade between two countries of goods produced by
the same industry
Japan exports Toyotas to Germany
 Germany exports BMWs to Japan

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COUNTRY SIMILARITY THEORY_2
Trade results from similarities of preferences
among consumers in countries that are at the
same stage of economic development
 Most trade in manufactured goods should be
between countries with similar per capita
incomes

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PRODUCT LIFE CYCLE THEORY
Describes the evolution of marketing strategies
 Stages

New product
 Maturing product
 Standardized product

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FIGURE 6.4 THE INTERNATIONAL PRODUCT
LIFE CYCLE: INNOVATING FIRM’S COUNTRY
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FIGURE 6.4 THE INTERNATIONAL PRODUCT
LIFE CYCLE: OTHER INDUSTRIALIZED
COUNTRIES
6-45
FIGURE 6.4 THE INTERNATIONAL PRODUCT
LIFE CYCLE: LESS DEVELOPED COUNTRIES
SUSTAINING COMPETITIVE ADVANTAGE
Owning intellectual property rights
 Investing in research and development
 Achieving economies of scale or scope
 Exploiting the experience curve

6-47
PORTER’S NATIONAL
COMPETITIVE ADVANTAGE

Success in trade comes from the interaction of four
country and firm specific elements
Factor conditions
 Demand conditions
 Related and supporting industries
 Firm strategy, structure, and rivalry

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FIGURE 6.5 PORTER’S DIAMOND OF
NATIONAL COMPETITIVE ADVANTAGE
Firm Strategy,
Structure,
and Rivalry
Factor
Conditions
Demand
Conditions
Related and
Supporting
Industries
6-49
HOW NATIONS ENHANCE COMPETITIVE ADVANTAGE
The contemporary view suggests that
governments can proactively implement policies
to enhance a nation’s competitive advantage,
beyond the natural endowments the country
possesses
 Governments can create national economic
advantage by: stimulating innovation, targeting
industries for development, providing low-cost
capital, minimizing taxes, investing in IT, etc.

50
MICHAEL PORTER’S DIAMOND MODEL:
SOURCES OF NATIONAL COMPETITIVE ADVANTAGE
1.
2.
3.
4.
Firm strategy, structure, and rivalry – the presence
of strong competitors at home serves as a national
competitive advantage
Factor conditions – labor, natural resources, capital,
technology, entrepreneurship, and know how
Demand conditions at home – the strengths and
sophistication of customer demand
Related and supporting industries – availability of
clusters of suppliers and complementary firms with
distinctive competences
51
INDUSTRIAL CLUSTERS



A concentration of suppliers and supporting firms
from the same industry located within the same
geographic area
Examples include: the Silicon Valley, fashion
cluster in northern Italy, pharma cluster in
Switzerland, footwear industry in Pusan, South
Korea, and the IT industry in Bangalore, India
Can serve as a nation’s export platform
53
NATIONAL INDUSTRIAL POLICY
Proactive economic development plan enacted by the government to
nurture or support promising industries sectors.
Typical initiatives:
 Tax incentives
 Investment incentives
 Monetary and fiscal policies
 Rigorous educational systems
 Investment in national infrastructure
 Strong legal and regulatory systems
(Examples: Japan, Dubai, and Ireland)
54
DOMINANCE OF FDI-BASED EXPLANATIONS OF THE INTERNATIONAL FIRM


Most IB theories about the firm emphasize the
MNE, since it was long the major player in
international business.
Foreign direct investment (FDI) is the main
strategy used by MNEs in international
expansion; thus, earlier theories emphasized
motives for, and patterns of, FDI
55
FDI BASED EXPLANATIONS:
MONOPOLISTIC ADVANTAGE THEORY
Suggests that FDI is preferred by MNEs because
it provides the firm with control over resources
and capabilities in the foreign market, and a
degree of monopoly power relative to foreign
competitors
 Key sources of monopolistic advantage include
proprietary knowledge, patents, unique knowhow, and sole ownership of other assets

56
FDI BASED EXPLANATIONS:
INTERNALIZATION THEORY


Explains the process by which firms acquire and
retain one or more value-chain activities inside
the firm – retaining control over foreign
operations and avoiding the disadvantages of
dealing with external partners.
In contrast to arm’s-length entry strategies (such
as exporting and licensing) which imply
developing contractual relationships with
external business partners, FDI provides the firm
with control and ownership of resources
57
FDI BASED EXPLANATIONS:
DUNNING’S ECLECTIC PARADIGM
Three conditions determine whether or not a company will
internalize via FDI:
1.
Ownership-specific advantages – knowledge, skills,
capabilities, relationships, or physical assets that form
the basis for the firm’s competitive advantage
2.
Location-specific advantages – advantages associated
with the country in which the MNE is invested,
including natural resources, skilled or low cost labor,
and inexpensive capital
3.
Internalization advantages – control derived from
internalizing foreign-based manufacturing, distribution,
or other value chain activities
58
NON-FDI BASED EXPLANATIONS:
INTERNATIONAL COLLABORATIVE VENTURES



While FDI-based internationalization is still common,
beginning in the 1980s firms have emphasized nonequity, flexible collaborative ventures to
internationalize.
Collaborative venture: a form of cooperation between
two or more firms. Through collaboration, a firm can
gain access to foreign partner’s know-how, capital,
distribution channels, and marketing assets, and
overcome government imposed obstacles.
Venture partners share the risk of their joint efforts,
and pool resources and capabilities to create synergy.
59
TWO TYPES OF
INTERNATIONAL COLLABORATIVE VENTURES
1.
Equity-based joint ventures result in the formation
of a new legal entity. Here, the firm collaborates with
local partner(s) to reduce risk and commitment of
capital.
2.
Project-based alliances involve cooperation in R&D,
manufacturing, design, or any other value-adding
activity, a partnership aimed at a narrowly defined
scope of activities and timeline
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