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Chapter 6
International Business: The New Realities, 3rd Edition
by
Cavusgil, Knight, and Riesenberger
Copyright © 2014 Pearson Education Inc.
Learning Objectives
1. Theories of international trade and investment
2. Why do nations trade?
3. How can nations enhance their competitive
advantage?
4. Why and how do firms internationalize?
5. How can internationalizing firms gain and sustain
competitive advantage?
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Theories of International Trade and Investment
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Theories of International Trade and Investment
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Theories of International Trade and Investment
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Mercantilism and Neomercantilism
• Mercantilism: A belief popular in the 16th century
that national prosperity results from maximizing
exports and minimizing imports.
• Today, some argue for neomercantilism --- the idea
that the nation should run a trade surplus.
• Supporters of neomercantilism include:
 Labor unions (who want to protect domestic jobs),
 Farmers (who want to keep crop prices high), and
 Some manufacturers (that rely on exports).
But is neomercantilism best for all?
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Free Trade
The absence of restrictions to the
flow of goods and services among nations.
• Free trade is usually best because it leads to:
 More and better choices for consumers and firms
 Lower prices of goods for consumers and firms
 Higher profits and better worker wages (because
imported input goods are usually cheaper)
 Higher living standards for consumers (because their
costs are lower).
 Greater prosperity in poor countries.
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Comparative Advantage
• The foundation concept of international trade that
answers the question of how nations can achieve
and sustain economic success and prosperity.
• It refers to the superior features of a country that
provide it with unique benefits in global competition.
• Comparative advantages are derived either from
natural endowments or from deliberate national
policies.
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Examples of National Comparative Advantage
• France has a climate and soil superior for producing
wine.
• Saudi Arabia has a natural abundance of oil for the
production of petroleum products.
• Over time, Japan has acquired a superior base of
knowledge and experience for producing cars.
• Over time, India has acquired a superior base of IT
workers for producing computer software.
What are the comparative advantages in your country?
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Competitive Advantage
• A foundation concept that explains how individual
firms gain and maintain distinctive competencies,
relative to competitors, that lead to superior
performance.
• It refers to the distinctive assets, competencies, and
capabilities that are developed or acquired by the
firm.
• The collective competitive advantages held by the
firms in a nation are the basis for the competitive
advantages of the nation at large.
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Examples of Firm Competitive Advantage
• Dell’s prowess in the management of its global
supply chain
• Samsung’s technological leadership in flat-panel
televisions
• Cadbury’s capabilities in international
marketing and distribution
• Herman Miller’s design strengths in
office furniture (e.g., Aeron chairs)
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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
(Labor Cost in Days of Production for One Ton)
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France
Germany
4 5 6 7
A
1
One Ton of
Cloth Wheat
France
6
8
Germany
10
4
B
2 3
Cloth
8
Labor
days
9 10
Example of Absolute Advantage
1
2 3
4 5 6 7
Wheat
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8
9 10 Labor
days
Adam Smith (1723-1790)
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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
(Labor Cost in Days of Production for One Ton)
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France
Germany
4 5 6 7
B
1
One Ton of
Cloth Wheat
France
8
6
Germany
2
4
A
2 3
Cloth
8
Labor
days
9 10
Example of Comparative Advantage
1
2 3
4 5 6 7
Wheat
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8
9 10 Labor
days
Comparative Advantage Principle (cont’d)
“Two men can make both shoes and hats, and one is superior
to the other in both employments, but in making hats he can
only exceed his competitor by one fifth or 20 percent, and in
making shoes he can excel him by one third or 33 percent;
Will it not be for the interest of both that the superior man
should employ himself exclusively in making shoes and the
inferior man in making hats?”
David Ricardo, 1817
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Comparative Advantage Principle (cont’d)
• While Germany can make both items cheaper than France,
it is still beneficial for Germany to trade with France.
• The key is the ratio of production costs. In the exhibit,
Germany is comparatively more efficient at producing cloth
than wheat: it can produce three times as much cloth as
France (30/10), but only two times as much wheat (40/20).
• Germany should specialize in producing cloth and import all
the wheat it needs from France. France should specialize in
producing wheat and import all its cloth from Germany.
• Each country benefits by specializing in the product in
which it has a comparative advantage and importing the
other product.
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Comparative Advantage Principle (cont’d)
• The principle applies to all goods. It reveals how
countries use scarce resources more efficiently.
Example
•Arguably, no country is better than Japan at making
cars and cell phones. But because Japan is especially
good at making cars, it concentrates its resources on
making them.
•Other countries, such as China and Finland, focus on
making cell phones.
•In this way, Japan makes maximal use of its
resources, and the world gets great cars.
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Comparative Advantage Principle (cont’d)
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Limitations of Early Trade Theories
• Fail to account for international transportation costs.
• Governments distort normal trade by selectively
imposing protectionism (e.g., tariffs) or investing in
certain industries (e.g., via subsidies).
• Services: Some cannot be traded; others can be traded
freely via the Internet or global telephony.
• For many firms, scale economies and superior
business strategies provide efficiencies and other
advantages. Early trade theories failed to account for
this. (E.g., Japan lacks comparative advantages, but its
firms succeeded anyway, via superior strategies.)
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Factor Proportions Theory
• Also known as the factor endowments theory, it
argues that 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.
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Factor Proportions Theory
• Also known as the factor endowments theory, it
argues that 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.
• However, the Leontief Paradox revealed that
countries can successfully export products that use
less abundant resources (e.g., the U.S. often exports
labor-intensive goods). Implies that international
trade is complex and cannot be fully explained by a
single theory.
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International Product Life Cycle Theory
• Each product and its associated manufacturing
technologies go through three stages of evolution:
introduction, maturity, and standardization.
• In the introduction stage, the inventor country enjoys
a monopoly both in manufacturing and exports.
Example: The television set.
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International Product life Cycle Theory (cont’d)
• Each product and its associated manufacturing
technologies go through three stages of evolution:
introduction, maturity, and standardization.
• In the maturity stage, the product’s manufacturing
becomes relatively standardized; other countries
start producing and exporting the product.
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International Product life Cycle Theory (cont’d)
• Each product and its associated manufacturing
technologies go through three stages of evolution:
introduction, maturity, and standardization.
• In the standardization stage, manufacturing ceases
in the original innovator country, which then becomes
a net importer of the product. Today under globalization, for many products, the cycle occurs quickly.
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New Trade Theory
• Argues that economies of scale are an important
factor in some industries for superior international
performance, even in the absence of superior
comparative advantages. Some industries succeed
best as their volume of production increases.
Example
The commercial aircraft industry has very high fixed
costs that necessitate high-volume sales to achieve
profitability.
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Comparative vs. Competitive Advantage
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Critical Role of Innovation
in National Economic Success
• Innovation is a key source of competitive advantage.
• The firm innovates in four major ways. It can
develop:
(1) A new product or improve an existing product
(2) New ways of manufacturing
(3) New ways of marketing
(4) New ways of organizing company operations.
• Many innovative firms in a nation leads to national
competitive advantage
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Critical Role of Productivity
in National Economic Success
• Productivity is the value of the output produced by a
unit of labor or capital.
• It is a key source of competitive advantage for firms.
• The greater the productivity of the firm, the more
efficiently it uses its resources.
• The greater the aggregate productivity of the firms in
a nation, the more efficiently the nation uses its
resources.
• Aggregate productivity is a key determinant of the
nation’s standard of living.
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Productivity Levels in Selected Countries
(Output per hour in manufacturing, 1990–2010; Indices, where 2002=100)
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Michael Porter’s Diamond Model:
Sources of National Competitive Advantage
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Diamond Model
Sources of National Competitive Advantage (cont’d)
• Factor conditions – Quality and quantity of labor,
natural resources, capital, technology, know-how,
entrepreneurship, and other factors of production.
Example
An abundance of cost-effective and well-educated
workers give China a competitive advantage in the
production of laptop computers.
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Diamond Model
Sources of National Competitive Advantage (cont’d)
• Related and supporting industries – the presence
of suppliers, competitors, and complementary firms
that excel within a given industry.
Example
The Silicon Valley in California is a great place to
launch a computer software firm because it is home
to thousands of knowledgeable firms and workers in
the software industry.
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Diamond Model
Sources of National Competitive Advantage (cont’d)
• Demand conditions at home – the strengths and
sophistication of customer demand.
Example
Japan is a densely populated, hot, and humid country
with very demanding consumers. These conditions
led Japan to become one of the leading producers of
superior, compact air conditioners.
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Diamond Model
Sources of National Competitive Advantage (cont’d)
• Firm strategy, structure, and rivalry – The nature of
domestic rivalry, and conditions that determine how a
nation’s firms are created, organized, and managed.
Example
Italy has many top firms in
design industries such as
textiles, furniture, lighting, and
fashion. Vigorous competitive
rivalry puts these firms under
constant pressure to innovate,
which has propelled Italy to a
leading position in design,
worldwide.
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Industrial Cluster
• A concentration of suppliers and supporting firms
from the same industry located within the same
geographic area. Similar to Porter’s Related and
Supporting Industries.
• A strong cluster can serve as an export platform for
the nation.
Examples
Silicon Valley; pharmaceutical cluster in Switzerland;
footwear industry in Pusan, South Korea; IT industry in
Bangalore, India; fashion cluster in northern Italy; and
Silicon Valley North near Ottawa, Canada.
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National Industrial Policy
• A proactive economic development plan
employed by the government to nurture or
support promising industry sectors with potential
for regional or global dominance. Initiatives can
include:
 Tax incentives
 Monetary and fiscal policies
 Rigorous educational systems
 Investments in national infrastructure
 Strong legal and regulatory systems
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Examples of National Industrial Policy
• Vietnam’s government in the 1990s privatized state
enterprises and modernized the economy,
emphasizing competitive, export-driven industries.
Vietnam became one of the fastest-growing
economies, averaging around 8 percent annual GDP
growth.
• Singapore adopted probusiness, proinvestment,
export-oriented policies, combined with statedirected investments in strategic corporations. The
approach stimulated economic growth that averaged
8 percent annually from 1960 to 1999.
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Examples of National Industrial Policy (cont’d)
• The Czech government in the 1990s created a
business-friendly legal and regulatory environment.
The country privatized state-owned companies.
Government FDI incentives attracted numerous
MNEs, such as Daewoo, ING, Siemens, and Toyota.
• New Zealand’s government, starting in 1984,
transformed the country from an agrarian,
protectionist, regulated economy to an industrialized,
free-market economy that today competes globally.
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Transformation of New
Zealand’s Economy, 1992 to 2012
Statistic
New Zealand in 1992
New Zealand in 2012
GDP per capita
51% of the G7 average
89% of the G7 average
Unemployment rate
9.8%
5.6%
National debt
89% of the nation’s GDP
30% of the nation’s GDP
New Zealand’s success resulted from:
• Implemented various pro-business policies – fiscal,
monetary, tax; investment in education
• Emphasized high-value industries, such as IT and
pharmaceuticals, that greatly grew GDP and reduced
unemployment.
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New Zealand (cont’d)
• Government-controlled wages, prices, and interest rates
were freed and allowed to fluctuate with market forces.
• The banking sector was liberalized, foreign exchange
controls were eliminated, and the New Zealand dollar
was allowed to float according to market forces.
• Most trade barriers were removed, and New Zealand
joined several free trade agreements.
• Agricultural and other subsidies were eliminated.
• The government worked earnestly with labor unions to
reduce wage inflation, helping maintain jobs in New
Zealand and minimizing outsourcing.
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New Zealand (cont’d)
• The government initiated programs to encourage
development of a knowledge economy. New Zealanders
continuously upgraded skills and knowledge, providing a
supply of scientists, engineers, and trained managers.
• Personal and corporate income tax rates were cut. The
tax base was diversified to stabilize government
revenues. This helped foster entrepreneurship, boost
consumer spending, and attract FDI into New Zealand.
• The government cut spending and borrowing, leading to
lower interest rates and stimulating the economy.
• State-owned enterprises – such as the national airline,
telecom, and other utilities – were privatized.
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Stages in Company Internationalization
Domestic Focus
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Stages in Company Internationalization
Domestic Focus
Pre-export Stage
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Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Experimental Involvement
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Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Experimental Involvement
Active Involvement
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Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Experimental Involvement
Active Involvement
Committed Involvement
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Stock of Inward
FDI: Leading FDI
Destinations
(Billions of U.S.
dollars) and
Percentage
Growth,
2000 to 2010
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Stock of
Outward FDI:
Top Sources of
Outward FDI
(Billions of U.S.
dollars) and
Percentage
Growth,
2000 to 2010
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How Firms Gain and Sustain
International Competitive Advantage
• Since the MNE was traditionally the major player in
international business, scholars have offered
numerous explanations of what makes these firms
pursue, and succeed in, internationalization
• Because FDI has been MNEs’ main strategy in
international expansion, theoretical explanations
have tended to emphasize it.
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FDI Based Explanations:
Monopolistic Advantage Theory
• Argues that MNEs prefer FDI because it provides
the firm with control over resources and capabilities
in the foreign market and a degree of monopolistic
power relative to foreign competitors.
• Key sources of monopolistic advantage include
proprietary knowledge, patents, unique know-how,
and sole ownership of other assets
Example
Novartis earns substantial profits by marketing various
patent medications through its subsidiaries worldwide.
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FDI Based Explanations:
Internalization Theory
• Explains how the MNE chooses to acquire and retain
one or more value-chain activities inside itself.
• Such ‘internalization’ provides the MNE with greater
control over its foreign operations.
• Internalization avoids the drawbacks of dealing with
external partners, such as reduced quality control
and the risk of losing proprietary assets to outsiders.
Example
In China, Intel owns much of its value chain, to ensure
that Intel knowledge, patents, and other assets are not
misused or illicitly obtained by potential rivals.
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FDI Based Explanations:
Dunning’s Eclectic Paradigm
• Three conditions determine whether or not a
company will enter a given foreign country via FDI:
1. Ownership-specific advantages – knowledge, skills,
capabilities, relationships, or physical assets that the firm
owns and which are the basis of its competitive
advantages
2. Location-specific advantages – similar to comparative
advantages, they are specific advantages that exist in the
country that the MNE has entered, or is seeking to enter,
such as natural resources, low-cost labor, or skilled labor
3. Internalization advantages – control derived from
internalizing foreign-based manufacturing, distribution, or
other value chain activities
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Example of the Eclectic Paradigm: Sony in China
• Ownership Specific Advantages. Sony possesses
a huge stock of knowledge and patents in the
consumer electronics industry, as represented by
products like the Playstation and Vaio laptop.
• Location Specific Advantages. Sony desires to
manufacture in China to take advantage of China’s
low-cost, highly knowledgeable labor.
• Internalization Advantages. Sony wants to
maintain control over its knowledge, patents,
manufacturing processes, and quality of its products.
Thus, Sony entered China via FDI
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Non-FDI Based Explanations:
International Collaborative Ventures
• A form of cooperation between two or more firms.
Partners pool resources and capabilities to create
synergies and share the risk of joint efforts.
• Starting in the 1980s, firms increasingly began using
collaborative ventures to expand abroad.
• Collaboration provides access to foreign partners’
know-how, capital, distribution channels, or
marketing assets and helps overcome government
imposed obstacles.
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Two Types of
International Collaborative Ventures
• Equity-based joint ventures result in the formation
of a new legal entity. In contrast to the wholly-owned
FDI, the firm collaborates with local partner(s) to
reduce risk and commitment of capital.
• Project-based alliances do not require equity
commitment from the partners but simply a
willingness to cooperate in R&D, manufacturing,
design, or any other value-adding activity. Since
project-based alliances have a narrowly defined
scope of activities and timeline, they provide greater
flexibility to the firm than equity-based ventures.
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