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Int’l Bus Strategy Lecture 3: The Global Business Environment © Ram Mudambi, Temple University, 2007 1 Learning Objectives Understanding the historical evolution of the international trade theories Understanding the politics and economics underlying the international business environment © Ram Mudambi, Temple University, 2007 2 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 Through 1700s 1776, Smith 1817, Ricardo 1920s 1966, Vernon 1980s 1990s Definitions Output per capita = GDP divided by population Standard of living depends on (among other things) the evolution of output per capita. Purchasing power parity (PPP) = adjustment when comparing output figures across countries. The Penn World Tables © Ram Mudambi, Temple University, 2007 4 capita per Output Real Income per Person A Growth History of the World $6,000 $5,000 Large-scale ocean-borne Trade Industrial revolution Technology $4,000 $3,000 $2,000 $1,000 $0 0 500 1000 1500 2000 Date © Ram Mudambi, Temple University, 2007 5 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 © Ram Mudambi, Temple University, 2007 6 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 1950s 1990s Employment in agriculture 77% 20% Manufacturing share of GNP 10% 30% © Ram Mudambi, Temple University, 2007 7 The Impact of Trade Policies Ghana 1970 GNP/capita • $250 1997 GNP/per capita • $370 Korea 1970 GNP/per capita • $260 1997 GNP/per capita • $10,550 GNP Growth/year GNP Growth/year • 1.5% (1997) • 5.1% (1997) Shift from comparative advantage uses (cocoa) to non-comparative advantage uses (subsistence agriculture). © Ram Mudambi, Temple University, 2007 Shift from non-comparative advantage uses (agriculture) to comparative advantage uses (labor-intensive manufacturing). 8 The Impact of Trade Policies Brazil 1970 GNP/per capita • $1,145 1997 GNP/per capita • $4,720 Korea 1970 GNP/per capita • $260 1997 GNP/per capita • $10,550 GNP Growth/year GNP Growth/year • 1.1% (1997) • 5.1% (1997) Blanket policies for the entire economy Policy characterized by crisis management © Ram Mudambi, Temple University, 2007 Specific policies for export sector. Strategic policy continuity 9 Growth in Modern Times © Ram Mudambi, Temple University, 2007 10 An Overview of Trade Theory Free Trade occurs 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 Trade allow 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). © Ram Mudambi, Temple University, 2007 11 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 © Ram Mudambi, Temple University, 2007 12 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. © Ram Mudambi, Temple University, 2007 13 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. © Ram Mudambi, Temple University, 2007 14 The Production Possibility Frontier* Cocoa PPF2 *Diminishing returns mean that the PPF is curved Production point = Consumption point PPF1 0 © Ram Mudambi, Temple University, 2007 Rice 15 The Influence of Free Trade on the PPF Cocoa PPF2 Production point Consumption point PPF1 Export Import 0 © Ram Mudambi, Temple University, 2007 Rice 16 Is the mercantilist theory still valid? A qualified Yes. Equate political power with economic power and economic power with a trade surplus. Japan, China © Ram Mudambi, Temple University, 2007 17 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. © Ram Mudambi, Temple University, 2007 18 International Product Trade Cycle Model production High Income Countries Exports Q u a n t i t y 1 2 3 4 Imports 5 6 7 8 9 10 Medium Income Countries 11 12 13 14 consumption 15 Exports Imports 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Low Income Countries Exports Imports 1 2 3 4 New Product 5 6 7 8 9 Maturing Product 10 11 12 13 14 15 Standardized Product Stages of Production Development Time 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 © Ram Mudambi, Temple University, 2007 20 First-Mover Advantage Founded 1915 by William Boeing Largest commercial airplane manufacturer Over 9,000 commercial jetliners in service © Ram Mudambi, Temple University, 2007 21 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 © Ram Mudambi, Temple University, 2007 22 Boeing vs. Airbus Net plane orders © Ram Mudambi, Temple University, 2007 23 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?” © Ram Mudambi, Temple University, 2007 24 Porter’s Diamond Determinants of National Competitive Advantage •Creation and organization of firms •Antitrust Firm Strategy, Structure and Rivalry Factor Endowments Key items: •Skilled labor •Technology •Economies of scale •Discerning customers Demand Conditions Related and Supporting Industries Policy and Luck Chance Company Strategy, Structure, and Rivalry Two external factors that influence the four determinants. Factor Conditions Government © Ram Mudambi, Temple University, 2007 Demand Conditions Related and Supporting Industries 26 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) 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 © Ram Mudambi, Temple University, 2007 28 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 © Ram Mudambi, Temple University, 2007 29 US Targets EU Beef Pork Sausages Corned Beef Roquefort Cheese Chocolate Products Mustards Chewing Gum © Ram Mudambi, Temple University, 2007 Soups and Broths Truffles Mineral Water Cut Flowers Yarn Electric Hair Clippers Motorcycles and Mopeds 30 Trade Policy and Politics Protecting jobs and industries: emerging industries. Increasing exports. National security. Retaliation. International product domination: New trade theory and subsidies. © Ram Mudambi, Temple University, 2007 31 Instruments of Trade Policy Tariffs Subsidies Quotas and voluntary export restraints (VERs) Local content requirements (LCRs) Anti-dumping policies Administrative policies © Ram Mudambi, Temple University, 2007 32 Instruments of Trade Policy Tariffs Tariffs - oldest form of trade policy Specific ad valorem Good for government Good for producers But reduces efficiency Bad for consumers © Ram Mudambi, Temple University, 2007 33 Instruments of Trade Policy Subsidies 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. © Ram Mudambi, Temple University, 2007 34 Instruments of Trade Policy Import Quotas 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. © Ram Mudambi, Temple University, 2007 35 Instruments of Trade Policy Local 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. © Ram Mudambi, Temple University, 2007 36 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. © Ram Mudambi, Temple University, 2007 37 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. © Ram Mudambi, Temple University, 2007 38 Instruments of Trade Policy Administrative Policies Bureaucratic rules designed to make it difficult for imports to enter a country. Japanese ‘masters’ in imposing rules. Unit inspections • Tulip bulbs • Cars © Ram Mudambi, Temple University, 2007 39 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 © Ram Mudambi, Temple University, 2007 40