Download Lecture_03 - Temple University

Int’l Bus Strategy
Lecture 3: The Global Business
Environment
© Ram Mudambi, Temple University, 2007
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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
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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
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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
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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
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 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%
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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).
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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
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Growth in Modern Times
© Ram Mudambi, Temple University, 2007
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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
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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
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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
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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.
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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
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The Influence of Free Trade on
the PPF
Cocoa
PPF2
Production point
Consumption point
PPF1
Export
Import
0
© Ram Mudambi, Temple University, 2007
Rice
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Is the mercantilist theory still
valid?
A qualified Yes.
Equate political power with economic
power and economic power with a trade
surplus.
Japan, China
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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
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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
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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
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First-Mover Advantage
Founded 1915 by William Boeing
Largest commercial airplane manufacturer
Over 9,000 commercial jetliners in service
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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
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Boeing vs. Airbus
Net plane orders
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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?”
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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
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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
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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
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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
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Trade Policy and Politics
Protecting jobs and industries:
emerging industries.
Increasing exports.
National security.
Retaliation.
International product domination:
New trade theory and subsidies.
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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
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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
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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
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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
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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
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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
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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
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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
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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
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