Stamford University Bangladesh

Department of Business Administration 744, Satmosjid Road Dhanmondi, Dhaka MBA Program

Subject: International Business (BUS 570)

Course Teacher: Mostafa Saidur Rahim Khan

Engr. Mohd. Abdus Sattar MBA 044 12301

Chapter 6 International Trade and Factor Mobility Theory

1. INTERVENTIONIST THEORIES Export or import of a country is totally or largely controlled by government. 1.1. MERCANTILISM This theory formed the foundation of economic though from about 1500-1800 BC. According to the theory, countries should export more than they import and, if successful, receive gold from countries that run deficits. 1.2. NEOMERCANTILISM A country that practices neomercantilism attempts to run an export surplus to achieve a social or political objective. For instance, a country may try to achieve full employment by setting economic policies that encourages its companies to produce in excess of demand at home and to send the surplus abroad. 2. FREE TRADE THORIES 2.1. ABSOLUTE ADVANTAGE THEORY Smith developed the theory of absolute advantage, which holds that different countries produce some goods more efficiently than other countries; thus global efficiency can increase through free trade. For example, if a country A produce rice more efficiently than country B and Country B produce wheat more efficiently than country A; Then according to Adam Smiths absolute advantage theory, country A will produce only rice and country B will produce only wheat. Country A will import wheat from country B and in the same way country B will import rice from country A. Through specialization, countries could increase their efficiency because of three reasons: 1. Labor could become skilled by repeating the same tasks. 2. Labor would not lose time in switching from the production of one kind of product to another. 3. Long production runs would provide incentives for the development of more effective working methods. Free trade will bring: Specialization Greater efficiency Higher global output Although Smith believed the marketplace would make the determination, he thought that a countrys advantage would be either natural or acquired. 2.1.1. NATURAL ADVANTAGE 1


A country may have natural advantage in producing a product because of climatic conditions, access to certain natural resources, or availability of certain labor forces. The countrys climate may dictate, for example, which agricultural products it can produce efficiently, e.g. Costa Ricas climate supports the production of coffee, bananas, and pineapples. 2.1.2. ACQUIRED ADVANTAGE Acquired advantage theory consists of either product or process technology that enables a country to produce a unique product or one that is easily distinguished from those of competitors. For example, Denmark exports silver tableware, not because there are rich Danish silver mines but Danish companies have developed distinctive products. 2.2. COMPARATIVE ADVANTAGE THEORY In 1817, David Ricardo examined this question: What happens when one country can produce all products at an absolute advantage? and developed the theory of comparative advantage. This theory says that global efficiency gains may still results from trade if a country specializes in those products it can produce more efficiently than other products-regardless of whether other countries can produce those same products even more efficiently. For example, If a country X is apparently efficient in producing Rice as well as Wheat but in real sense, it has comparative advantage of producing only rice (say labor or transportation cost is less) then according to comparative advantage theory global efficiency will increase if country X produces only Rice. 2.3. ASSUMPTIONS AND LIMITATIONS OF FREE TRADE/SPECIALIZATION THEORIES 1. Full Employment The theories of absolute advantage and comparative advantage both assume that resources are fully employed which is not a valid assumption. 2. Economic Efficiency Countries goals may not be limited to economic efficiency. They may avoid overspecialization because of the vulnerability created by changes in technology and by price fluctuations. Share of gains is not equal.

3. Divisions of Gains

4. Two Countries, Two Commodities For simplicitys sake, both Smith and Recardo originally assumed a simple world composed of only two countries and two commodities which is unrealistic. 5. Transport Cost Transportation costs sometimes dampen the gains from trade.


6. Statics and Dynamics Efficiency level of any country can change at any time. So, the theory is valid only for static country, not a dynamic country. The theories of absolute advantage and comparative advantage deal with products rather than services. The theories of absolute advantage and comparative advantage assume that resources can move domestically from the production of one good to another-and at no cost. But this assumption is not completely valid.

7. Services 8. Mobility

3. TRADE PATTERN THEORIES The free trade theories of absolute advantage and comparative advantage demonstrate how economic growth occurs through specialization and trade; however, they do not deal with issues such how much a country will depend on trade if it follows a free trade policy, what types of products countries will export and import, and with which partner countries will primarily trade. These draw backs are explained in trade pattern theories. 3.1. HOW MUCH DOES A COUNTRY TRADE? Theory of Country Size: The theory of country size holds that large countries usually depend less on trade than small countries. Countries with large land areas are apt to have varied climates and an assortment of natural resources, making them more self-sufficient than smaller countries. Size of Economy: The worlds top 10 exporters and importers are all developed countries except for China. China, although not a developed country, has a very large economy by virtue of its large population. In fact, these countries account for over half the worlds exports and imports. 3.2. WHAT TYPES OF PRODUCTS DOES A COUNTRY TRADE? Factor-Proportions Theory: Swedish economists Eli Heckscher and Bertil Ohlin developed factor-proportions theory, which is based on countries production factors-land, labor, and capital. This theory holds that a countrys relative endowment of land, labor, and capital will determine the relative cost of these factors. These factors, in turn, determine which goods the country can produce most efficiently which means the factors in relative abundance are cheaper than factors in relative scarcity. Production Technolgy: Production technology helps explain where products are made. For instance, Bangladesh produce rice by using a smaller number of machines in comparison to its abundant and cheap labor. In contrast, Italy produces rice with a capital-intensive method because of its abundance of low cost capital relative to labor. 3


3.3. WITH WHOM DO COUNTRIES TRADE? Country-Similarity Theory: According to country-similarity theory, most trade occurs among high-income countries because they share similar market characteristics and because they produce and consume so much more than emerging countries. This theory says that once a company has developed a new product in response to observed market conditions in its home market, it turns to markets it sees as most similar to those at home. The effects of Distance: The geographic distance between two countries accounts for many of the world trade relationships. Greater distances usually mean higher transportation costs; thats why Intels cost to ship semiconductors from Costa Rica to USA is lower than if had bring them from Argentina. 4. PRODUCT LIFE CYCLE(PLC) THEORY According to the PLC theory of trade, the production location for many products moves from one country to another depending on the stage in the products life cycle. The Product Life Cycle consists of four stages: Introduction Growth Maturity, and Decline Life Cycle of the International Product:
Basis 1
1. Production Location

2. Market Location

1. Introduction stage 2 In innovating (usually industrial) country. Mainly in innovating country with come export.

2. Growth Stage 3 In innovating and other industrial countries. Mainly in industrial countries. Shift in export markets as foreign production replaces exports in some markets Fast-moving demand Number of competitors increases. Some competitors begin price cutting. Product becoming more standardized.

3. Maturity Stage 4 Multiple Countries

Growth

in developing countries. Some decrease in industrial countries. Overall stabilized demand. Number of competitors decreases. Price is very important especially in developing countries.

4. Decline Stage 5 Mainly in developing countries. Mainly in developing countries. Some developing country exports. Overall declining demand. Price is key weapon. Number producers continues decline. of to

3. Competitive Factors

Near monopoly
position. Sales based on uniqueness rather than price. Evolving product Characteristics.


4. Production Technology

Short production runs. Evolving methods to coincide with product evolution. High labor input and labor skills relative to capital input.

Capital increases.

input

Methods

more

standardized.

Long production runs using high capital inputs. Highly standardized. Less labor skills needed.

Unskilled labor on mechanized long production runs.

4.1. INTRODUCTION The Introduction stage is marked by Innovation in response to observed need, Exporting by the innovative country, Evolving Product Characteristics. 4.2. GROWTH The Growth stage is characterized by Increases in exports by the innovating country. More competition Increased capital intensity Some foreign production 4.3. MATURITY The Maturity stage is characterized by Decline in exports from the innovating country More product standardization More capital intensity Increased competitiveness of price Production start-ups in emerging countries 4.4. DECLINE The Decline stage is characterized by Production increased in emerging economies Innovating country becoming net importer VERIFICATION AND LIMITATIONS OF PLC THEORY High transportation costs limit export opportunities, regardless of the life cycle stage Shifts in production site do not change for many types of products -innovating country maintains its export ability throughout the life cycle products with very short life cycles luxury products for which cost is not a concern for the consumer products used to promote differentiation strategy products requiring specialized technical labor to evolve

Multinational enterprises (MNEs) increasingly introduce new products at home and abroad simultaneously


5. THE PORTER DIAMOND THEORY Harvard Business School Professor Michael Porters theory of national competitive advantage is the newest addition to international trade theory. Porter believes that success in international trade comes from the interaction of four country- and firmspecific elements: Factor conditions Demand conditions Related and supporting industries Firm strategy, structure, and rivalry

1. FACTOR CONDITIONS
Porter acknowledges the importance of basic factors (such as labor, natural resources, climate, and surface features) in what a country produces and exports, but adds the significance of advanced factors, which include skill levels of the workforce and quality of the technological infrastructure. Account for the sustained competitive advantage that a country enjoys in a product.

2. DEMAND CONDITIONS

Sophisticated buyers in the home market are important to national competitive advantage in a product area. A sophisticated domestic market drives companies to modify existing products to include new design features and develop new products and technologies.


3. RELATED AND SUPPORTING INDUSTRIES
a. Companies in internationally competitive industries do not exist in isolation. Supporting industries provide inputs, forming clusters of related activities in the same region that reinforce productivity and competitiveness. b. Exporting clusters are those that export products or make investments to compete outside the local area and can lead to long-term prosperity.

4. FIRM STRATEGY, STRUCTURE, AND RIVALRY

a. Strategic decisions of firms have lasting effects on future competitiveness, but equally important is industry structure and rivalry between companies. b. The more intense the struggle to survive between domestic companies, the greater is their competitiveness. This heightened competitiveness helps them to compete against imports and against companies that might develop a production presence in the home market.

LIMITATION OF PORTAL THEORY Existence of the four favorable conditions does not guarantee that an industry will develop in a locale. Absence of one of the four conditions from a country may not inhibit companies from becoming globally competitive.

Chapter 7 Governmental Influence on Trade

All countries seek to influence trade, and each has economic, social, and political objectives: Conflicting Objectives. Interest Groups. 1. GOVERNMENTAL INTERVENTION IN TRADE Governmental intervention in trade may be classified as either economic or non-economic. Economic Rationales Preventing Unemployment Protecting Infant Industries Promoting Industrialization Improving Competitive Position. Non-Economic Rationales Maintaining essential industries. Dealing with unfriendly countries. Maintaining or extending spheres of influence. Preserving National Identity.

ECONOMIC RATIONALES:
FIGHTING UNEMPLOYMENT Unemployed can form effective pressure group for import restrictions Import restrictions to create domestic employment May lead to retaliation by other countries. Are less likely retaliated against effectively by small countries. Are less likely to be met with retaliation if implemented by small economies. May decrease export jobs because of price increases for components. May decrease export jobs because of lower incomes abroad. Even if no country retaliates, the restricting country may gain jobs in one sector only to lose jobs elsewhere because of three factors: 1. Fewer imports of a product mean fewer import-handling jobs. 2. Import restrictions may cause lower sales in other industries because they must incur higher costs for components. 3. Imports stimulates exports, although less directly, by increasing foreign income and foreign exchange earnings, which are then spent on new imports by foreign consumers. Possible costs of import restrictions include higher prices and higher taxes. Such costs should be compared with those of unemployment.


INFANT-INDUSTRY ARGUMENT Government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports. Initial output costs may make products noncompetitive in world markets. Over time costs will decrease due to: greater economies of scale greater worker efficiency Problems with argument Hard to identify industries with high probability of success Protection may serve as disincentive for managers to adopt innovations needed to become competitive DEVELOPING AN INDUSTRIAL BASE Countries seek protection to promote industrialization because that type of production Brings faster growth than agriculture. Brings in investment funds. Diversifies the economy. Brings more incomes than primary products do. Reduces imports and promotes exports. Helps the nation-building process. Use of surplus workers Many workers can leave the agricultural sector without affecting output. Influx of workers into industrial sector may result in several problems: Demands on social and political services in cities may increase. Output increases if the marginal productivity of agricultural workers is very low. Development possibilities in the agricultural sector may be overlooked Promoting investment flows Import restrictions may increase foreign direct investment, which provide capital, technology, and jobs. If import restrictions keep out foreign made goods, foreign companies may invest to produce in the restricted country to avoid loss of lucrative or potential market. Diversification Price variations due to uncontrollable factors can cause havoc on economies dependent on exports Change from agriculture to industry in emerging economies may simply shift the dependence from a few agricultural products to a few industrial products Greater growth for manufactured products

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Growth in Manufactured Goods Terms of trade refers to the quantity of imports that a given quantity of a countrys exports can buy. Historically, the prices of raw material and agricultural commodities do not rise as fast as prices of finished goods. Emerging economies may deteriorate because: Demand for primary products grows more slowly. Production cost savings for primary products will be passed on to consumers. Import substitution and Export-led development Traditionally, developing countries promoted industrialization by restricting imports in order to boost local production for local consumption of goods that they would otherwise import. On the contrary, some countries have achieved rapid economic growth by promoting the development of industries that export their output. This approach is known as export-led development. Nation Building Industrialization helps countries build infrastructure, advance rural development, and boost the skills of the workforce. ECONOMIC RELATIONSHIPS WITH OTHER COUNTRIES Balance-of-trades adjustments If balance-of-trade difficulties arise and exists, a government may attempt to reduce import or encourage exports to balance its trade account. Comparable access or fairness Domestic producers may be disadvantaged if their access to foreign markets is less than foreign producers access to their market. Price-control objectives Export restrictions may: Keep up world prices. Raise costs to prevent smuggling. Lead to substitution Keep domestic prices down by increasing domestic supply Give producers less incentive to increase output Shift foreign production and sales. Dumping Companies sometimes export below cost or below their home-country price, a practice called Dumping. Import restrictions may: Prevent dumping from being used to put domestic producers out of business. Get foreign producers to lower their prices 11

NON-ECONOMIC RATIONALES:
Maintaining Essential Industries Government applies trade restrictions to protect essential domestic industries during peacetime so that country is not dependent on foreign sources of supply during war. This is called the essential-industry argument. In protecting essential industries; Countries must determine which industries are essential consider costs and alternatives consider political consequences Dealing with Unfriendly countries Prevention of exports that might be acquired by potential enemies May lead to retaliation that prevents securing other essential goods Trade controls on non-defense goods also may be used as a weapon of foreign policy Maintaining Spheres of Influence Governments may: Provide aid and credits to, and encourage imports from, countries that are political allies Impose trade restrictions to coerce foreign countries to follow certain political actions Preserving Cultures and National Identity Countries have a common sense of identity that separates them from other nationalities May limit foreign products and services to protect their separate identity INSTRUMENTS OF TRADE CONTROL TARIFFS The barrier that may directly affect the prices is called tariff barriers. A tariff also called a duty is the most common type of trade control and a tax that governments levy on goods shipped internationally export tariffcollected by exporting country transport tariffcollected by country through which the goods have passed import tariffcollected by importing country Used to protect domestically produced goods Used as a source of governmental revenue Criteria for Assessing Tariffs: specific dutytariff assessed on per unit basis ad valorem dutyassessment is a percentage of the value of the item compound dutycombination of specific duty and ad valorem duty on the same product

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NON-TARIFF BARRIERS-Direct Price Influence: The barrier that may directly affect either price or quantity is called non-tariff barrier. Subsidies Direct government payments to domestic companies to compensate them for losses incurred from selling abroad other types of government assistance makes it cheaper or more profitable to sell abroad subsidies to overcome market imperfections are least controversial there is little agreement on what a subsidy is there has been a recent increase in export-credit assistance Aid and loans Government gives aid and loan to other countries with the proviso that the funds be spent in the donor country known as tied aid or tied loans. Tied aid helps win large contracts for infrastructure, such as telecommunications, railways, and electric power projects. Customs valuation Procedures for assessing value when customs agents levy tariffs May be based on invoice price value of identical goods similar goods coming in at the same time final sales value or on reasonable cost Valuation problems created by the large number of products that are traded Other direct price influences special fees customs deposits minimum price levels NON-TARIFF BARRIERS-QUANTITY CONTROLS: Quotaslimits the quantity of a product allowed to be imported in a given year Most-common restriction based on quantity amount frequently reflects guarantee that domestic producers will have access to a certain percentage of the domestic market problems with quotas transshipping goods among countries transforming product into one for which there is no quota export quotas assure domestic consumers a supply of goods at low price prevent depletion of natural resources raise export prices

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Embargoquota that prohibits all trade

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Buy local legislation-governments favor purchasing goods produced domestically legislation that prescribes a minimum percentage of domestic value Standards and labelsclassification, labeling, and testing standards limit sales of foreign products Specific permission requirements import licensepotential importers or exporters require governmental permission before conducting trade transactions foreign-exchange controlimporter required to apply to a governmental agency to secure foreign currency to pay for a product Administrative delaysintentional delays that create uncertainty and raise the cost of carrying inventory Reciprocal requirementsgovernmental requirements that exporters take merchandise in lieu of money exporters promise to buy merchandise or services in the country to which they export counter trade or offsetbarter transaction Restriction on servicesexist for three reasons Essentialitycountries do not want to depend on foreign companies for strategic services Standardsensure qualifications of providers little reciprocal recognition in licensing from one country to another Immigrationprotect employment of countrys own citizens require local search for qualified personnel before hiring a foreigner

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