International

Business
Environments & Operations
Trade and Factor-Mobility
Theory
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Laissez-Faire vs. Intervention

🞐 In trade theory the basic questions asked are…
■ Why nations (or companies in a nation) trade? ■ What
factors determine trade?
■ How much and with whom should a nation trade?
■ Should a government intervene trade?

🞐 Twodifferent approaches that answer these

questions are…
■ Laissez-faire approach-absolute advantage and
 comparative advantage
■ Intervention approach-Mercantilism and
neomercantilism

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Trade Theories
🞐 Mercantilism(and Neomercantilism)
🞐 Adam Smith’s Absolute Advantage 🞐
Ricardo’s Comparative Advantage 🞐
Heckscher-Ohlin’s Theory of Factor
Proportion
🞐 International Product Life Cycle (IPLC)
🞐 Porter’s
Diamond and International
Competitiveness of Nations

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Trade Theories and Business

What Major Trade Theories Do and Don’t Discuss: A Checklist
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Mercantilism
🞐 Initial
trade theory that was the foundation of
economic thought from 1500–1800 AD
🞐 The mercantilists believed that the way for
 nations to become rich and powerful was to have
a favorable balance of trade, i.e., we should
export more and import less.
🞐 They advocated strict government control of all
economic activity and preached economic
nationalism.
🞐 Neomercantilism preaches export surplus to
achieve a country’s social and political objective.
It also tacitly supports colonialism—it is alright to
have colonies to generate trade surplus.
Theory of Absolute Advantage
(Adam Smith, 1776)
🞐 Believedthat countries are at different levels in
terms of trade because of natural or acquired
 advantage. Resource base, country size,
technology or resource efficiencies (as absolute
advantages) is the basis (or reason) for trade.
🞐 A country can (i) maximize its economic wellbeing
by specializing in the production of those goods
and services in which it has absolute advantage
and (ii) enhance global efficiency through
participation in free trade.
🞐 Advocated that market forces, and not the
government, should determine the direction,
volume, and composition of international
trade.
Theory of Absolute
Advantage Production Possibilities under Conditions
of Absolute Advantage

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Theory of Comparative Advantage

 (David Ricardo, 1817)
🞐 Relative or comparative advantage or efficiency is
the main argument.
🞐 Comparative advantage stems from the relative
efficiency of one nation over another. A country
will produce and export those goods and services
in which it has comparative advantage.
🞐 Free trade fosters global efficiency. Global gains
are made through comparative efficiency.
Everyone is producing those products in which
they are best.
🞐 If an individual happens to be the best lawyer
and the best typist in a town, which profession
will s/he choose? Answer: the one that offers
relative efficiency
 8

Theory of Comparative Advantage

Production Possibilities under Conditions of Comparative
Advantage

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 Theory of Factor Proportion
(Eli Heckscher, 1919 and Bertil Ohlin, 1933)
🞐 Inputs, factors of production is the main issue. 🞐
Differences in a country’s relative endowments of
land, labor, and capital explain differences in the
cost of production factors. A country will produce
and export those goods and services in which it is
relatively better endowed.
🞐 The comparative advantage in relative prices and
factor inputs would be the basis for trade. Given
this, a capital abundant country will have
comparative advantage in capital-intensive goods
and will export those for labor-intensive goods.
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Assumptions and Limitations of the
Three Trade Theories
🞐 Theassumptions of the three trade
theories based on specialization may not
be valid
■ fullemployment
■ economic efficiency
■ division of gains
■ transport costs
■ statics and dynamics
■ services
■ production networks
■ mobility
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Product Life Cycle Theory

Life Cycle of the International Product
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International Product Life Cycle

(IPLC) Theory
Introduction Growth Maturity Decline

Production Location

Market
Location

Competitive Factors

Production Technology

13
 Porter’s Diamond- International
Competitiveness of Nations
Diamond of National
Advantage The Diamond of National Competitive
Advantage
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International Competitiveness of
Nations (Michael Porter 1990)
🞐 Itis a departure from the previous trade
theories. Most trade theories are from a country
 perspective but it is the companies that make
decisions about trade.
🞐 Porter argues that the dynamic interplay of the
four factors that determine international
competitiveness are:
- Demand Conditions
- Factor Conditions
- Related and Supporting Industries
- Firm Structure and Rivalry.
🞐 Other two factors that also influence the
competitiveness of nations are Chance and
Government.
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Back to the questions we begun this

chapter with-Trade Pattern Theories
 🞐 How much does a country trade? ■
Depends on the size of the country,
larger economies trade more
🞐 What products does a country trade? ■
Factor proportion theory (Heckscher
Ohlin) explains that
🞐 With whom do countries trade?
■ Country Similarity Theory

■ Geography/proximity also influences

Trade and Factor Mobility-1
🞐 Trade, Production and Investment move
 simultaneously, we need a comprehensive
explanation instead of a piecemeal theory.
🞐 Factor mobility/movements alter factor
endowments, can be substantial for some
countries, and insignificant for others
🞐 The lowest costs occur when trade and
production factors are both mobile

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Trade and Factor Mobility-2

🞐 Relationship among land, labor, and capital
movements will continue to evolve 🞐
International division of labor will continue
to reshape the global specialization and
trade patterns
🞐 Displacement of jobs will continue to be a
source of conflict
🞐 International labor migration can be a
source conflict as demographics change:
brain drain, inward vs. outward
remittances

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What Does A Country Trade?
Worldwide Trade by Major Sectors

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