Global Business Today 10th Edition Hill Solutions Manual

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Global Business Today Tenth Edition Chapter 6
International Trade Theory
Chapter Outline
OPENING CASE: The Trans Pacific Partnership
INTRODUCTION
AN OVERVIEW OF TRADE THEORY
The Benefits of Trade

The Pattern of International Trade
Trade Theory and Government Policy
MERCANTILISM
Country Focus: Is China a Neo-Mercantilist Nation?
ABSOLUTE ADVANTAGE
COMPARATIVE ADVANTAGE
The Gains from Trade

Qualifications and Assumptions
Extensions of the Ricardian Model
Country Focus: Moving U.S. White-Collar Jobs Offshore
HECKSCHER-OHLIN THEORY
The Leontief Paradox
THE PRODUCT LIFE-CYCLE THEORY
Product Life-Cycle Theory in the Twenty-First Century
NEW TRADE THEORY
Increasing Product Variety and Reducing Costs

Economies of Scale, First Mover Advantages, and the Pattern of Trade
Implications of New Trade Theory
NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND
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Factor Endowments
Demand Conditions
Related and Supporting Industries
Firm Strategy, Structure, and Rivalry
Evaluating Porter’s Theory
FOCUS ON MANAGERIAL IMPLICATIONS: Location, First-Mover Advantages, and

Government Policy
KEY TERMS
SUMMARY
CRITICAL THINKING AND DISCUSSION QUESTIONS
globalEDGE RESEARCH TASK
CLOSING CASE: Creating the World’s Biggest Free Trade Zone
APPENDIX: INTERNATIONAL TRADE AND THE BALANCE OF PAYMENTS
Balance-of-Payment Accounts
Does the Current Account Deficit Matter?
Learning Objectives
6.1 Understand why nations trade with each other.
6.2 Summarize the different theories explaining trade flows between nations.
6.3 Recognize why many economists believe that unrestricted free trade between nations will raise
the economic welfare of countries that participate in a free trade system.
6.4 Explain the arguments of those who maintain that government can play a proactive role in
promoting national competitive advantage in certain industries.
6.5 Understand the important implications that international trade theory holds for management
practice.
Chapter Summary
This chapter focuses on the benefits of international trade and introduces several theories that help
explain the patterns of international trade that are observed in practice. The discussion begins with
an explanation of the theory of mercantilism, and then proceeds to discuss the theories of absolute

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advantage and comparative advantage. Four additional theories are discussed, including the
Heckscher-Ohlin theory, the product life cycle theory, the new trade theory, and the theory of
national competitive advantage. Each of these theories helps explain why certain goods are (or
should be) made in certain countries. The chapter ends by discussing the link between the theories
of international trade and (1) a firm’s decision about where (in the world) to locate its various
productive activities, (2) the importance of establishing first-mover advantages, and (3)
government trade policies.
Chapter Activity
In groups of four or five, give each group ten minutes to share their ideas about one of the several
theories discussed in this chapter (e.g., mercantilism, absolute advantage, comparative advantage,
Heckscher-Ohlin, product life cycle, new trade, and Porter’s diamond).
Then, ask a student representative from each group to explain their theory using a few main points.
Suggest the group create one or two PowerPoint slides to illustrate, or draw a graphic illustration
on the board. This is a way to create some enthusiasm about theories by tackling them
interactively, instead of putting them to sleep with a lecture on trade theories.
The Trans Pacific Partnership

opening case
Summary
The opening case provides an overview of a free trade deal called the Trans Pacific Partnership
(TPP). The agreement, signed by twelve governments on February 4, 2016, is expected to reduce
tariffs considerably in a variety of industries across the countries involved with the TPP. In fact,
the trade pact is expected to add about $285 billion to global GDP by 2025. Many of the tariff
changes will take place in countries outside the United States. Even though there is considerable
support in the United States for the TPP from some companies in the agriculture, manufacturing,
and technology industries, other firms and elected as well as aspiring politicians are hesitant to
support the deal. Depending on studies of the impact of the TPP on the United States economy,
estimates do not seem to indicate a massive drop in employment as a result of the pact’s
implementation.
Discussion Questions
QUESTION 1: Do you agree with the characterizations of the TPP as “a terrible deal” and
“disastrous”? Discuss the pros and cons for the United States of enacting the trade agreement?
ANSWER 1: Many companies and experts support the TPP as it will provide more business
opportunities for companies located in the United States. As agricultural tariffs would be reduced

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considerably in foreign markets, firms such as Cargill support the deal. In addition, other
companies see the possibility of being more price competitive in the aerospace and technology
industries, as well. However, some companies (such as Ford) do not like the TPP as it reduces
tariffs on imports into the United States. Labor unions and many politicians are against the deal
based on the concern of lost jobs as a result of the agreement. Several studies indicate that, at
worst, the reduction of jobs in the United States workforce would be minimal.
QUESTION 2: What are the differences across the studies focusing on the TPP’s impact on the
United States economy? What is your assessment of the trade deal’s influence on United States
workers?
ANSWER 2: Three studies are presented from the World Bank, the Institute of International
Economics (IIE), and Tufts University. The World Bank and IIE studies indicate a slight increase
in wages upon comparison of a situation without the TPP. In addition, the IIE estimated that
United States exports would increase by $357 billion by 2030. Though some sectors will
experience job loss in the IIE study, overall there would not be widespread job loss. However, the
Tufts University indicates that 450,000 jobs would be lost in the United States over ten years.
Video Note: For excerpts of an interview concerning the Trans Pacific Partnership, go to
{http://www.cnn.com/2016/09/06/politics/obama-tpp-politics-congress/index.html}.
Chapter Outline with Lecture Notes, Video Notes, and Teaching Tips
Introduction
A) According to economists and experts, the role of free trade is to stimulate economic growth.
The free trade of goods and services across borders has been the driving force behind the
formation of the World Trade Organization, the European Union, and the North American Free
Trade Agreement.
B) This chapter has two goals. The first goal is to review the theories that explain why it is
beneficial for a country to engage in international trade. The second goal is to explain the pattern
of international trade that is observed in the world economy.
Lecture Note: It is often worth asking students before discussing the theories why countries trade
the products they do. They will frequently, with a little prompting, hit upon many of the ideas
presented in this chapter and consequently relate better to the various theories that are discussed.
An Overview of Trade Theory

A) Free trade refers to a situation where 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.

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THE BENEFITS OF TRADE

B) The great strength of the theories of Smith, Ricardo, and Hecksher-Ohlin is that they identify
with precision the specific benefits of trade. Common sense suggests that some trade is beneficial.
The theories of Smith, Ricardo and Hecksher-Ohlin go beyond common sense to show why it is
beneficial for a country to engage in international trade even for products it is able to produce for
itself. The gains arise because international trade allows a country to specialize in the manufacture
and export of products that can be produced most efficiently in that country, while importing
products that can be produced more efficiently in other countries.
Did You Know Video Clip:

The video clip asks: “Did you know that sugar prices in the United States are much higher than
sugar prices in the rest of the world?”
Suggested Questions
Question 1: Why are sugar prices in the U.S. nearly double the average world price of sugar?
Answer 1: There are two sugar futures markets―world sugar #11 and U.S. sugar #16. U.S. sugar
#16 is priced much higher that the world sugar prices, often twice as high. Sugar is the same
around the world, and the price difference is due to subsidies and a tariff program that supports
U.S. sugar farmers.
True, sugar has been produced in the U.S. for over 200 years, but the climate is not ideal and it
costs more to produce it in the U.S. than in, say, Brazil and India. But U.S. sugar lobbyists have
gotten U.S. sugar farmers a lucrative price for their sugar, and limited sugar imports from other
nations. So U.S. companies pay inflated prices for sugar.
Question 2: Do you agree that U.S. taxpayers should protect U.S. sugar farmers against less
expensive imports?
Answer 2: Students will probably answer no, unless perhaps they are from farming families that
may have experienced the benefits of subsidies. Remind students of earlier discussions about free
and fair trade. Subsidies on U.S. sugar are an example of fair, not free, trade. Subsidies are
exceptions to free trade policies such that certain products produced domestically are protected
from foreign competition by tariffs, quotas, duties, and subsidies. Since many leading sugar
producing nations are emerging markets with lower GDPs and per-capita incomes, a moral
argument may be made against U.S. agricultural subsidies because they create artificial trade
barriers that prohibit more efficient producers from less affluent countries from competing in
markets.
Question 3: Do you agree that U.S. consumers should keep paying twice as much for sugar than
people in other parts of the world?
Answer 3: This is an extension to the second question, and many students will answer no. Since
U.S. companies pay inflated prices for sugar, U.S. consumers are hit twice: once by taxpayer-
funded subsidies that keep sugar prices high, and again by higher consumer product prices that are
passed on to them.

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Learn about the two sugar futures markets:

https://www.thebalance.com/markets-for-us-and-world-sugar-809301
THE PATTERN OF INTERNATIONAL TRADE

C) Some patterns of trade are easy to explain. It is obvious why Saudi Arabia exports oil, Ghana
exports cocoa, and Brazil exports coffee. Yet others are not so obvious or easily explained. Why
does Switzerland export chemicals, pharmaceuticals, watches, and jewelry? Why does Japan
export automobiles, consumer electronics, and machine tools?
D) New trade theory stresses that in some cases countries specialize in the production and export
of particular products not because of underlying differences in factor endowments, but because in
certain industries the world market can support only a limited number of firms. So a country’s
pattern of trade may be a reflection of the ability of firms in that nation to capture first-mover
advantages.
E) Michael Porter suggested that a country’s factor endowments as well as domestic demand and
domestic rivalry are important in explaining a nation’s dominance in the production and export of
particular products.
TRADE THEORY AND GOVERNMENT POLICY

F) While all the trade theories discussed in the text agree that international trade is beneficial to a
country, they lack agreement in their recommendations for government policy. Mercantilism
makes a crude case for government involvement in promoting exports and limiting imports. Smith,
Ricardo, and Heckscher-Ohlin all promote the notion of unrestricted free trade. The argument for
unrestricted free trade is that both import controls and export incentives (such as subsidies) are self
defeating and result in wasted resources. Yet both the new trade theory and Porter’s theory of
national competitive advantage can be interpreted as justifying some limited and selective
government intervention to support the development of certain export-oriented industries.
Mercantilism
A) The first theory of international trade emerged in England in the mid-16th century. Referred to
as mercantilism, its principle assertion was that it is in a country’s best interest to maintain a trade
surplus, to export more than it imports. Consistent with this belief, the mercantilist doctrine
advocated government intervention to achieve a surplus in the balance of trade.
Teaching Note: A historical perspective of mercantilism is available at

{http://www.referenceforbusiness.com/encyclopedia/Man-Mix/Mercantilism.html}.
B) The flaw of mercantilism was that it viewed trade as a zero-sum game, one in which a gain by
one country results in a loss by another. It was left to Adam Smith and David Ricardo to show the
shortsightedness of this approach and to demonstrate that trade is a positive-sum game. As an
economic philosophy, mercantilism is problematic and not valid. Yet many political views today
have the goal of boosting exports while limiting imports by seeking only selective liberalization of
trade.

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country FOCUS: Is China a Neo-Mercantilist Nation?

Summary
This feature analyzes claims that China is a neo-mercantilist nation. Exports are largely
responsible for China’s recent rapid economic growth. The country, capitalizing on its cheap labor
force, has focused on converting raw materials into products that are exported to developed
countries like the United States. In 2008, China’s trade surplus was a record $280 billion before
dropping to $155 billion in 2011. Even so, some critics have suggested that China is following a
neo-mercantilist policy. That stated, in 2015 and early 2016, there was a relative withdrawal
among investors from the Chinese economy.
1. Are the claims that China is following a neo-mercantilist policy valid? Why or why not?
Discussion Points: Some critics claim that China’s deliberate steps to maintain a low currency
relative to the dollar is indicative of the country’s neo-mercantilist policy which tries to
simultaneously increase exports and limit imports. Many students will probably note that China’s
impressive growth in recent years is largely export led, which would support the claims of the
critics. China’s trade surplus in 2008 was $280 billion, and the country had foreign exchange
reserves of more than $1.95 trillion, 70 percent of which were in U.S. dollars. At the same time,
the country appears to have implemented an import substitution policy as it now produces products
such as steel and paper that had been formerly imported.
2. What incentive does China have to open its markets to foreign products? Why might China
resist such a move?
Discussion Points: China is under significant pressure from many countries including the United
States to open its markets to foreign goods. Students will probably recognize that if the country
does open its markets, the impressive economic growth the country has been experiencing would
probably be affected. However, students may also note that the country may have to make some
changes to its policies if only to appease other nations and prevent retaliatory trade measures.
Already the country, in response to pressure from the United States, has allowed its currency to
appreciate relative to the dollar.
3. Is there evidence that China is pursuing an import substitution policy? How would this type of
policy benefit the country?
Discussion Points: Countries following an import substitution policy try to substitute domestic
production for products that were previously imported, regardless of whether it is more efficient to
produce them domestically or not. Most students will probably suggest that in China’s case, this
certainly appears to be occurring. The country used to import steel, aluminum, and paper, but now
produces those products domestically, and in doing so, avoids the cash outflows that would
accompany imports. With its greater reserves of foreign currencies, China gains economic power

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over other nations.
Lecture Note: For more information on China’s currency policy and its interrelationship with the
U.S. economy, go to {http://www.bloomberg.com/news/articles/2016-01-14/the-market-thinks-
china-s-currency-policy-drives-u-s-monetary-policy}.
Absolute Advantage
A) In his 1776 landmark book The Wealth of Nations, Adam Smith attacked the mercantilist
assumption that trade is a zero-sum game. Smith argued that countries differ in their ability to
produce goods efficiently, and that a country has an absolute advantage in the production of a
product when it is more efficient than any other country in producing it. According to Smith,
countries should specialize in the production of goods for which they have an absolute advantage
and then trade these goods for the goods produced by other countries. The text provides a
numerical example of Smith’s theory.
B) When each country has an absolute advantage in one product, it is clear that trade is beneficial.
But what if one country has an absolute advantage in both products?
Comparative Advantage
A) David Ricardo took Adam Smith’s theory one step further by exploring what might happen
when one country has an absolute advantage in the production of all goods. Smith’s theory of
absolute advantage suggests that such a country might derive no benefits from international trade.
In his 1817 book Principles of Political Economy, Ricardo showed that this was not the case.
According to Ricardo’s theory of comparative advantage, it makes sense for a country to
specialize in the production of those goods that it produces most efficiently and to buy the goods
that it produces less efficiently from other countries, even if this means buying goods from other
countries that it could produce more efficiently itself. The textbook provides a detailed example to
explain the rationale of this theory.
B) The simple example of comparative advantage presented in the text makes a number of
assumptions: only two countries and two goods; zero transportation costs; similar prices and
values; resources are mobile between goods within countries, but not across countries; constant
returns to scale; fixed stocks of resources; and no effects on income distribution within countries.
While these are all unrealistic, the general proposition that countries will produce and export those
goods in which they are most efficient has been shown to be quite valid.
Teaching Tip: For more on the ideas and philosophies of David Ricardo, go to
{http://www.econlib.org/library/Enc/bios/Ricardo.html}.
THE GAINS FROM TRADE

C) The theory of comparative advantage argues that trade is a positive sum gain in which all
benefit. It provides a strong rationale for encouraging free trade.

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QUALIFICATIONS AND ASSUMPTIONS

D) The simple example of comparative advantage presented in the text makes a number of
assumptions: only two countries and two goods; zero transportation costs; similar prices and
values; resources are mobile between goods within countries, but not across countries; constant
returns to scale; fixed stocks of resources; and no effects on income distribution within countries.
While these are all unrealistic, the general proposition that countries will produce and export those
goods in which they are most efficient has been shown to be quite valid.
EXTENSIONS OF THE RICARDIAN MODEL

E) The text explores the effects of relaxing the assumptions that resources are mobile between
goods within a country, and that trade does not change a country’s stock of resources or the
efficiency with which those resources are utilized.
Immobile Resources
F) As illustrated by the example in the text, resources do not always move freely from one
economic activity to another.
Diminishing Returns
G) The model of comparative advantage assumes constant returns to specialization (the units of
resources required to produce a good are assumed to remain constant no matter where one is on a
country’s production possibility frontier). However, it is more realistic to assume diminishing
returns to specialization (more units of resources are required to produce each additional unit).
H) Diminishing returns are more realistic because not all resources are of the same quality, and
because different goods use resources in different proportions. Diminishing returns to
specialization suggest that the gains from specialization will probably be exhausted before
specialization is complete. Still, unrestricted free trade makes sense even if the gains are not as
great as suggested by the constant returns case.
Dynamic Effects and Economic Growth

I) Opening an economy to trade is likely to generate dynamic gains of two types. First, trade might
increase a country's stock of resources as increased supplies become available from abroad.
Second, free trade might increase the efficiency of resource utilization, and free up resources for
other uses.
The Samuelson Critique

J) Samuelson argues that in some cases, the dynamic gains from trade may not be so beneficial.
He argues that the ability to off-shore services jobs that were traditionally not internationally
mobile may have the effect of a mass inward migration into the United States, where wages fall,
effectively negating the gains of international trade.

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country FOCUS: Moving White-Collar Jobs Offshore

Summary
This feature goes to the heart of a debate that has been played out many times over the past half
century—the transference of jobs from the United States to lower-wage countries. The difference
now however, is that rather than blue-collar jobs being transferred, the new trend is for white-
collar jobs to move, jobs associated with the knowledge-based economy.
1. Will the United States suffer from the loss of highly skilled and high paying jobs? What does
the transference of white-collar jobs mean to the average American?
Discussion Points: This hot issue is a highly sensitive one for many Americans—especially those
who have seen their once secure jobs being shipped offshore. Many students will probably know
someone who has suffered from this very situation, and may claim that companies have lost all
loyalty to their employees and simply become profit seekers. Other students, however, may point
that companies are in business to make a profit, and do well for other stakeholders such as
investors. Some students will simply argue that the loss of white-collar jobs is merely a
manifestation of companies viewing the world as a borderless market—where they seek resources
wherever they are cheapest, produce in the optimal location, and sell wherever there is demand.
2. What does the transference of white-collar jobs mean to recipient countries such as India and the
Philippines?
Discussion Points: For developing countries like India and the Philippines, the transference of
white-collar jobs from the United States not only generates new jobs, it also brings new skills and
knowledge that could be vital to the countries as they continue on the path toward greater
economic development. Students should recognize that greater employment levels will of course
have the effect of pushing wages up, and creating greater economic prosperity in these nations.
This in turn should be beneficial for American companies as new export markets develop.
3. Why do American companies transfer white-collar jobs to countries like India and the
Philippines?
Discussion Points: India offers companies a well-educated workforce that is willing to work for a
fraction of what companies would pay in the United States. By transferring skilled jobs to India or
the Philippines, American companies increase their global competitiveness and profitability.
Students will probably note that the trend to outsource is likely to continue as companies seek an
edge wherever they can find one. Already, the trend is being seen in new industries such as
healthcare where not only paperwork but even radiology services are now being routinely
outsourced.

10
Lecture Note: Outsourcing call centers and other white collar jobs is common in many industries
today, however it can also be controversial. To extend the discussion of outsourcing to include this
angle, consider {http://www.bloomberg.com/news/articles/2016-02-05/uaw-president-bemoans-
work-moving-to-mexico-to-cut-labor-costs}.
Lecture Note: To extend this discussion, consider

{http://www.bloomberg.com/news/articles/2012-03-15/outsourcing-a-passage-out-of-india}. This
multi-country analysis explores the advantages and drawbacks of outsourcing to several different
locations.
Lecture Note: Outsourcing is not always beneficial for companies. To extend this discussion,
consider {http://www.bloomberg.com/news/articles/2013-10-28/more-companies-see-advantage-
to-manufacturing-in-the-u-dot-s} and {http://www.bloomberg.com/news/articles/2012-02-02/for-
some-u-dot-s-dot-manufacturers-time-to-head-home}.
Evidence for the Link between Trade and Growth

K) Studies exploring the relationship between trade and economic growth suggest that countries
that adopt a more open stance toward international trade enjoy higher growth rates than those that
close their economies to trade.
Heckscher-Ohlin Theory
A) Heckscher and Ohlin argued that comparative advantage arises from differences in national
factor endowments (land, labor, and capital). As a result, the Heckscher-Ohlin theory predicts
that countries will export goods that make intensive use of those factors that are locally abundant,
while importing goods that make intensive use of factors that are locally scarce.
Teaching Tip: To learn more about Bertil Ohlin go to

{http://www.econlib.org/library/Enc/bios/Ohlin.html}.
THE LEONTIEF PARADOX

B) Using the Heckscher-Ohlin theory, Leontief, in 1953, postulated that since the United States
was relatively abundant in capital compared to other nations, the United States would be an
exporter of capital intensive goods and an importer of labor-intensive goods. To his surprise,
however, he found that U.S. exports were less capital intensive than U.S. imports. Since this result
was at variance with the predictions of the theory, it has become know as the Leontief Paradox.
Teaching Tip: A more extensive discussion of Wassily Leontief is available at

{http://www.econlib.org/library/Enc/bios/Leontief.html}.
C) Recent research suggests that the Heckscher-Ohlin theory gains predictive power if the impact
of differences in technology on productivity is controlled for.

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The Product Life-Cycle Theory

A) Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s. According
to the theory, as products mature, both the location of sales and the optimal production location
will change affecting the flow and direction of trade.
B) According to Vernon, early in the life cycle of a typical new product, while demand is starting
to grow in the United States, demand in other advanced countries is limited to high-income groups.
The limited initial demand in other advanced countries does not make it worthwhile for firms in
those countries to start producing the new product, but it does necessitate some exports from the
United States to those countries. Over time, however, demand for the new product starts to grow in
other advanced countries. As it does, it becomes beneficial for foreign producers to begin
producing for their home markets. In addition, U.S. firms might set up production facilities in
those advanced countries where demand is growing. Consequently, production within other
advanced countries begins to limit the potential for exports from the United States.
C) As the market in the United States and other advanced nations matures, the product becomes
more standardized, and price becomes the main competitive weapon. One result is that producers
based in advanced countries where labor costs are lower than the United States might now be able
to export to the United States.
D) If cost pressures become intense, the process might not stop there. The cycle by which the
United States lost its advantage to other advanced countries might be repeated once more as
developing countries begin to acquire a production advantage over advanced countries.
E) The consequence of these trends for the pattern of world trade is that the United States (and
other advanced countries) switches from being an exporter of the product to an importer of the
product as production becomes more concentrated in lower-cost foreign locations.
PRODUCT LIFE-CYCLE THEORY IN THE TWENTY-FIRST CENTURY

F) While the product life cycle theory accurately explains what has happened for products like
photocopiers and a number of other high technology products developed in the United States in the
1960s and 1970s, the increasing globalization and integration of the world economy has made this
theory less valid in today's world. In fact, the product life-cycle as introduced by Vernon could be
considered ethnocentric, as well. As such, this approach may be best suited to explain the pattern
of international trade during the period of American global dominance.
New Trade Theory

A) New trade theory suggests that the ability of firms to realize economies of scale (unit cost
reductions associated with a large scale of output) may help explain international trade patterns.
B) New trade theory makes two important points. First, trade can increase the variety of goods
available to consumers and decrease the average cost of those goods. Second, in industries where
the output necessary to attain economies of scale is significant relative to total world demand, only
a few companies may be able to survive. Being a first mover in these industries is important.

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INCREASING PRODUCT VARIETY AND REDUCING COSTS

C) According to new trade theory, with trade a nation may be able to specialize in producing a
narrower range of products than it would in the absence of trade. By buying goods that it does not
make from other countries, each nation can simultaneously increase the variety of goods available
to its consumers and lower the costs of those goods.
ECONOMIES OF SCALE, FIRST-MOVER ADVANTAGES, AND THE PATTERN OF

TRADE
D) A second theme in new trade theory is that the pattern of trade we observe in the world
economy may be the result of first-mover advantages (economic and strategic advantages that
accrue to early entrants into an industry) and economies of scale.
IMPLICATIONS OF NEW TRADE THEORY

E) New trade theory suggests that nations may benefit from trade even when they do not differ in
resource endowments or technology. The theory also suggests that a country may predominate in
the export of a good simply because it was lucky enough to have first mover firms.
F) New trade theory is at variance with the Heckscher-Ohlin theory, which suggests that a country
will predominate in the export of a product when it is particularly well endowed with those factors
used intensively in its manufacture. New trade theory does not contradict the theory of
comparative advantage, but instead identifies a source of comparative advantage.
G) An obvious and controversial extension of new trade theory is the implication that governments
should consider strategic trade policies. Strategic trade policies would suggest that governments
should nurture and protect firms and industries where first mover advantages and economies of
scale are likely to be important, as doing so can increase the chance that a firm will build
economies of scale and eventually end up a winner in the global competitive race.
National Competitive Advantage: Porter’s Diamond

A) Porter’s 1990 study tried to explain why a nation achieves international success in a particular
industry. This study found four broad attributes―factor endowments, demand conditions, relating
and supporting industries, and firm strategy, structure, and rivalry―that promote or impede the
creation of competitive advantage. These are shown as a diamond in Figure 6.5. Porter argues that
firms are most likely to succeed in industries where the diamond is favorable.
FACTOR ENDOWMENTS
B) A nation's position in factors of production such as skilled labor or infrastructure necessary to
compete in a given industry can be critical. These factors can be either basic (natural resources,
climate, location) or advanced (skilled labor, infrastructure, technological know-how). While
either can be important, advanced factors are more likely to lead to competitive advantage.
DEMAND CONDITIONS
C) The nature of home demand for the industry’s product or service influences the development of
capabilities. Sophisticated and demanding customers pressure firms to be competitive.

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RELATING AND SUPPORTING INDUSTRIES

D) The presence of supplier and related industries that are internationally competitive in a nation
can spill over and contribute to other industries. Successful industries tend to be grouped in
clusters in countries; having world class producers of semi-conductor processing equipment can
lead to (and be a result of having) a competitive semi-conductor industry.
FIRM STRATEGY, STRUCTURE, AND RIVALRY

E) The conditions in the nation governing how companies are created, organized, and managed,
and the nature of domestic rivalry impact firms’ competitiveness. Firms that face strong domestic
competition will be better able to face competitors from other firms.
EVALUATING PORTER’S THEORY

F) In addition to these four main attributes, government policies and chance can impact any of the
four. Government policy can affect demand through product standards, influence rivalry through
regulation and antitrust laws, and impact the availability of highly educated workers and advanced
transportation infrastructure.
G) The four attributes of the diamond work as a reinforcing system, complementing each other and
in combination creating the conditions appropriate for competitive advantage. To date, Porter’s
theory has not been subjected to detailed empirical testing.
FOCUS ON MANAGERIAL IMPLICATIONS: Location, First-

Mover Advantages, and Government Policy
A) There are at least three main implications of the material discussed in this chapter for
international businesses: location implications, first-mover implications, and policy implications.
Location
B) One way in which the material discussed in this chapter matters to an international business
concerns the link between the theories of international trade and a firm’s decision about where to
locate its various productive activities. Underlying most of the theories is the notion that different
countries have particular advantages in different productive activities. Thus, from a profit
perspective, it makes sense for a firm to disperse its various productive activities to those countries
where, according to the theory of international trade, they can be performed most efficiently.
First-Mover Advantages
C) Being a first mover can have important competitive implications, especially if there are
economies of scale and the global industry will only support a few competitors. Firms need to be
prepared to undertake huge investments and suffer losses for several years in order to reap the
eventual rewards.
Government Policy

14
D) The theories of international trade also matter to international businesses because business
firms are major players on the international trade scene. Because of their pivotal role in
international trade, business firms can and do exert a strong influence on government trade policy.
Government policies with respect to free trade or protecting domestic industries can significantly
impact global competitiveness.
E) One of the most important implications for businesses is that they should work to encourage
governmental policies that support free trade. If a business is able to get its goods from the best
sources worldwide, and compete in the sale of products into the most competitive markets, it has a
good chance of surviving and prospering. If such openness is restricted, a business’s long-term
survival will be in greater question.
Teaching Tip: For information about foreign governments and their approaches to international
trade, visit the Electronic Embassy at {http://www.embassy.org/}. This site provides links to all of
the foreign embassies located in Washington D.C.
Critical Thinking and Discussion Questions

1. Mercantilism is a bankrupt theory that has no place in the modern world. Discuss.
Answer: Mercantilism, in its purest sense, is a bankrupt theory that has no place in the modern
world. The principle tenant of mercantilism is that a country should maintain a trade surplus, even
if it means that imports are limited by government intervention. This policy is bankrupt for at least
two reasons. First, it is inconsistent with the general notion of globalization, which is becoming
more and more prevalent in the world. A policy of mercantilism will anger potential trade partners
because it will exclude their goods from free access to the mercantilist country’s markets.
Eventually, a country will find it difficult to export if it imposes oppressive quotas and tariffs on its
trading partners. Second, mercantilism is bankrupt because it hurts the consumers in the
mercantilist country. By denying its consumers access to either “cheaper” goods from other
countries or more “sophisticated” goods from other countries, the mercantilist country’s ordinary
consumers suffer.
2. Is free trade fair? Discuss!
Answer: This question is designed to stimulate class discussion. Trade theory suggests that
specialization and free trade benefits all countries. However, a case can be made in some situations
for imposing trade barriers. For example, if a developing country is trying to establish a new
industry, trade barriers may be needed in the short term until the industry can become competitive.
While it could be argued that another country could make the product more efficiently already, is it
fair to limit a country’s ability to develop its industrial base?

15
3. Unions in developed nations often oppose imports from low-wage countries and advocate trade
barriers to protect jobs from what they often characterize as “unfair” import competition. Is such
competition “unfair?” Do you think that this argument is in the best interests of (a) the unions, (b)
the people they represent, and/or (c) the country as a whole?
Answer: The theory of comparative advantage suggests that a country should specialize in
producing those goods that it can produce most efficiently, while buying goods that it can produce
relatively less efficiently from other countries. Furthermore, the theory suggests that opening a
country to free trade stimulates economic growth, which creates dynamic gains from trade.
Therefore, it would follow that if low-wage countries can make certain products more efficiently
than high wage countries, the low wage countries should produce and export those products.
While trade barriers may protect workers and companies, they are a short-term fix at best.
Moreover, by protecting industries, the government is not encouraging companies to become more
efficient. Instead, they are promoting inefficiency. Consumers lose out because they have higher
prices and less choice.
4. What are the potential costs of adopting a free trade regime? Do you think governments should
do anything to reduce these costs? What?
Answer: Students will probably be divided on this question, and a lively debate should ensue. For
example, students will probably recognize that by adopting a free trade regime, jobs will be lost in
some industries, however they may not agree on exactly what should be done about the jobs losses.
Some students might suggest that the government provide retraining programs while others may
argue that people lose their jobs everyday and do not get government assistance to find new ones.
5. Reread the Country Focus on “Is China a Neo-Mercantilist Nation?”

a) Do you think China is pursuing an economic policy that can be characterized as neo-
mercantilist?
b) What should the United States, and other countries, do about this?
Answer: Many students will probably suggest that indeed, China appears to be following a neo-
mercantilist philosophy. China has run a trade surplus for years. In fact, in 2008, the country hit a
record trade surplus of $280 billion. Some critics have suggested that China is limiting its imports
by following an import substitution policy. Other students however, may note that in 2008, the
growth in China’s imports actually exceeded the growth in its exports. Students may argue that this
indicates a change in China’s policy, and note that in 2011, China’s trade surplus had dropped to
$155 billion. Even so, most students will probably suggest that in order to continue to correct the
country’s massive trade surplus, foreign countries like the United States should continue to
pressure China to allow its currency to appreciate, and maintain open markets.
6. Reread the Country Focus feature on moving U.S. white-collar jobs offshore.
a) Who benefits from the outsourcing of skilled white-collar jobs to developing nations? Who
are the losers?
b) Will developed nations like the United States suffer from the loss of high-skilled and high-
paying jobs?

16
c) Is there a difference between the transference of high paying white-collar jobs such as
computer programming and accounting, to developing nations, and low paying blue collar
jobs? If so, what is the difference, and should government do anything to stop the flow of
white-collar jobs out of the country to countries like India?
Answer: This question is likely to generate a lively debate. Many students will suggest that the
outward flow of white-collar jobs is indeed a serious issue, one that should be the focus of
government attention. Students taking this perspective are likely to suggest that white-collar jobs
are more important to the nation’s future, and therefore they should remain at home. Other
students however, may argue that companies cannot afford to pay the higher wages commanded by
white-collar jobs and still remain profitable. Therefore, the argument might be that by taking these
jobs outside the country, the company is able to remain viable, and keep other people employed.
7. Drawing upon the new trade theory and Porter’s theory of national competitive advantage,
outline the case for government policies that would build national competitive advantage in
biotechnology. What kind of policies would you recommend that the government adopt? Are these
policies at variance with the basic free trade philosophy?
Answer: Porter’s theory of national competitive advantage argues that four broad attributes of a
nation shape the environment in which local firms compete, and that these attributes promote or
impede the creation of competitive advantage. These attributes are: factor endowments, demand
conditions, related and supporting industries, and firm strategy, structure, and rivalry. Porter goes
on to argue that firms are most likely to succeed in industries in which the diamond (which are the
four attributes collectively) is favorable. Porter later added two factors to the list of attributes
described above: chance and government policy. The New Trade theory addresses a separate issue.
This theory argues that due to the presence of substantial scale economies, world demand will
support only a few firms in many industries. Underpinning this argument is the notion of first-
mover advantages, which are the economic and strategic advantages that accrue to early entrants
into an industry. One could argue that when the attributes of a nation are conducive to the
production of a product, and when the manufacturers of that product have experienced some
“chance” events that have provided them first-mover advantages, the governmental policies of that
nation should promote the building of national competitive advantage in that particular area. This
could be accomplished through government R&D grants, policies that favor the industry in capital
markets, policies towards education, the creation of a favorable regulatory atmosphere, tax
abatements, and the like. Ask students whether they think this policy is at variance with the basic
free trade philosophy. One could argue that it is, because the government intervention is creating
the basis for comparative advantage. Conversely, one could argue that if a country establishes a
comparative advantage in a particular area that is based on a unique set of attributes (such as Swiss
production of watches), world output will be favorably impacted by letting that country pursue its
area of comparative advantage.
8. The world’s poorest countries are at a competitive disadvantage in every sector of their
economies. They have little to export. They have no capital; their land is of poor quality; they
often have too many people given available work opportunities; and they are poorly educated.
Free trade cannot possibly be in the interests of such nations. Discuss.

17
Answer: This is a difficult question. Certainly, most students will recognize that these countries are
in dire straights and need assistance from richer countries. Most students will probably be
sympathetic to their cause and suggest various aid programs including education and monetary
support to help the countries develop. However, others may be more cautious and promote the
notion that assistance would have to come in an organized form with multiple nations working
together. The question is an interesting one that should provide students with an eye-opening
discussion.
Creating the World’s Biggest Free Trade Zone

closing case
Summary
The closing case describes the benefits of a new free trade deal between the United States and the
European Union. The agreement, expected to be finalized in 2019 or 2020, should reduce or
eliminate the already low tariffs between the United States and the European Union effectively
leaving both in a better position. Many are hailing the proposed agreement as acting as a cost-free
stimulus package that will help to create new jobs and economic growth in both European Union
counties and in the United States. Discussion of the case can revolve around the following
questions:
QUESTION 1: Supporters of the proposed new trade deal between the United States and the
European Union claim that it will make all countries involved better off. Do you agree? Who
stands to lose as a result of the trade pact?
ANSWER 1: Free trade agreements like the proposed pact between the United States and the
European Union are generally recognized as positive sum games bringing benefits to all countries
involved usually in the form of lower tariffs, more choice for consumers, lower prices, increased
jobs, economic growth, and so on. However, for those that have benefitted from government
intervention, free trade deals are typically viewed with less enthusiasm. Students may note for
example that agriculture may experience some negative effects as a result of the U.S.-EU trade
deal. Tariffs on agricultural products have been higher than many products traded between the
countries and their elimination, while opening new markets for some, are likely to have negative
consequences for others.
QUESTION 2: What does the proposed agreement between the United States and the European
Union mean for U.S. companies selling to the European Union? Will consumers benefit?

18
ANSWER 2: Most students will probably suggest that U.S. companies currently doing business
with the European Union will welcome the new trade agreement between the countries. Students
may note for example, that in the auto industry, the proposed deal should eliminate the double set
of regulations that companies must adhere to. For consumers, this should be good news as the
reduced costs of doing business are passed on in the form of lower prices. In addition, some
students may agree that the new trade deal creates a greater interdependency among the countries,
which could reduce the potential for future government intervention.
Teaching Tip: For more information on the on the trade deal, go to

{http://www.bloomberg.com/news/articles/2016-02-26/eu-u-s-push-for-trans-atlantic-trade-deal-
before-end-of-2016}.
Continuous Case Concept

In the last few decades, the auto industry has shifted from one in which a few, large companies
primarily manufactured in their domestic markets and sold in their domestic markets, to one in
which a few large companies serve the world market, manufacturing around the globe to capture
competitive advantages wherever they can.
• Ask students to reflect on the changes in the industry. Why do companies like Toyota and
Nissan have large operations in the U.S. market? Why don’t American companies have a
large presence in Japan?
• Next, consider why BMW and Mercedes have established manufacturing operations in the
U.S. market, while American companies are shifting their production to places like
Mexico. Similarly, reflect on the new agreement between Toyota and Mazda whereby
Mazda will produce cars at its plant in Mexico for Toyota to sell in the United States.
• Finally, ask students to use the theories presented in the chapter to explain the changes in
the industry, and to predict what may occur in the next decade. Volkswagen, for example,
has just committed to opening a new factory in Tennessee where wage rates are relatively
low, and the Chennai region of India is now being referred to as the Detroit of India
because so many automakers and suppliers have established operations there.
The first two parts of this exercise can be used either at the beginning of a discussion of trade
theory, or threaded through the discussion of the material. The last question works well as a way
of applying the theories to a real world situation, and makes a nice conclusion to the discussion of
the theories.

19
globalEDGE Exercises
The resources for each exercise can be easily located by using the search box at the top of the
globalEDGE website at http://globalEDGE.msu.edu
Exercise
Search phrase: World Trade Organization International Trade Statistics
Resource Name: World Trade Organization (WTO): International Trade Statistics
Website: https://www.wto.org/english/res_e/statis_e/statis_e.htm
globalEDGE Category: Global, Statistical Data Sources, Publications
Additional Info:
There are several ways to get a list of Top 10 exporters and importers in the world from this
website. The easiest is to access the interactive “International Trade and Market Access Data” tool.
You can get a ranking of the countries at the bottom of this tool. The default is for exports, but
there is a drop-down at the top to allow you to switch the data for imports.
Additional Readings and Sources of Information

WTO Rejects U.S. Appeal of Meat Labeling in Canadian Win
http://www.bloomberg.com/news/articles/2015-05-18/wto-rejects-u-s-appeal-of-meat-labeling-in-
canadian-win
U.S. Urges Japan to be Bolder in Opening Markets

http://www.dailymail.co.uk/wires/ap/article-2801181/US-urges-Japan-bolder-opening-
markets.html
The Indian Outsourcing Issue is Back

http://www.bloomberg.com/news/articles/2012-05-18/the-indian-outsourcing-issue-is-back
From Outsourcing to Consulting

http://www.bloomberg.com/news/articles/2015-12-03/from-outsourcing-to-consulting-cognizant-
tries-to-take-on-ibm
Indian Outsourcers Settlement with the U.S. May Hurt Indian Outsources in the U.S.
http://www.bloomberg.com/news/articles/2013-10-29/indian-outsourcers-settlement-with-the-u-
dot-s-dot-may-hurt-indian-outsourcers-in-the-u-dot-s
Why Some Global Tech Startups Are Offshoring to Delaware

http://www.bloomberg.com/news/articles/2016-06-21/why-some-global-tech-startups-are-
offshoring-to-delaware

20
U.S. Reaches Deal With Brazil Ending Cotton Dispute

http://www.bloomberg.com/news/articles/2014-10-01/u-s-reaches-deal-with-brazil-ending-cotton-
trade-dispute
Canada’s Freeland Blames U.S. Protectionism for Lumber Dispute

http://www.bloomberg.com/news/articles/2016-09-04/canada-s-freeland-blames-u-s-
protectionism-for-lumber-dispute
WTO Leaders Agree to End Farm Subsidies as Doha Unresolved

http://www.bloomberg.com/news/articles/2015-12-19/wto-trade-leaders-agree-to-end-farm-
subsidies-as-doha-unresolved
How Nebraska is Winning Foreign Business

http://www.bloomberg.com/news/articles/2012-08-23/how-nebraska-is-winning-foreign-business
China’s Export Machine Is Grabbing More of the Global Market

http://www.bloomberg.com/news/articles/2016-09-06/china-export-machine-defying-gravity-
grabs-global-market-share
Japan Joins World Trade Organization Case on China Aircraft Tax

http://www.bloomberg.com/news/articles/2016-01-05/japan-joins-world-trade-organization-case-
on-china-aircraft-tax
World’s Biggest Shipping Firm Warns Against U.S. Protectionism

https://www.bloomberg.com/news/articles/2016-08-14/world-s-biggest-shipping-firm-warns-
against-u-s-protectionism

21

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Global Business Today 10th Edition Hill

International Trade Theory

AN OVERVIEW OF TRADE THEORY

The Benefits of Trade

Country Focus: Is China a Neo-Mercantilist Nation?

The Gains from Trade

The Leontief Paradox

THE PRODUCT LIFE-CYCLE THEORY

Product Life-Cycle Theory in the Twenty-First Century

NEW TRADE THEORY

Increasing Product Variety and Reducing Costs

NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND

© 2018 by McGraw-Hill Education.

FOCUS ON MANAGERIAL IMPLICATIONS: Location, First-Mover Advantages, and

CRITICAL THINKING AND DISCUSSION QUESTIONS

globalEDGE RESEARCH TASK

CLOSING CASE: Creating the World’s Biggest Free Trade Zone

APPENDIX: INTERNATIONAL TRADE AND THE BALANCE OF PAYMENTS

© 2018 by McGraw-Hill Education.

The Trans Pacific Partnership

© 2018 by McGraw-Hill Education.

An Overview of Trade Theory

© 2018 by McGraw-Hill Education.

THE BENEFITS OF TRADE

Did You Know Video Clip:

© 2018 by McGraw-Hill Education.

Learn about the two sugar futures markets:

THE PATTERN OF INTERNATIONAL TRADE

TRADE THEORY AND GOVERNMENT POLICY

Teaching Note: A historical perspective of mercantilism is available at

© 2018 by McGraw-Hill Education.

country FOCUS: Is China a Neo-Mercantilist Nation?

© 2018 by McGraw-Hill Education.

over other nations.

THE GAINS FROM TRADE

© 2018 by McGraw-Hill Education.

QUALIFICATIONS AND ASSUMPTIONS

EXTENSIONS OF THE RICARDIAN MODEL

Dynamic Effects and Economic Growth

The Samuelson Critique

© 2018 by McGraw-Hill Education.

country FOCUS: Moving White-Collar Jobs Offshore

© 2018 by McGraw-Hill Education.

Lecture Note: To extend this discussion, consider

Evidence for the Link between Trade and Growth

Teaching Tip: To learn more about Bertil Ohlin go to

THE LEONTIEF PARADOX

Teaching Tip: A more extensive discussion of Wassily Leontief is available at

© 2018 by McGraw-Hill Education.

The Product Life-Cycle Theory

PRODUCT LIFE-CYCLE THEORY IN THE TWENTY-FIRST CENTURY

New Trade Theory

© 2018 by McGraw-Hill Education.

INCREASING PRODUCT VARIETY AND REDUCING COSTS

ECONOMIES OF SCALE, FIRST-MOVER ADVANTAGES, AND THE PATTERN OF

IMPLICATIONS OF NEW TRADE THEORY

National Competitive Advantage: Porter’s Diamond

© 2018 by McGraw-Hill Education.

RELATING AND SUPPORTING INDUSTRIES

FIRM STRATEGY, STRUCTURE, AND RIVALRY

EVALUATING PORTER’S THEORY

FOCUS ON MANAGERIAL IMPLICATIONS: Location, First-

© 2018 by McGraw-Hill Education.

Critical Thinking and Discussion Questions