BBA- 6th SEM

INTERNATIONAL TRADE

NOTES (UNIT-1)

 INTRODUCTION

The term trade refers to exchange of goods and services and when it takes place across the countries,
it is called international trade.

International Trade or Business is defined as an exchange of goods, services, & capital across
national territories.

International business involves transactions across the national boundaries. It includes the transfer of
goods, services, technology, managerial knowledge and capital to other countries. International
business has gained greater visibility and importance in recent years because of the large
multinational corporations.

International Trade means trade between two or more countries.

Any commercial transaction taking place across the boundary lines of a sovereign entity is defined as
an International Business.

International Trade refers to commercial activities that go beyond the geographical limits of a
country.

International Trade involves not only the international movements of goods & services, but also
capital, personnel, technology & intellectual property like patents, trademarks, know-how & copy
rights.

International trade is referred to as the exchange or trade of goods and services between different
nations. This kind of trade contributes and increases the world economy. The most commonly traded
commodities are television sets, clothes, machinery, capital goods, food, and raw material, etc.,

International trade has increased exceptionally that includes services such as foreign transportation,
travel and tourism, banking, warehousing, communication, advertising, and distribution and
advertising. Other equally important developments are the increase in foreign investments and
production of foreign goods and services in an international country. This foreign investments and
production will help companies to come closer to their international customers and therefore serve
them with goods and services at a very low rate.

All the activities mentioned are a part of international business. It can be concluded by saying that
international trade and production are two aspects of international business, growing day by day
across the globe.

Foreign trade is exchange of capital, goods, and services across international borders or territories. In
most countries, it represents a significant share of gross domestic product (GDP). While international
trade has been present throughout much of history, its economic, social, and political importance has
been on the rise in recent centuries.

According to Wasserman and Haltman, ―International trade consists of transaction between

residents of different countries‖.

According to Anatol Marad, ―International trade is a trade between nations‖.

According to John D. Daniels, ―International trade consists of all business transactions- Private and
Government that involves two or more countries. Private Co. undertake such transactions for profits
what may or may not do the same in their transactions‖.

 DIFFERENCE BETWEEN TRADE AND COMMERCE

 CLASSIFICATION OF INTERNATIONAL TRADE:

(a) Import Trade: It refers to purchase of goods from a foreign country. Countries import goods
which are not produced by them either because of cost disadvantage or because of physical
difficulties or even those goods which are not produced in sufficient quantities so as to meet their
requirements.

(b) Export Trade: It means the sale of goods to a foreign country. In this trade the goods are sent
outside the country.
(c) Entrepot Trade: When goods are imported from one country and are exported to another
country, it is called entrepot trade. Here, the goods are imported not for consumption or sale in the
country but for re- exporting to a third country. So importing of foreign goods for export purposes is
known as entrepot trade.

 CHARACTERISTICS OR FEATURES OF INTERNATIONAL TRADE:

The following are the distinguishing features of international trade:

1. Immobility of Factors: The degree of immobility of factors like labour and capital is
generally greater between countries than within a country. Immigration laws, citizenship,
qualifications, etc. often restrict the international mobility of labour.

2. Heterogeneous Markets: In the international economy, world markets lack homogeneity on

account of differences in climate, language, preferences, habit, customs, weights and measures,
etc. The behaviour of international buyers in each case would, therefore, be different.

3. Different National Groups: International trade takes place between differently cohered
groups. The socio-economic environment differs greatly among different nations.

4. Different Political Units/Legal Systems: International trade is a phenomenon which occurs

amongst different political units.

5. Different National Policies and Government Intervention: Economic and political policies
differ from one country to another. Policies pertaining to trade, commerce, export and import,
taxation, etc., also differ widely among countries though they are more or less uniform within the
country. Tariff policy, import quota system, subsidies and other controls adopted by governments
interfere with the course of normal trade between one country and another.

6. Different Currencies: Another notable feature of international trade is that it involves the use
of different types of currencies. So, each country has its own policy in regard to exchange rates
and foreign exchange.

7. Procedures and documentations: The different laws and customs of trade in each country
demand different procedures and documentary requirements for the import and export of the
goods and services.

 SCOPE OF INTERNATIONAL TRADE

1. Exports and Imports - It includes merchandise (tangible or having physical existence) of Goods.
Export merchandise means sending goods to other nations. Import merchandise means receiving
goods from other nations. It does include the trade of services.

2. Service Trade - It is also known as invisible trade. It includes the trade of services (intangible or
no physical existence). There is both export and import of services. Services like tourism, hotel,
transportation, training, research etc.,
 3. Licensing & Franchising - Under this permission is given to the organization of other countries.
To sell the product of a particular company. Under its trademark, patents in return of some fees.
Example– Pepsi and Coca Cola are produced and sold through different sellers abroad.
Franchising is similar to licensing but associated with services. Example- Dominos, burger king,
etc.,

4. Foreign Investment - It includes the investment of available funds in foreign companies to get
returns. It can be of 2 types :(1) Direct investment means investing funds in plant and machinery for
marketing and production, also known as a foreign direct investment (FDI). Sometimes these
investments are done jointly known as joint ventures. (2) Portfolio investment means one company
invests in another company by way of investing in its securities and earn income in the form of
interest and dividends.

5. Consultancy services – The exporting company offers consultancy service by undertaking

Turnkey projects in foreign countries. For this purpose it sends its consultants and experts to foreign
countries who guide and direct the manufacturing activities of the spot.

6. Exchange of Technical and Managerial Knowhow – The Technicians and Managerial

personnel of the exporting company guide and train the technicians and the manager of the importing
company.

 IMPORTANCE OF EXPORT BUSINESS IN INDIA

1. Meeting imports of industrial needs – Imports of capital equipments, raw materials of critical
nature, technical know-how for building the industrial base in the country for rapid industrialization
and developing the necessary infrastructure.

2. Debt Servicing – India has been receiving external aid over the years for its industrial
development resulting in the need for debt servicing. Therefore, it is essential to concentrate on
export earnings to cover both imports and debt servicing.

3. Fast Economic Growth – The countries that would like it grow economically should create
exportable surpluses i.e., surpluses after meeting domestic demands.

4. Optimum Use of Natural Resources – Foreign exchange can be utilized in establishing industrial
unit based on different natural resources availability in the country by making the necessary imports
of plant and machinery for the purpose.

5. Meeting Competitions – To improve the exports, the government announces several concessions
and incentives. By utilizing these concessions domestic producers concentrates his mind towards the
improvement of quality of goods produced and reduces the cost of production so as to face the acute
competitive situation in the foreign markets by making intensive use of latest technology.

6. Increasing Employment Opportunities – The problem of employment and underemployment

can be solved to some extent by increasing the level of export.

7. Increasing National Income – A country’s national income increases to a sizable extent through
organized export marketing.
8. Increasing the standard of Living in the following ways a. Import of necessary items. b.
Purchasing power increases. c. Widespread industrialization. d. Competitive quality

9. Develops International Collaboration – To settle international issues some countries from

group or a common platform to discuss various issues concerning their international trade and take
decision. OPEC & EEC are such groups.

10. Develops Cultural Relations – Local representatives and other related persons come into
contact with foreign representatives and know their habits and customs.

11. Brings Political Peace – Various countries with different political ideologies import or export
their product, which enhances the chances of peace.

 ADVANTAGES OF INTERNATIONAL TRADE

(i) Optimal use of natural resources: International trade helps each country to make
optimum use of its natural resources. Each country can concentrate on production of those
goods for which its resources are best suited. Wastage of resources is avoided.

(ii) Availability of all types of goods: It enables a country to obtain goods which it cannot
produce or which it is not producing due to higher costs, by importing from other
countries at lower costs.

(iii) Specialisation: Foreign trade leads to specialisation and encourages production of

different goods in different countries. Goods can be produced at a comparatively low cost
due to advantages of division of labour.

(iv) Advantages of large-scale production: Due to international trade, goods are produced
not only for home consumption but for export to other countries also. Nations of the
world can dispose of goods which they have in surplus in the international markets. This
leads to production at large scale and the advantages of large scale production can be
obtained by all the countries of the world.

(v) Stability in prices: International trade irons out wild fluctuations in prices. It equalizes
the prices of goods throughout the world (ignoring cost of transportation, etc.)

(vi) Exchange of technical know-how and establishment of new industries:

Underdeveloped countries can establish and develop new industries with the machinery,
equipment and technical know-how imported from developed countries. This helps in the
development of these countries and the economy of the world at large.
(vii) Increase in efficiency: Due to international competition, the producers in a country
attempt to produce better quality goods and at the minimum possible cost. This increases
the efficiency and benefits to the consumers all over the world.

(viii) Development of the means of transport and communication: International trade

requires the best means of transport and communication. For the advantages of
international trade, development in the means of transport and communication is also
made possible.

(ix) International co-operation and understanding: The people of different countries come
in contact with each other. Commercial intercourse amongst nations of the world
encourages exchange of ideas and culture. It creates cooperation, understanding, cordial
relations amongst various nations.

(x) Ability to face natural calamities: Natural calamities such as drought, floods, famine,
earthquake etc., affect the production of a country adversely. Deficiency in the supply of
goods at the time of such natural calamities can be met by imports from other countries.

(xi) Other advantages: International trade helps in many other ways such as benefits to
consumers, international peace and better standard of living.

 DISADVANTAGES OF INTERNATIONAL TRADE

(i) Impediment in the Development of Home Industries: International trade has an

adverse effect on the development of home industries. It poses a threat to the survival of
infant industries at home. Due to foreign competition and unrestricted imports, the
upcoming industries in the country may collapse.

(ii) Economic Dependence: The underdeveloped countries have to depend upon the
developed ones for their economic development. Such reliance often leads to economic
exploitation. For instance, most of the underdeveloped countries in Africa and Asia have
been exploited by European countries.

(iii) Political Dependence: International trade often encourages subjugation and slavery. It
impairs economic independence which endangers political dependence. For example, the
Britishers came to India as traders and ultimately ruled over India for a very long time.

(iv) Mis-utilisation of Natural Resources: Excessive exports may exhaust the natural
resources of a country in a shorter span of time than it would have been otherwise. This
will cause economic downfall of the country in the long run.
(v) Import of Harmful Goods: Import of spurious drugs, luxury articles, etc. adversely
affects the economy and well-being of the people.

(vi) Storage of Goods: Sometimes the essential commodities required in a country and in
short supply are also exported to earn foreign exchange. This results in shortage of these
goods at home and causes inflation. For example, India has been exporting sugar to earn
foreign trade exchange; hence the exalting prices of sugar in the country.

(vii) Danger to International Peace: International trade gives an opportunity to foreign

agents to settle down in the country which ultimately endangers its internal peace.

(viii) World Wars: International trade breeds rivalries amongst nations due to competition in
the foreign markets. This may eventually lead to wars and disturb world peace.

(ix) Hardships in times of War: International trade promotes lopsided development of a

country as only those goods which have comparative cost advantage are produced in a
country. During wars or when good relations do not prevail between nations, many
hardships may follow.
  DRIVING FORCES OF INTERNATIONAL TRADE

1. Higher Rate of Profits: The basic objective of the business is to achieve profits. When the
domestic markets don't promise a higher rate of profits, business firms search for foreign
markets where there is a scope for a higher rate of the profits. Therefore the objective of
profit affects & motivates the business to expand operations to the foreign countries.

2. Expanding the Production Capacities beyond the Demand of Domestic Country: Some
of the domestic companies expand their production capacities more than the demand for the
product in the domestic countries. In such cases, these companies are forced to sell their extra
production in foreign developed countries. Toyota of Japan is an example.

3. Limited Home Market: When a size of the home market is limited either due to the smaller
size of the population or due to the lower purchasing power of all people or both, the
companies internationalize their operations. For example, most of the Japanese automobiles
& electronics firms entered the USA, Europe & even African markets due to the smaller size
of the home market. ITC entered the European market due to the lower purchasing power of
the Indians with regard to high-quality cigarettes.

4. Political Stability vs. Political Instability: The Political stability doesn't simply mean that
the continuation of the same party in power, but it means that continuation of the same
policies of the Government for a quite long period. It is viewed that the USA is a politically
stable country; countries like the UK, France, Germany, Italy & Japan are also politically
stable. Most of the African countries & some of the Asian countries are politically unstable
countries. Business firms prefer to enter the politically stable countries & are restrained from
locating their own business operations in politically unstable countries. In fact, business firms
shift their operations from politically unstable countries to politically stable countries.

5. Availability of Technology & Competent Human Resources: The Availability of

advanced technology & competent human resources in some countries act like pulling factors
for business firms from other countries. For example, American & European companies, in
recent years, have been depended on Indian companies for the software products & the
services through their business process outsourcing (BPO). This is due to the cost of human
resources in India is almost/approximately 10 to 15 times less compared to the US &
European labor markets.

6. High Cost of Transportation: Initially the companies enter foreign countries for their
marketing operations. But the home companies in any country enjoy their higher profit
margins as compared to the foreign firms on account of the cost of transportation of the
products. Under such conditions, the foreign companies are inclined to increase their profit
margin by locating their manufacturing facilities in foreign countries through Foreign Direct
 Investment (FDI) route to satisfy the demand of either one of the countries or the group of
neighboring countries. For example, Mobil which was supplying petroleum products to
Ethiopia, Kenya, Eritrea, Sudan etc., from its refineries in Saudi Arabia, established its
refinery facilities in Eritrea in order to reduce the cost of transportation.

7. Availability of Raw Materials: The source of highly qualitative raw materials & bulk raw
materials is a major factor in attracting companies from various foreign countries. For
example, Vedanta Resources is a London Stock Exchange (LSE) listed UK based company
operating principally in India due to the availability of raw materials such as iron ore,
copper, zinc & lead.

8. Liberalization & Globalization: Most of the countries around the globe liberalized their
economies &opened their countries to the rest of the globe. These change in the policies
attracted multinational companies to the extent their operations to these countries.

9. Growth in Market Share: Some of the large-scale business firms would like to enhance
their market share in the global market by expanding & intensifying their operations in
various foreign countries. The Smaller companies expand internationally for survival while
the larger companies expand to increase their market share. For example Ball Corporation,
the 3rd largest beverage can manufacturer in the USA, bought the European packaging
operations of Continental Can Company.

 RESTRAINING FORCES OF INTERNATIONAL TRADE

1. Culture Differences:- The culture of the nation and the companies should have an international
vision. The long term perspective of companies should be to move wherever market opportunities
are good. Inward-looking culture makes companies remain local.

2. Market Competition in Host Country: If the best global companies enter the markets, the
competition goes intense, and accordingly, inefficient companies have to close their shops.

3. Costs: The competition calls for marketing quality products at competitive prices. If prices are
high the market rejects the products.

4. National Controls: The nation-build barriers for outside country manufacturers by increasing
trade barriers. Trade barriers will be direct by way of high customs duties. Indirect barriers will be
licensing procedures, quota system, inspection, certification, and tedious paperwork.

5. Nationalization and Prejudices: Due to Ideological differences and personal opinions, some
nations do not trade with nations of their dislike.

6. War and Terrorism: The political uncertainties and war-like situation are blockages to the
growth of trade.
7. Shortsightedness of Management: Some management ignores vast business opportunities across
national borders. The companies do not wish to go beyond national borders. If a company does
not adapt to local conditions it does not survive.

8. International Business is Organization History and Capacity Challenges: The companies who
are contended and like to remain within a nation due to the production capacity.

9. Domestic Forces and Trade Barriers: The government or social restrictions imposed on
commerce and industry become a hurdle in a company going global.

10. International Business is Conflict within companies and within the international
organization: Difference of opinion in strategies to be adopted between different management
levels in international business. If support is inadequate the international business proposal fails.

 THEORIES OF INTERNATIONAL TRADE

Theories of international trade tend to explain the nature and movement of international trade. Such
theories can be classified into:

 Classical Country-Based Theories:

1. Mercantilism,
2. Absolute Advantage,
3. Comparative Advantage
4. Heckher-Ohlin Theory.

 Modern Firm-Based Theories:

1. Country Similarity,
2. Product Life Cycle,
3. Global Strategic Rivalry
4. Porter's National Competitive Advantage.
 CLASSICAL COUNTRY-BASED THEORIES:

1. Theory of Mercantilism

Developed in the sixteenth century, mercantilism was one of the earliest efforts to develop an
economic theory. This theory stated that a country’s wealth was determined by the amount of its gold
and silver holdings. In it’s simplest sense, mercantilists believed that a country should increase its
holdings of gold and silver by promoting exports and discouraging imports. In other words, if people
in other countries buy more from you (exports) than they sell to you (imports), then they have to pay
you the difference in gold and silver. The objective of each country was to have a trade surplus, or a
situation where the value of exports are greater than the value of imports, and to avoid a trade deficit,
or a situation where the value of imports is greater than the value of exports. A closer look at world
history from the 1500s to the late 1800s helps explain why mercantilism flourished. The 1500s
marked the rise of new nation-states, whose rulers wanted to strengthen their nations by building
larger armies and national institutions. By increasing exports and trade, these rulers were able to
amass more gold and wealth for their countries. One way that many of these new nations promoted
exports was to impose restrictions on imports. This strategy is called protectionism and is still used
today.

Nations expanded their wealth by using their colonies around the world in an effort to control more
trade and amass more riches. The British colonial empire was one of the more successful examples;
it sought to increase its wealth by using raw materials from places ranging from what are now the
Americas and India. France, the Netherlands, Portugal, and Spain were also successful in building
large colonial empires that generated extensive wealth for their governing nations. Although
mercantilism is one of the oldest trade theories, it remains part of modern thinking. Countries such as
Japan, China, Singapore, Taiwan, and even Germany still favor exports and discourage imports
through a form of neo-mercantilism in which the countries promote a combination of protectionist
policies and restrictions and domestic-industry subsidies.

Nearly every country, at one point or another, has implemented some form of protectionist policy to
guard key industries in its economy. While export-oriented companies usually support protectionist
policies that favor their industries or firms, other companies and consumers are hurt by
protectionism. Taxpayers pay for government subsidies of select exports in the form of higher taxes.
Import restrictions lead to higher prices for consumers, who pay more for foreignmade goods or
services. Free-trade advocates highlight how free trade benefits all members of the global
community, while mercantilism’s protectionist policies only benefit select industries, at the expense
of both consumers and other companies, within and outside of the industry.

2. Theory of Absolute Advantage

In 1776, Adam Smith questioned the leading mercantile theory of the time in The Wealth of
Nations.Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (London: W.
Strahan and T. Cadell, 1776). Recent versions have been edited by scholars and economists. Smith
offered a new trade theory called absolute advantage, which focused on the ability of a country to
produce a good more efficiently than another nation. Smith reasoned that trade between countries
shouldn’t be regulated or restricted by government policy or intervention. He stated that trade should
flow naturally according to market forces. In a hypothetical two-country world, if Country A could
produce a good cheaper or faster (or both) than Country B, then Country A had the advantage and
could focus on specializing on producing that good.

Similarly, if Country B was better at producing another good, it could focus on specialization as well.
By specialization, countries would generate efficiencies, because their labor force would become
more skilled by doing the same tasks. Production would also become more efficient, because there
would be an incentive to create faster and better production methods to increase the specialization.
Smith’s theory reasoned that with increased efficiencies, people in both countries would benefit and
trade should be encouraged. His theory stated that a nation’s wealth shouldn’t be judged by how
much gold and silver it had but rather by the living standards of its people.

Example - In a hypothetical two-country world, if Country A could produce a good cheaper or faster
(or both) than Country B, then Country A had the advantage and could focus on specializing on
producing that good. Similarly, if Country B was better at producing another good, it could focus on
specialization as well.

• There is international benefit from trade – Everyone better off without making anyone worse off.

• His theory stated that a nation’s wealth shouldn’t be judged by how much gold and silver it had but
rather by the living standards of its people.
 3. Theory of Comparative Advantage

The challenge to the absolute advantage theory was that some countries may be better at producing
both goods and, therefore, have an advantage in many areas. In contrast, another country may not
have any useful absolute advantages. To answer this challenge, David Ricardo, an English
economist, introduced the theory of comparative advantage in 1817. Ricardo reasoned that even if
Country A had the absolute advantage in the production of both products, specialization and trade
could still occur between two countries.

Comparative advantage occurs when a country cannot produce a product more efficiently than the
other country; however, it can produce that product better and more efficiently than it does other
goods. The difference between these two theories is subtle. Comparative advantage focuses on the
relative productivity differences, whereas absolute advantage looks at the absolute productivity.

Let’s look at a simplified hypothetical example to illustrate the subtle difference between these
principles. Miranda is a Wall Street lawyer who charges Rs500 per hour for her legal services. It
turns out that Miranda can also type faster than the administrative assistants in her office, who are
paid Rs40 per hour.

Even though Miranda clearly has the absolute advantage in both skill sets, should she do both jobs?
No. For every hour Miranda decides to type instead of do legal work, she would be giving up Rs460
in income. Her productivity and income will be highest if she specializes in the higher-paid legal
services and hires the most qualified administrative assistant, who can type fast, although a little
slower than Miranda. By having both Miranda and her assistant concentrate on their respective tasks,
their overall productivity as a team is higher. This is comparative advantage. A person or a country
will specialize in doing what they do relatively better. In reality, the world economy is more complex
and consists of more than two countries and products. Barriers to trade may exist, and goods must be
transported, stored, and distributed. However, this simplistic example demonstrates the basis of the
comparative advantage theory.

4. Hecker-Ohlin Theory

The theories of Smith and Ricardo didn’t help countries determine which products would give a
country an advantage. Both theories assumed that free and open markets would lead countries and
producers to determine which goods they could produce more efficiently. In the early 1900s, two
Swedish economists, Eli Heckscher and Bertil Ohlin, focused their attention on how a country
could gain comparative advantage by producing products that utilized factors that were in abundance
in the country. Their theory is based on a country’s production factors—land, labour, and capital,
which provide the funds for investment in plants and equipment. They determined that the cost of
any factor or resource was a function of supply and demand. Factors that were in great supply
relative to demand would be cheaper; factors in great demand relative to supply would be more
expensive. Their theory, also called the factor proportions or factor Endowment theory, stated that
countries would produce and export goods that required resources or factors that were in great supply
and, therefore, cheaper production factors. In contrast, countries would import goods that required
resources that were in short supply, but higher demand.

For example, China and India are home to cheap, large pools of labor. Hence these countries have
become the optimal locations for labour-intensive industries like textiles and garments.

MODERN FIRM-BASED THEORIES:

In contrast to classical, country-based trade theories, the category of modern, firmbased theories
emerged after World War II and was developed in large part by business school professors, not
economists. The firm-based theories evolved with the growth of the multinational company (MNC).
The country-based theories couldn’t adequately address the expansion of either MNCs or intra
industry trade, which refers to trade between two countries of goods produced in the same industry.
For example, Japan exports Toyota vehicles to Germany and imports Mercedes-Benz automobiles
from Germany. Unlike the country-based theories, firm-based theories incorporate other product and
service factors, including brand and customer loyalty, technology, and quality, into the understanding
of trade flows.

1. Country Similarity Theory

Swedish economist Steffan Linder developed the country similarity theory in 1961, as he tried to
explain the concept of intra industry trade. Linder’s theory proposed that consumers in countries that
are in the same or similar stage of development would have similar preferences. In this firm-based
theory, Linder suggested that companies first produce for domestic consumption. When they explore
exporting, the companies often find that markets that look similar to their domestic one, in terms of
customer preferences, offer the most potential for success. Linder’s country similarity theory then
states that most trade in manufactured goods will be between countries with similar per capita
incomes, and intra industry trade will be common. This theory is often most useful in understanding
trade in goods where brand names and product reputations are important factors in the buyers’
decision-making and purchasing processes.

2. Product Life Cycle Theory

Raymond Vernon, a Harvard Business School professor, developed the product life cycle theory in
the 1960s. The theory, originating in the field of marketing, stated that a product life cycle has three
distinct stages: (1) new product, (2) maturing product, and (3) standardized product.

The theory assumed that production of the new product will occur completely in the home country of
its innovation. In the 1960s this was a useful theory to explain the manufacturing success of the
United States. US manufacturing was the globally dominant producer in many industries after World
War II.

It has also been used to describe how the personal computer (PC) went through its product cycle.
The PC was a new product in the 1970s and developed into a mature product during the 1980s and
1990s. Today, the PC is in the standardized product stage, and the majority of manufacturing and
production process is done in low-cost countries in Asia and Mexico. The product life cycle theory
has been less able to explain current trade patterns where innovation and manufacturing occur around
the world. For example, global companies even conduct research and development in developing
markets where highly skilled labor and facilities are usually cheaper. Even though research and
development is typically associated with the first or new product stage and therefore completed in the
home country, these developing or emerging-market countries, such as India and China, offer both
highly skilled labor and new research facilities at a substantial cost advantage for global firms.

3. Global Strategic Rivalry Theory

Global strategic rivalry theory emerged in the 1980s and was based on the work of economists Paul
Krugman and Kelvin Lancaster. Their theory focused on MNCs and their efforts to gain a
competitive advantage against other global firms in their industry. Firms will encounter global
competition in their industries and in order to prosper, they must develop competitive advantages.
The critical ways that firms can obtain a sustainable competitive advantage are called the barriers to
entry for that industry. The barriers to entry refer to the obstacles a new firm may face when trying to
enter into an industry or new market.

The barriers to entry that corporations may seek to optimize include:

• Research and Development,

• The ownership of intellectual property rights,

• Economies of scale,

• Unique business processes or methods as well as extensive experience in the industry, and

• The control of resources or favorable access to raw materials.

4. Porter’s National Competitive Advantage Theory

In the continuing evolution of international trade theories, Michael Porter of Harvard Business
School developed a new model to explain national competitive advantage in 1990. Porter’s theory
stated that a nation’s competitiveness in an industry depends on the capacity of the industry to
innovate and upgrade. His theory focused on explaining why some nations are more competitive in
certain industries.

To explain his theory, Porter identified four determinants that he linked together. The four
determinants are (1) local market resources and capabilities, (2) local market demand conditions, (3)
local suppliers and complementary industries, and (4) local firm characteristics.

1. Local market resources and capabilities (factor conditions). Porter recognized the value
of the factor proportions theory, which considers a nation’s resources (e.g., natural resources
and available labor) as key factors in determining what products a country will import or
export. Porter added to these basic factors a new list of advanced factors, which he defined as
skilled labor, investments in education, technology, and infrastructure. He perceived these
advanced factors as providing a country with a sustainable competitive advantage.

2. Local market demand conditions. Porter believed that a sophisticated home market is
critical to ensuring ongoing innovation, thereby creating a sustainable competitive advantage.
Companies whose domestic markets are sophisticated, trendsetting, and demanding forces
continuous innovation and the development of new products and technologies. Many sources
credit the demanding US consumer with forcing US software companies to continuously
innovate, thus creating a sustainable competitive advantage in software products and services.

3. Local suppliers and complementary industries. To remain competitive, large global firms
benefit from having strong, efficient supporting and related industries to provide the inputs
 required by the industry. Certain industries cluster geographically, which provides
efficiencies and productivity.

4. Local firm characteristics. Local firm characteristics include firm strategy, industry
structure, and industry rivalry. Local strategy affects a firm’s competitiveness. A healthy
level of rivalry between local firms will spur innovation and competitiveness.

In addition to the four determinants of the diamond, Porter also noted that government and
chance play a part in the national competitiveness of industries. Governments can, by their
actions and policies, increase the competitiveness of firms and occasionally entire industries.
Porter’s theory, along with the other modern, firm-based theories, offers an interesting
interpretation of international trade trends. Nevertheless, they remain relatively new and
minimally tested theories.

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