Chapter 5:

How to measure the importance of International trade? To examine the volume of a country’s
trade relative to its total output (Benefits of IT & volume of IT)

Trade theory helps managers and government policymakers focus on these questions:
• What products should we import and export?
• How much should we trade?
• With whom should we trade?

What are the theories that support government intervention in the trade flow ? (Interventionist
theories)
- Mercantilism ( countries should export more than they import) (maintain a favorable
balance of trade surplus) (Avoid an unfavorable balance of trade deficit)
- Nero mercantilism (the running of a favorable balance of trade to achieve some social or
political objective)

THEORY OF ABSOLUTE ADVANTAGE:(different countries produce different things more

efficiently than others and that consumers should not have to buy domestically produced goods
when they can buy them more cheaply from abroad.) it could increase its efficiency for three
reasons:
1. Labor could become more skilled by repeating the same tasks.
2. Labor would not lose time in switching production from one kind of product to another.
3. Larger amounts of production would provide incentives for developing more effective
working methods.

Natural Advantage A country’s natural advantage in production comes from climatic conditions,
access to certain natural resources, or availability of certain labor forces.

Acquired Advantage occurs through either product or process technology.

Free trade will bring

- • specialization
- • higher global output

Theory of comparative advantage: global efficiency gains may still result from trade if a country
specializes in what it can produce most efficiently.

THEORIES OF SPECIALIZATION: SOME ASSUMPTIONS AND LIMITATIONS:

- Full employment: (not necessarily a valid assumption of absolute and comparative
advantage)
- Economic efficiency (Countries’ goals may not be limited to economic efficiency)
- division of gains
 - Transport costs (If it costs more to transport the goods than is saved through
specialization, the advantages of trade are negated)
- insufficient demand (If trade increases production by more than normally acceptable tea
and wheat consumption there is an advantage)
- statistics and dynamics
- services
- production networks (having portions of products produced in those countries where
there is an absolute or comparative advantage saves costs)
- Mobility

HOW MUCH DOES A COUNTRY TRADE?

Non-tradable goods—products and services (haircuts, retail grocery distribution, etc.) that are
seldom practical to export because of high transportation costs—are produced in every country.

Theory of Country Size The theory of country size holds that countries with larger land masses
usually depend less on trade than smaller ones.

Size of the Economy While land area helps explain the relative dependence on trade, countries’
economic size helps explain absolute differences in the amount of trade.

WHAT TYPES OF PRODUCTS DOES A COUNTRY TRADE?

General Observation Factor proportions theory appears logical, and a general obser- vation
gives many examples that conform to the theory.

A Closer Observation (Production factors, such as land and labor, are not homogeneous)

Process Technology Factor proportions analysis becomes more complicated when the same
product can be created by different methods, such as with labor versus capital intensity.

Product Technology (Manufacturing is the largest sector in world trade, with commercial
services the fastest-growing sector) (Most new products originate in developed countries)

WITH WHOM DO COUNTRIES TRADE?

Developed countries trade primarily with each other because they
• produce and consume more
• emphasize technical breakthroughs in different industrial sectors

- The country-similarity theory says that companies create new products in response to
market conditions in their home market.
- Specialization and Acquired Advantage In order to export, a company must provide
consumers abroad with an advantage over what they could buy from their domestic
producers.
 - Product Differentiation Trade also occurs because companies differentiate products, thus
creating two-way trade in seemingly similar products. (Product differentiation causes
countries to conduct two-way trade in seemingly similar products)
- The Effects of Cultural Similarity Importers and exporters perceive greater ease in doing
business in countries that are culturally similar to their home country, such as those that
speak a common language. (Trading partners are affected by • cultural similarity, •
political relations between countries, • distance )
- The Effects of Political Relationships and Economic Agreements Political relationships
and economic agreements among countries may discourage or encourage trade
between them.
- The Effects of Distance Although no single factor fully explains specific pairs of trading
partners, the geographic distance between two countries is important in as much as
transport costs increase with distance.

PRODUCT LIFE CYCLE (PLC) THEORY:

- Product Introduction Most new products and process technologies originate in devel-
oped countries in response to companies’ observation of nearby needs for them
- Growth Sales growth attracts competitors to the market, particularly in other developed
countries where firms have technology to replicate the innovating company’s product.
(Growth is characterized by • increases in exports by the innovating country, • more
competition, • increased capital intensity, • some foreign production.)
- Maturity: In the maturity stage, worldwide demand begins to level off, although growing
perhaps in some countries and declining in others. (Maturity is characterized by • a
decline in exports from the innovating country, • more product standardization, • more
capital intensity,• increased competitiveness of price, • production start-ups in emerging
economies.)
- Decline: As a product moves into the decline stage, those factors occurring during the
maturity stage continue to evolve. (Decline is characterized by • a concentration of
production in developing countries, • an innovative country becoming a net importer.)

The diamond of national competitive advantage is a theory showing four features as important
for competitive superiority: demand conditions; factor conditions; related and supporting
industries; and firm strategy, structure, and rivalry.
Facets of the Diamond Usually, all four conditions need to be favorable for an industry within a
country to attain and maintain global supremacy.

● Factor conditions: Are sufficient quantities and combinations of the quality of labor,
capital, and raw materials available at acceptable prices?
● Demand conditions: Are consumers likely to buy what we can produce with the factor
conditions above and at the price we can deliver to them?
● Related and supporting industries: Can we outsource production of sufficient
components and services to allow us to concentrate our efforts on what we can do best?
 ● Firm strategy, structure, and rivalry: Will competitive conditions and our reactions to them
enable us to evolve our operations to sustain and improve our market position?

Limitations of the Diamond of National Advantage Theory The existence of the four favorable
national conditions does not guarantee that a flourishing industry will develop. Entrepreneurs
may face favorable conditions for many different lines of business.

how globalization affects each of the four conditions:

1. Observations of foreign or foreign-plus-domestic demand conditions have spurred much of
the recent Asian export growth. In fact, such Japanese companies as Uniden and Fujitech
target their sales almost entirely to foreign markets.30
2. Companies and countries do not depend entirely on domestic factor conditions. For example,
capital and managers are now internationally mobile, and companies may de- pend on foreign
locations for portions of their production.
3. If related and supporting industries are not available locally, materials and components are
now more easily brought in from abroad because of transportation advancements and relaxed
import restrictions. In fact, many MNEs now assemble products with parts supplied from a
variety of countries.
4. Companies react not only to domestic rivals but also to foreign-based rivals at home and
abroad. Thus the prior domestic absence of any of the four conditions from the diamond may
not inhibit companies and industries from gaining these conditions and becoming globally
competitive.

- Using the Diamond for Transformation By expanding the diamond of national advantage
theory to include changes brought about by globalization, we can see its validity for
countries’ economic policies