Bases of International Marketing

Chapter 2
 International Trade Theories

A number of theories have been developed to explain the patterns of trade among countries and how the
benefits of trade are distributed. These include:

 The classical theory of international trade, which demonstrates with fairly simple 2-country, 2-
product models the conditions under which both countries in a trading relationship benefit;

 The factor proportion theory, which offers an explanation for the differences in comparative costs
between trading partners;

 The product life-cycle theory, which attempts to explain why international trading patterns began to
change in the 1960s.
 The classical theory of international trade

What a country exports and imports is determined not by its character in isolation but in relation to
those of its trading partners. The concept of economic advantage states that countries tend to specialize in
those products in which they have an advantage, namely, lower cost of production. This means simply
that a country produces for domestic consumption and for export those items that it makes better or more
cheaply than other countries, and imports those products that it can acquire more cheaply from abroad
than at home. The essence of the logic behind economic advantage is that any nation can only hurt itself
by excluding imports that can be obtained more cheaply from abroad than at home.
There are three different situations concerning international differences in costs that must be
considered – absolute differences, comparative differences, and equal differences. The extent to which
trade is carried on and its very nature depends on which of these three conditions exists in any given
potential trading relationship and upon the nature of reciprocal demand structures. In the classical theory
it is assumed that the supply price is the same as the money cost of production, that is, transport costs,
marketing costs, and individual firm profits are not considered. In the real world, of course, these costs
certainly exist, and are quite significant in most cases. But the concept of supply price remains
unchanged; only absolute magnitudes are affected.
 Absolute advantage

A condition of absolute advantage exists when one country has a cost advantage over another
country in the production of one product (that is, it can be produced using fewer resources) while the
second country has a cost advantage over the first in producing a second product. In a two-country
two-product world, international trade and specialization will be beneficial to each country when the
country is absolutely more efficient than its trading partner. For a given set of productive resources
(capital and labor inputs), specialization and trade lead to a greater output of both products.
 Comparative advantage

Suppose, for simplicity, that each has 1,000 workers, and each makes two goods: computers and bicycles. West’s
economy is far more productive than East’s. To make a bicycle, West uses 10 workers while East uses 100. Suppose there is
no trade, and that in each country half the workers are in each industry. West produces 250 bicycles and 50 computers. East
makes 125 bikes and five computers.
Now suppose that the two countries specialize. Although West makes both products more efficiently than East, it has a
bigger edge in computer making. It now devotes most of its resources to that industry, employing 700 workers to make
computers and only 300 to make bikes. This raises computer output to 70 and cuts bike production to 150, as shown in Table
2.1. East switches entirely to bicycles, turning out 250. World output of both goods has risen. Both countries can consume
more of both if they trade.
At what price? Neither will want to import what it could make more cheaply at home. So West will want at least five
bikes per computer; and East will not give up more than 25 bikes per computer (these are the domestic exchange ratios that
set the limits within which the international exchange ratio must fall for gains to accrue to both trading partners). Suppose the
terms of trade are fixed at 12 bicycles per computer and that 120 bikes are exchanged for 10 computers (the exact
international exchange ratio will depend upon the existing reciprocal demand situation). Then West ends up with 270 bikes
and 60 computers, and East with 130 bicycles and 10 computers. Both are better off than they would be if they did not trade.
 Comparative advantage

Output and consumption Output after Consumption

under autarky specialization after trade
Bicycles Computers Bicycles Computers Bicycles Computers

East 125 5 250 0 130 10

West 250 50 150 70 270 60
Equal advantage

A condition of equal advantage exists when one country has an absolute advantage over
another in production of all products but no superior advantage in the production of any one
product.
Equal advantage

Country Production costs per unit

(in hours of labor)
Shoes Clothing
Guatemala 30 60
Italy 10 20
 Equal advantage

In producing both products Italy has an absolute advantage over Guatemala. In fact Italy is twice as
efficient in both products. The domestic exchange ratio of shoes to clothes in each country is the same,
1 : 2. Using the reasoning above, there is no range of possible international trade ratios, which means
that each country will neither gain nor lose anything by trading. Under such conditions, trade could not
possibly exist as the incentive of gain is lacking. It is reasonable to ask what the limitations and
implications of this analysis are. The equal ratios for these two products might be the same for any
number of reasons, such as better machinery being used in Italy. However, it seems unlikely that ratios of
labor costs for all products in both countries would be the same. Therefore, while trade in some products
might not be feasible, it might be advantageous for other products where the ratios differ. But could trade
still be advantageous if Guatemala had higher costs in hours of labor for every product than Italy? The
answer is yes. Over time the monetary exchange rates would change to reflect the differences in
productivity in the two countries – not precisely, but enough to make trade feasible in some products in
which Guatemala had less of a comparative disadvantage in labor costs.
The factor proportion theory

The factor proportion theory argues that relative price levels differ among countries
because (1) they have different relative endowments of factors of production (capital and labor
inputs) and (2) different commodities require that the factor inputs be used with differing
intensities in their production (factor intensities – capital/labor relationships). Given these
circumstances the factor proportion theory can be formulated as follows:
A nation will export that product for which a large amount of the relatively abundant (cheap) input is
used, and it will import that product in the production of which the relatively scarce (expensive) input is
used.
The principal explanation of the pattern of international trade lies in the uneven distribution
of world resources among nations, coupled with the fact that products require different
proportions of the factors of production. While the production of clothing, for example, is very
labor intensive, the manufacturing of machines is much more capital intensive.
 The product life-cycle theory of
international trade
According to the product life-cycle concept, many manufactured goods, in particular
technologically advanced products such as electronic products and office machinery, undergo a trade
cycle.
During the process, which can be described in various stages, the innovator country of a new
product is initially an exporter, then loses its competitive advantage vis-à-vis its trading partners, and
may eventually become an importer of the product some years later. The introduction stage of the trade
cycle begins when the innovator company establishes a technological breakthrough in the production of a
manufactured item. The country where the innovating company is located initially has an international
technological gap in its favor, and is typically a high-income developed economy. At the start, the
relatively small local market (home market) for the product and technological uncertainties imply that
mass production is not feasible.
 The product life-cycle theory of
international trade

During the trade cycle’s next stage, the innovator manufacturer begins to export its product to foreign
markets, which are likely to be countries with similar tastes, income levels, and demand structures, that is,
other developed countries. The manufacturer finds that during this stage of growth and expansion, its market
becomes large enough to support mass-production operations and the sorting out of inefficient production
techniques, which means that increasing amounts can be supplied to world markets.
As time passes, the manufacturer realizes that to protect its foreign sales and export profits it must locate
production operations closer to the foreign markets. The domestic industry enters its mature stage as
innovating firms establish subsidiaries abroad, usually in advanced countries first. A major reason for this is
that the cost advantage initially enjoyed by the innovator is not likely to last indefinitely. Over a period of
time, the innovating country may find that its technology has become more commonplace and that
transportation costs
 The product life-cycle theory of
international trade

Although an innovating country’s monopoly position may be prolonged by legal rights (for example,
patents and other intellectual property rights), it often breaks down over time. This is because knowledge
tends to be a free item in the long run. The Internet contributes to this. Once the innovative technology
becomes fairly commonplace, foreign producers begin to imitate the production process. The innovating
country gradually loses its comparative advantage and its export cycle begins to experience a declining
phase. The trade cycle is complete when the production process becomes so standardized that it can be
easily utilized by all nations, including lesser-developed countries. The innovating country may finally
itself become a net importer of the product as its monopoly position is eliminated by foreign competition.
Concerns over free trade

 Are reduced barriers to trade really beneficial to all countries?

 Are they needed to protect particular industries or groups of people?
 Are open markets really politically feasible?
Export behavior theories and motives

 Basic goals
To make a profit

 Specific reasons
Specific reasons
 Specific reasons

 Managerial urge
 Unique product/technology competence
 Risk diversification
 Foreign market opportunities
 Change agents
 Economies of scale
 Foreign marketing advantages
 Extend sales of seasonal product
Specific reasons

 Excess capacity of resources

 Unsolicited foreign orders
 Small domestic market
 Stagnant or declining home market
 Resources
 Multinational, global, world companies
 Other goals
The development of export in the firm:
internationalization stages
A more comprehensive view of, say, the stages of manufacturing firms is:
1. export operation stage;
2. foreign sales subsidiary stage;
3. licensing and contracting alliances;
4. foreign production subsidiary or alliance stage.
Exporting and the network model

Firms in industrial markets establish and develop lasting business relationships with other
businesses. This is known as relationship marketing. In particular, this is true in international
markets, where a company is engaged in a network of business relationships comprising a
number of different firms – export distributors, agents, foreign customers, competitors, and
consultants as well as regulatory and other public agencies. These business relationships are
connected by networks, where the parties build mutual trust and knowledge through
interaction, and that interaction means strong commitment to the relationships.
Exporting and the network model
Class Assignment

The productivities of factor inputs with respect to

different products are determined by a combination of
natural and acquired advantages. Is the productivity of the
Japanese due primarily to natural or acquired advantages?
How about the French, or the Chinese? Explain.
Ethical/moral issues

Defining ethics
Ethical behavior, at its most basic level, is what most people in a given society or group
view as being moral, good, or right.
Possible bases for ethical decision-making

 Principle of Utilitarianism
 Principle of Rights
 Principle of Justice
Applying ethics in international marketing

 The product (or service) should be safe and effective for use in the intended manner.
 In activities related to market entry and expansion, care should be taken to ensure that
methods used do not conflict with either local or home country values, and will not be
construed as including bribery.
 Advertising and promotion should honestly represent the product or service, avoiding
misleading or confusing claims.
 Prices should be set at a level that will be viewed as reasonable or fair, given the
conditions in the target market.
 Customers, employees, and suppliers should all be treated in a manner viewed as equitable
and proper in their country.
Social responsibility and the business
environment
 business must respond to changes in society and its demands/expectations;
 profit maximization in the long run requires a socially and physically healthy environment;

it was necessary to do so in order to avoid increasing government regulation;
 it would provide a better corporate image, with benefits in the ability to attract better employees, increased sales,
improved access to capital, and improved stock performance;
 it might open up additional opportunities profitably to meet existing
Arguments against companies going further than required in attempting to improve society included the following:
 it would reduce the company’s ability to meet its primary objective of maximizing profits to stockholders;
 it would undermine free enterprise and result in business assuming functions that should be handled by the
government or social institutions;
 it would place individual business leaders in the position of personally making nonbusiness-related decisions about
spending corporate money;
 the whole concept is fuzzy.
The stakeholder concept
Class Assignment

 Explain the legal practices, business–government

relations, and social responsibility in two different
countries