International Business

Sixteenth Edition, Global Edition

Chapter 5
Trade and Factor
Mobility Theory

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Learning Objectives (1 of 2)
5-1 Understand why policymakers rely on international trade
and factor mobility theories to help achieve economic
objectives
5-2 Illustrate the historical and current rationale for
interventionist and free trade theories
5-3 Describe theories that explain national trade patterns

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Learning Objectives (2 of 2)
5-4 Explain why a country’s export capabilities are dynamic
5-5 Summarize the reasons for and major effects of
international factor movements
5-6 Assess the relationship between foreign trade and
international factor mobility

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Factor Mobility and Trade Theory Questions
Objective 5-1

• 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?

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 Interventionist Theories
Objective 5-2
• 1. MERCANTILISM?
Mercantilism holds that a country’s wealth is measured
by its holdings of “treasure,” which usually means its
gold.

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• 1.1Governmental policies
• To run a trade surplus, governments restricted imports
and subsidized noncompetitive production. Countries
with colonies imported commodities from them that
they would otherwise have to purchase from
elsewhere.
• They monopolized colonial trade in order to force the
colonies to export less highly valued raw materials to
them and import more highly valued manufactured
products from them.

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• 1.2. The Concept of Balance of Trade
Some mercantilist terminology has endured. For
example, a favorable balance of trade (also called a
trade surplus) still indicates that a country is
exporting more than it imports. An unfavorable
balance of trade (also known as a trade deficit)
indicates the opposite

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 2. NEOMERCANTILISM

• is the running of a favorable balance of trade to

achieve some social or political objective.
• For example, a country may reduce unemployment
by encouraging its companies to produce in excess of
the home demand and send the surplus abroad. Or it
may attempt to maintain political influence in an area
by sending more merchandise there than it receives,
such as a government granting merchandise aid or
loans to a foreign government.

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 Free Trade Theories
Objective 5-2
• Why Trade at all?
• No nation has all the natural resources, geographic
conditions, and technology necessary to produce
everything we consume today. In addition, two free
trade theories further help answer this question:
absolute Advantage AND Comparative Advantage

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• 1. Theory of Absolute Advantage
Adam Smith (1776) declared that a country’s well-being
is its citizens’ access to goods and services rather than
the mercantilists’ concept of its ownership of gold.
This theory holds that 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.

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• 1.1. Natural Advantage
A country’s natural advantage in production comes
from climatic conditions, access to certain natural
resources, or availability of certain labor forces.
• 1.2. Acquired Advantage Most of today’s world
trade is in manufactured goods that compete
through an acquired advantage, usually in either
product or process technology.

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Illustration of Absolute Advantage
Objective 5-2
Figure 5.2 Production Possibilities under Conditions of Absolute Advantage

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• 2. Theory of comparative advantage
• In 1817, David Ricardo examined the question,
“What happens when one country can produce all
products at an absolute advantage?”

• His resulting theory of comparative advantage

says that global efficiency gains may still result
from trade if a country specializes in what it can
produce most efficiently—regardless of other
countries’ absolute advantage.

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• Comparative advantage by analogy
• a country gains if it concentrates its resources on
the commodities it can produce most efficiently. It
then trades some of those for commodities
produced abroad. The following discussion
clarifies this theory.
• Production Possibility

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Illustration of Comparative Advantage
Objective 5-2
Figure 5.3 Production Possibilities under Conditions of Comparative Advantage

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Map of State and Relative Country Economies
Objective 5-2
Map 5.2 U.S. States’ Economies Compared to National Economies

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 Theories to Explain Trade Patterns
Objective 5-3
• How much does a country trade?
– 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
– Larger economies are the biggest traders
because they produce and consume more.
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What types of products should a country trade?
• Factor Proportions Theory: According to the
factor proportions theory, countries have their
best trade advantage when depending on their
relatively abundant production factors
With whom do countries trade?
• Country-Similarity theory: says that companies
create new products in response to market
conditions in their home market.
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• They then turn to markets they see as most
similar to what they are accustomed, especially
those markets where consumers have
comparable levels of per capita income

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PLC Theory
Objective 5-4
• What is the Product Lifecycle Theory (PLC)?
• According to the PLC theory of trade, the
production location for many products moves
from one country to another depending on the
stage in the product’s life cycle

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• Introduction
• Growth
• Maturity
• Decline

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Limitations of PLC Theory
Objective 5-4

• Exceptions to PLC Theory

• According to the diamond of national competitive
advantage theory, companies’ development and
maintenance of internationally competitive
products depends on favorable demand
conditions, factor conditions, related and
supporting industries, firm strategy, structure, and
rivalry.

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 Diamond of National Competitive Advantage Theory
Objective 5-4
Figure 5.4 The Diamond of National Competitive Advantage

Source: Based on Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review, 68:2 (March–April
1990).

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• 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. In fact, comparative
advantage theory holds that resource limitations may
cause a country’s firms to avoid competing in some
industries despite having an absolute advantage.

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Why Production Factors Move
Objective 5-5
• Capital
• People
• Effects of factor movements
– Brain drain

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• What is the Factor Mobility Theory?
• This theory focuses on why production factors
move, the effects of that movement on
transforming factor endowments, and the impact
of international factor mobility (especially people)
on world trade.

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 The Relationship Between Trade and
Factor Mobility
Objective 5-6

• Substitution: There are pressures for the most

abundant factors to move to areas of scarcity.
Complementarity: Factor mobility through foreign
investment often stimulates trade because of the need
for components, the parent company’s ability to sell
complementary products, the need for equipment for
subsidiaries.

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