Week 4:

International Business: INSTRUCTOR:

Theories and Practice MC ARON J. MONREAL, CPA

RESOURCES:
INTERNATIONAL BUSINESS: THIRD EDITION
WALL, S. MINOCHA, S. REES, B.
INTERNATIONAL BUSINESS: A GLOBAL PERSPECTIVE
KATSIOLUDES, M. HADJIDAKIS S.
International Trade in General and its
Importance
 Global Trade – all commercial transactions, whether domestic or international.
 International Business – encompasses all commercial transactions – private and
governmental between two or more countries
 Trade – the concept of exchanging goods and services between two people or
entities
 International Trade
• the exchange of goods and services between people, organizations, and countries.
• has been a vital means of the countries’ and businesses’ economies.
International Trade Theories
 These are simply different theories to explain international trade
 It is a sub-field of economics that analyzes the patterns of international trade, and
its welfare implications.
 It is used to evaluate the effects of trade policies.
 Categorized as either classical country-based theories or modern firm-based
theories.
Classical/Country-based Theories
 Mercantilism
 a sixteenth century theory stated that a country’s wealth was determined by the amount
of its gold and silver holdings. In its simplest sense, mercantilists believed that a
country should increase its holdings of gold and silver by promoting exports and
discouraging imports. Countries such as Japan, China, Singapore, Taiwan, and even
Germany are still currently implementing neo-mercantilism in their business and trade.
These norms vary from one country to another, and they are reflected in attitudes
toward certain products, advertising, work, and relationships among the people of a
given society.
 The objective of each country was to have a trade surplus and avoid trade deficit.
Classical/Country-based Theories
 Absolute Advantage
 from Adam Smith’s ‘The Wealth of Nations; which focused on the ability of a country
to produce a good more efficiently than another nation; making a more skilled
workforce and thus increasing the living standards of its people.
 Only considers Labor as a fundamental measure of value
 It measures absolute productivity.
 By ‘absolute advantage’ Smith meant the ability to produce those products at lower
resource cost (e.g. fewer labor and capital inputs) than the other countries
Classical/Country-based Theories
 Comparative Advantage
 as introduced by David Ricardo; it 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.
 Only considers Labor as a fundamental measure of value
 It measures relative productivity.
 In this approach even where a country has an absolute advantage (less resource cost)
over the other country in both products, it can still gain by specialization and trade in
that product in which its absolute advantage is greatest, i.e. in which it has a
comparative advantage. Similarly, the other country that has an absolute disadvantage
(higher resource cost) in both products can still gain by specialization and trade in that
product in which its absolute disadvantage is least, i.e. in which it also has a
comparative advantage
Classical/Country-based Theories
 Comparative Advantage

 The example above shows that country A is said to have a comparative advantage in the
production of textiles whilst B is said to have a comparative advantage in the production of
steel.
 In developing the theory of comparative advantage it is possible to use the concept of
opportunity cost, defined as the output foregone by producing one more unit of a particular
product.
Classical/Country-based Theories
 Limitations of the Theory of Comparative Advantage
1. Returns to Scale
2. Full employment
3. Reciprocal demand
4. Transport Costs
5. Factor mobility
6. Free Trade
Classical/Country-based Theories
 Heckscher-Ohlin Theory (Factor Proportions Theory)
 Proposed because the theories of Smith and Ricardo didn’t help countries determine
which products would give a country an advantage.
 Proposed by Eli Heckscher and Bertil Ohlin
 In this approach, it focuses on how a country could gain a comparative advantage by
producing products that utilized factors that were in abundance in the country.
 incorporates a number of realistic characteristics of production that are left out of the
simple Ricardian model.
 It is based on a country’s production factors—land, labor, 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.
Classical/Country-based Theories
 Heckscher-Ohlin Theory (Factor Proportions Theory)
Classical/Country-based Theories
 Heckscher-Ohlin Theory (Factor Proportions Theory)
 also called the factor proportions theory, which states 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 in higher demand.
 Use of Capital/Labor Ratio. The difference in technology is what made the H-O model
advantageous. (must be high)
 The H-O model incorporates a number of realistic characteristics of production that are
left out of the simple Ricardian model.
 Under the H-O model, productivity of labor is assumed to vary across countries, which
implies a difference in technology between nations
 For example, China and India are home to cheap, large pools of labor. Hence these
countries have become the optimal locations for labor-intensive industries like textiles
and garments.
Classical/Country-based Theories
 Difference between the Ricardian Model and the Heckscher-Ohlin Theory
 Ricardian model assumes that production technologies differ between countries, whereas
H-O model assumes that production technologies are the same.
 The H-O model says that capital-abundant country will export capital-intensive goods
while the labor-abundant countries will export labor-intensive goods.
 The relative factor costs of exporting between a labor-intensive country and a capital-
intensive country would lead countries to excel in the production and export of products
that used their abundant, and therefore cheaper, production factors. (ex. Outsourcing)
 Despite new models in trade theory, the H-O theory is still extraordinarily useful.
 Leontief Paradox
 Reverse of the Heckscher-Ohlin Theory
 In subsequent years, economists have noted historically at that point in time, labor in the
United States was both available in steady supply and more productive than in many other
countries; hence it made sense to export labor-intensive goods.
Modern/Firm-based Theories
 Country Similarity Theory
 further explain the concept of Intra-industry trade, companies often find that markets
that look similar to their domestic ones, in terms of customer preferences, offer the
most potential for success.
 further explain the concept of Intra industry trade, companies often find that markets
that look similar to their domestic one, in terms of customer preferences, offer the most
potential for success.
 This theory shows that developed countries trade more with developed countries,
countries in the same cultural milieu trade more amongst themselves, countries in
similar geo-features trade inter se more, countries with similar political and economic
interests trade more inter se, and the Intra-industry trade abetted by similarity factor
Modern/Firm-based Theories
 Country Similarity Theory
 further explain the concept of Intra-industry trade, companies often find that markets
that look similar to their domestic ones, in terms of customer preferences, offer the
most potential for success.
 further explain the concept of Intra industry trade, companies often find that markets
that look similar to their domestic one, in terms of customer preferences, offer the most
potential for success.
 This theory shows that developed countries trade more with developed countries,
countries in the same cultural milieu trade more amongst themselves, countries in
similar geo-features trade inter se more, countries with similar political and economic
interests trade more inter se, and the Intra-industry trade abetted by similarity factor
Modern/Firm-based Theories
 Product Life Cycle Theory
 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.
 Introduced by Raymond Vernon
 The theory assumed that the production of the new product will occur completely in the
home country of its innovation.
 The model claims that many products go through a trade cycle, during which the United
States in initially an exporter, then loses its export markets and may finally become an
importer of the product.
 The model suggests that many products go through a cycle during which high-income,
mass consumption countries are initially exporters, then lose their export markets, and
finally become importers of the product.
 However, they lose their exports initially to developing countries and subsequently to less
developed countries and eventually become importers of these goods.
Modern/Firm-based Theories
 Product Life Cycle Theory
Modern/Firm-based Theories
 Product Life Cycle Theory
 China is now considered one of the leading makers and distributors of cellular phones and other technological products.
 Bangladesh is now one of the market point of garments.
 example is the development of Personal Computers over the years.
 The suggestion here is that the pattern and extent of internationalization achieved by the firm, and future prospects for
continuation of that process, will depend in part on the stage in the IPLC reached by the firm.
 Interest in products and its acceptance or rejection will depend upon its cultural relevance
 One od the difference between Vernon’s perception of IPLC and marketer’s view of the IPLC is that the former focuses
mainly on inventions and new products. It overlooks the tried and well-established products in the domestic market,
which do not enter international markets to take advantage of the economies of scale.
 McDonald’s, Pizza Hut and KFC did not go international until the domestic markets were nearly saturated.
 Louis Wells identifies the four phases in PLC Theory:
 1. Unites States exports strength
 2. Foreign production starts
 3. Foreign production becomes competitive in export markets
 Import Competition begins
Modern/Firm-based Theories
 Product Life Cycle Theory
 3 Life Cycle Stages:
1. New product stage. (Introduction and growth) Here production is concentrated in the
innovating country, as is market demand. A typical scenario for this stage would be where
the (initially) relatively low output is sold at premium prices to a price-inelastic domestic
market segment (with few, if any, exports).
2. Mature product stage. (Maturity) Both production and consumption typically continue to
rise in the innovating country, with scale economies beginning to reduce costs and price to a
new, more price sensitive mass market segment. Exports to other countries become a higher
proportion of total sales.
3. Standardized product stage. (Decline and Extinction) At this stage the technology
becomes more widely diffused and is often largely ‘embodied’ in both capital equipment
and process control.
Modern/Firm-based Theories
 Product Life Cycle Theory
 Important Points in IPLC
1. IPLC relates to rejuvenation or rebirth in international markets of a product that is in
decline domestically for market-related reasons or is close to extinction. Example is
when America open the markets for its cigarettes in China, Eastern Europe and
Russia, when Americans’ pattern of consumption have declined due to health
consciousness and public policies toward public smoking.
2. If a culture-specific product is designed for the international market, it can attain a
new dimension of the product life cycle that is not possible in the domestic market.
Examples include fast food outlets like Burger King and McDonald’s can design a
product for cultures permeated by Buddhist or Hindu vegetarian values.
Modern/Firm-based Theories
 Global Strategic Rivalry 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 that corporations may seek to optimize include:
1. Research and Development
2. the ownership of intellectual property rights,
3. economies of scale,
4. unique business processes or methods as well as extensive experience in the industry, and
5. the control of resources or favorable access to raw materials.
Modern/Firm-based Theories
 Global Strategic Rivalry Theory
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 Porter’s theory stated that a nation’s competitiveness in an industry depends on the capacity of the
industry to innovate and upgrade.
 Also called as ‘Porter’s Diamond of National Advantage’
 Theorized by ‘Michael Porter’
 It aims to understand the competitive advantage that nations or groups possess due to certain
factors available to them, and to explain how governments can acts catalysts to improve a country’s
position in a globally competitive economic environment.
 Another application of the Porter Diamond is in corporate strategy, to use as a framework to
analyze the relative merits of investing and operating in various national markets.
 According to him, ‘A nation attains competitive advantages if its firms are competitive’
 Firms become more competitive through Innovation
 His theory focused on explaining why some nations are more competitive in certain industries.
 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.
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 The four determinants are (1) factor conditions - local market resources and
capabilities, (2) local market demand conditions, (3) local suppliers and
complementary industries (supporting industries), and (4) local firm characteristics.
1. Local market resources and capabilities (factor conditions) - skilled labor, investments in
education, technology, and infrastructure.
2. Local market demand conditions. - Companies whose domestic markets are sophisticated,
trendsetting, and demanding forces continuous innovation and the development of new
products and technologies.
3. Local suppliers and complementary industries. - Certain industries cluster geographically,
which provides efficiencies and productivity.
4. Local firm characteristics. - include firm strategy, industry structure, and industry rivalry.
(A healthy level of rivalry between local firms will spur innovation and competitiveness.)
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 Six Key Variables as potentially giving a country a competitive advantage over other
countries.
1. demand conditions: the extent and characteristics of domestic demand;
2. factor conditions: transport infrastructure, national resources, human capital endowments, etc.;
3. firm strategies: structures and rivalries: the organization and management of companies and
the degree of competition in the market structures in which they operate;
4. related and supporting industries: quality and extent of supply industries, supporting business
services, etc.;
5. government policies: nature of the regulatory environment, extent of state intervention in
industry and the regions, state support for education and vocational training, etc.;
6. chance.
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 The first four of these variables form a diamond shape and regarded as the most
important determinants of national competitive advantage
 these elements in the diamond constitute a system and are self-reinforcing (innovating)
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 FACTOR CONDITIONS
 “key factors” of production are created and not inherited.
 These includes labor, land, natural resources, capital, infrastructures
 Specialized factors involve heavy, sustained investment, including skilled labor, capital and
infrastructures, that leads to competitive advantage
 Switzerland – first country to experience labor shortages. They abandoned labor-intensive
watches and concentrated on innovative/high-end watches.
 Japan - has high-priced land so its factory space is at a premium. This lead to justin-time
inventory techniques—Japanese firms cannot have a lot of stock taking up space, so to cope
with the potential of not having goods around when they need it, they innovated traditional
inventory techniques.
 In several Middle Eastern countries, due to the climatic conditions—lots of sun, limited rain
fall, scarcity of water—the need to use solar energy for heating up water became a necessity.
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 DEMAND CONDITIONS
 Firms that face a sophisticated domestic market are likely to sell superior products because
the market demands high quality and a close proximity to such consumers enables the firm to
better understand the needs and desires of the customers.
 French wine industry. The French are sophisticated wine consumers. These consumers force,
help, and expect French wineries to produce high-quality wines.
 Italian consumers are sophisticated in terms of leather products; thus they force, help, and
expect the Italian leather industry to produce high-quality leather products
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 RELATED AND SUPPORTING INDUSTRIES
 includes suppliers and related industries
 Silicon Valley in the United States, Detroit (for the auto industry), and Italy (leather shoes
and other leather goods industry)
 CLUSTERING/AGGLOMERATION - phenomenon of competitors (and upstream and/or
downstream industries) locating in the same area.
 Advantages to locating close to your rivals:
• Potential technology knowledge spillovers
• An association of a region on the part of consumers with a product and high quality and therefore
some market power
• An association of a region on the part of applicable labor force.
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 RELATED AND SUPPORTING INDUSTRIES
 Disadvantages to locating close to your rivals:
• Potential poaching of your employees by rival companies
• Obvious increase in competition possibly decreasing markups.

 FIRM STRATEGY, STRUCTURE AND RIVALRY

1. Strategy
 Capital Markets - Countries with a short-run outlook (like the United States) will tend to be more competitive in
industries where investment is short-term (like the computer industry). Countries with a long-run outlook (like
Switzerland) will tend to be more competitive in industries where investment is long-term (like the pharmaceutical
industry).
 Individuals’ Career Choices: Individuals base their career decisions on opportunities and prestige. A country will
be competitive in an industry whose key personnel hold positions that are considered prestigious
1. Structure
2. Rivalry
Modern/Firm-based Theories
 Porter’s National Competitive(PNC) Advantage Theory
 FIRM STRATEGY, STRUCTURE AND RIVALRY
2. Structure - Those countries will tend to be more competitive in industries for which that style of
management is suited. For example, Germany tends to have a hierarchical management structure
comprising managers with strong technical backgrounds and Italy has smaller, family-run firms.
3. Rivalry – “intense competition spurs innovation”
 IMPLICATIONS OF GOVERNMENT
Governments can influence all four of Porter’s determinants through a variety of actions such as:
• subsidies to firms, either directly (money) or indirectly (through infrastructure)
• tax codes applicable to corporation, business, or property ownership
• educational policies that affect the skill level of workers
• establishment of technical standards and product standards, including environmental regulations
• government’s purchase of goods and services
• antitrust regulation
…FIN
Q&A

…FIN
DISCUSSION OF NEXT WEEKS’ ACTIVITES