Topic 2 International Trade

Global Business Environment
CRT 6001
PGDM C
Dr. Ronny Thomas

Asst. Professor
Rajagiri Business School
Global Business Environment PGDM-C Tri-4 RBS

Theories of International Trade
Global Business Environment PGDM-C Tri-

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1. Mercantilist Trade Theory

2. Theory of Absolute Advantage
3. Theory of Comparative Advantage
4. Heckscher-Ohlin Theory
5. Product Life-Cycle Theory
6. New Trade Theory
7. Porter’s Diamond Model Of Competitive Advantage

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Why Countries Trade?
What explain the pattern of trade?

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Absolute
Free
Free Trade
Trade Advantage
Absolute Advantage
Trade Surplus
Trade Surplus Efficiency
Specialisation
Specialization
Comparative
Advantage
Comparative Advantage
Product Life
Key Concepts Product Life cycle and
trade
Relative
Productivity/Effriciency cycle
Efficiency
Economies of Competitive
Competitive Advantage
scale Advantage

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6. New Trade Theory

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What Is Mercantilism?
 Mercantilism (mid-16th century) suggests that it is in a

country’s best interest to maintain a trade surplus
 Advocates Protectionism
 Mercantilism views trade as a zero-sum game

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Mercantilism: Context

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Mercantilism
Today, some argue for neomercantilism – the idea that the
nation should run a trade surplus.
• Supporters of neomercantilism include:

 Labor unions (who want to protect domestic jobs),
 Farmers (who want to keep crop prices high), and
 Some manufacturers (that rely on exports).

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Chinese trade and neo-mercantilism

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6. New Trade Theory

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Theory of Absolute Advantage
Adam Smith (1776), ‘An inquiry into the nature and cause of wealth of nations’
Argued that “mercantilism robs individuals of the ability to trade
freely and benefit from voluntary exchanges”

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What Is Smith’s Theory Of Absolute Advantage?
 Supports free trade.
Countries should specialize in the production of goods in which

they are efficient than any other country and then trade these goods
for goods produced by other countries.

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Example: France & England Trade

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Absolute advantage theory
One barrel/ton of
Wine Textile
---------------------------------------------
France 30 40
England 100 20
----------------------------------------------
Example of Absolute Advantage (labor cost
in days of production for one barrel/ton)
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6. New Trade Theory

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The theory of comparative advantage
David Ricardo (1817) The principles of political economy and taxation:
“what happens when one country has an absolute advantage in the production of all
goods”
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Comparative advantage theory
 Supports free trade
 It is beneficial for two countries to trade even if one has

absolute advantage in the production of all products –
 what matters is not the absolute cost of production but the

relative efficiency with which it can produce the product.

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One ton/barrel of
Wine Textile
---------------------------------------------
France 30 60
England 25 20
----------------------------------------------
Example of Comparative Advantage (labor cost
in days of production for one ton/barrel)
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What are the commodities for which India has got a

comparative advantage?

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“Two men can make both shoes and hats, and one is superior to the
other in both employments, but in making hats he can only exceed
his competitor by one fifth or 20 percent, and in making shoes he
can excel him by one third or 33 percent; Will it not be for the
interest of both that the superior man should employ himself
exclusively in making shoes and the inferior man in making hats?”
David Ricardo, 1817

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6. New Trade Theory

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Heckscher-Ohlin Theory
1920: Factor Proportions Theory/ Factor Endowments Theory

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Supports free trade
The pattern of trade is determined by ‘factor endowments’
 Heckscher and Ohlin predict that countries will

 exportgoods that make intensive use of locally
abundant factors
 import goods that make intensive use of factors

that are locally scarce

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Does this explain any pattern of trade
today?

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What do you think India should specialise on based on
this theory?

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Does The Heckscher-Ohlin Theory Hold?
Leontief Paradox:
 Wassily Leontief (1953) theorized that the U.S. would

be an exporter of capital intensive goods and an
importer of labor-intensive goods.
 However, he found that U.S. exports were less capital intensive

than U.S. imports
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6. New Trade Theory

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Product Life Cycle Theory
Ray Vernon (1966)

Quarterly Journal of Economics, "International Investment and
International Trade in the Product Cycle"
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 Explains the evolutionary process that occurs in the
development and diffusion of products to global markets.
Three stages of evolution of the product and manufacturing

technology: introduction, growth, and maturity.

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Poduct life cycle theory

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Does The Product Life Cycle Theory Hold?

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Applicability to the contemporary global economy:
 Today, the cycle from innovation to maturity is much

shorter making it harder for the innovator country to
sustain its lead in a particular product

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6. New Trade Theory

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New Trade Theory
New trade theory emerged in the 1980s

Paul Krugman won the Nobel prize for his work in
2008
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New Trade Theory
 According to NTT - Pattern of trade we observe in the
world is because of
1. Economies of Scale
2. First Mover Advantage
3. Specialization

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New Trade Theory
 New trade theory: Economies of scale as an important factor in trade

for some industries.
Economies of scale, is a key factor for superior international

performance, and would explain why trade grew fastest among
industrial countries that held similar factors of production
First Movers – Scale Advantage

 Some industries succeed best as their volume of production increases.

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New Trade Theory

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New Trade Theory
 With out trade: nations might not be able to produce those
products where economies of scale are important.
 Trade: markets are large enough to support the production

necessary to achieve economies of scale.
 Trade is mutually beneficial because:

1) allows for the specialization of production
2) the realization of scale economies
3) production of a greater variety of products at lower
prices Global Business Environment PGDM-C Tri-
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New Trade Theory
Implication to the firm:
 first mover advantages & Scale economies
 first movers can gain a scale based cost advantage that

later entrants find difficult to match

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Porter’s Diamond Model Of Competitive Advantage
Michael Porter (The competitive advantage of nations,1990)
why a nation achieves international success in a particular industry
 identified four attributes that promote or impede the creation of competitive

advantage
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Porter’s Diamond Model Of Competitive Advantage
1. Firm strategy, structure, and rivalry
2. Factor Endowments
3. Demand Conditions
4. Related Supporting Industries

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Michael Porter’s Diamond Model:
Sources of National Competitive Advantage
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2019/20 Tri-4 RBS
Michael Porter’s Diamond Model
Factor Conditions:
Quality and quantity of labor, natural resources, capital,
technology, know-how, entrepreneurship, and other factors of
production.

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Related Supporting Industries:
– the presence of suppliers, competitors, and complementary
firms that excel within a given industry.

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Supporting Industries: Industrial Clusters
 Switzerland: Pharmaceutical Cluster

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Demand Conditions:
– the strengths and sophistication of customer demand.

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Demand Conditions:
– the strengths and sophistication of customer demand.

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Firm Strategy, Structure and Rivalry
- The nature of domestic rivalry, and conditions that determine
how a nation’s firms are created, organized, and managed.

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Implication of porters theory
 Government policy can:
 affect demand through product standards
 influence rivalry through regulation and antitrust laws
 impact the availability of highly educated workers and

advanced transportation infrastructure.
Implementation of STRONG National Industrial Policy

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Need for National Industrial Policy
 A proactive economic development plan employed by
the government to nurture or support promising
industry sectors with potential for regional or global
dominance. Initiatives can include:
 Tax incentives.
 Monetary and fiscal policies.
 Rigorous educational system.
 Investment in national infrastructure.
 Strong legal and regulatory systems.

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National Industrial Policy
 Vietnam’s government in the 1990s privatized state enterprises
and modernized the economy emphasizing competitive,
export-driven industries.
Vietnam became one of the

fastest-growing economies,
averaging around 8 percent
annual GDP growth.

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National Industrial Policy
Singapore adopted probusiness, proinvestment, export-oriented
policies, combined with state-directed investments in strategic
corporations.
Economic growth that averaged 8 percent annually from 1960 to
1999.
Lee Kuan Yew

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What Are The Implications Of Trade Theory For
Managers?
1. Location implications
2. First-mover implications
3. Policy implications

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Topic 2 International Trade

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Global Business Environment

Dr. Ronny Thomas

Global Business Environment PGDM-C Tri-4 RBS

Global Business Environment PGDM-C Tri-

1. Mercantilist Trade Theory

Global Business Environment PGDM-C Tri-

What explain the pattern of trade?

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

1. Mercantilist Trade Theory

Global Business Environment PGDM-C Tri-

 Mercantilism (mid-16th century) suggests that it is in a

 Mercantilism views trade as a zero-sum game

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

• Supporters of neomercantilism include:

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

1. Mercantilist Trade Theory

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Countries should specialize in the production of goods in which

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

1. Mercantilist Trade Theory

Global Business Environment PGDM-C Tri-

David Ricardo (1817) The principles of political economy and taxation:

 It is beneficial for two countries to trade even if one has

 what matters is not the absolute cost of production but the

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

What are the commodities for which India has got a

Global Business Environment PGDM-C Tri-

David Ricardo, 1817

Global Business Environment PGDM-C Tri-

1. Mercantilist Trade Theory

Global Business Environment PGDM-C Tri-

1920: Factor Proportions Theory/ Factor Endowments Theory

Global Business Environment PGDM-C Tri-

The pattern of trade is determined by ‘factor endowments’

 Heckscher and Ohlin predict that countries will

 import goods that make intensive use of factors

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

 Wassily Leontief (1953) theorized that the U.S. would

 However, he found that U.S. exports were less capital intensive

1. Mercantilist Trade Theory

Global Business Environment PGDM-C Tri-

Ray Vernon (1966)

Three stages of evolution of the product and manufacturing

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Global Business Environment PGDM-C Tri-

Applicability to the contemporary global economy:

 Today, the cycle from innovation to maturity is much