International Business: The New Realities

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 Learning Objectives

1. Theories of international trade and

investment
2. Why do nations trade?
3. How can nations enhance their competitive
advantage?
4. Why and how do firms internationalize?
5. How can internationalizing firms gain and
sustain competitive advantage?

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 Mercantilism and Neomercantilism

• Mercantilism: A belief, popular in the 16th century,

that national prosperity results from maximizing
exports and minimizing imports.
• Today, some argue for neomercantilism—the idea
that a nation should run a trade surplus.
• Supporters of neomercantilism include:
 Labor unions (want to protect domestic jobs)
 Farmers (want to keep crop prices high)
 Some manufacturers (rely on exports)
But is neomercantilism best for all?
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 Free Trade

The absence of restrictions to the

flow of goods and services among nations
• Free trade is usually best because it leads to:
 More and better choices for consumers and firms
 Lower prices of goods for consumers and firms
 Higher profits and better worker wages (because
imported input goods are usually cheaper)
 Higher living standards for consumers (because
their costs are lower)
 Greater prosperity in poor countries

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 Comparative Advantage

• The foundation concept of international trade;

answers the question of how nations can achieve
and sustain economic success and prosperity
• Refers to the superior features of a country that
provide it with unique benefits in global
competition
• Derived either from natural endowments or from
deliberate national policies

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 Examples of National Comparative Advantage

• France has a superior climate and soil for

producing wine.
• Saudi Arabia has a natural abundance of oil for the
production of petroleum products.
• Over time, Japan has acquired a superior base of
knowledge and experience for producing cars.
• Over time, India has acquired a superior base of IT
workers for producing computer software.

What are the comparative advantages in your

country?
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 Absolute Advantage Principle
A country should produce only those products in which it has
absolute advantage or those it can produce using fewer
resources than another country.

(Labor Cost in Days of Production for One

Ton)
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Adam Smith (1723-1790)

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 Comparative Advantage Principle
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.

(Labor Cost in Days of Production for One Ton)

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 Comparative Advantage Principle (cont.)

“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

International Business: The New Realities 6-10

 Comparative Advantage Principle (cont.)

• While Germany can make both items more cheaply than

France, it is still beneficial for Germany to trade with France.
• The key is the ratio of production costs. In the exhibit,
Germany is comparatively more efficient at producing cloth
than wheat: It can produce three times as much cloth as
France (30/10), but only two times as much wheat (40/20).
• Germany should specialize in producing cloth and import all
the wheat it needs from France. France should specialize in
producing wheat and import all its cloth from Germany.
• Each country benefits by specializing in the product in which
it has a comparative advantage and importing the other
product.

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 Comparative Advantage Principle (cont.)

• The principle applies to all goods. It reveals how

countries use scarce resources more efficiently.
Example
•Arguably, no country is better than Japan at making
cars and cell phones. But because Japan is especially
good at making cars, it concentrates its resources on
making them.
•Other countries, such as China and Finland, focus on
making cell phones.

•In this way, Japan makes maximal use of its

resources, and the world gets great cars.
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Comparative Advantage Principle (cont.)

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 Limitations of Early Trade Theories

• Fail to account for international transportation costs.

• Governments distort normal trade by selectively imposing
protectionism (e.g., tariffs) or investing in certain
industries (e.g., via subsidies).
• Services: Some cannot be traded; others can be traded
freely via the Internet or global telephony.
• For many firms, scale economies and superior business
strategies provide efficiencies and other advantages.
Early trade theories failed to account for this (e.g., Japan
lacks comparative advantages, but its firms succeeded
anyway, via superior strategies).

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 Factor Proportions Theory

• Also known as the Factor Endowments Theory, it

argues that each country should produce and export
products that intensively use relatively abundant factors
of production, and import goods that intensively use
relatively scarce factors of production.

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 Factor Proportions Theory (cont.)

• However, the Leontief Paradox revealed that

countries can successfully export products that use
less abundant resources (e.g., the U.S. often
exports labor-intensive goods).
• This implies that international trade is complex and
cannot be fully explained by a single theory.

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International Product Life Cycle Theory

• Each product and its associated manufacturing

technologies go through three stages of evolution:
introduction, maturity, and standardization.
• In the introduction stage, the inventor country
enjoys a monopoly both in manufacturing and
exports. Example: the television set.

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 International Product life Cycle Theory (cont.)

• In the maturity stage, the product’s manufacturing

becomes relatively standardized, and other
countries start producing and exporting the product.

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 International Product life Cycle Theory (cont.)

• In the standardization stage, manufacturing

ceases in the original innovator country, and this
country becomes a net importer of the product.
Today, due to globalization, the cycle occurs
quickly for many products.

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 New Trade Theory

• Argues that economies of scale are an important

factor in some industries for superior international
performance, even in the absence of superior
comparative advantages. Some industries succeed
best as their volume of production increases.

Example
The commercial aircraft industry has very high fixed
costs that necessitate high-volume sales to achieve
profitability.

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Comparative vs. Competitive Advantage

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 Critical Role of Innovation
in National Economic Success

• Innovation is a key source of competitive

advantage.
• The firm innovates in four major ways. It can
develop:
(1) A new product or improve an existing product
(2) New ways of manufacturing
(3) New ways of marketing
(4) New ways of organizing company operations
• Many innovative firms in a nation leads to national
competitive advantage
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 Critical Role of Productivity
in National Economic Success

• Productivity is the value of the output produced by a

unit of labor or capital.
• It is a key source of competitive advantage for firms.
• The greater the productivity of the firm, the more
efficiently it uses its resources.
• The greater the aggregate productivity of the firms in
a nation, the more efficiently the nation uses its
resources.
• Aggregate productivity is a key determinant of the
nation’s standard of living.

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Productivity Levels in Selected Countries
(Output per hour in manufacturing, 1985–2005; Indices, where 1992=100)

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 Michael Porter’s Diamond Model:
Sources of National Competitive Advantage

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 The Diamond Model:
Sources of National Competitive Advantage (cont.)

• Factor conditions: Quality and quantity of labor,

natural resources, capital, technology, know-how,
entrepreneurship, and other factors of production

Example
An abundance of cost-effective and well-educated
workers gives China a competitive advantage in the
production of laptop computers.

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 The Diamond Model:
Sources of National Competitive Advantage (cont.)

• Related and supporting industries: The presence

of suppliers, competitors, and complementary firms
that excel within a given industry

Example
Silicon Valley in California is a great place to
launch a computer software firm because it is home
to thousands of knowledgeable firms and workers in
the software industry.

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 The Diamond Model:
Sources of National Competitive Advantage (cont.)

• Demand conditions at home: The strengths and

sophistication of customer demand

Example
Japan is a densely populated, hot, and humid country
with very demanding consumers. These conditions
led Japan to become one of the leading producers of
superior, compact air conditioners.

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 The Diamond Model:
Sources of National Competitive Advantage (cont.)
• Firm strategy, structure, and rivalry: The nature
of domestic rivalry and the conditions that
determine how a nation’s firms are created,
organized, and managed
Example
Italy has many top firms in design
industries such as textiles,
furniture, lighting, and fashion.
Vigorous competitive rivalry puts
these firms under constant
pressure to innovate, which has
propelled Italy to a leading position
in design worldwide.

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 Industrial Cluster

• A concentration of suppliers and supporting firms

from the same industry located within the same
geographic area; similar to Porter’s Related and
Supporting Industries.
• A strong cluster can serve as an export platform for
the nation.
Examples
Silicon Valley; pharmaceutical cluster in Switzerland;
footwear industry in Pusan, South Korea; IT industry in
Bangalore, India; fashion cluster in northern Italy; and
Silicon Valley North near Ottawa, Canada
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 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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 Examples of National Industrial Policy

• In the 1990s, Vietnam’s government 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.
• Singapore adopted pro-business, pro-investment,
export-oriented policies, combined with state-
directed investments in strategic corporations. The
approach stimulated economic growth that
averaged 8 percent annually from 1960 to 1999.
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 Examples of National Industrial Policy (cont.)

• New Zealand’s government, starting in 1984,

transformed the country from an agrarian,
protectionist, regulated economy to an
industrialized, free-market economy that today
competes globally.
• The Czech government in the 1990s created a
business-friendly legal and regulatory environment.
The country privatized state-owned companies.
Government FDI incentives attracted numerous
MNEs, such as Daewoo, ING, Siemens, and
Toyota.
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 Examples of National Industrial Policy (cont.)

• In the 1990s, Ireland

implemented various
pro-business policies—
fiscal, monetary, tax;
investment in education;
and emphasis on high-
value industries such as
pharma and IT—that
dramatically grew GDP
and reduced
unemployment.

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National Industrial Policy and Dubai

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Stages in Company Internationalization

Domestic Focus

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Stages in Company Internationalization

Domestic Focus

Pre-export Stage

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Stages in Company Internationalization

Domestic Focus

Pre-export Stage

Experimental Involvement

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Stages in Company Internationalization

Domestic Focus

Pre-export Stage

Experimental Involvement

Active Involvement

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Stages in Company Internationalization

Domestic Focus

Pre-export Stage

Experimental Involvement

Active Involvement

Committed Involvement
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Stock of Inward FDI: Leading FDI Destinations
(Millions of U.S. Dollars)

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Stock of Outward FDI: Top Sources of Outward FDI
(Millions of U.S. Dollars)

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 How Firms Gain and Sustain
International Competitive Advantage

• Because the MNE was traditionally the major player

in international business, scholars have offered
numerous explanations of what makes these firms
pursue, and succeed in, internationalization.
• Because FDI has been MNEs’ main strategy in
international expansion, theoretical explanations
have tended to emphasize it.

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 FDI-Based Explanations:
Monopolistic Advantage Theory

• Argues that MNEs prefer FDI because it provides

the firm with control over resources and capabilities
in the foreign market and a degree of monopoly
power relative to foreign competitors.
• Key sources of monopolistic advantage include
proprietary knowledge, patents, unique know-how,
and sole ownership of other assets.

Example
Novartis earns substantial profits by marketing various
patent medications through its subsidiaries worldwide.

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 FDI-Based Explanations:
Internalization Theory
• Explains how the MNE chooses to acquire and retain
one or more value-chain activities inside itself.
• Such “internalization” provides the MNE with greater
control over its foreign operations.
• Internalization avoids the drawbacks of dealing with
external partners, such as reduced quality control and
the risk of losing proprietary assets to outsiders.

Example
In China, Intel owns much of its value chain, which ensures
that Intel knowledge, patents, and other assets are not
misused or illicitly obtained by potential rivals.

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 FDI-Based Explanations:
Dunning’s Eclectic Paradigm

• Three conditions determine whether or not a

company will enter a given foreign country via FDI:
1. Ownership-specific advantages: Knowledge, skills,
capabilities, relationships, or physical assets that the firm owns
and that are the basis of its competitive advantages
2. Location-specific advantages: Similar to comparative
advantages; specific advantages that exist in the country that
the MNE has entered, or is seeking to enter, such as natural
resources, low-cost labor, or skilled labor
3. Internalization advantages: Control derived from internalizing
foreign-based manufacturing, distribution, or other value-chain
activities

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 Example of the Eclectic Paradigm: Sony in China

• Ownership-Specific Advantages. Sony possesses

a huge stock of knowledge and patents in the
consumer electronics industry, as represented by
products like the Playstation and Vaio laptop.
• Location-Specific Advantages. Sony desires to
manufacture in China in order to take advantage of
China’s low-cost, highly knowledgeable labor force.
• Internalization Advantages. Sony wants to maintain
control over its knowledge, patents, manufacturing
processes, and quality of its products.

Thus, Sony entered China via FDI

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 Non-FDI-Based Explanations:
International Collaborative Ventures

• A form of cooperation between two or more firms.

Partners pool resources and capabilities to create
synergies and share the risk of joint efforts.
• Starting in the 1980s, firms increasingly began
using collaborative ventures to expand abroad.
• Collaboration provides access to foreign partners’
know-how, capital, distribution channels, and
marketing assets. It also helps overcome
government-imposed obstacles.

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 Two Types of
International Collaborative Ventures

• Equity-based joint ventures result in the formation

of a new legal entity. In contrast to the wholly owned
FDI, the firm collaborates with local partner(s) to
reduce risk and commitment of capital.
• Project-based alliances do not require equity
commitment from the partners, but simply a
willingness to cooperate in R&D, manufacturing,
design, or any other value-adding activity. Because
project-based alliances have a narrowly defined
scope of activities and timeline, they provide greater
flexibility to the firm than equity-based ventures.

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