Peng GB4e PPT ch05

Chapter 5
Trading Internationally
Peng, Global Business, 4th Edition. © 2017 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

• 5-1 use the resource-based and institution-based views to answer why
nations trade.
• 5-2 understand classical and modern theories of international trade.
• 5-3 realize the importance of political realities governing international trade.
• 5-4 participate in two leading debates concerning international trade.
• 5-5 draw implications for action.
IMPORTING AND EXPORTING
export – selling abroad

import – buying from abroad
merchandise (goods) – tangible products being traded
service – intangible services being traded
Table 5.1: Leading Trading Nations (1 of 2)
Top 10 Value World Annual Top 10 Value World Annual
merchandise (US$ share change merchandise (US$ share change
exporters billion) (%) (%) importers billion) (%) (%)
1 China 2,209 11.7% 8% 1 United States 2,329 12.3% 0%
2 United States 1,580 8.4% 2% 2 China 1,950 10.3% 7%
3 Germany 1,453 7.7% 3% 3 Germany 1,189 6.3% 2%
4 Japan 715 3.8% −10% 4 Japan 833 4.4% −6%
5 Netherlands 672 3.6% 3% 5 France 681 3.6% 1%
6 France 580 3.1% 2% 6 United Kingdom 655 3.5% −5%
7 South Korea 562 3.0% 2% 7 Hong Kong, China 622 3.3% 12%
8 United Kingdom 542 2.9% 15% 8 Netherlands 590 3.1% 0%
9 Hong Kong, China 536 2.8% 9% 9 South Korea 516 2.7% −1%
10 Russia 523 2.8% −1% 10 Italy 477 2.5% −2%
World total 18,816 100% 2% World total 18,890 100% 2%
Table 5.1: Leading Trading Nations (2 of 2)
Value World Annual Value World Annual
Top 10 service Top 10 service
(US$ share change (US$ share change
exporters importers
billion) (%) (%) billion) (%) (%)
1 United States 662 14.3% 5% 1 United States 432 9.8% 4%
2 United Kingdom 293 6.3% 2% 2 China 329 7.5% 18%
3 Germany 286 6.2% 8% 3 Germany 317 7.2% 8%
4 France 236 5.1% 10% 4 France 189 4.3% 8%
5 China 205 4.4% 7% 5 United Kingdom 174 4% −1%
6 India 151 3.2% 4% 6 Japan 162 3.7% −7%
7 Netherlands 147 3.2% 12% 7 Singapore 128 2.9% 4%
8 Japan 145 3.1% 2% 8 Netherlands 127 2.9% 7%
9 Spain 145 3.1% 6% 9 India 125 2.8% −3%
10 Hong Kong, China 133 2.9% 6% 10 Russia 123 2.8% 18%
World total 4,644 100% 6% World total 4,381 100% 11%
Source: Adapted from World Trade Organization, 2014, Word Trade Report 2014, Appendix Tables 3 and 5, Geneva: W TO (www.wto.org). All data are for 2013.
WHY DO NATIONS TRADE?
• There are economic gains from trade

• “Nations trade” is a misleading statement; a more accurate expression is
“firms from different nations trade”
? What benefits might nations or firms within nations receive by trading

internationally?
Figure 5.1: Growth in World Trade Generally Outpaces
Growth in World GDP (Annual % Change)
Source: World Trade Organization, 2014, Modest trade growth anticipated for 2014 and 2015 following two-year slump,
press release, April 14, Geneva: W TO (www.wto.org). The figure refers to merchandise (goods) exports.
INTERNATIONAL TRADE
trade deficit – an economic condition in which a nation imports more than it

exports
trade surplus – an economic condition in which a nation exports more than it
imports
balance of trade – the aggregation of importing and exporting that leads to the
country-level trade surplus or deficit
TYPES OF INTERNATIONAL TRADE THEORIES
classical trade theories – the major theories of international trade that were
advanced before the 20th century, which consist of (1) mercantilism, (2)
absolute advantage, and (3) comparative advantage
modern trade theories – the major theories of international trade that were
advanced in the 20th century, which consist of (1) product life cycle, (2)
strategic trade, and (3) national competitive advantage of industries
MERCANTILISM
theory of mercantilism – a theory that suggests that the wealth of the world is
fixed and that a nation that exports more and imports less will be richer
protectionism – the idea that governments should actively protect domestic
industries from imports and vigorously promote exports
ABSOLUTE ADVANTAGE
free trade – the idea that free market forces should determine how much to
trade with little or no government intervention
theory of absolute advantage – a theory that suggests that under free trade,
a nation gains by specializing in economic activities in which it has an absolute
advantage
absolute advantage – the economic advantage one nation enjoys that is
absolutely superior to other nations
Figure 5.2: Absolute Advantage
Table 5.2: Absolute Advantage
Total units of resources = 800 for each country Wheat Aircraft
(1) Resources required to produce 1,000 tons of wheat and 1 aircraft. China 20 resources 40 resources
US 80 resources 20 resources
(2) Production and consumption with no specialization and without trade (each
China (point B) 20,000 tons 10 aircraft
country devotes half of its resources to each activity).
US (point C) 5,000 tons 20 aircraft
Total production 25,000 tons 30 aircraft
(3) Production with specialization (China specializes in wheat and produces no
China (point A) 40,000 tons 0
aircraft, and the United States specializes in aircraft and produces no wheat).
US (point D) 0 40 aircraft
(4) Consumption after each country trades one-quarter of its output while
China 30,000 tons 10 aircraft
producing at points A and D, respectively (Scenario #3).
US 10,000 tons 30 aircraft
Total consumption 40,000 tons 40 aircraft
(5) Gains from trade: Increase in consumption as a result of specialization and
China +10,000 tons 0
trade (Scenario #4 versus #2).
US +5,000 tons +10 aircraft
COMPARATIVE ADVANTAGE
theory of comparative advantage – a theory that focuses on the relative (not

absolute) advantage in one economic activity that one nation enjoys in
comparison with other nations
comparative advantage – relative (not absolute) advantage in one economic
activity that one nation enjoys in comparison with other nations
opportunity cost – cost of pursuing one activity at the expense of another
activity, given the alternatives (other opportunities)
Figure 5.3: Comparative Advantage
Table 5.3: Comparative Advantage
Total units of resources = 800 for each country Wheat Aircraft
(1) Resources required to produce 1,000 tons of wheat and 1 aircraft. China 80 resources 40 resources
US 64 resources 20 resources
(2) Production and consumption with no specialization and without trade (each country
China (point F) 5,000 tons 10 aircraft
devotes half of its resources to each activity).
US (point B) 6,250 tons 20 aircraft
(3) Production with specialization (China devotes all resources to wheat, and the United
States devotes one-fifth of its resources to wheat and four-fifths of its resources to China (point E) 10,000 tons 0
aircraft)
US (point C) 2,500 tons 32 aircraft
(4) Consumption after China trades 4,000 tons of wheat for 11 U S aircraft while
China 6,000 tons 11 aircraft
producing at points E and C, respectively (Scenario #3).
US 6,500 tons 21 aircraft
Total consumption 12,500 tons 32 aircraft
(5) Gains from trade: Increase in consumption as a result of specialization and trade
China +1,000 tons +1 aircraft
(Scenario #4 versus #2).
US +250 tons +1 aircraft
SOURCE OF ABSOLUTE AND COMPARTIVE
ADVANTAGES
factor endowment – the extent to which different countries possess various
factors of production such as labor, land, and technology
factor endowment theory (Heckscher-Ohlin theory) – a theory that suggests
that nations will develop comparative advantages based on their locally
abundant factors
PRODUCT LIFE CYCLE
product life cycle theory – a theory that accounts for changes in the patterns
of trade over time by focusing on product life cycles
Figure 5.4: Theory of Product Life Cycles
STRATEGIC TRADE
strategic trade theory – a theory that suggests that strategic intervention by

governments in certain industries can enhance their odds for international
success
first-mover advantage – benefit that accrues to firms that enter the market
first and that late entrants do not enjoy
strategic trade policy – government policy that provides companies a
strategic advantage in international trade through subsidies and other supports
Figure 5.5: Entering the Very Large, Super-Jumbo
Market?
Panel A. Without Government Subsidy (Outcome = Airbus, Boeing)
Panel B. With $10 Billion Subsidy from European Governments (Outcome = Airbus, Boeing)
NATIONAL COMPETITIVE ADVANTAGE OF
INDUSTRIES
theory of national competitive advantage of industries (“diamond”
theory) – a theory that suggests that the competitive advantage of certain
industries in different nations depends on four aspects that form a “diamond”
Figure 5.6: National Competitive Advantage of
Industries: The Porter Diamond
Source: M. Porter, 19 90, The competitive advantage of nations (p. 77), Harvard Business Review, March–April: 73–93. Reprinted with
permission.
Table 5.4: Theories of International Trade: A Summary (1 of 2)
Classical theories Main points Strengths and influences Weaknesses and debates
Mercantilism (Colbert, • International trade is a zero-sum game— • Forerunner of modern-day • Inefficient allocation of
1600s–1700s) trade deficit is dangerous. protectionism. resources.
• Governments should protect domestic • Reduces the wealth of the
industries and promote exports. nation in the long run.
Absolute advantage • Nations should specialize in economic • Birth of modern economics. • When one nation is
(Smith, 1776) activities in which they have an absolute • Forerunner of the free trade absolutely inferior than
advantage and trade with others. movement. another, the theory is
• By specializing and trading, each nation • Defeats mercantilism, at unable to provide any
produces more and consumes more. least intellectually. advice.
• The wealth of all trading nations, and the • When there are many
world, increases. nations, it may be difficult
to find an absolute
advantage.
Comparative • Nations should specialize in economic • More realistic guidance to • Relatively static, assuming
advantage (Ricardo, activities in which they have a comparative nations (and their firms) that comparative
1817; Heckscher, advantage and trade with others. interested in trade but advantage and factor
1919; Ohlin, 1933) • Even if one nation is absolutely inferior to having no absolute endowments do not
another, the two nations can still gainfully advantage. change over time.
trade. • Explains patterns of trade
• Factor endowments underpin comparative based on factor
advantage. endowments.
Table 5.4: Theories of International Trade: A Summary (2 of 2)
Modern theories Main points Strengths and influences Weaknesses and debates
Product life cycle • Comparative advantage first resides in the • First theory to incorporate • The United States may not
(Vernon, 1966) lead innovation nation, which exports to other dynamic changes in always be the lead
nations. patterns of trade. innovation nation.
• Production migrates to other advanced • More realistic with trade in • Many new products are
nations and then developing nations in industrial products in the now launched
different product life cycle stages. 20th century. simultaneously around the
world.
Strategic trade • Strategic intervention by governments may • More realistic and positively • Ideological resistance from
(Brander, Spencer, help domestic firms reap first-mover incorporates the role of many “free trade” scholars
Krugman, 1980s) advantages in certain industries. governments in trade. and policy makers.
• First-mover firms, aided by governments, may • Provides direct policy • Invites all kinds of
have better odds at winning internationally. advice. • industries to claim they are
strategic.
National competitive • Competitive advantage of different industries • Most recent, most complex, • Has not been
advantage of in different nations depends on the four and most realistic among comprehensively tested.
industries interacting aspects of a “diamond.” various theories. • Overseas (not only
(Porter, 1990) • The “diamond” consists of (1) factor • As a multilevel theory, it domestic) demand may
endowments, (2) domestic demand, (3) firm directly connects firms, stimulate the
strategy, structure, and rivalry, and (4) related industries, and nations. competitiveness of certain
and supporting industries. industries.
EVALUATING THEORIES OF INTERNATIONAL
TRADE
• The classical pro-free trade theories seem common sense today; however,
they were revolutionary 200 years ago, when the world was dominated by
mercantilistic thinking
• Classical theories rely on highly simplistic assumptions of a model consisting
of only two nations and two goods
• The theories assume perfect resource mobility—the assumption that a
resource used in producing a product for one industry can be shifted and put
to use in another industry
• Classical theories assume no foreign exchange complications and zero
transportation costs
TARIFF BARRIERS
tariff barrier – trade barrier that relies on tariffs to discourage imports

import tariff – a tax imposed on imports
deadweight cost – net losses that occur in an economy as a result of tariffs
Figure 5.7: Tariff on Rice Imports in Japan
NONTARIFF BARRIERS (NTBs)
nontariff barrier (NTB) – trade barriers that rely on nontariff means to

discourage imports
TYPES OF NONTARIFF BARRIERS (NTBs) (1 of 2)
subsidy – government payments to domestic firms

import quota – restrictions on the quantity of imports
voluntary export restraint (VER) –international agreement that shows that
exporting countries voluntarily agree to restrict their exports
TYPES OF NONTARIFF BARRIERS (NTBs) (2 of 2)
local content requirement – requirement stipulating that a certain proportion

of the value of the goods made in one country must originate from that country
administrative policy – bureaucratic rules that make it harder to import
foreign goods
antidumping duty – tariff levied on imports that have been “dumped” (selling
below costs to “unfairly” drive domestic firms out of business)
ECONOMIC ARGUMENTS AGAINST FREE TRADE
Prominent economic arguments against free trade are:

• The need to protect domestic industries, firms, and jobs from “unfair” foreign
competition—in short, protectionism
• The necessity to shield infant industries
• infant industry argument – argument that if domestic firms are as young as
“infants,” in the absence of government intervention, they stand no chance of
surviving and will be crushed by mature foreign rivals
POLITICAL ARGUMENTS AGAINST FREE TRADE
Political arguments against free trade advance a nation’s political, social, and
environmental agenda, regardless of possible economic gains from trade, and
include:
• National security
• Consumer protection
• Foreign policy
• trade embargo – politically motivated trade sanction against foreign countries to
signal displeasure
• Environmental and social responsibility
TRADE DEFICIT VERSUS TRADE SURPLUS
• Free traders argue that international trade is not about competition but rather
about mutually beneficial exchange
• Critics argue that international trade is about competition—about markets,
jobs, and incomes
Table 5.5: Debate on the US Trade Deficit with China (1 of 2 )
US trade deficit with China is a huge problem US trade deficit with China is not a huge problem
Naïve trader versus unfair protectionist (in China) Market reformer versus unfair protectionist (in the U S)
• The United States is a “naïve” trader with open • China’s markets are already unusually open. Its trade
markets. China has “unfairly” protected its markets. volume (merchandise and services) is 53% of G DP,
whereas the US volume is only 30%.
Greedy exporters Eager foreign investors
• Unscrupulous Chinese exporters are eager to gut U S • Two-thirds of Chinese exports are generated by foreign-
manufacturing jobs and drive US rivals out of invested firms in China, and numerous U S firms have
business. invested in and benefited from such operations in China.
The demon who has caused deflation Thank China (and Wal-Mart) for low prices
• Cheap imports sold at “the China price” push down • Every consumer benefits from cheap prices brought from
prices and cause deflation. China by US firms such as Wal-Mart.
Intellectual property (I P) violator Inevitable step in development
• China is a major violator of I P rights, and US firms • True, but (1) the US did that in the 19th century (to the
lose billions of dollars every year. British), and (2) IP protection has been improving in
China.
Table 5.5: Debate on the US Trade Deficit with China (2 of 2)
US trade deficit with China is a huge problem US trade deficit with China is not a huge problem
Currency manipulator Currency issue is not relevant
• The yuan is severely undervalued, giving Chinese • The yuan is somewhat undervalued, but (1) U S and other
exports an “unfair” advantage in being priced at an foreign firms producing in China benefit, and (2) the U S also
artificially low level. manipulates its own currency via quantitative easing.
Trade deficit will make the United States poorer Trade deficit does not cause a fall in the U S standard of living
• Since imports have to be paid, the United States • As long as the Chinese are willing to invest in the U S
borrows against its future with disastrous • economy (such as Treasury bills), what’s the worry?
outcomes.
Something has to be done Remember the gains from trade argued by classic theories?
• If the Chinese don’t do it “our way,” the United • Tariffs will not bring back U S jobs, which will simply go to
States should introduce drastic measures (such as Mexico or Malaysia, and will lead to retaliation from China, a
slapping 20%– 30% tariffs on all Chinese imports). major importer of US goods and services.
Sources: Based on (1) BusinessWeek, 2009, Free trade in the slow lane, September 21: 50; (2) China Business Review, 2008, US exports to China hit new high,
September-October: 36–39; (3) Economist, 2005, From T-shirts to T-bonds, July 30: 61–63; (4) Economist, 2014, A number of great import, February 15: 40; (5)
Economist, 2014, Picking the world champion of trade, January 18: 72–73; (6) Economist, 2014, Trading places, April 5: 49; (7) G. Locke, 2011, A message from the
US Ambassador to China, China Business Review, October: 16; (8) M. W. Peng, D. Ahlstrom, S. Carraher, & W. Shi, 2014, How history can inform the debate over
intellectual property, Working paper, Jindal School of Management, University of Texas at Dallas; (9) O. Shenkar, 2005, The Chinese Century, Philadelphia: Wharton
School Publishing.
CLASSIC THEORIES VERSUS NEW REALITIES
• This debate centers on service trade and high-skill jobs in high technology
• Classical theorists and modern-day theorists disagree about the benefits and
effects of outsourcing
Table 5.6: Implications for Action
• Discover and leverage comparative advantage of world-class locations.

• Monitor and nurture the current comparative advantage of certain locations,
and take advantage of new locations.
• Be politically active to demonstrate, safeguard, and advance the gains from
international trade.

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Chapter 5

After studying this chapter, you should be able to:

export – selling abroad

• There are economic gains from trade

? What benefits might nations or firms within nations receive by trading

trade deficit – an economic condition in which a nation imports more than it

theory of comparative advantage – a theory that focuses on the relative (not

strategic trade theory – a theory that suggests that strategic intervention by

tariff barrier – trade barrier that relies on tariffs to discourage imports

nontariff barrier (NTB) – trade barriers that rely on nontariff means to

subsidy – government payments to domestic firms

local content requirement – requirement stipulating that a certain proportion

Prominent economic arguments against free trade are:

• Discover and leverage comparative advantage of world-class locations.

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