International Trade and Investment Theory

•International Trade

•Trade: voluntary exchange of goods, services, assets, or money between one person or organization and another

•International trade: trade between residents of two countries

 

Classical Country-Based Trade Theories 

•Mercantilism 

•Absolute Advantage 

•Comparative Advantage 

•Comparative Advantage with Money 

•Relative Factor Endowments 

 

Mercantilism 

•A country’s wealth is measured by its holdings of gold and silver 

•A country’s goal should be to enlarge holdings of gold and silver by 

–Promoting exports 

–Discouraging imports 

 

Modern Mercantilism

Neomercantilists or protectionists 

–American Federation of Labor-Congress of Industrial Organizations 

–Textile manufacturers 

–Steel companies 

–Sugar growers 

–Peanut farmers

 

Disadvantages of Mercantilism 

•Confuses the acquisition of treasure with the acquisition of wealth 

•Weakens the country because it robs individuals of the ability 

–To trade freely 

–To benefit from voluntary exchanges 

•Forces countries to produce products it would otherwise not in order to minimize imports

 

Absolute Advantage 

•Export those goods and services for which a country is more productive than other countries 

•Import those goods and services for which other countries are more productive than it is  

 

Absolute Advantage’s Flaw 

•What happens to trade if one country has an absolute advantage in both products? 

•No trade would occur  

 

Comparative Advantage 

•Produce and export those goods and services for which it is relatively more productive than other

countries 

•Import those goods and services for which other countries are relatively more productive than it is  

 

Differences between Comparative and Absolute Advantage 

•Absolute versus relative productivity differences 

•Comparative advantage incorporates the concept of opportunity cost 

–Value of what is given up to get the good  

 

Comparative Advantage with Money 

•One is better off specializing in what one does relatively best 

•Produce and export those goods and services one is relatively best able to produce 

•Buy other goods and services from people who are better at producing them  

 

Relative Factor Endowments 

•Heckscher-Ohlin Theory 

•What determines the products for which a country will have a comparative advantage? 

–Factor endowments vary among countries 

–Goods differ according to the types of factors that are used to produce them  

 

Relative Factor Endowments_2 

•A country will have a comparative advantage in producing products that intensively use resources

(factors of production) it has in abundance 

–China: labor 

–Saudi Arabia: oil 

–Argentina: wheat  

 

Modern Firm-Based Trade Theories 

•Country Similarity Theory 

•Product Life Cycle Theory 

•Global Strategic Rivalry Theory 

•Porter’s National Competitive Advantage  

 

Growth of Firm-Based Theories 

•Growing importance of MNCs 

•Inability of the country-based theories to explain and predict the existence and growth of

 intraindustry trade 

•Failure of Leontief and others to empirically validate country-based Heckscher-Ohlin Theory  

 

Firm-Based Trade Theories 

•Incorporate additional factors into explanations of trade flows 

–Quality 

–Technology 

–Brand names 

–Customer quality  

 

Country Similarity Theory 

•Explains the phenomenon of intraindustry trade 

–Trade between two countries of goods produced by the same industry 

•Japan exports Toyotas to Germany 

•Germany exports BMWs to Japan 

  

Country Similarity Theory_2 

•Trade results from similarities of preferences among consumers in countries that are at the same

stage of economic development 

•Most trade in manufactured goods should be between countries with similar per capita incomes  

 

Product Life Cycle Theory 

•Describes the evolution of marketing strategies 

•Stages 

–New product 

–Maturing product 

–Standardized product 

 

Global Strategic Rivalry Theory 

•Firms struggle to develop sustainable competitive advantage 

•Advantage provides ability to dominate global marketplace 

•Focus: strategic decisions firms use to compete internationally  

 

Sustaining Competitive Advantage 

•Owning intellectual property rights 

•Investing in research and development 

•Achieving economies of scale or scope 

•Exploiting the experience curve  

 

Porter’s National Competitive Advantage 

•Success in trade comes from the interaction of four country and firm specific elements 

–Factor conditions 

–Demand conditions 

–Related and supporting industries 

–Firm strategy, structure, and rivalry  

 

Theories of International Trade 

Country-Based Theories 

•Country is unit of analysis 

•Emerged prior to WWII 

•Developed by economists 

•Explain interindustry trade 

•Include 

–Mercantilism 

–Absolute advantage 

–Comparative advantage 

–Relative factor endowments 

 

Firm-Based Theories

 

•Firm is unit of analysis 

•Emerged after WWII 

•Developed by business school professors 

•Explain intraindustry trade 

•Include 

–Country similarity theory 

–Product life cycle 

–Global strategic rivalry 

–National competitive advantage  

 

Types of International Investments 

•Does the investor seek an active management role in the firm r merely a return from a passive

investment? 

–Foreign Direct Investment 

–Portfolio Investment  

 

International Investment Theories 

•Ownership Advantages 

•Internalization 

•Dunning’s Eclectic Theory  

 

Ownership Advantages 

•A firm owning a valuable asset that creates a competitive advantage domestically can use that

advantage to penetrate foreign markets through FDI 

•Why FDI and not other methods?  

 

Internalization Theory 

•FDI is more likely to occur when transaction costs with a second firm are high 

•Transaction costs: costs associated with negotiating, monitoring, and enforcing a contract  

 

Dunning’s Eclectic Theory 

•FDI reflects both international business activity and business activity internal to the firm 

•3 conditions for FDI 

–Ownership advantage 

–Location advantage 

–Internalization advantage