Quiz #2 INTB 1205

Two ways to look at FDI

1) the flow of FDI 2) the stock of FDI

franchising

advantages and disadvantages

specific tariff

tariff levied as a fixed charge for each unit of good imported --ex: $3 per barrel of oil

Voluntary Export Restraint (VER)

(import quota variant) a quota on trade imposed from the exporting country's end, instead of the importer's end; usually imposed when the importing country's govt requests for an import quota --essentially restricts how much the exporter country is sending to the importer --foreign producers agree to VERs in order to avoid other trade actions like: more damaging punitive (extremely high) tariffs or import quotas that inhibit future international business growth --agreeing to VER is seen as a way to make the best of a bad situation by appeasing protectionist pressures in a country, in order to protect that country's domestic market --domestic producers gain by limiting import competition --consumers lose bc VER raises the domestic price of a good

Who benefits from import quotas and voluntary export restraints?

--benefits domestic producers by limiting import competition --losses for consumers bc they raise the price of imported goods (law of supply and demand: when supply decreases, price of demand increases)

Policy implications of international trade today

--international firms have an incentive to lobby for free trade (bc trade barriers limit firm's global expansion and raise costs above a free trade market) --long-term impact of govt protection can backfire (govt retaliation w/ sanctions can result in trade war, or domestic trade policies that don't benefit the country as a whole)

Implications of New Trade Theory

--nations may benefit from trade even when they do not differ in resource endowments or technology --a country may predominate in the export of a good simply bc it was lucky enough to have one or more of the firms among the first to produce that good --so, new trade theory provides an economic rationale for a proactive trade policy that differs from other free trade theories (unique in that you don't need to have a difference in factor endowments for trade to be beneficial, and that first mover advantages are enough for a country to dominate in exports of a good)

free trade isn't free bc...

--of tariffs, subsidies... govt intervention for human rights --domestic producers benefit from govt protectionism at the expense of the consumer (paying more for imported goods) --utilitarianism, (greatest utility for the greatest amount of people) because some countries agree to trade with others that violate human rights. These countries don't want to place sanctions against the unethical policies of the other country bc they don't want to impede on trade opportunities with that country.

Theory of Comparative Advantage (main idea)

--potential world production is greater with unrestricted free trade than it is with restricted trade --suggests that trade is a positive-sum game in which all countries that participate experience economic gains --trade patterns are related to the productivity of different factors of production in different countries --countries will specialize in products that they can make most efficiently, while importing product that they can produce less efficiently --countries have comparative advantage in producing certain goods that have lower opportunity costs for producing that good over others --strong rationale for encouraging free trade

The Source of FDI

--since World War II, the U.S. has been the largest source country for FDI --other important source countries: the United Kingdom, the Netherlands, France, Germany, and Japan (all accounted for 60% of all FDI outflows) --these nations dominate bc they had the largest economies postwar period --Notably, Chinese firms have recently emerged as major foreign investors (mainly bc they need raw materials); although their outward investment is mainly in Africa for raw materials, they are starting to turn attention to the U.S.

Unrestricted Free Trade argument

--supported by theories of Smith, Ricardo, and Heckscher-Ohlin --both import controls and export incentives (such as subsidies) are self-defeating and result in wasted resources

Why should international managers care about the political economy of free trade, or about the relative merits of arguments for free trade and protectionism? In other words, what are the implications of the political economy of free trade for managers?

--trade barriers impact firm strategy --firms can play a role in promoting free trade or barriers

As a pattern in FDI, it is common for firms in the same industry to:

1) Have similar strategic behavior and undertake foreign direct investment around the same time 2) Direct their investment activities towards similar target markets (investment in certain locations at certain stages in the product life cycle)

Economic Arguments for Intervention

1) Infant Industry arguments 2) Strategic trade policy

3 Main Implications for International Business

1) Location Implications 2) First-mover implications 3) Policy Implications

Assumptions of Comparative Advantage

1) Only 2 countries and 2 goods 2) Zero transportation costs 3) similar prices and values 4) resources are mobile between goods within countries, but not across countries 5) constant returns to scale 6) fixed stocks of resources 7) no effects on income distribution within countries

6 Political Arguments for Intervention

1) Protecting jobs and industries 2) National security 3) Retaliation 4) Protecting consumers 5) Furthering foreign policy objectives 6) Protecting human rights

Two forms of FDI

1) a greenfield investment which is the establishment of a wholly new operation in a foreign country 2) Acquisition or merging with an existing firm in the foreign country

7 main instruments of trade policy

1) tariffs 2) subsidies 3) import quotas 4) voluntary export restraints 5) local content requirements 6) administrative policies 7) antidumping duties

economic analysis of the effect of import tariffs:

1) tariffs are pro-producer and anti-consumer --restriction of supply raises domestic prices --impose significant costs on domestic consumers in the form of higher prices 2) import tariffs reduce the overall efficiency of the world economy --bc a protective tariff encourages domestic firms to produce products at home that could theoretically be produced more efficiently abroad --consequence is that there is an inefficient utilization of resources

knowledge flows occur...

1) when employees move between firms within a region 2) when national industry associations bring employees from different companies together for regular conferences or workshops

Extensions of the Ricardian Model

1. Immobile Resources 2. Diminishing Returns 3. Dynamic Effects and Economic Growth 4. The Samuelson Critique 5. The Link between Trade and Growth

Why do governments intervene in trade?

2 arguments for this: 1) Political arguments - concerned with protecting the interests of certain groups within a nation 2) Economic arguments - concerned with boosting the overall wealth of a nation

David Ricardo's Theory of Comparative Advantage

A country should specialize in the production of the goods that it produces most efficiently and buy the goods that it produces less efficiently from other countries --explains comparative advantage in terms of international differences in labor productivity: a country's difference in labor productivity influences difference in technology, therefore, the source of a country's comparative advantage in production comes from labor --main point: country should still engage in trade even if it has absolute advantage in both goods - produce the comparative advantage good and trade the other --consumers in all nations can consume more if there are no restrictions on trade --begs to question Smith: what happens when one country has an absolute advantage in production of all goods? Adam Smith's theory of absolute advantage suggests that a country might derive no benefits from international trade if they have absolute advantage in the production of all goods --Ricardo says that it makes sense for a country to specialize in the production of goods that it produced most efficiently and to buy the goods that it produces less efficiently from other countries, even if it means buying goods from other countries that your country could produce more efficiently yourself --ex: Ghana has an absolute advantage in production of cocoa and rice, but only a comparative advantage in cocoa. Ghana can produce 4 times as much cocoa as South Korea, but only 1.5 times as much rice, so Ghana is comparatively more efficient at producing cocoa than rice --by engaging in trade, the two countries can increase combined productions of rice and cocoa, and so consumers from both nations can consume both goods, so thank you to free trade!

Policy implications for International Business

Businesses encourage free trade where they locate productive activities and govts should help them increase their basic and advanced factors of production

Government (Porter's National Competitive Advantage)

By its choice of policies, government can detract from or improve national advantage. For example: 1) govt regulation can alter home demand conditions (thru local product standards, or regulations that influence buyer needs) 2) antitrust policies, tax policy, and capital market regulation can influence the intensity of rivalry within an industry 3) government investments in education can change factor endowments (more educated entrepreneurs)

Advantages of FDI (theories of FDI)

Favored over exporting when: --transportation costs are high --trade barriers are high Favored over licensing when: --the firm wants control over its technological know-how --the firm wants control over its operations and business strategy --the firm's capabilities are not amendable to licensing

Porter's Diamond Model

Firms are most likely to succeed in industries or industry segments where the diamond is most favorable. --the combined impact of the 4 dimensions will represent the degree to which a nation is likely to achieve international success in a certain industry --this is a mutually reinforcing system as the effect of one determinant is contingent on the state of others --ex: favorable demand conditions will not result in a competitive advantage unless the state of rivalry is sufficient to cause firms to respond to demand conditions and compete --2 additional variables influence the national diamond: chance and government --strong competition within domestic markets makes firms stronger international competitors

Theories of FDI (preference of FDI over...)

Firms prefer FDI over either: 1) Exporting - producing goods at home and then shipping them to the receiving country for sale 2) Licensing - granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on every unit that the foreign entity sells

The Direction of FDI

Historically, most FDI has been directed at the developed nations of the world (like the U.S. and EU): --stable political and economic systems are most favorable for FDI inflows --developed nations of EU (most popularly France and UK) receive FDI inflows from the U.S. and other members of EU More recently, developing nations have been the recipients of FDI: --South, East, and Southeast Asia, and China have received significant inflows --Latin America is also emerging as an important region for receiving FDI inflows (Brazil most popular)

Revised Case for Free Trade (new trade theorists)

In criticism of the Strategic Trade Theory (as in practice it's not realistic), this revised case offers that there are two situations in which restrictions on trade would be inappropriate: 1) Retaliation 2) Domestic policies --new trade theorists believe that govt intervention in international trade is justified (classical trade theorists would disagree)

Retaliation and War (revised case for free trade)

Krugman - strategic trade policies to establish domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost the national income at the expense of other countries --a country that attempts to use such policies will probably provoke retaliation and lead to a trade war, making both countries worse off --solution: if your foreign competitor is already supported by govt subsidies, instead of engaging in retaliatory action, firms should establish rules to minimize the use of trade-distorting subsidies through the WTO

Should Factor Endowments (O-H Theory) or Productivity (Ricardo's Theory) drive trade?

Pg. 168 Based on Leontief's Paradox, Productivity predicts trade patterns more accurately than factor endowments. Solutions to trade issues involving factor endowments may require fixing differences in productivity/technology (proven by Leontief Paradox). --Ricardo's theory is too limited, but makes more accurate prediction of trade patterns because it drops some assumptions from comparative advantage theory --H-O's theory is preferred for theoretical grounds (and most economists) because it makes fewer simplifying assumptions, but it less accurately predicts real-word international trade --Ricardo's theory shows that a country can derive advantages by trade even if it has absolute advantage in producing all products (bc you should trade with your comparative advantage good even if you make the other good more efficiently) --for H-O's theory (that a country should export goods that use locally abundant factors of production and import goods that use locally scarce factors) to hold power, the impact of differences of technology across countries on productivity must be controlled for: that way countries can actually follow H-O's theory; since this isn't true for many countries, Ricardo's theory is more accurate

Furthering Foreign Policy Objectives (political argument for govt intervention)

Preferential trade terms given to countries that a govt wants to build strong relations with --"rogue states" that don't abide by international laws or norms can be punished --thus, trade policy may pressure rogue states to change their ways

WTO: Experience to Date

The WTO has emerged as an effective advocate and facilitator of future trade deals --so far, most countries have adopted WTO recommendations for trade disputes --the WTO has brokered negotiations to reform the global telecommunications and financial services industries --the 1999 meeting of the WTO in Seattle demonstrated that issues surrounding free trade have become mainstream, and dependent on popular opinion

The Future of the WTO

The WTO is currently focusing on: 1) Anti-dumping policies --encouraging members to strengthen regulations governing the imposition of antidumping duties 2) Protectionism in agriculture --concerned with the high level of tariffs and subsidies in the agricultural sector of many economies 3) Protecting intellectual property --members believe that the protection of intellectual property rights is essential to the international trading system 4) Market access for nonagricultural goods and services --bring down tariff rates on nonagricultural goods and services, and reduce the scope for the selective use of high tariff rates 5) New round of talks - Doha - focusing on: --cutting tariffs on industrial goods and services --phasing out subsidies to agricultural producers --reducing barriers to cross-border investment --limiting the use of anti-dumping laws

4 Determinants of National Competitive Advantage (Porter's Diamond)

The determinants of National Competitive Advantage: 1) Factor Endowments 2) Demand Conditions 3) Related and supporting industries 4) Firm strategy, structure, and rivalry (chance and government also influences national advantage)

Factor Endowments

The extent to which a country is endowed with such factors of production or resources such as land, labor, capital, and entrepreneurship that will be utilized for production of goods. --a nation's position in factors of production such as skilled labor or the infrastructure necessary to compete in a given industry --center of Heckscher-Ohlin theory

constant returns to specialization

The units of resources required to produce a good (cocoa and rice) are assumed to remain constant no matter where you are on a country's production possibility frontier.

Protectionist Trends of 1980-1993

The world trading system came under strain in this period because: 1) Japan's economic success (in semiconductors and automobiles) in the early 1980s strained the world trading system that had more equal trading patterns; Japanese markets were closed to imports and foreign investment thru administrative trade barriers 2) persistent trade deficits by the U.S. caused significant problems in some industries and political problems for the govt -- domestic producers lost their market share to foreign competitors, resulting in unemployment which arose new demands for protection against imports in the U.S. Congress 3) many countries found ways to get around GATT regulations that limit the use of tariffs as there are other forms of intervention that had the same effect without violating GATT. --exporting countries use VERs to avoid more damaging punitive tariffs (neither the importing country nor the exporting country complains to the GATT bureaucracy in Geneva so there is nothing they can do about it)

Product Life-Cycle Theory (Raymond Vernon)

Theory that as products mature, both the location of sales and optimal production location will change, and thus affect the flow and direction of trade --this theory developed in the mid-60's when the wealth and size of the U.S. market gave a strong incentive to U.S. firms to develop new products ----suggests that early in their life cycle, most new products are produced in and exported from the country in which they were developed: Vernon argues that most new products were initially produced in America b/c pioneering firms want to keep production facilities close to the firm and the market. He also says that the demand for these products isn't related to it's price, so firms can charge relatively high prices for new products, making the search for low-cost production in other countries unnecessary --the new product will be exported to other countries, but not in large quantity b/c typically only high-income groups can afford it. As demand for the product in other countries grows, then production facilities will start in those countries where demand is growing, thus limiting the exports coming from the U.S. --as a result, the product becomes more standardized, and price becomes the main competing factor. Now, the producers in advanced countries where labor costs are lower than the U.S. (ex: Italy and Spain) can export to the U.S. product may be exported back to the country of its original innovation --then, developing countries (e.g. Thailand) begin to acquire production advantage over advanced countries --thus, production switches from the U.S. to other advanced nations (with cheaper labor costs than the U.S.) and then to developing nations --this theory explains the failure of Heckscher-Ohlin's theory of comparative advantage because some countries may develop products that they don't necessarily have the most ideal factors of production (land, labor, and capital) for (i.e. when they produce globally popular products) --today's globalization and the integration of the world economy makes the theory less valid b/c many new products are now introduced (simultaneously or not) in the U.S., Japan, and Europe. Also less valid b/c production may be dispersed to those locations where it is most favorable (in terms of comparative advantage theory with productivity and factor endowments)

Trade Barriers and Firm Strategy (implications for managers)

Trade barriers can limit a firm's ability to disperse production globally, and also raise costs for consumers above what they may be in a world of free trade: --trade barriers raise the cost of exporting --quotas limit quantity of exports --firms may have to locate production activities within a country to meet local content regulations (most of the components of a good should be manufactured it's home country) --the threat of future trade barriers can influence firm strategy

Increasing Product Variety and Reducing Costs

Without trade: A small nation may not be able realize economies of scale to certain products because there is not enough demand in that market, so certain products may not be produced; or products are produced but at such low volumes that unit costs and prices are unreasonably high With Trade: A nation may be able to specialize in producing a narrower range of products and then buy the goods that it does not make from from other countries. Each nation then simultaneously increases the variety of goods available to its consumers and lowers the costs of those goods.

Absolute Advantage

a country has an absolute advantage in the production of a product when it's more efficient than any other country at producing it --then trade these goods for those produced by other countries --a country should never produce goods at home that it can buy at a lower cost from other countries --coined by Adam Smith --ex: Ghana and South Korea in production of rice or cocoa. While the have the same amount of resources to produce these products, Ghana has an absolute advantage in the production of cocoa and South Korea has an absolute advantage in production of rice

Production Possibilities Frontier (PPF)

a curve that shows the maximum combinations of output that the economy can possibly produce given the available factors of production and the available production technology --shows the tradeoffs/opportunity cost of decisions

Import Quota

a direct restriction on the quantity of a good that can be imported into a country --enforced by issuing import licenses to a group of individuals or firms --ex: U.S. import quota on cheese, only certain trading companies can trade a maximum number of pounds of cheese each year --can raise prices for both the domestically produced and imported good if a domestic industry lacks the capacity to meet demand (higher prices means greater profits for the industry) --domestic producers gain by limiting import competition --consumers lose bc import quotas raise the domestic price of a good

Tariff Rate Quota

a hybrid of a quota and a tariff where a lower tariff rate is applied to imports within the quota than those over the quota --allows a lower tariff rate on imports of a given product within a specific quantity, and then implements a higher tariff on imports that exceed the specified quantity --ex: lower tariff rate (ad valorem tariff rate of 10%) is levied on 1 million tons of rice imports to South Korea (after 80% out-of-rate quota is applied). So, South Korea would import 2 million tons of rice, 1 million at 10% tariff rate and 1 million at 80% tariff --common in agriculture where their goal is to limit imports over quota --ex: in Japan, they want to limit imports of wheat bc consumers there have a high demand for wheat products, so it would be risky for Japan to rely on the imports of wheat from international trade in order to fulfill their consumers demand (what if they lose their good relations with the trading country and can't get wheat anymore?)

Neo-mercantilism

a policy regime that encourages exports, discourages imports, controls capital movement, and centralizes currency decisions in the hands of a central government --theory of some nations that big trade surpluses make them rich --equates political power with economic power, and economic power with a balance-of-trade surplus --nation have adapted this strategy to boost exports and limit imports --ex: argue that China deliberately keeps its currency value low against the U.S. dollar in order to sell more goods to the U.S. and other developed nations (since it becomes so cheap for these countries) and thus they generate a trade surplus and foreign exchange reserves

export ban

a policy that partially or entirely restricts the export of a good. Purpose: --to ensure sufficient supply of the domestic good at home country, thus keeping domestic price down and boosting national security --ex: U.S. crude oil had an export ban enacted by Congress in 1975. The restriction of oil supply was to punish Western countries for supporting Israel in IP Conflict by driving up oil prices. Ban was lifted in 2015 when American oil producers realized that they could charge higher prices on world markets.

Local Content Requirement (LCR)

a requirement demanding that some specific fraction of a good is to be produced domestically --can be in physical terms (75% of component parts for this product must be produced locally) or in value terms (75% of the value of this product must be produced locally) --provides protections for a domestic producer of parts by limiting foreign competition (like import quota does) --benefits domestic producers by enforcing countries to manufacture component parts for goods locally and protects local jobs from foreign competition --losses to consumers bc they face higher prices --ex: a U.S. law, Buy America Act, requires that an "American" product must have at least 51% of it's components produced domestically.

Uruguay Round (1986)

a series of negotiations that sought to dramatically lower trade barriers worldwide by governing the protection of intellectual property, reducing agricultural subsidies, and strengthen GATT's monitoring and enforcement mechanisms; concluded in 1994 by creating the World Trade Organization. Negotiations focused on: 1) Services and Intellectual Property: --trade issues related to services and intellectual property and agriculture were emphasized --against trends of protectionism, sought to reduce tariffs rather than raise them 2) The World Trade Organization (WTO): --established as a more effective policeman of the global trade rules compared to GATT --encompassed GATT and the General Agreement on Trade in Services (GATS) and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) The official agreement stated: reduced tariffs on industrial goods, manufactured goods, reduced agricultural subsidies, GATT fair trade and market access rules were extended to services and to provide enhanced protection for intellectual property, reduced barriers on trade in textiles, and creation of WTO

constant returns to scale

a situation in which a firm's long-run average costs remain unchanged as it increases output

positive-sum game

a situation in which all countries can benefit (even if some benefit more than others) --ends in net gains for all involved --based in the theory of comparative advantage

zero-sum game

a situation in which an economic gain by one country results in an economic loss by another --general idea that someone can't gain without someone else losing --flaw of Mercantilism

free trade

a situation where the govt does not attempt to restrict what its citizens can buy from another country or what they can sell to another country. --while many nations are nominally committed to free trade, their govts tend to intervene in international trade to protect the interests of politically important groups --results in the absence of barriers to the free flow of goods and services between countries --govt doesn't influence what citizens can buy or sell to another country

tariff

a tax levied on imports (or exports) that effectively raises the cost of imported products relative to domestic products. objectives: 1) to increase govt revenues 2) to protect domestic producers from foreign competitors (by increasing the cost of imported foreign goods) 3) force consumers to pay more for certain imports --2 types: specific and ad valorem --governments gain revenue from tariffs --domestic producers gain from the increased cost of imported foreign goods resulting in protection against foreign competitors for domestic producers --consumers lose because they must pay more for certain imports --Do gains to the govt and domestic producers exceed the loss to consumers? depends on the amount of the tariff, the importance of the imported good to domestic customers, the number of jobs saved in the protected industry etc... --intended to make imported goods less appealing to consumers so that they purchase more domestically produced goods --UPSHOT: pro-producer, anti-consumer

export tariffs

a tax placed on the export of a good --unpopular bc most countries try to encourage exports --the goal is to discriminate against exporting so that the exporting country can maintain a sufficient supply of that good in the country --ex: China raised an export tariff on the export of grain to ensure that there is a sufficient supply in China

Administrative Trade Policies

administrative policies/bureaucratic rules that are designed to make it difficult for imports to enter a country --used to restrict imports or boost exports --ex: Japan restricts many foreign companies from exporting their goods to Japan bc they implement administrative policies that make it impossible to do business. For instance, when Holland tried to export tulip bulbs to Japan, custom inspectors insisted on checking each bulb by cutting it open (can't sell a bulb that is cut open) --losses to consumers by denying access to possibly superior foreign products

Strategic Trade Policy (economic argument for intervention)

aims to improve the competitive position of a domestic industry and/or domestic firm in the world market --in cases where there may be important first mover advantages, govts can use subsidies to help firms from their country attain these advantages by commercializing the firm's goods in these newly emerging industries --also suggests that govts can help firms overcome barriers to entry into industries where foreign firms have an initial advantage with subsidies --to help domestic firms become viable competitors in the global market, a combination of home-market protection (subsidies to help commercialize goods domestically) and export-promoting subsidies (until the domestic firm has first mover advantages in the global market) may be needed

mercantilism

an economic philosophy advocating that it is in a country's best interest to maintain a trade surplus - to export more than it imports --advocates for government intervention to achieve a surplus in the balance of trade (unstable argument for govt. involvement in promoting exports and limiting imports) --from 16th and 17th centuries but used in modern political debates and trade policies of countries --govt policies to maximize exports and minimize imports: imports limited by tariffs and quotas, while exports are subsidizes --flawed bc an inflow of cash (from lots of exports) would swell the domestic money supply and generate inflation --would have the opposite effect on the trading country with limited exports: lack of money so the money supply would contract and prices would fall --as a result, the country with less exports would buy fewer goods from the country with large exports because they are too expensive (due to their price fall) and the country with large exports would buy more goods from the other country because those goods became cheaper --in the long run, no country could sustain a surplus on the balance of trade --this flaw is known as a zero-sum game --theories of Smith, Ricardo, and Heckscher-Ohlin form the case for unrestricted free trade that mercantilism neglects

Limitations of Exporting (theories of FDI)

an exporting strategy can be limited by transportation costs and trade barriers. --when transportation costs are high, exporting can be unprofitable --FDI is a way for firms to avoid trade barriers such as import tariffs or quota

oligopoly

an industry composed of a limited number of large firms ex: wireless carriers in the U.S.: Verizon, AT&T, Sprint-Nextel, and T-Mobile

infant industry argument (economic argument for intervention)

an industry should be protected (from international competition) until it can develop and be viable and competitive internationally --accepted as a justification for temporary trade restrictions under the WTO Criticisms: --it is useless unless it makes the industry more efficient --if a country has the the potential to develop a viable competitive position, its firms should be capable of raising necessary funds

Michael Porter's Theory of National Competitive Advantage

attempts to explain why particular nations achieve international success in certain industries --in addition to factor endowments, a countries factors like domestic demand and domestic rivalry gives a nation dominance in the production and export of particular goods --justifies limited govt intervention to support development of certain export-oriented industries

Adam Smith (1723-1790)

believed that countries differ in their ability to produce goods efficiently, so trade is not a zero-sum game like mercantilism explains --Smith emphasizes ABSOLUTE ADVANTAGE- a country should trade goods they have an absolute advantage in producing with a country that has absolute advantage in producing a different good --advocated free trade and "the Invisible Hand of competition" --the invisible hand (rather than govt policy) should determine what a country imports and exports --trade is not a zero-sum game --countries should specialize in the production of goods for which they have an absolute advantage, and then trade these goods for the goods produced by other countries

Trends in FDI

both the flow and stock of FDI in the world economy have increased over the last 35 years FDI has grown more rapidly than world trade and world output bc: --firms still fear protectionist policies (avoid trade barriers thru FDI) --in many countries, the shift toward democratic political institutions and free market economies encourages FDI --globalization is prompting firms to ensure that they have a significant presence in many regions of the world (also, invest in foreign production near home country)

Government international trade policy is affected by...

businesses that lobby (band together to influence policy) to promote free trade or trade restrictions. --theories of international trade say that promoting free trade is in a country's best interest, but not necessarily an individual firm's best interest, so many firms lobby for open markets --tariffs on foreign imports are self-defeating because the increased cost of the good in the new country will increase the cost of the good produced by other firms, thus limiting the competition in the world market --conversely, tariffs on imports from products that are too cheap in the global market help instigate competition --import barriers block firms from international competition and leave industries with no incentive to increase their efficiency, so the industry loses many of its export markets to more efficient foreign competitors, leading the industry to shrink --Porter's theory suggests that a firm should invest in upgrading advanced factors of production (like better training for staff) and to increase its commitment to research and development ----thus, businesses should urge govt to increase investment in education, infrastructure, and basic research (enhancement of advanced factors) and to adopt policies that promote strong competition within domestic markets (which makes firms stronger international competitors)

Chance (Porter's National Competitive Advantage)

chance events, such as major innovations, can reshape industry structure and allow the opportunity for one nation's firms to supplant (replace) another's

Factor Endowments (Porter's Diamond)

characteristics of factors of production. hierarchies among factors: --basic factors (e.g. natural resources, climate, location, and demographics) --advanced factors (e.g. communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how) --advanced factors create a significant competitive advantage and are a product of investment by individuals, companies, and governments. nations can upgrade their advanced factors --basic factors can provide an initial advantage that is reinforced and extended by investment in advanced factors --disadvantages in basic factors can create pressures to invest in advanced factors (ex: Japan is geographically disadvantaged, but they make up for it with their large pool of engineers) --factor endowments can be affected by subsidies, policies toward capital markets, policies toward education, and so on

World Trade Organization (WTO)

combines GATT with two sister bodies (on services and intellectual property)

Heckscher-Olin Theory of Comparative Advantage

comparative advantage reflects differences in national factor endowments (land, labor, and capital) --emphasizes the interplay between the proportions of factor endowments available in different countries and the proportions of factor endowments that are needed for producing particular goods --the more abundant a factor, the lower its cost --under the assumption that countries have different endowments of the various factors of production, countries will: 1) export goods that make intensive use of those factor endowments that are locally abundant 2) import goods that make intensive use of factors that are locally scarce

economies of scale

cost advantages associated with large-scale production; unit cost reductions that happen due to a large scale of output --economies of scale have a number of sources for the cost advantages that occur from large scale production: ex 1: the ability to spread fixed costs over a large volume ex 2: the ability of large-volume producers to utilize specialized employees and equipment that are more productive than less specialized employees and equipment --major source of cost reduction for industries (like computer software, automobiles, pharmaceuticals, and aerospace). ex 1: Microsoft spreads the fixed costs of developing updated versions of Windows operating system over the computers that already have Windows installed ex 2: automobile companies produce a high volume of automobiles from an assembly line where each employee has a specialized task

The Link Between Trade and Growth (Ricardian Model)

countries that are open to trade have higher growth rates than countries that close their economies to trade --higher growth rates raise income levels and living standards

Quota Rent Equation

demand price - supply price = Quota Rent --the cost of a product or service in a country with quota rent minus the cost in a free market --if demand and supply price are equal, there will be no extra profit for producers as quota rent = 0 (no quota rent) --if demand price exceeds supply price, then quota rent will be higher (more profit resulting from import quotas or VERs) --if supply price exceeds demand price, then quota rent will be lower (less profit resulting from import quotas or VERs)

Antidumping Policies

designed to punish foreign firms that engage in dumping and thus protect domestic producers from "unfair" foreign competition --U.S. firms that believe a foreign firm is dumping can file a complaint with the government --if the complaint has merit, anti-dumping duties (aka countervailing duties), may be imposed --ex: Magnesium (for cars) in the U.S. was not as good as other firms, so they used anti-dumping legislation to gain protection from unfair foreign competitors --anti-dumping policies tend to increase supply in home country and decrease demand bc it increases price for consumers (pro-producer, anti-consumer)

who gains and who loses?

determinants for tariffs and subsidies to understand it's affect on the global market place. do gains exceed losses? producers or consumers gain or lose based on the tariff or subsidy implemented?

The Samuelson Critique (Ricardian Model)

dynamic gains can lead to less beneficial outcomes --being able to purchase goods less expensively within a (richer) country may not (produce a net gain in richer country)/make up for the wages lost in moving production to a less expensive (poorer) country --basically: trade with poorer countries might result in job loss/lower wages for employees in richer countries (bc the poorer countries will upgrade the skill level of their workforce to increase production efficiency for cheaper goods), making trade not beneficial --protectionist measures (e.g. trade barriers) to guard this theoretical possibility that free trade may harm the richer country may create more losses (perversion of democracy and deadweight distortion losses) and worsen the situation more than the disease that trying to be prevented --ex: countries that engaged in this kind of trade with China lost more manufacturing jobs and overall employment decline. Also resulted in increased govt payments bc there was an increase in workers receiving unemployment insurance, food stamps, and disability payments --free trade with poor country in order for consumers in the richer country to buy cheaper imported goods: results in lower wage rates in the richer country (bc either more migrants will come to work at the rich country in search for better pay, or bc the poor country will improve the skillset of their workforce to improve production) which may outweigh the positive benefits of free trade

Smoot-Hawley Act

enacted in 1930 by the U.S. Congress, this act created significant import tariffs on foreign goods (making the cost of imported goods extremely high) --almost every industry was effected by this tariff --damaging effect on employment abroad as other countries reacted by raising their own tariff barriers --U.S. exports decreased in response to other nations that took similar steps to raise their import tariffs like the U.S. did, sliding the world into a deeper depression

Why is acquisition and merging the most common/preferred method of FDI?

favorable as it is much quicker to execute than greenfield investments where you build from the ground up: --it is less risky to buy or merge with an existing firm and then increase its efficiency --easier and cheaper to acquire desired assets through this method rather than starting from the bottom --increase the efficiency of an acquired unit by transferring capital, technology, or managerial skills across firms (this way firms will better understand the local market)

Economies of Scale and First Mover Advantages

firms with first-mover advantages will develop economies of scale and create barriers to entry for other firms. --these firms benefit from a lower cost structure bc they are able to understand the scale economies (how large quantity of output necessary to achieve lower costs) before later entrants to the market, thus resulting in barriers to entry for later entrants --the pattern of trade we observe in the world economy may be the result of first-mover advantages and economies of scale

Dynamic Effects and Economic Growth (Ricardian Model)

free trade generates two dynamic gains: 1) trade might increase a country's stock of resources as increased supplies become available from abroad 2) trade might increase the efficiency of resource utilization and free up resources for other uses --no longer assume that trade doesn't change a country's stock of resources or the efficiency with which those resources are utilized --causes a country's PPF to shift outward, thus stimulating economic growth

subsidy

government payment/financial assistance to a domestic producer. Lowering in production costs help domestic producers in two ways: 1) competing against low-cost foreign imports 2) gaining export markets --forms include: cash grants, low-interest loans, tax breaks, and govt equity participation in domestic firms --domestic producers gain as their international competitiveness increases from subsidies lowering production cost, or from the employment and tax revenues that the company can now generate --consumers lose because they absorb the costs of subsidies from their taxes (increased subsidies, increases consumer taxes) --major source of cost reduction for industries (like computer software, automobiles, pharmaceuticals, and aerospace) --tend to protect the inefficient and promotes excess production --not beneficial in international trade bc if a company relies on subsidies for its success in the domestic market, then how could it be successful internationally?

Domestic Policies (revised case for free trade)

governments can be influenced by special interest groups (political groups) that can distort the economy to benefit only their political group --a govts decision to intervene in a market may appease a certain group, but not necessarily support the interests of the country as a whole --solution: to establish a blanket policy of free trade (not optimal according to strategic trade theory) is the best policy that a country will get

Protecting human rights (political argument for govt intervention)

governments can use trade policy to improve the human rights policies of trading partners --some critics have argued that the best way to change the internal human rights of a country is to engage that country in international trade --ex: the decision to grant China MFN status in 1999 was based on this philosophy --ex: Western govts used trade sanctions against South Africa to pressure it to drop its apartheid policies

National Security (political argument for govt intervention)

governments protect industries important for national security --common in defense-related industries where certain products are essential in weapon production and would be unwise to rely on foreign producers for them ex: agriculture; Wheat in Japan (trade regulations to encourage production in home to ensure they never run out of supply in the case that they lose relations with a supplier country of wheat); steel; protecting consumers from dangerous products (like lead paint in toys)

Limitations of Licensing (theories of FDI)

internalization theory (aka market imperfections approach to FDI) suggests that licensing: 1) could result in a firm's giving away valuable technological know-how to a potential foreign competitor 2) does NOT give a firm tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability 3) may be difficult if the firm's competitive advantage is not amendable to it. Meaning that if the firm's advantage is not based on the products, but rather the management, marketing, and manufacturing capabilities to produce those products, then the firm is not profitable in the foreign market. ex: Although a foreign licensee may be able to physically reproduce a firm's product, if they are unable to do it as efficiently as the firm then it is not profitable in a foreign market

the Form of FDI

most cross-border investment involves mergers and acquisitions over greenfield investments bc they are less risky --greenfield investments are riskier since you have to invest a ton of money and build from the ground up

General Agreement on Tariffs and Trade (GATT)

multilateral agreement, established in 1947, whose objective was to liberalize trade by eliminating tariffs, subsidies, import quotas, and the like. Intended to gradually eliminate barriers to trade (from 1947-1979) and led to the creation of WTO (World Trade Organization) in 1995 --GATT regulations act as a referee to monitor trade between countries --GATT's membership grew from 19 to more than 120 nations --the move toward free trade appeared to stimulate economic growth

nontariff barriers

nontax form of limiting imports (form other than tariffs) such as quotas (ceilings on how many goods of a certain kind can be imported), subsidies, voluntary export restraints, and antidumping duties

Foreign Direct Investment (FDI)

occurs when a firm invests directly in new facilities to produce or market a good or service in a foreign country --a firm engaged in FDI is a multinational enterprise --by U.S. standards, FDI occurs whenever a U.S. citizen, organization, or affiliated group takes an interest of 10% or more in a foreign business entity --most commonly occurs thru mergers and acquisitions --firms engage in FDI (invest directly into the foreign market) in order to have control over how their brand is used in that market

Diminishing Returns (Ricardian Model)

occurs when more units of resources are required to produce each additional unit --diminishing returns of goods produced bc resources run out --the simple model assumes constant returns to specialization (the units of resources required to produce a good are assumed to remain constant) --no longer can assume that there are constant returns to scale (mentioned in point before) --an assumption of diminishing returns is more realistic bc: 1) not all resources have the same quality, and 2) different goods use different resources at different proportions --it is worth it to specialize until the point where resulting gains from trade are outweighed by diminishing returns --says that gains from unrestricted free trade might not be as the simple model suggests

Protecting Consumers (political argument for govt intervention)

protecting consumers from unsafe products --often involves the limiting or banning the import of certain products --typically related to health consequences of the consumption of certain products --important bc some consumers aren't always informed and rely on their govt to regulate products as responsibly sources

distinction between tariffs and quotas

quotas do not reduce the profits of foreign producers, whereas tariffs do (reduce profits of foreign producers). --tariffs reduce the profits of foreign exporters/producers in the short run --quotas raise the price of production, but not the cost of production and thus may increase profits. Rationale: bc quotas impose a limit on quantity, new firms don't enter the market like the would in perfect competition, thus any profits the exporter country makes in other countries with this restricted quantity is not affected (since new firms don't enter and in effect reduce profits). Essentially, a quota blocks the entry of new foreign firms to earn the profits available in the U.S.

Multilateral or Bilateral Trade Agreements

reciprocal trade agreements between two or more partners. --designed to capture gain from trade beyond the agreements under WTO treaties --in response to the failure of the Doha Round (negotiations to reduce trade barriers) many nations pushed forward with this --these agreements are allowed under WTO rules, and the countries involved in these agreements are required to notify the WTO

Flow of FDI

refers to the amount of FDI undertaken over a given time period (normally a year) --outflows of FDI are the flows of FDI out of a country --inflows of FDI are the flows of FDI into a country

Stock of FDI

refers to the total accumulated value of foreign-owned assets at a given time

Immobile Resources (Ricardian Model)

resources don't always move freely from one economic activity to another --no longer can assume (based in comparative advantage assumptions) that resources move freely from the production of one good to another within a country --shift in free trade would require producers from different industries to lose their jobs as production in the industry decreases. Workers become displaced as resources don't move easily from one economic activity to another (ex: a textile worker in South Carolina is not qualified to write software for Microsoft) --workers and unions in certain countries oppose the move to free trade bc they would lose their jobs to it --govt may help retrain displaced workers and improve labor productivity, resulting in beneficial gains from trade

opportunity cost

sacrifice when making an economic choice. in other words: whatever must be given up to obtain some item --it is the value of the goods that you give up/sacrifice when you choose a different good over that one --countries that have lower opportunity costs in producing one good over another will have a comparative advantage in that good, and thus, specialize and trade that good

dumping

selling goods in a foreign market for less than their cost of production or below their "fair" market value --often predatory behavior, bc it drives other firms out of practice. Producers use profits from their home markets to subsidize prices in a foreign market with a goal of driving out indigenous competitors --ex: Big airlines will drop their prices when they see small firms coming into the market. Since big carriers have lots of revenue, they are able to incur the temporary losses from dropping their prices in order to drive the small carriers out and subsequently raise back up their prices.

Porter's Theory

states that a nation's or firm's competitiveness in an industry depends on the capacity of the industry and firm to innovate and upgrade. if Porter is correct, then his model should predict international trade patterns in the real world: --countries should export products from industries where the diamond is favorable --countries should import products from areas where the diamond is not favorable

New Trade Theory

suggests that: 1) Trade can increase the variety of goods available and decrease the average cost of those goods b/c of economies of scale (unit cost reductions associated with a large scale of output) 2) When the output required to attain economies of scale represents a significant proportion of total world demand, the global market may only be able to support a small number of firms --THUS world trade in certain products may be dominated by countries whose firms were first movers in their production --developed by Paul Krugman in response to Heckscher-Ohlin and Raymond Vernon's theories --justifies limited govt intervention to support development of certain export-oriented industries --some countries specialize in the production and export of particular products bc in certain industries the world market can only support a limited number of firms --in such industries, firms that enter the market first can build a competitive advantage that is difficult to challenge (first-mover advantage) --ex: U.S. is a major exporter of commerical jet aircraft bc the US had first mover firms in the world market (Boeing); even countries with equal factor endowments have a hard time challenging Boeing

ad valorem tariff

tariff levied as a proportion of the value of an imported good

absolute advantage

the ability of a country to produce more of a given good or service than competitors, using the same amount of resources --Adam Smith advocated for this

first-mover advantage

the ability of an innovative company to achieve long-term competitive advantages by being the first to offer a certain product in the marketplace --first-mover firms may subsequently dominate global trade in that product, particularly in industries where the global market can only support a limited number of firms (New Trade Theory) --its worth it to invest substantial financial resources in trying to build a first-mover advantage, even if that means several years of losses before the firm is profitable

gains from trade

the combined output of two different goods increases when each country specializes in one of the goods (comparative advantage) --both countries benefit from trade because they produce/get more of each product than they would would specialization and trade (positive-sum game) --potential world production is greater with unrestricted free trade than it is with restricted trade --limitations on imports are often due to the economic interests of domestic producers (not consumers)

Firm Strategy, Structure, and Rivalry (Porter's Diamond)

the conditions in the nation governing how companies are created, organized, and managed and the nature of domestic rivalry --there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry 1) different nations are characterized by different management ideologies, which either help them, or do not help them build national competitive advantage --consequence of different management ideologies is a relative loss of U.S. competitiveness in those engineering-based industries where manufacturing processes and product design issues are all-important (e.g. the automobile industry) 2) strong association bw vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry --domestic rivalry induces firms to look for ways to improve efficiency, creates pressure to innovate, to improve quality, to reduce costs, and to invest in upgrading advanced factors

quota rent

the extra profit that producers make when supply is artificially limited by an import quota --occurs when imports are limited to a low percentage of the market by a quota or VER, and so the price is bid up for that limited foreign supply

First mover implications on International Business

the first mover dominates the trade industry (through it's success on technology and patents, as well as recognizing economies of scale), and second movers should learn through the first mover's mistakes (i.e. pioneering costs)

strategic balancing act

the idea that countries wont stop all production of products they produce less efficiently than another country because they prefer to be as efficient as possible (by international trade when advantageous) and also self-sufficient (production in home country) --begs to question which goods should be produced in home country and which imported? answered by comparative advantage theory

Demand Conditions (Porter's Diamond)

the nature of home demand for the industry's product or service --influences the development of capabilities --sophisticated and demanding domestic consumers pressure firms to be more competitive and pressure firms to be more competitive and to produce high quality, innovative products --ex: Japan's knowledgeable buyers of cameras helped stimulate the Japanese camera industry (product quality and innovative models)

the Leontief Paradox

the phenomenon that exports are less capital intensive than import-competing goods --since the U.S. was relatively abundant in capital, it would export capital intensive goods and import labor-intensive goods (predicted by H-O theory) --Leontief found that, in contrast to the predictions of the Heckscher-Ohlin theory, US exports are less capital intensive than US imports. Possible explanations: 1) the U.S. has a special advantage in producing products made with innovative technologies that are less capital intensive; so the U.S. is exporting goods that require heavily skilled labor and entrepreneurship (factor endowments), like computer software, and then importing heavy manufacturing products that require spending large amounts of capital 2) differences in technology lead to differences in productivity which then drives international trade patterns; ex: Japan has been successfully exporting automobiles since the 70's because it has developed innovative manufacturing technology that allowed for greater productivity levels than other countries with automobile production that also have abundant capital

Related and Supporting Industries (Porter's Diamond)

the presence (or absence) of supplier industries or related industries that are internationally competitive --investing in these industries can spill over and contribute to success in other industries: the benefits of investments in advanced factors of productions that pertain to related and supporting industries can spill into one industry and thus helps the industry develop a strong competitive position internationally --ex: Swedish strength in fabricated steel products (e.g. ball bearing and cutting tools) has drawn on strengths in Sweden's specialty steel industry --consequence of this process is that successful industries within a country tend to be grouped into clusters of related industries which then prompts knowledge flows between firms --ex: the German textile and apparel sector created a cluster of high-quality cotton, wool, synthetic fibers, sewing machine needles, and a wide range of textile machinery; this benefits the cluster bc there is a valuable flow of knowledge bw different firms within a geographic cluster

specialization

the tendency of countries to specialize in certain products which they trade for other goods, rather than producing all consumption goods on their own. --happens because of comparative advantage

Trade Policies and Tariffs: who gains, who loses?

trade regulations are pro-producers and anti-consumer --producers gain from limited competition generally --consumers lose from increased price of goods resulting from limited supply

Protecting Jobs and Industries (political argument for govt intervention)

typically, jobs and industries must be protected due to the political pressures coming from unions or industries that are "threatened" by more efficient foreign producers. Also, these unions or industries have more political clout than the consumers who will eventually pay the costs --in other words, governments want to protect politically powerful laborers or industries, so they may restrict imports and guarantee prices, which in effect leads to consumer loss by paying the higher costs from this protection

Retaliation (political argument for govt intervention)

when governments take (or threaten to take) specific actions, other countries may remove trade barriers --these actions are typically punitive (disciplinary) trade sanctions like tariffs --if it works, retaliation from govts may liberalize trade and bring economic gains; "don't beat me up, I'm just going to restrict what I'm going to send/export" --however, if threatened govts don't back down, tensions can escalate and instead those govts will respond by enacting new trade barriers of it's own and resulting in economic loss to all involved; can also result in a trade war