Module 2: International Trade and Investment

Gains from Specialization and trade

each nation specialized in producing the product at which it more efficient and then traded it surplus for goods it could not produce as efficiently both nation benefited

Historically, approximately two-thirds of the value of corporate investments made in the United States from abroad have been spent to acquire going companies rather than to establish new ones (similarly, the majority of U.S. investments into foreign markets have gone to the acquisi¬ tion of going companies). A number of reasons are responsible for this fact:

(1) corporate restructuring in the United States caused management to offer for sale those businesses or other assets that either did not meet management's profit standards or were considered unrelated to the company's main business (2) foreign companies wanted to gain rapid access in the United States to advanced technology, especially in computers and communications; (3) management of foreign firms felt that entrance into the large and prosperous U.S. market could be more successful if they acquired known brand names rather than spending the time and money to promote new, unknown brands (4) increased international competitive pressures, including the pursuit of improved economies of scale, have led to restructuring and consolidation in many industries, and the acquisition of companies in major markets such as the United States has been a by-product of these industrial trends.

Many Asian countries are both import and export partners of the United States because

(1) their rising standards of living enable their people to afford more imported products, and the countries' export earnings provide the monies necessary to pay for them (2) they are purchasing large amounts of capital goods to further their industrial expansion (3) they are importing raw materials and components that will be assembled into subassemblies or finished goods that will subsequently be exported, often to the United States (4) their governments, pressured by the U.S. government to lower their trade surplus

Trade in services has been growing faster than trade in merchandise

- for the last 20 years. -60% of global output is now destined for international trade another indication of the extent to which international trade has become a critical factor in the economic activity of many, if not most, of the countries of the world.

Theory of comparative advantage

-English David Richard -even though one nation held an absolute advantage over another in the production of each of two different good international trade could still be a positive sum game in which both countries benefit -only limitation benefits create trade is less efficient nation can't be equally less efficient production of both goods

diamond model of national advantage

1. Demand conditions: The nature of domestic demand matters, rather than merely the size. -if company strive produce high quality will obtain a global competitive advantage over companies located where domestic pressure is less. 2. Factor conditions: Porter distinguishes between basic factors (inherited factors, such as land, location, or natural resources) and advanced factors (those created from investments made by individuals, companies, or governments, such as a nation's transportation systems, or university research institutes). Ex: Lack of natural endowments has caused nations to invest in creating advanced factors, such as an educated workforce, deep-water ports 3. Related and supporting industries: Firms in an industry, with their suppliers, their suppliers' suppliers, and so forth, tend to form a cluster in a given location, providing a network of suppliers and subcontractors and a commercial infrastructure. 4. Firm strategy, structure, and rivalry: companies subject to heavy competition in their domestic markets are constantly striving to improve their efficiency and innovativeness, which makes them more competitive internationally. -compartor have enter market just because of there compartors

(absolute advantage )perfect competition

A market situation in which there is a sufficiently large number of well-informed buyers and sellers of a homogeneous product, such that no individual participant has enough power to determine the price of the product, resulting in a marketplace that is efficient in production and allocation of products us advantage soybean they make 3 out (china) china adv cloth 4to 1(US)

absolute advantage

A nation's ability to produce more of a good or service than another country for the same or lower cost of inputs -both nation gain from trade Adam Smith argued against mercantilism by claiming that market forces, not government controls, should determine the direction, volume, and composition of international trade.

MERCANTILISM

An economic philosophy based on the belief that (I) a nation's wealth depends on accumulated treasure, usually precious metals such as gold and silver (2) to increase wealth, government policies should promote exports and discourage imports most ppl see to trade is to lose something to gain In balance-of-payments accounting, an export that brings money to the country is called positive, but imports that cause monetary outflows are labeled negative.

Level and Direction of FDI

Even though it is impossible to make an accurate determination of the present value of foreign investments, we can get an idea of the rate and amounts of such investments and of the places in which they are being made. -If a nation is continuing to receive appreciable amounts of foreign investment, its investment climate must be favorable. This means the political forces of foreign environment are relatively attractive and the opportunity to earn a profit is greater there than elsewhere.

FDI: Theories of International Investment

FDI can take place through greenfield investment, or cross-border acquisition -To be successful with their foreign investment activities, firms must possess advantages not available to local firms in order to overcome liabilities associated with being a foreigner—such as lack of knowledge about local market conditions, increased costs of operating at a distance, or differences in culture, language, laws and regulations, or institutions.

(Direction of Trade) Increasing Regionalization of Trade

Growth is due in part to developing countries' increasing ability to export manufactured goods. It also reflects the growing volume of trade among international companies' affiliates around the world, such as when a clothing manufacturer sends cloth manufactured in its Indian operations to its production facility in Bangladesh, where the cloth will be sewn into garments. -members of trade groups are increasingly selling to each other will influence international companies' choices of locations for their plants and other operations.

The Outstanding Stock of Foreign Direct:

Investment The book value—or the value of the total outstanding stock—of all foreign direct investment (FDI) worldwide

trade surplus

The amount by which the value of a nation's exports exceeds the value of its imports

trade deficit

The amount by which the value of imports into a nation exceeds the value of its exports

Annual Inflows of FDI

The industrialized nations invest primarily in one another, just as they trade more with one another.

economies of scale

The predictable decline in the average cost of producing each unit of output as a production facility gets larger and output increases This occurs because larger and more efficient equipment can be employed, companies can obtain volume discounts on their larger-volume purchases, and fixed costs such as research and design and administrative overheads can be allocated over a larger quantity of output.

cross-border acquisition

The purchase of an existing business in another nation

portfolio investment

The purchase of stocks and bonds to obtain a return on the funds invested -Although portfolio investors are not directly concerned with the control of a firm, they invest immense amounts in stocks and bonds from other countries. -foreign portfolio investment is sizable and will continue to grow as more international firms list their bonds and equities on foreign exchanges.

direct investment

The purchase of sufficient stock in a firm to obtain significant management control

experience curve

The rising scale on which efficiency improves as a result of cumulative experience and learning -Production costs also drop because of the experience curve, -That is, as firms produce more, they learn ways to improve production efficiency, reduc¬ ing production costs by a predictable amount.15

DIRECTION OF TRADE according to this theory countries would export products require large amounts of abundant production factors and import products require large amount of their abundant production factors.

This theory explains it international trade it in many primary product such as forest as production petroleum and minerals. It can also explain why the US exports capital intensive products such as Aircrafts while importing labor intensive products such as jeans or athletic shoes

comparative advantage

When a nation is less efficient than another nation in the production of each of two good the less, efficient nation has nation has a competitive advantage good for which absolute disadvantage of less -both are good but sometime one is a bit less efficient and choose to buy from them gain from specialization and trade -compared to advantage serves as a basis for international trade even when one nation has an advantage over another in the production of each of a good thing trade we have not mention money however a nation comparative adv can be affected by difference between the cost of production factor in that country In that country's currency and their costs and other currencies

Economies of scale and the experience curve affect international trade because ____________________________________

they can permit a nation's industries to become low-cost producers without having an abundance of the resources used as inputs, such as minerals or labor.

Many of the world's managers see China as a present-day "fortress of mercantilism" that raises_________________

barriers to imported goods while giving its own exporters an unfair advantage. Despite impressive economic growth and burgeoning trade surpluses, Chinese authorities have limited the extent to which the yuan can appreciate in value relative to the U.S. dollar.

The distinction between portfolio investment and direct investment

components has begun to blur, particularly with the growing size and number of international mergers, acquisitions, and alliances in recent years. For example, investments by a foreign investor in the stock of a domestic company generally are treated as direct investment when the investor's equity participation ratio is 10 percent or more.

FOREIGN DIRECT INVESTMENT (FDI)

direct investment abroad, including the volume, level, and direction of foreign direct investment and the influence of international trade on foreign direct investment. -The Outstanding Stock of Foreign Direct: -Annual Outflows of FDI -Annual Inflows of FDI

DOES TRADE LEAD TO FDI?

engaging in foreign trade is typically less costly and less risky than making a direct investment into foreign markets. -Typically firm uses domestic or foreign agents to export. As the export business increases, the firm sets up an export department and perhaps hires sales representatives to live in overseas markets. It might even establish a sales company to import and sell the company's products in a foreign country.

The rapid expansion of world exports since 1980 demonstrates that the opportunity to increase sales by ________________________________________________

exporting is a viable growth strategy and one that can benefit the exporting nations by creating jobs for their citizens. At the same time, however, the growth of exports from individual nations should be a warning to managers that they must be prepared to meet increased competition from these exports in their own domestic markets.

National Competitive Advantage from Regional Clusters

why, in many industries, firms tend to cluster together on a geographic basis.He suggested three reasons: (1) the pooling of a common labor force means staffing requirements can be met quickly, even with unexpected fluctuations in demand (2) specialized local suppliers can coordinate their operations and skills with the needs of the buyers; (3) technological information can be readily shared, enhancing the rate of innovation.

Eli Heckscher and Bertil ohlin at Stockholm school of economics suggest different resources endowment will make developed countries more likely to trade

with developing countries resources endowment are likely to be very similar and other developed countries whose endowment are similar

Annual Outflows of FDI

—the amount invested each year into other nations—often fluctuates substantially, due to factors such as the level of economic growth within and across nations and regions of the world. For example, FDI outflows hit a historical high in 2000—$1.24 trillion, more than 2.5 times the level in 1997.

Direction of Trade Where are all these merchandise exports going?

international trade consists mainly of manufactured goods exported by the industrialized nations to the developing nations in return for raw materials. -More than 1/2 exports from developing nations do go to developed countries, but this proportion has been declining as the developing nations participate more extensively in trade with other developing nations -2/3 of exports from developed economies go to other industrialized nations.

We can divide foreign investment into two components:

1.portfolio investment 2.direct investment,

oligopolistic industry

An industry with a limited number of competing firms

WHICH NATIONS ACCOUNT FOR THE MOST EXPORTS AND IMPORTS?

As you can see, they are generally developed countries, although China ranks in the top 5 on each list and India in the top 10 for imports of merchandise and for both imports and exports of services.

Of the top 15 nations from which the United States imports, 9 have consistently remained on the list over the past 45 years, though their rankings have changed over time. They are :

Canada, Mexico, Japan, Germany, the United Kingdom, Italy, France, Venezuela, and Brazil.

Nations Asia, besides long-term trade partner:

Japan, China, Singapore, South Korea, Taiwan

Explaining Trade: International Trade Theories

MERCANTILISM THEORY OF ABSOLUTE ADVANTAGE Theory of comparative advantage

MAJOR TRADING PARTNERS OF THE UNITED STATES

Mexico and Canada are major U.S. trading partners in great part because they are joined with the United States in NAFTA. They also each share a common border with the United States, which means lower freight charges, shorter delivery times, and easier and less expensive contacts between buyers and sellers than would otherwise be the case.

Current devaluation

a reduction in value of a country's currency relative to other currencies

(absolute advantage) Each Country Specializes

Suppose each nation decides to use its resources to produce only the product in which it has an absolute advantage.

greenfield investment

The establishment of new facilities from the ground up

Overlapping demand

The existence of similar preference and demand for products and services among nations with similar levels of per capita income -PPL taste highly depend on income level -ppl high income desire high name brands and producer will produce that demand to meet there need and will reflect on the country income what manufactures will produce Note that the theory of overlapping demand differs from the theory of comparative advantage in that it does not specify in which direction a given good will go.

product differentiation

Unique differences producers build into their products with the intent of positively influencing demand ex:Apple is able to export its cell phones to Japan and Japan's Sony can export cell phones to the United States because consumers in these different markets perceive a difference between the brands.

(absolute advantage) Terms of Trade (Ratio of International Prices)

With specialization, the total production of both goods is greater, but to consume both products, the two countries must trade some of their surplus. Tons of soybeans 6(US) 0 (China) Bolts of cloth 0(US) 8 (china)

National competitiveness

is a nation's ability to design, produce, distribute, or service products within an international trading context while earning increasing returns on its resources.

why international trade will occur

resource endowment overlapping demand

Resource endowment

the land labor capital and related protection factor in nations possesses

Exchange rate

the price of one Currency states in terms of another example 1 dollar equals 8 yuan

(eclectic theory of international production )for a firm to invest in facilities overseas, it must have three kinds of advantages: ownership specific, location specific, and internalization:

1. Ownership-specific advantage. - firm has or can develop a firm-specific advantage through ownership of tangible and intangible assets that are not available to other firms and that can be transferred abroad. The three basic types of tangible or intangible ownership-specific advantages: technology, economies of scale or scope, and monopolistic advantages -advantage generates lower costs and/or higher revenues that will offset the added costs of operating at a distance within a foreign location. 2. Location-specific advantage. -must have specific economic, social, or political characteristics, like market size, tariff or nontariff barriers, or transport costs that will permit the firm to profitably exploit its firm-specific advantages by locating to that market rather than exporting to it. 3. Internalization advantage. Firms have various alternatives to entering foreign markets, ranging from making arm's-length market transactions to operating wholly owned subsidiaries. It is in the firm's best interests to exploit its ownership-specific advantages through internalization options, which mean retaining ownership and control, where either the market does not exist or it functions inefficiently, making the transaction costs of market-based (arm's-length) options too high.

international product life cycle (IPLC)

A theory explaining why a product that begins as a nation's export eventually becomes its import This theory addresses the role of innovation in trade patterns by explaining why a product that begins as a nation's export eventually becomes its import, thus viewing a product as going through a full life cycle. The initial stage of the cycle, innovation, borrows from the theory of overlapping demand in terms of the motivations and response of entrepreneurs to develop products that meet the demands arising in a market. international competition and short product life cycles encourage more firms to introduce new products globally, this theory may be less applicable.

International Product Life Cycle 4 stages

Stage 1. U.S. innovates and exports: Because the US has the largest population of high-income consumers of any nation in the world, competition for their patronage is intense. Manufacturers constantly search for better ways to satisfy their customers' needs, maintaining large research and development laboratories and keeping in close contact both with the home market and with suppliers of the materials they need for product development, who are often local. Stage 2. Foreign production begins: Overseas consumers, especially in developed nations, are similar to U.S. customers in their need for and their ability to purchase the product. Export volume grows and may become large enough to support production abroad, especially in larger markets. The technology for producing the good has become fairly stable, and if the innovator is a multinational firm, it will often be sending new product information to subsidiaries, with complete details on how to produce it. Stage 3. Foreign competition appears in export markets: As early foreign manufacturers gain experience in marketing and production, their costs will fall. Saturation of their local markets will cause them to look for buyers elsewhere. Stage 4. Import competition appears in the United States: If foreign producers attain sufficient economies of scale, they may be able to compete in quality with and underprice U.S. firms in the domestic market. From that point on, the U.S. market will be served exclusively (or nearly so) by imports.

eclectic theory of international production

Theory proposing that for a firm to invest in facilities overseas, it must have three kinds of advantages: ownership specific, location specific, and internalization

strategic behavior theory

Theory suggesting that strategic rivalry between firms in an oligopolistic industry wil result in firms closely following and imitating each other's international investments in order to keep a competitor from gaining an advantage

dynamic capability theory

Theory that for a firm to successfully invest overseas, it must have not only ownership of unique knowledge or re¬ sources, but also the ability to dynamically create, sustain, and exploit these capabilities over time

monopolistic advantage theory

Theory that foreign direct investment is made by firms in industries with relatively few competitors, due to their possession of technical and other advantages over indigenous firms

internalization theory

Theory that to obtain a higher return on its investment, a firm will transfer its superior knowledge to a foreign subsidiary that it controls, rather than sell it in the open market

(Direction of Trade) MAJOR TRADING PARTNERS: THEIR RELEVANCE FOR MANAGERS

Why should we know which countries are our own nation's major trade partners? Here are some of the advantages: 1. The business climate in these importing nations is already relatively favorable. 2. Export and import regulations are not insurmountable. 3. There should be no strong cultural objections at home to buying that nation's goods. 4. Satisfactory transportation facilities have already been established. 5. Import channel members (merchants, banks, and customs brokers) are experienced in handling import shipments from the exporter's area. 6. Currency from the foreign country is available to pay for the exports. 7. The government of a trading partner may be applying pressure on its importers to buy from countries that, like the United States, are good customers for that nation's exports.