Chapter 6 International Trade and Investment

The Lincoln Fallacy

"I know this much. When we buy goods manufacture abroad, we get the goods and the foreigner gets the money. When we buy good manufactured at home, we get both the goods and the money." Lincoln is correct in asserting that buying goods from foreign producers sends our money abroad, whereas buying goods from domestic producers keeps our money in our country. However, what his argument fails to consider is the resources - the factors of production - needed to create the goods. When we buy goods produced domestically, domestic factors of production, such as labor, land and natural resources, must be consumed and thus are unavailable for other uses. When we buy goods produced by foreigners, foreign resources are used, leaving the domestic factors of production available to be used for other purposes That, of course, is the benefit of free trade in the eyes of proponets like Adam Smith and David Ricardo; it allows a country to allocate its domestic resources to produce goods for whigh the country has a comparative advantage..

Factor Conditions

A country's endowment of factors of production affects its abilty to compete internationally. Porter goes beyond the basic factors - land, labor, and capital - considered by the classical trade theorists to include more advanced factors such as the educational level of the workforce and the quality of the country's infrastructure. His work stresses the role of factor creation through training, research, and innovation.

Leontief paradox

A finding by Wassily Lentief, a Nobel prizewinning economist, which shows That the United States, supirsingly, exports relatively more labor intensive goods and imports capital-intensive goods.

Mercantilism

A sixteenth-century economic philosophy that maintains that a country's wealth is measured by its holdings of gold and silver. According to mercantilists, a country's goal should be to enlarge these holdings by promoting exports and discouraging imports.

Theories of International Trade "Country-Based Theories"

Country is unit of anlysis Emerged prior to World War II Developed by economists Explain iterindustry trade Include: Mercantilism Absolute advantage Comparative advantage Relative factor endowments (Heckscher-Ohlin)

Theory of Comparative Advantage

David Ricardo, an early-nineteenth-centrury British economist, developed the theory of comparative advantage, which states that a country should produce and export those goods and services for which it is Relatively more productive than other countries are and import those goods and services for which other coutries are Relatively more productive than it is.

New Trade Theory

Developed by: Elhanes Helpman, Paul Krugman, and Kelvin Lancaster in the 1970's and 1980's extends Linder's analysis by incorporating the impact of economies of scale on trade ib differentiated goods.

Theories of International Trade "Firm - Based -Theories

Firm is unit of analysis Emerged after World War II Developed by business school professors Explain intraindustry trade Include: Country similarity theory Product life cycle New trade theory National copetitive advantage

Neomercantilists or Protectionist

Modern supporters of merantilist policies and include such diverse U.S. groups as the American Federation of Labor-Congress of Industrial Organizations, textile manufacturers, steel companies, sugar growers, and peanut farmers.

Porter's Theory of National Competitive Advantage

Newest addition to international trade theory. Porter believes that success in international trade comes from the interaction of four country - and firm specific elements: factor conditions; demand conditions; related and supporting industries; and firm strategy, structure, and rivalry.

Economies of scale

Occur if a firm's average cost of producing a good decrease as its output of that good increases. In industries in which economies of scale are important, we would expect firms to be particulary aggressive in expanding beyod their domestic markets.

Ownership advantage

Resources owned by a firm that grant it a competitive advantage over its industry rivals

Theory of Absolute Advantage

Smith developed the theory of absolute advantage, which suggests that a country should export those goods and services for which it is more productive than other countries and import goods and services for which other countries are more productive than it is

Undifferentiated goods

Such as coal, petroleum products, and sugar, are those for which brand names and product reputations play a minor role at best in consumer purchase decisions.

Ownership Advantage Theory

Suggests that a firm owning a valuable asset that creates a competitive advantage dometically can use that advantage to penetrate foreig markets through FDI. The assset could be, for example, a superior technologym a well-know brand name or economoies of scale.

Linder's country similarity theory

Suggests that most trade in manufactured goods should be between countries with simiar per capita incomes and that intraindustry trade in manufactured goods should be common. This theory is particularly useful in explaining trade in differentiated goods such as automobiles, expensive electronics equipment, and personal care products, for which brand names and product reputations play an important role in consumer decision making.

Supply Factors, Demand Factors, Political Factors

Supply Factors include Production costs, Logistics, Resource availability, Access technology. Demand Factors: Customer access, Marketing advantages, Exploitation of competitive advantages, Customer mobility Political Factors: Avoidance of trade barriers and Economic development incentives

Opportunity cost

The cost of a good is the value of what is given up to get the good. Most of us apply the principles of comparative advantage and opportunity cost without realizing it.

Transaction costs

The costs of entering into a transactionk that isk those connected to negotiating monitoring, and enforcing a contract.

Firm Strategy, structure, and rivalry

The domestic environment in which firms compete shapes their abiltiy to compete in intenational markets. , Strong competitive rivalry increases firm efficiency, further increasing their ability to compete internationally. May be the strongest of the four factors. Strong competition may also spur international strategy directly, to get out of the hot spot of domestic competition. Certain structures may be better suited to certain industries.

Related and Supporting Industries

The emergence of an industry often stimulates the development of local suppliers eager to meet that industry's production, marketing, and distribution needs. , One of the reasons the United States is competitive in high-technology industries is because of the existence of places like Silicon Valley in California. There you can find top-level universities, experienced technology firms and a pool of talented engineers from around the world. This is an example of ____________ that may give the United States a competitive advantage in the global marketplace?

Demand Conditions

The existance of a large, sopisticated domestic consumer base often stimulates the development and distribution of innovative products as firms struggle for dominance in their domestic markets.

Internalization advantage

The firm must benefit more from controlling the foreign business activity than from hiring a independent local company to provide the service.

Trade

The voluntary exchange of goods, services, assets, or money between one person or organization and another. Because it is voluntary, both parties to the transaction must believe they will gain from the exchange or else they would not complete it.

International Trade

Trade between residents of two countries. The residents may be individuals, firms, not-for-profit organizations, or other forms of associations.

Relative Factor Endowments

Two Swedish economist, Eli Heckscher and Bertil Ohlin, developed the therory of relative factor endowments, now ofter referred to as the Hecksher-Ohlin theroy. These economists made two basic observations: 1. Factor endowments (or types of resources) vary amoung countries. For example, Argentina has much fertile land, Saudi Arabia has large crude oil reserves, and Bangladesh has a large pol of unskilled labor. 2. Goods differ according to the types of factors that are use to produce them. For example, wheat requires fertile land, oil production requires crude oil reserves, and apparel manufacturing requires unskilled labor.

Location advantage

Undertaking the business activity must be more profitable in a foreign location than undertaking it in a domestic location.

Foreign direct investment (FDI)

acquisition of foreign assets for the purpose of controlling them. U.S. government statisticians define FDI as "ownership or control of 10 percent or more of an enterprise's voting securities or the equivalent interest in an unincorporated business." FDI may take many forms, including purchase of existing assets in a foreign country new investment in property, plant, and equipment, and participation in a joint venture with a local partner.

Dunning's Eclectic Theory

combines ownership advantage, location advantage, and internalization advantage to form a unified theory of FDI. This theory recofnized that FDI reflects both international business activity and business activitiy internal to the firm. According to Dunning, FDI will occur when three conditions are satisfied: 1. Ownership advantage 2. Location advantage 3. Internalization advantage

Foreign portfolio investments (FPI)

represent passive holdings of securities such as foreign stock, bonds or other financial assets, none of which entails active management or control of the securities' issuer by the investor.

Internalization theory

suggests that FDI is more likely to occur- that is, international production will be internalized within the firm- when the costs of negotiating, monitoring, and enforcing a contract with a second firm are high. For example, Toyota's primary competitive advantages are its reputation for high quality and its sophisticated manufactuing techniques, neither of which is easily conveyed by contract.

Interindustry trade

the exchange of goods produced by one industry in country A for goods produced by a different industry in country B, such as the exchange fo French wines for Japanese clock radios.

Product Life Cycle Theory

the theory that certain kinds of products go through a cycle consisting of four stages (new product stage, maturing, standardized product(market stabilizes), and decline) and that the location of production will shift internationally depending on the stages of the life cycle

INTRAindustry trade

trade between tow countries of goods produced by the same industry, For example, Japan exports Toyotas to Germany and Germany exports BMWs to Japan. Intra-industry trade accounts for approxiamately 40 percent of world trade, and it is not predicted by country-based theories.