Chapter 5: Theories of International Trade and Investment
national advantages under national industrial policy
iNHERITED VS created Inherited advantageous are important. However, according to porter created national advantages are becoming increasingly more valuable in the economic development process.
Why is the mercantilist view unsustainable in the long run?
if each and every country were to try to export more than its imports, there will be too many sellers and not enough buyers
Born global firms
innovative start-ups that initiate IB soon after their founding
Comparative advantage principle
it may be beneficial for two countries to trade with each other as long as one is relatively more efficient at producing a product needed by the other production or (factor) efficiency
Trade surplus
leads to inflows of precious metals generate net inflows of precious metals, make nation wealthy
Define as winner/loser consumer exporter importers of raw materials to produce goods importers of finished goods:resellers farmers exporting agricultural products Workers in import-oriented industries Governments Cause of global free trade
loser winner loser loser (unknown) loser winner (unknown) loser
Mercantilism policy recommendation
nation should run surpluses Goal: to accumulate as much of the precious metals as possible often cited example :china Allegation: china keeps yuan intentionally undervalued to increase its exports
Factor conditions:
nations resources such as labor, natural resources and advanced factors such as capital, technology, entrepreneurship, advanced work force skills and know how. Each nation has a relative abundance of certain factor endowments. land, labor, capital, natural resources
Firm strategy, structure and rivalry
nature of domestic rivalry and conditions in a nation that determines how firms are created, organized, and managed. Vigorous competitive rivalry puts these firms under continual pressure to innovate and improve. Presence of strong competitors in a nation helps to create and maintain national competitive advantage. levels of competition
Demand conditions:
nature of home-market demand for specific products and services. The presence of demanding customers pressures firms to innovate faster and produce better products. income level, knowledgable, well-informed or discerned buyers
Ratio for input to output
output/input
Related and supported industries
presence of clusters of suppliers, competitors, and skilled workforce. industry cluster
Free Trade
relative absence of restrictions to the flow of goods and services between nations
Monpolistic advantage
resources or capabilities a company holds that few other firms have. Firms that use FDI as an internationalization strategy must own or control certain resources and capabilities not easily available to competitors. This gives them a degree of monopoly power over local firms in foreign markets.
Created:
taxation policy, monetary policy, free trade zones, rigorous ed system, stock of technology and know how financial and physical infrastructure
Absolute advantage principle
the idea that a country benefits by producing only those products it can produce using fewer resources (nations differ in their ability to produce a product efficiently is a well-accepted premise) Production efficiency or factor: labor cost low and production higher He argued that instead of restricting trade, if countries were to (a) specialize based on their respective absolute (cost) advantages, (b) produce goods and services utilizing their national resources, and (c) engage in freer trade (i.e., cross-border exchange) they would be economically better off: Raise their standards of living by consuming more goods and services Rationale: Each country is relatively more efficient in the production of certain products (while less-efficient in the production of other products) Thus, a country would economically benefit by specializing in the production of those products in which it has an absolute advantage
Industrial cluster
to a concentration of businesses, suppliers,and supporting firms in the same industry located a particular geographic location. Ex: fashion in northern italy
FDI stock
total value of assets that MNEs invest abroad
International product life cycle theory
vernon observed that each product and its manufacturing technologies go through three stages evolution: introduction, maturity and standardization. Innovation
What are the three contemporary trade theories?
1) Competitive advantage of nations (Michael Porter) 2) National diamond model (mcihael porter) 3) National industrial policy (Porter)
What outcomes does free trade produce?
1) Consumers and firms can readily buy the products they want 2) Imported products may be cheaper than domestically produced products 3) Lower-cost imports can help reduce company expenses, raising profits. 4) Lower-cost imports help consumers save money, increasing living standards 5) Unrestricted international trade generally increases the overall prosperity of poor countries
2) Determinants of national competitiveness: 1) Porters diamond model: Four main elements
1) Demand conditions 2)Firm strategy 3) Factor conditions 4) Related and supported industries
What are the four reasons why nations trade?
1) Enables countries to use their natural resources more efficiently through specialization and thus enable industries and workers to be more productive 2) These outcomes help keep the cost of many everyday products low, which means higher living standards 3) W/o International trade, most nations would be able to feed, cloth, and house their citizens at current levels. 4) Modern life would be nearly impossible w/o trade
What are the two main reasons born globals have emerged in large numbers?
1) Globalization has made doing business easier than ever before 2) Advances in communication and transportation technologies have reduced the costs of operating internationally 3) International entrepreneurship
What are the six classical theories perspectives and who is the founder?
1) Mercantilism 2) Absolute advantage principle (smith) 3) Comparative advantage principle (ricardo) 4) Factor proportions theory and Leontief Paradox (Eli huckster and betrayal olin) 5) International product life cycle theory (raymond vernon) 6) New Trade theory (Paul Krugman)
FDI explanations: Three theories of how firms can use FDI to gain and sustain competitive advantage
1) Monopolistic advantage theory 2) Internationalization theory 3) Dunnin's electric paradigm
What two premises does the factor endowment theory rest on?
1) Products differ in the types and quantities of factors (labor, natural resources, and capital) required for their production 2) Countries differ in the type and quantity of production factors that they possess. It differs from earlier theories by emphasizing the importance of each nation's factor of production, differences in the quantity of production factors countries hold also determine international trade patterns. A country that possess an abundance of a given production factor (labor, land) obtains a per-unit-cost advantage in the production of goods that use that factor intensively.
How can nations enhance their competitive advantage?
1) The competitive advantage of nations 2) Determinants of national competitiveness 3) National industrial policy
What questions does firm-level theories of address?
1) Why and how do firms internationalize? 2) How can internationalizing firms gain and sustain competitive advantage?
What questions do national level theories: classical theories address?
1) Why do nations trade? 2) How can nations enhance their competitive advantage?
What are the two conditions that monopolistic argues should be present for a firm to target a foreign market over its home market?
1) returns accessible in the foreign market should be superior to those available in the home market. (provide firms with incentives to expand abroad) 2) returns achievable in the foreign market should be superior to those earned by existing domestic competitors in the foreign market. Gives firm opportunity to earn monopoly profits.
Dunning's eclectic paradigm
3 conditions: ownership specific advantages, location specific advantages, and internationalization advantages.
Factors of proportion: basis of specialization
Basis of Specialization: Labor-abundant Countries: Should specialize in producing products that involve labor-intensive production processes Capital-abundant Countries: Should specialize in producing products that involve capital-intensive production processes The total production of Goods and Services under specialization would be higher (than under the condition that both countries try to be self-sufficient in both products) Free Trade: The two countries then should engage in international trade (cross-border exchange of goods and services) Specialization and trade will make both countries economically better off (wealthier)
Factors of production
Capital: •Funds•Labor: People•Skilled personnel•Un-skilled personnel•Assets:•Plant and Equipment•Technology & Know-how:•Patents, Know-how, Designs, Processes,
What is the foundational logic for free trade?
Comparative advantage
What is comparative advantage also known as?
Country-specific advantage
*Neo-mercantilism
Explains why nations attempt to run a trade surplus-- export more goods than they import. Many people believe running a trade surplus is beneficial
What is competitive advantage also known as?
Firm-specific advantage
Who does mercantilism tend to harm?
Firms that import: raw materials and parts used in the manufacture of finished goods Consumers because restricting imports reduces choice of products they can buy
foreign direct investment
It involves movement of factors of productionacross national borders. •In internationalinvestment, it is the firm that crosses national borders
Who support neo-mercantilism?
Labor unions (protect home-country jobs) Farmers (who want to keep crop prices high) Certain manufacturers (rely heavily on exports)
Knowledge and skills
MOST IMPORTANT sources of national advantage because it helps decide where firms will locate. Most important source of long-run competitive advantage.
INherited vs created
Michael Porter uses the term "competitive advantage" more generally to refer to all of the advantages inherited by a nation as well as all of the advantages acquired over time by its firms If a country possesses abundant arable lands (Canada, U.S., or Argentina), it has an inherited competitive advantage If a country (e.g., Ireland, Singapore) is able to create a cluster of firms (i.e., a center of excellence) in a particular industry, it has acquired a competitive advantage
What are the two leading theories of national trade and investment?
National-level theories: classical theories Firm-level theories: contemporary theories
Who explains comparative advantage?
Ricardo
Comparative advantage
Superior features of a nation that provide unique benefits in global competition. Country be able to carry out a particular economic activity (specialization) more efficiently than another activity.
Why is it beneficial for two countries to trade even though one of them may have an absolute advantage in the production of all products?
The absolute cost of production doesn't matter, but the relative efficiency with which the two countries can produce the products.
Mercantilism
Trade philosophy in 16th century The belief that national prosperity is the result of a positive balance of trade, achieved by maximizing exports and minimizing imports. - variable, explanations, and wisdom that mercantilism gives us
absolute advantage
When a Country (X) can produce certain goods/services by using fewer labor input or resources than another Country (Y), then Country X has an Absolute Advantage over Country Y.
3) National industrial policy
a proactive economic development plan a government initiates to build or strengthen a particular industry, often implemented in collaboration with the private sector. Features: tax incentives, monetary and fiscal policies, educational systems, infrastructures, and legal and regulatory systems. Ex: new Zealand Perhaps the greatest contribution of Michael Porter's work has been to underscore the notion that national competitive advantage does not derive entirely from the store of natural resources (inherited endowments) that each country holds In contrast, he argues that a country can attain economic prosperity by systematically cultivating new or superior factor endowments By pursuing a proactive national industrial policy He also finds that inherited national factor endowments are relatively less important now a days than they were in the past Under the national industrial policy, countries target certain strategic industries and then aggressively develop or support these industries as part of an economic development plan (often in collaboration with the private sector) Countries that have succeeded with national industrial policy: Dubai, Ireland, Taiwan, Brazil Japan, Singapore, South Korea
Inherited:
abundant land, low-cost labor, mineral, favorable climates, natural harbor, forest lands, access to sea, navigable rivers
Internationalization theory
an explanation of the process by which firms acquire and retain one or more value-chain activities inside the firm. This minimizes the disadvantages of dealing with external partners and allows for greater control over foreign operations.
New Trade Theory:
argues that increasing returns on scale,especially economies of scale, are important for superior international performance in industries that succeed best as their production volume increases. Economies of scale of certain industries fixed cost oriented industries like shipbuilding, automotive, steel
Competitive advantage
assets or capabilities of a firm that are difficult for competitors to imitate. Derive from specific knowledge, competencies, skills, or superior strategies.
What does smith argue about free trade?
attacks the mercantilist view by suggesting that nations have much to benefit from free trade. Argued that mercantilism deprives individuals of the ability to trade freely and to benefit from voluntary exchange. By minimizing imports and maximizing exports, a country wastes much of its national resources by having to produce products it not suited to produce efficiently
Mercantilism: Beggar thy nieghbor policy
creates a zero-sum situation. The prosperity of exporting countries come at the expense of importing countries.
The competitive advantage of nations
depends on the collective competitive advantage of the nation's firms, over time, the relationship is reciprocal; the competitive advantages the nation holds tend to drive the development of new firms and industries with these same competitive advantage. At both firms and national levels, competitive advantage and technological advances grow out of innovation: develop new product designs, new production processes, new approaches to marketing and new ways of organizing or training. Firms sustain innovation (and by extension, competitive advantage) by continually finding better products, services, and ways of doing things. European, Japanese, and US rims spend half or more of their total R&D in countries other than where they are headquartered because: Gain access to talent To cut-costs by hiring lower-paid engineers and scientists abroad to replace higher-paid personnel in the home country. To relocate certain R&D activities abroad where they can gain insights on specific nights of target markets. Innovation also promotes productivity, measured as output per unit of labor or capital. Innovations lead to higher productivity (lowering cost of production )--> leading to higher national competitiveness-> exports--> higher standard of living
Why and how do firms internationalize? stages in the internationalization process of a firm
domestic focus--> pre-export stage--> experimental involvement --> active involement--> committed involvement
Factors Proportions theory
each country should export products that intensively use relatively abundant factors of production and import goods that intensively use relatively scarce factors of production. Factor abundance: availability of factors of production Products can be divided into two groups based on the proportion of factors (i.e., ratio of labor and capital) they use up in the production process: Products involving a labor-intensive production process Products involving a capital-intensive production process
Assumptions of Mercantilism
exports are good imports are bad precious metals are the key source of national wealth (or prosperity)
What is another name for factors proportion theory?
factor endowment theory
Porters nation diamond model attempts to explain determinants of nations prosperity in a range of factors
firm specific, industry specific, and home country