1 International Trade and Investment Theory. 2 OBJECTIVES Understand the motivation for international tradeUnderstand the motivation for international.

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InternatioInternational Trade nal Trade and and InvestmenInvestment Theoryt Theory

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OBJECTIVESOBJECTIVES

• Understand the motivation for Understand the motivation for international tradeinternational trade

• Summarize and discuss the differences Summarize and discuss the differences among the classical country-based among the classical country-based theories of international tradetheories of international trade

• Use the modern firm-based theories of Use the modern firm-based theories of international trade to describe global international trade to describe global strategies adopted by businessesstrategies adopted by businesses

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OBJECTIVES OBJECTIVES CONTINUEDCONTINUED

• Describe and categorize the Describe and categorize the different forms of international different forms of international investmentinvestment

• Explain the reasons for foreign Explain the reasons for foreign direct investmentdirect investment

• Summarize how supply, demand, Summarize how supply, demand, and political factors influence and political factors influence foreign direct investmentforeign direct investment

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International TradeInternational Trade

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

• International trade: trade International trade: trade between residents of two between residents of two countriescountries

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Sources of the World’s Sources of the World’s Merchandise Exports, 2001Merchandise Exports, 2001

37%

12%7%

4%

40%

European UnionUnited StatesJapanCanadaOther countries

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The largest The largest component of component of

the annual the annual $1.5 trillion $1.5 trillion

trade in trade in international international services is services is travel and travel and tourismtourism

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Classical Country-Based Classical Country-Based Trade TheoriesTrade Theories

• MercantilismMercantilism• Absolute AdvantageAbsolute Advantage• Comparative AdvantageComparative Advantage• Comparative Advantage with Comparative Advantage with

MoneyMoney• Relative Factor EndowmentsRelative Factor Endowments

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MercantilismMercantilism

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

• A country’s goal should be to A country’s goal should be to enlarge holdings of gold and enlarge holdings of gold and silver by silver by – Promoting exportsPromoting exports– Discouraging importsDiscouraging imports

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Modern Mercantilism Modern Mercantilism

• Neomercantilists or Neomercantilists or protectionistsprotectionists– American Federation of Labor-American Federation of Labor-

Congress of Industrial Congress of Industrial OrganizationsOrganizations

– Textile manufacturersTextile manufacturers– Steel companiesSteel companies– Sugar growersSugar growers– Peanut farmersPeanut farmers

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Disadvantages of Disadvantages of MercantilismMercantilism

• Confuses the acquisition of treasure Confuses the acquisition of treasure with the acquisition of wealthwith the acquisition of wealth

• Weakens the country because it robs Weakens the country because it robs individuals of the ability individuals of the ability – To trade freelyTo trade freely– To benefit from voluntary exchangesTo benefit from voluntary exchanges

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

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Absolute AdvantageAbsolute Advantage

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

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

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Table 6.1 The Theory of Table 6.1 The Theory of Absolute Advantage: An Absolute Advantage: An

ExampleExample

WineWine 22 11

Clock Clock radiosradios

33 55

France JapanOUTPUT PER HOUR OF LABOR

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Absolute Advantage’s Absolute Advantage’s FlawFlaw

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

• No trade would occurNo trade would occur

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Comparative AdvantageComparative Advantage

• Produce and export those goods Produce and export those goods and services for which it is and services for which it is relativelyrelatively more productive than more productive than other countriesother countries

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

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Differences between Differences between Comparative and Absolute Comparative and Absolute

AdvantageAdvantage• AbsoluteAbsolute versus versus relativerelative

productivity differencesproductivity differences• Comparative advantage Comparative advantage

incorporates the concept of incorporates the concept of opportunity costopportunity cost– Value of what is given up to get Value of what is given up to get

the goodthe good

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The Theory of Comparative The Theory of Comparative Advantage: An ExampleAdvantage: An Example

WineWine 44 11

Clock Clock radiosradios

66 55

France JapanOUTPUT PER HOUR OF LABOR

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Comparative Comparative Advantage with MoneyAdvantage with Money

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

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

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

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The Theory of The Theory of Comparative Advantage Comparative Advantage

with Money: with Money: An ExampleAn Example

French French MadeMade

Japanese Japanese MadeMade

French French MadeMade

Japanese Japanese MadeMade

WineWine €€33 €€88 ¥375¥375 ¥1,000¥1,000

Clock Clock RadiosRadios

€€33 €€1.61.6 ¥250¥250 ¥200¥200

Cost of Goods in France Cost of Goods in Japan

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Relative Factor Relative Factor EndowmentsEndowments

• Heckscher-Ohlin TheoryHeckscher-Ohlin Theory• What determines the products What determines the products

for which a country will have a for which a country will have a comparative advantage?comparative advantage?– Factor endowments vary among Factor endowments vary among

countriescountries– Goods differ according to the types Goods differ according to the types

of factors that are used to produce of factors that are used to produce themthem

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Relative Factor Relative Factor EndowmentsEndowments

• A country will have a comparative A country will have a comparative advantage in producing products advantage in producing products that intensively use resources that intensively use resources (factors of production) it has in (factors of production) it has in abundanceabundance– China: laborChina: labor– Saudi Arabia: oilSaudi Arabia: oil– Argentina: wheatArgentina: wheat

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U.S. Imports and Exports, U.S. Imports and Exports, 1947: 1947:

The Leontief ParadoxThe Leontief Paradox

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Modern Firm-Based Modern Firm-Based Trade TheoriesTrade Theories

• Country Similarity TheoryCountry Similarity Theory• Product Life Cycle TheoryProduct Life Cycle Theory• Global Strategic Rivalry TheoryGlobal Strategic Rivalry Theory• Porter’s National Competitive Porter’s National Competitive

AdvantageAdvantage

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Growth of Firm-Based Growth of Firm-Based TheoriesTheories

• Growing importance of MNCs Growing importance of MNCs • Inability of the country-based Inability of the country-based

theories to explain and predict theories to explain and predict the existence and growth of the existence and growth of intraindustry tradeintraindustry trade

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

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Firm-Based Trade Firm-Based Trade TheoriesTheories

• Incorporate additional factors into Incorporate additional factors into explanations of trade flowsexplanations of trade flows– QualityQuality– TechnologyTechnology– Brand namesBrand names– Customer qualityCustomer quality

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Country Similarity Country Similarity TheoryTheory

• Explains the phenomenon of Explains the phenomenon of intraindustry tradeintraindustry trade– Trade between two countries of goods Trade between two countries of goods

produced by the same industryproduced by the same industry• Japan exports Toyotas to GermanyJapan exports Toyotas to Germany• Germany exports BMWs to JapanGermany exports BMWs to Japan

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Country Similarity TheoryCountry Similarity Theory

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

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

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Product Life Cycle TheoryProduct Life Cycle Theory

• Describes the evolution of Describes the evolution of marketing strategiesmarketing strategies

• StagesStages– New productNew product– Maturing productMaturing product– Standardized productStandardized product

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The International Product Life The International Product Life Cycle: Innovating Firm’s Cycle: Innovating Firm’s

CountryCountry

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The International Product The International Product Life Cycle: Other Life Cycle: Other

Industrialized CountriesIndustrialized Countries

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Figure 6.4 The International Figure 6.4 The International Product Life Cycle: Less Product Life Cycle: Less

Developed CountriesDeveloped Countries

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Global Strategic Rivalry Global Strategic Rivalry TheoryTheory

• Firms struggle to develop Firms struggle to develop sustainable competitive sustainable competitive advantageadvantage

• Advantage provides ability to Advantage provides ability to dominate global marketplacedominate global marketplace

• Focus: strategic decisions firms Focus: strategic decisions firms use to compete internationallyuse to compete internationally

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Sustaining Sustaining Competitive Competitive AdvantageAdvantage• Owning intellectual property Owning intellectual property

rightsrights• Investing in research and Investing in research and

developmentdevelopment• Achieving economies of scale or Achieving economies of scale or

scopescope• Exploiting the experience curveExploiting the experience curve

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Porter’s National Porter’s National Competitive AdvantageCompetitive Advantage

• Success in trade comes from the Success in trade comes from the interaction of four country and interaction of four country and firm specific elementsfirm specific elements– Factor conditionsFactor conditions– Demand conditionsDemand conditions– Related and supporting industriesRelated and supporting industries– Firm strategy, structure, and rivalryFirm strategy, structure, and rivalry

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Porter’s Diamond of Porter’s Diamond of National Competitive National Competitive

AdvantageAdvantage

Firm Strategy, Structure,

and Rivalry

Related and SupportingIndustries

FactorConditions

DemandConditions

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The intense The intense competitivecompetitive

ness ness of Japanese of Japanese

market market forces forces

manufacturmanufacturers to ers to

continually continually develop and develop and

fine-tune fine-tune new new

productsproducts

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Theories of Theories of International TradeInternational Trade

Country-Based TheoriesCountry-Based Theories• Country is unit of analysisCountry is unit of analysis• Emerged prior to WWIIEmerged prior to WWII• Developed by economistsDeveloped by economists• Explain interindustry Explain interindustry

tradetrade• IncludeInclude

– MercantilismMercantilism– Absolute advantageAbsolute advantage– Comparative Comparative

advantageadvantage– Relative factor Relative factor

endowmentsendowments

Firm-Based TheoriesFirm-Based Theories• Firm is unit of analysisFirm is unit of analysis• Emerged after WWIIEmerged after WWII• Developed by business Developed by business

school professorsschool professors• Explain intraindustry tradeExplain intraindustry trade• IncludeInclude

– Country similarity Country similarity theorytheory

– Product life cycleProduct life cycle– Global strategic rivalryGlobal strategic rivalry– National competitive National competitive

advantageadvantage

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Types of Types of International International InvestmentsInvestments• Does the investor seek an Does the investor seek an

active management role in the active management role in the firm r merely a return from a firm r merely a return from a passive investment?passive investment?– Foreign Direct InvestmentForeign Direct Investment– Portfolio InvestmentPortfolio Investment

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Stock of Foreign Direct Stock of Foreign Direct Investment, by recipientInvestment, by recipient

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Sources of FDI for the Sources of FDI for the U.S., U.S.,

end of 2002end of 2002United KingdomUnited Kingdom 283.3283.3

FranceFrance 170.6170.6

NetherlandsNetherlands 154.8154.8

JapanJapan 152.152.

GermanyGermany 137.0137.0

SwitzerlandSwitzerland 113.2113.2

CanadaCanada 92.092.0

LuxembourgLuxembourg 34.334.3

Bermuda, Bahamas, Caribbean islandsBermuda, Bahamas, Caribbean islands 32.532.5

Other European countriesOther European countries 113.3113.3

All other countriesAll other countries 65.065.0

TotalTotal 1,348.01,348.0

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Destinations of FDI for the Destinations of FDI for the U.S., end of 2002U.S., end of 2002

United KingdomUnited Kingdom 255.4255.4

CanadaCanada 152.5152.5

NetherlandsNetherlands 145.5145.5

Bermuda, Bahamas, Caribbean islandsBermuda, Bahamas, Caribbean islands 98.198.1

SwitzerlandSwitzerland 70.170.1

JapanJapan 65.765.7

GermanyGermany 64.764.7

MexicoMexico 58.158.1

FranceFrance 44.044.0

Other European countriesOther European countries 217.2217.2

All other countriesAll other countries 349.7349.7

TotalTotal 1,521.01,521.0

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International International Investment TheoriesInvestment Theories

• Ownership AdvantagesOwnership Advantages• InternalizationInternalization• Dunning’s Eclectic TheoryDunning’s Eclectic Theory

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Ownership AdvantagesOwnership Advantages

• A firm owning a valuable A firm owning a valuable asset that creates a asset that creates a competitive advantage competitive advantage domestically can use that domestically can use that advantage to penetrate advantage to penetrate foreign markets through FDIforeign markets through FDI

• Why FDI and not other Why FDI and not other methods?methods?

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Internalization TheoryInternalization Theory

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

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

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Dunning’s Eclectic Dunning’s Eclectic TheoryTheory

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

• 3 conditions for FDI3 conditions for FDI– Ownership advantageOwnership advantage– Location advantageLocation advantage– Internalization advantageInternalization advantage

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Factors Affecting Factors Affecting the FDI Decisionthe FDI Decision

Supply FactorsSupply Factors Demand FactorsDemand Factors Political FactorsPolitical Factors

Production costsProduction costs Customer accessCustomer access Avoidance of trade Avoidance of trade barriersbarriers

LogisticsLogistics Marketing Marketing advantagesadvantages

Economic Economic development development incentivesincentives

Resource Resource availabilityavailability

Exploitation of Exploitation of competitive competitive advantagesadvantages

Access to Access to technologytechnology

Customer mobilityCustomer mobility

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Ikea Ikea aggressiveaggressively exports ly exports

its its furniture furniture to other to other

countriescountries