Chap. 2. economic rational of multinational trade & business

MKTG 26 - International Marketing

Chapter 2 – Economic Rational of Multinational

Trade and Business

PASIG CATHOLIC COLLEGE

Theory of Comparative Advantage

Modern trade take place because a foreign country is able to provide a material or product cheaper than native industry can.

The theory of comparative advantage states that even if a country is able to produce all its goods a lower costs than another country can, trade still benefits both countries, based on comparative, not absolute, cost.

Example:Theory of Comparative Advantage

COUNTRYCOUNTRY Hand Hand CalculatorCalculator

Bottles of Bottles of WineWine

United StateUnited State 66 88

ItalyItaly 3030 55

Labor Costs Per Unit ( In Hours )

Rational for Seeking Comparative Advantage Every nation seeks to increase the material

standard of living of its people; living standard increase as a function of productivity.

With greater productivity, the same amount of labor yield more goods and services.

As productivity increases, greater material wealth results.

Ex. Sweden has made a choice of longer vacations; the U.S. prefer increased material possession. Whatever the eventual choice, increased productivity affords a wider range of choice.

Relative Productivity : A Hypothetical Example

OperatingOperating 11 33

Capital cost Capital cost

AmortizationAmortization1 1 22

Total Total 22 55

World Price -World Price -InIn

Labor hr Labor hr Equv.Equv.

5.05.0 5.55.5

IncomeIncome

( per labor ( per labor hr) hr)

2.52.5 1.11.1

Labor Hours per BarrelCountry A Country B

Business Specialization and Trade

The economic law of comparative advantage states that every nation benefits when specialization and trade take place. Even when one nation cannot produce goods more efficiently than another can, it is still in the economic interest of both nation for each to specialize.

Business Specialization and TradeRegardless of its productivity relative

to other suppliers, every nation has comparative advantages in producing certain goods rather than others.

The specialization and the advantage are achieved on the basis on one or more factors.

1. Natural resources 4. Managerial know-how 2. Technology 5. Labor 3. Capital

Product Life Cycle and International Trade

The product life cycle model states that products go through the following four stages.

Phase I U.S. export strength builds Phase II Foreign production starts Phase III Foreign production becomes competitive in export markets. Phase IV Import competition begins in domestic U.S. markets

International TheoryThe international theory assumes

that the firm has a global horizon, and it recognize that the enterprise needs a competitive advantage or a unique asset to expand.

Underlying thesis of internalization is the firm’s desire to extend its own direct operation rather than use external markets.

International TheoryThe internalization approach rests

on two general axioms:(a) firms choose the least-cost

location for each activity they perform.

(b) firms grow by internalizing markets up to the point where the benefits of further internalization are outweighed by the costs.

International TheoryThe internalization theory provides an economic

rationale for the existence of MNC’s. The sourcing decision rests on the cost and benefits to the firm, taking into consideration industry-specific factors(e.g. nature of the product), region-specific factors(e.g. geographic location), nation-specific factors (e.g. political climate), and firm-specific factors(e.g. managerial ability to internalize).

The internationalization theory primarily focuses on the motives and decision processes within the multinational firm but pay little attention to the host country policies and other external factors that may affect internalization cost/benefits.

Trade Barriers and Trade Liberation

Government impose all sorts of barriers to restrict trade and business across national boundaries. But there are reasons for trade barriers and for the effort that have been made internationally to liberate trade.

These are the two types of trade barriers: 1. Tariff 2. Non-tariff

Tariff BarriersTo all nations except those that have tariff

treaties with particular country. A tariff may be worked out on the basis of a tax permit, called specific duty, or as a percentage of Tariff refer to taxes levied on goods moved between nations. The most important of these is the tax usually called the custom duty that is levied by the importing nation. But tax may also be imposed by the exporting nation, and that is called an export tax.

Different nations handle tariff barriers differently.1. A country may have a single tariff system for all

goods from all sources. This is called a unlinear or single-column tariff.

2. The general-conventional tariff implies f the value of the item, which is referred to as advalorem tax.

Nontariff Barriers

Nontariff barriers include quotas, import equalization taxes, road taxes, laws giving preferential treatment to domestic suppliers, administration of antidumping measures, exchange controls, and a variety of ‘invisibe” tariffs that impede trade.

The Principal Nontariff barriers in the following categories

Specific limitation on tradeCustoms and administrative entry

procedures.StandardsGovernment participation in tradeCharges on importsothers categories like voluntary export

restraints and ordinary marketing agreements.

Tariff Reduction ProgramsInternationally, systematic tariff reduction

program started after world war II. In 1947, the U.S. and 22 other major trading countries got together in Geneva to find ways to reduce tariffs and remove trade barriers.

The General Agreement on Tariffs and Trade (GATT) resulted. Since then, eight major efforts to reduce trade barriers have been undertaken under GATT’s auspices.

Dimension of Agreement Under GATT

Major Agreement Number ofContractingParties

Value of worldTrade involved

Percent ofaverage tariffreduction

1947 Geneva 23 $ 10.0 n.a.

1949 Annecy, France

33 n.a. n.a.

1951 Torquay, England

37 n.a. n.a.

1956 Geneva 35 2.5 4

1962 Geneva(Dillon Round)

40 4.9 7

1967 Geneva( Kennedy Round)

70 40.0 35

Multilateral Trade OrganizationThe agreement creates a World

Trading Organization (WTO) to replace the GATT secretariat, but details of the new organization’s powers remain unclear.

The WTO would, however,, have more authority to oversee trade in services and agriculture than GATT now does.

U.S. Trade LiberalizationLiberalization of U.S. foreign trade began

with enactment of the Reciprocal Trade Agreement Act of 1934. With the act, Congress authorized the president to reduce then-existing tariff duties by 50 percent.

A noteworthy aspect of the act was the inclusion of the most-favored-nation clause, which limited discrimination in trade by extending to third parties the same terms provided to contracting parties.

MNC’s and World MarketsMultinational corporations (MNC’s) are

among the most, if not the most, influential factors in global economic life today. Within the last 30 years they have become the most formidable single factor in world trade and investment.

MNC’s play a decisive role in the allocation and use of the world resources. They conceive new products and services, create and stimulate demand for them, and develop new modes of manufacture and distribution.

SummaryWe have examined the rationale for world trade and

business activity. The classic explanation of world trade is provided by the theory of comparative advantage.

When one country has an advantage over another, not only in the production of one product but all products, and its advantage in the production of the one product is greater than its advantage in the production of their other products, country, according to the theory, has a comparative advantage, each country should figure out which product have a comparative advantage and concentrate its productive efforts on those other products should be imported in exchange.