Overview of Global Theory and Practice

8/6/2019 Overview of Global Theory and Practice

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Chapter 1Chapter 1

OVERVIEW OF GLOBAL THEORYOVERVIEW OF GLOBAL THEORY

AND PRACTICEAND PRACTICE


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Chapter OutlineChapter Outline

Meaning and nature international businessMeaning and nature international business

environmentenvironment Distinctions between internal and internationalDistinctions between internal and international

businessbusiness Advantages and disadvantages of internationalAdvantages and disadvantages of international

trade/businesstrade/business Theories in international tradeTheories in international trade

MercantilismMercantilism Theory of absolute cost advantageTheory of absolute cost advantage Comparative cost advantageComparative cost advantage Heckscher Ohlin theoryHeckscher Ohlin theory

International investmentInternational investment

Global forces effecting international tradeGlobal forces effecting international trade


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What is business and businessWhat is business and business

environment?environment?

Business is a wide term andBusiness is a wide term and signifies allsignifies all

economic activities carried on with theeconomic activities carried on with the

objective of earning money/profit/gainobjective of earning money/profit/gain..

Economic activities involveEconomic activities involve production,production,exchange, distribution and consumption ofexchange, distribution and consumption of

goods and services.goods and services.

In short, the definition of aIn short, the definition of a business as abusiness as acommercial activity to make a profit of ancommercial activity to make a profit of an

organisation (private or public).organisation (private or public).


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Important decisions related to business

such as What business to do, where to

do the business, when to do thebusiness, how to do the business,

whether to expand a business and if

where and how to expand it areinfluenced by a number of factors.

In a broad sense, business environment

refers to all those internal and externalfactors that have a bearing on the

business.


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DefinitionsDefinitions B.O. WheelerB.O. Wheeler Business is an institution Business is an institution

organised and operated to provide goodsorganised and operated to provide goodsand services to society under the incentive ofand services to society under the incentive ofprivate gain.private gain.

The Income Tax Act 1961The Income Tax Act 1961 Business Businessmeans any trade, commerce or manufacturemeans any trade, commerce or manufactureor any adventure in the nature of trade,or any adventure in the nature of trade,commerce or manufacturing.commerce or manufacturing.

The above definition emphasis that businessThe above definition emphasis that businessis a wide term and includes all types ofis a wide term and includes all types ofeconomic activities carried on with aeconomic activities carried on with a

profit motive.profit motive.


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TransformationProcess

Management

External Environment

Input Output

Chart: 1.1 Input and output model


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The success and failure of a businessdepends on various factors like physical

resources, financial resources,technological, human resources, skillsand organisation.

Thus, success and survival of a firm,depend on two sets of factors internalfactors and external factors.

The business environment consists of anumber of factors which have differenttypes and degrees of influence on thebusiness.


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Some factors have a favourable impact on

the business, some of the them are

adversely affected and some are neutral. For example New Economic Policy

Liberalisation, Privatisation &

Globalisation generate employmentopportunities, new technology, increases in

income, importing raw-material etc.

Keith DavisKeith Davis business environment as the business environment as theaggregate of all condition, events &aggregate of all condition, events &

influences that surround and influence it.influences that surround and influence it.


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Business Environment

Internal Environment External Environment

Micro ExternalEnvironment

Macro ExternalEnvironment

Chart: 1.1 Classification of Business Environment


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Internal factorsInternal factors are generally regarded as

controllable factors because the company has because the company has

control over these factors it can alter or modifycontrol over these factors it can alter or modify

such factors as its such factors as its personnel, physical personnel, physical

facilities, organisation and functionalfacilities, organisation and functional..

External factorsExternal factors by and large, beyond theby and large, beyond the

control of a companycontrol ofa company. The external factors such. The external factors such

asas economic factors, socio-cultural factors,economic factors, socio-cultural factors,

government and legal factors, demographic government and legal factors, demographic

factors, physical factorsfactors, physical factors etc.etc.


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Internal Environment Internal environmental factors are -

controllable factors because the firm canchange or modify these factors to improve itsefficiency.

Internal environment includes such factors as

Value system, Mission and objectives of the firm,

Management structure,

Quality of its human resources, Corporate culture

Physical assets,


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BusinessOrganisation

Corporate

Culture

Value

System

Mission &Objectives

PhysicalResources

OrganisationStructure

HumanResource

Chart 1. 2 Internal Environment


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1. Value System The value system of a business organisation

also determines its behaviour towards itsemployees, customers and society at large. The value system of the promoters of a business

firm has an important bearing on the choice ofbusiness and the adoption of business policiesand practices.

Value system makes an important contribution toits success and its prestige in the world ofbusiness.

Infosys Technologies which won the firstnational corporate governance award in 1999attributes its success to its high valuesystem.


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2. Mission and Objectives

The objective of all firms is assumed to be

maximisation of long run profits. Butmission is different from this narrowobjective of profit maximisation.

Mission is defined as the overall purposewhich guides and influences its businessdecision and economic activities.

For example, to become a world class

company and to achieve global dominancehas been the mission of Reliance Industriesof India.


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3. Organisation Structure

Organisation structure is the composition of

board of directors, the number of independentdirectors, the extent of professional

management and share holdingpattern.

The nature of organisational structure has asignificant influence over decision making

process in an orgnisation.

An efficient working of a business organisation

requires that its organisation structure should beconducive to quick decision making.

Board of directors is the highest decision

making body in a business organisation.


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4.Corporate culture & Style of Functioning oftop Management

Corporate culture & Style of Functioning of topmanagers is important factor for determing theinternal environment of a company.

Corporate culture is generally considered as

either closed and threatrening or open andparticipatory.

In a closed and thretening type of corportateculture the business decision are taken by top

level managers, While middle level and lower level managers

have no say in business decision making.


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5.Quality of Human Resources Quality of employees of a firm is an important

factor of internal environment of a firm. The success of a business organisation

depends to a great extent on the skills,capabilities, attitudes and commitment of itsemployees.

Employees differ with regard to thesecharacteristics.

It is difficult for the top management to dealdirectly with all the employees of the businessfirm.

Therefore, for efficient management of humanresources, employees are divided intodifferent groups.


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6. Labour Unions Labour unions are other factor determining internal

environment of a firm.

Unions collectively bargain with top managers regardingwages, working conditions of different categories ofemployees.

Smooth working of a business organisation requires that

there should be good relations between management andlabour union.

7. Physical Resources and Technological Capabilities Physical resources such as plant and equipment and

technological capabilities of a firm determine its competitivestrength which is an important factor determining itsefficiency and unit cost of production

R & D capabilities of a company determine its ability tointroduce innovations which enhance productivity of

workers.


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External Environment External environment are by, and large, beyond

the control of a company. External environment consists of those factors

that affect a business enterprise from outside.

External environment is generally classified

into micro environment and macroenvironment.

External Micro environment includes Suppliers of Inputs, customers, competitors

market Intermediaries and publics. External Macro Environment are classified

into Economic, social, technological,political and legal and demographic


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11.. External Micro EnvironmentExternal Micro Environment

External micro environment orExternal micro environment or task environmenttask environment

refers to thoserefers to those individuals, groups and agenciesindividuals, groups and agencieswith which the organisations comes into direct andwith which the organisations comes into direct and

frequent contact in the course of its functioning.frequent contact in the course of its functioning.

Micro environmental factors exercise a directMicro environmental factors exercise a direct

influence on the operations of the enterpriseinfluence on the operations of the enterprise.. Therefore, it is also known as direct actionTherefore, it is also known as direct action

environment or stakeholders.environment or stakeholders.

For examples -For examples - customers, competitors,customers, competitors,suppliers, marketing intermediaries, financierssuppliers, marketing intermediaries, financiers

and publicsand publics


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Management

Suppliers ofInputs

Custo

mers

Publics

Marketingintermediaries

Finan

ciers

Competitors

Chart: 1. 3: External Micro Environment


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1. Suppliers of inputs1. Suppliers of inputs

An important factor in the external microAn important factor in the external micro

environment of a firm is the suppliers of its inputsenvironment of a firm is the suppliers of its inputssuch as raw-materials and components.such as raw-materials and components.

A smooth and effective working of a businessA smooth and effective working of a business

firm requires supply of inputs such as raw-firm requires supply of inputs such as raw-

materials and power etc.materials and power etc.

Energy input is an important input in theEnergy input is an important input in the

manufacturing business.manufacturing business.

If supply of raw materials are uncertain, then aIf supply of raw materials are uncertain, then afirm will have to keep a large stock of rawfirm will have to keep a large stock of raw

material to continue its transformation processmaterial to continue its transformation process

uninterrupted.uninterrupted.


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2.2.CustomersCustomers The primary task of any business is to create andThe primary task of any business is to create and

sustain customers.sustain customers.

Without customers business is unthinkableWithout customers business is unthinkable.. The success of business depends upon how best itThe success of business depends upon how best it

monitors the sensitivity of customers.monitors the sensitivity of customers.

3. Competitors3. Competitors

Business firms compete with each other not only forBusiness firms compete with each other not only forsale of their product but also in other areas.sale of their product but also in other areas.

Generally, market forms ofGenerally, market forms of monopolisticmonopolisticcompetition & differentiated oligopoliescompetition & differentiated oligopolies exist inexist in

the real work.the real work. This competition may be on the best of pricing ofThis competition may be on the best of pricing oftheir products.their products.

Non- price competition Non- price competition advertisement & salesadvertisement & salespromotionspromotions


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In USA, American firms faced a lot ofIn USA, American firms faced a lot ofcompetition from Japanesecompetition from Japanese firms producingfirms producing

electronic and automobiles goods.electronic and automobiles goods. Similarly, theSimilarly, the Indian firms are facing a lot ofIndian firms are facing a lot ofcompetition from Chinese productscompetition from Chinese products..

4. Marketing intermediaries4. Marketing intermediaries

Marketing intermediaries play an essential role ofMarketing intermediaries play an essential role ofselling and distributing its product to the finalselling and distributing its product to the finalbuyers.buyers.

Marketing intermediaries includesMarketing intermediaries includes agents andagents andmerchants such as distribution firms,merchants such as distribution firms,wholesalers, retailers.wholesalers, retailers.

Marketing intermediaries are responsible forMarketing intermediaries are responsible forstocking and transporting goods from theirstocking and transporting goods from their

production ultimate buyersproduction ultimate buyers..


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External Macro environmentExternal Macro environment Macro environment refers to theMacro environment refers to the generalgeneral

environmentenvironmentor remote environment within whichor remote environment within which

a business firm and forces in its microa business firm and forces in its microenvironment operate.environment operate.

The external macro environment determines theThe external macro environment determines theopportunities for a firm to exploit for promoting itsopportunities for a firm to exploit for promoting its

businessbusiness The macro environment has both positive andThe macro environment has both positive and

negative aspects.negative aspects. An important fact that macro environmental An important fact that macro environmental

forces is the uncontrollable by theforces is the uncontrollable by themanagement of a firmmanagement of a firm.. Because of the uncontrollable nature of macroBecause of the uncontrollable nature of macro

forces a firm has to adjust or adapt itself to theseforces a firm has to adjust or adapt itself to theseexternal forces.external forces.


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BusinessOrganisation

EconomicEnvironment

Social & culturalEnvironment

Political & LegalEnvironment

NaturalEnvironment

DemographicEnvironment

TechnologicalEnvironment

Chart 1. 2 External Macro Environment


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Classification of Macro environment -Classification of Macro environment -

1.1. Economic environmentEconomic environment

2.2. Social and cultural environmentSocial and cultural environment

3.3. Political and Legal EnvironmentPolitical and Legal Environment4.4. Technological EnvironmentTechnological Environment

5.5. Demographic EnvironmentDemographic Environment

6.6. Natural EnvironmentNatural Environment


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1. Economic Environment1. Economic Environment

Economic environment includes the type ofEconomic environment includes the type of

economic systemeconomic system that exists in thethat exists in theeconomy and nature and structure economy and nature and structure capital, social & mixed economy.capital, social & mixed economy.

TheThe phases of business cyclephases of business cycle boom or boom orrecission.recission.

TheThe fiscal, monetary and financialfiscal, monetary and financialpoliciespolicies of the government.of the government.

These economic policies of the govtThese economic policies of the govtpresent both thepresent both the opportunitiesopportunities as well asas well asthethe threatsthreats for the business firms.for the business firms.


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Industrial Policy 1948, 1956, 1980, 1990Industrial Policy 1948, 1956, 1980, 1990

& 1991.& 1991. Foreign Exchange Regulation Act (FERA).Foreign Exchange Regulation Act (FERA).

Monopolistic & Restrictive Trade PolicyMonopolistic & Restrictive Trade Policy

(MRTP)(MRTP) Structural Adjustment Programme (SAPs)Structural Adjustment Programme (SAPs)

New Economic Policy 1991 New Economic Policy 1991

Liberalisation, Privatisation andLiberalisation, Privatisation andGlobalisation (LPG).Globalisation (LPG).


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2. Social and Cultural Environment2. Social and Cultural Environment The buying and consumption habits of the people,The buying and consumption habits of the people,

their language, belief & values customs &their language, belief & values customs &

traditions, tastes and preference, education etc.traditions, tastes and preference, education etc. The socio-cultural fabric is an important environmentalThe socio-cultural fabric is an important environmental

factor that should be analyzed while formulatingfactor that should be analyzed while formulatingbusiness strategies.business strategies.

For a business to be successful, its strategy should beFor a business to be successful, its strategy should bethe one that is appropriate in the socio-culturalthe one that is appropriate in the socio-culturalenvironment.environment.

Good corporate governance should be judged notGood corporate governance should be judged not

only by the productivity and profits earned by aonly by the productivity and profits earned by abusiness firm but also by its social welfarebusiness firm but also by its social welfare

promoting activities.promoting activities.


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3. Political and Legal Environment Business are closely related to the govt.

The political philosophy of the govt wields agreat influence over business policies.

The industrial policies 1948, 1956, 1980,

1990 & 1991. Foreign Exchange Regulation Act

(FERA)

Monopolistic & Restrictive Practices(MRTP) Act

Structural Adjustment Programmes(SAPs) 1991.


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4.4.Technological EnvironmentTechnological Environment The nature of technology used for productionThe nature of technology used for production

of goods & services is an important factorof goods & services is an important factorresponsible for the success of a business firmresponsible for the success of a business firm..

Technology consists of the type of machinesTechnology consists of the type of machinesand processes available for use by a firm andand processes available for use by a firm andthe way of doing things.the way of doing things.

The improvement in technologyThe improvement in technology raises total factorraises total factor productivity of a firm and reduces of cost of productivity of a firm and reduces of cost ofoutputoutput..

The use of a superior technology by a firm for itsThe use of a superior technology by a firm for itstransformation process determining its competitivetransformation process determining its competitivestrength.strength.


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5. Demographic Environment

Demographic environment includes the size

of growth of population, life expectancyat birth, rural and urban distribution of

population etc.

All these demographic features have animportant bearing on the functioning of

business firms.

The demographic environment affectsboth the supply and demand sides of

business organisations.


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6.6.Natural environmentNatural environment Natural environment is theNatural environment is the ultimate sources ofultimate sources of

many inputs such as raw-materials, energymany inputs such as raw-materials, energywhich business firms use in their productivewhich business firms use in their productive

activityactivity..

The availability of natural resources in a region isThe availability of natural resources in a region is

a basic factor in determining business activity.a basic factor in determining business activity.

Natural environment which includesNatural environment which includes

geographical as well as ecological factorsgeographical as well as ecological factors

minerals, oil resources, forest resourcesminerals, oil resources, forest resources.. Fore example, the availability of minerals such asFore example, the availability of minerals such as

iron, coal etc in a region influence the location ofiron, coal etc in a region influence the location of

certain industries in that region.certain industries in that region.


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Global Business EnvironmentGlobal Business Environment The global environment refers to those globalThe global environment refers to those global

factors which are relevant to business such asfactors which are relevant to business such asWTO principle & agreements, otherWTO principle & agreements, otherinternational conventions treaties, agreementinternational conventions treaties, agreementdeclaration & protocols etc.declaration & protocols etc.

Economic conditionsEconomic conditions in other countries mayin other countries mayaffect the business.affect the business.

International political factorsInternational political factors war, political war, politicaltension or uncertainties.tension or uncertainties.

Developments in information &Developments in information &communication technologiescommunication technologies..

Certain developments such as aCertain developments such as a hike in thehike in thecrude oil price have global impact.crude oil price have global impact.


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Modern business is very much influencedModern business is very much influencedby global or international environment.by global or international environment.

The increasing importance ofThe increasing importance ofliberalization, privatization &liberalization, privatization &globalization (LPG)globalization (LPG) has significant bearinghas significant bearingon business activities.on business activities.

The establishment of GATT & later WTOThe establishment of GATT & later WTOhas profound impact on global businesshas profound impact on global businessenvironment.environment.

The trade liberalization has offered manyThe trade liberalization has offered manyopportunities for business firms.opportunities for business firms.

If the firm will have to beIf the firm will have to be efficient &efficient &

dynamicdynamicto survive the global competition.to survive the global competition.


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International Business Environment

Internal Environment External Environment

External MicroEnvironment

External MacroEnvironment

Value System

Mission &

Objectives

Corporate culture

Organisational structure

Human Resource

Physical Resources

Share holders

Creditors

Bankers & FIs

Competitors

Suppliers

Market Intermediaries

Customers

Social &

cultural

Technological

EconomicPolitical

International

Natural


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Evolution of international Business

The origin of international business goes back

to human civilization. The concept of international business is a

broader concept relating to the integration of

economies and societies.

The first phases of globalization begin around1870 and ended with first world war 1919.

This results by the industrial revolution in the UK,

Germany & the USA. The colonial empires importing raw-material

and exporting finished goods at higher prices.


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Later stage, various govts initiated and imposed a

number of barriers to trade to protect their

domestic production that led to decline in traderatio.

1913 22,1%

1930 9.1%

That leads severe set back to advanced countries. In addition to breakdown of the gold standard

resulted severe set back on international trade.

Therefore, world nations felt the need forinternational co-operation in global trade and

BOP affairs.


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These efforts resulted in the establishment

of the IMF & IBRD

After the second world war most of thecountries adopted protection policy to

protect themselves.

After Geneva Conference GATT hascame to picture in 1947.

After concluded the Uruguay round WTO

came into establish in 1995.


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Drivers of Globalization

Various economies including the former

communist and socialist countries openedtheir economy with rest of the globe.

The shifts in globalization and international

business have been encourage to fast growth

after 1990s.

The external factors have been contributing

significantly for the remarkable strides in

global business. Globalisation influences on various aspects.


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G

LOBA

LISATION

Establishment of WTO

Regional Integration

Decline in Trade Barriers

Decline in Investment Barriers

Increase in FDI

Changes inTechnology

Growth of MNCs


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1. Establishment of World TradeOrganisation

General Agreement on Trade and Tariff (GATT)concluded in the Uruguay round 15th

December, 1994.

Marrakesh Declaration 15th

April 1994strengthen world trade through investment,

employment and income growth.

On 1st January 1995 WTO was established.

The value of exports increased by 245% andimport increased by 1014% after establishment

of WTO during 1995 & 2006.


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2. Regional Integration Integration has developed as an alternative to

the policy of free trade.

It is an arrangement in which certain countrieshaving common economic interest and

political system decide to reduce or removetariff and other trade barriers amongthemselves.

The two essential features are free tradeamong the member countries and imposition of

a common external tariff policy on non-members.

The significant regional integrations includes European Union, NAFTA, ASEAN, SAARC,

EFTA, APEC, MERCOSUR & ANDEAN.


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1. EU European Union 1952 West Germany,France, Italy, Belgium, Netherlands & luxembourg.

2. NAFTA North American Free Trade Agreement -1989 - USA, Canada & Mexico.3. ASEAN The Association of South-east Asian

Nations 1967 Singapore, Brunei, Malaysia,Philippines, Thailand & Indonesia.

4. SAARC South Asian Association for RegionalCo-operation 1985 Indian, Bangladesh, Bhutan,Pakistan, Maldives, Nepal & Srilanka.


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5.EFTA The European Free Trade Association 1960 Austria, Norway, Portugal, Sweden, &

Switzerland.6. APEC Asia-Pacific Economic Co-operation

1989 21 members Canada, Chile, China,

China Republic, Hong Kong, Indonesia, Japan,

Republic Korea, Malaysia, Mexico, New

Zealand & Peru.

7. MERCOSUR 1991 Argentina, Brazil,

Paraguay, Uruguay, Chile & Bolivia.8. ANDEAN 1993 Bolivia, Colombia, Ecuador,

Peru & Venezuela


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3. Declining Trade Barriers Another significant drivers of globalization is the

declining trade barriers. Govts used to impose trade barriers like quotas

and tariffs in order to protect domestic businessfrom the external business.

Advanced countries after World War II agreedto reduce tariffs in order to encourage freeflow of goods.

GATT in various rounds of negotiations

agreed to reduce the tariff rates. Uruguay round negotiations contributed to

further reduction of trade barriers to covermanufactured goods and services.


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1913 1950 1990 2000

USA 44% 14% 4.8% 3.9%

Japan 30% 18% 5.3% 3.9%

Declining Trade Barriers

The bilateral treaties increased from 181 in 1980

and 1,856 in 2000 among 160 countries.


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4. Declining Investment Barriers

Global business firms invest capital in order to

establish manufacturing and other facilities inforeign countries.

Foreign govts impose barriers on foreign

investment in order to protect domestic industry.

After the globalization policy, various countries

have been removing these barriers on foreign

direct investment in order to encourage the global

business Various govt made 1,238 changes in the laws

governing FDI between 1991 and 2007.


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5. Growth in FDI

Foreign direct investment means investment

in a foreign country where the investor retainscontrol over the investment.

There are a number of reasons for the growth

of FDI in recent years. Increase in sales and profits

Rapid growth of markets

Reduce costs

Consolidate trade blocs

Protect domestic & foreign markets

Acquire technology


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6. Changes in Technology Technological change is amazing and phenomenal

after 1980s. Infact, it is like a revolution in

telecommunication, information technology,transportation technology.

In addition, the latest developments in informationtechnology have enabled the global company todevelop.

Micro-processors and Telecommunication

Internet and worldwide webOn-line globalisation

Transportation technology.


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6. Growth of Multinational Companies

A multinational corporation is anorganization doing business in more than

one country.

Transnational company produces, markets,

invests and operates across the world.

European Union - 163

USA - 162

Japan - 67

Developing countries - 53

India - 06

Internal and international trade


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Internal and international trade Internal trade is meant transactions taking place

within the geographical boundaries of a nation

or region domestic or intra regional or hometrade.

International trade, on the other hand, is tradeamong different countries or trade across

political frontiers. International trade, thus, refers to the exchange of

goods and services between one country withother countries.

In brief, trade between one nation with other nationis called international trade and trade within theterritory (political boundary) of a nation internaltrade.


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Reasons for international trade

1. Inter dependence of each and every

nations.

2. Factor endowments in different

countries in differ

3. Technological advancementof different

countries in differ

4. Labour and entrepreneurial skills differs in

different countries.

5. Factors of production are highly

immobile between countries.

S


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SAI

LENT

FE

ATUR

E

Immobility of Factors

Heterogeneous Markets

Different National Groups

Different Political Units

Different NationalPolicy & Govt

Different Currencies


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1. immobility of Factors The degree of immobility of factors of production

like labour & capital which is generally greaterbetween countries than within the country.

Immigration laws, citizenship, qualifications

etcoften restrict international mobility of labour.

For instance, wages may be equal in Mumbai

and Pune but not in Bombay & London.

Prices of G/S similarity within the economy but at

internationally differentiated - Dumping


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2. Heterogeneous Markets

In the international trade lack of

homogeneity on account of differences inclimate, language, preferences, habit,customs, weights and measurementsetc.

Socio-economic environment differs greatlybetween nations, while it is more or lessuniform within the country.

Frederick List domestic trade is amongus and international trade is between us &them.


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3. Different National Groups

International trade is a phenomenon which occurs

among different political units.4. Different Political Units.

International trade occurs between different

political units, while domestic trade occurs within

the same political unit.

The government in each country is keen about

welfare of its own nations against that of the

people of other countries. Hence, in international trade policies of each

government tries to see its own interest at the cost

of the other country.

5 Diff t N ti l P li i & G t i t ti


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5. Different National Policies & Govt interventions

Economic & political policies differ from one country

to another.

Policies pertaining to trade, commerce, export &

import, taxation etc also differ widely among countries

through they are more or less uniform within the

country. Tariff policy, import quota system, subsidies &

other controls adopted by a government interfere

with the course of normal trade between us & other

countries.


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6. Different currencies

Another notable feature of international

trades is that it involves the use of differenttypes of currencies.

So, each country has its own policy in

regard to exchange rates and foreignexchange policies.

That is why there is the problem of

exchange rates & foreign exchange.


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Internal and international trade or internal Internal trade is meant transactions taking place

within the geographical boundaries of a nationor region domestic or intra regional or hometrade.

International trade, on the other hand, is trade

among different countries or trade acrosspolitical frontiers. International trade, thus, refers to the exchange of

goods and services between one country withother countries.

In brief, trade between one nation with other nationis called international trade and trade within theterritory (political boundary) of a nation internaltrade.


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Reasons for international trade

1. Inter dependence of each and every

nations.

2. Differences in Factorendowments

3. Differences in Technological

advancement

4. Differences in Labour and entrepreneurial

skills between the countries.

5. Factors of production are highly

immobile between countries.

Diff b t d ti b i


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Differences between domestic businessand international business

Basically, domestic business andinternational business operate on similarlines.

But there are certain differences betweenthese two business.

The significant differences between thesetwo emerge from foreign exchange,

quotas, tariff, regulations of a number ofgovernments, wide variations in cultureetc.


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The classical economists argues that there

were certain fundamental differences

between internal and international businessAdam Smith, David Ricardo & J.S. Mill

They propounded a separate theory of

international trade. But modern economists like Bertil Ohlin &

Haberler view and opine that the

differences between interregional andinternational trade are of degree rather

than of kind.

Indicators International business Internal business


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Factors ofProduction

Perfectly immobile between thecountries

Perfectly mobile withineach regions

Natural

Resources

Greater differences between

countries

Not much differences

between regionsGeographical &Climaticconditions

Different geographical & climaticconditions

Not much differences

Different

Markets

Language, usage, taste &

preferences, weights andmeasurement

Homogeneous in

characteristic

DifferentCurrencies

Different currencies Dollar,Pound, Yen etc.

Single currency - Rupees

Transport Cost More transport costs Less Transport costs

BOP It is perpetual in internationaltrade

No need of BOP

National

policies

Different national policies Homogeneous policy

S


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SAI

LENT

FE

ATUR

E

Immobility of Factors

Heterogeneous Markets

Different National Groups

Different Political Units

Different NationalPolicy & Govt

Different Currencies


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2 H t M k t


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2. Heterogeneous Markets

In the international trade lack of

homogeneity on account of differencesinclimate, language, preferences, habit,customs, weights and measurementsetc.

Socio-economic environment differs greatlybetween nations, while it is more or lessuniform within the country.

Frederick List domestic trade isamong us and international trade isbetween us & them.

3 Diff t N ti l G


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3. Different National Groups

International trade is a phenomenon which occurs

among different political units.4. Different Political Units.

International trade occurs between different

political units, while domestic trade occurs within

the same political unit.

The government in each country is keen about

welfare of its own nations against that of the

people of other countries. Hence, in international trade policies of each

government tries to see its own interest at the cost

of the other country.

5 Different National Policies & Govt interventions


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5. Different National Policies & Govt interventions

Economic & political policies differ from one country

to another.

Policies pertaining to trade, commerce, export &

import, taxation etc also differ widely among countries

through they are more or less uniform within the

country. Tariff policy, import quota system, subsidies &

other controls adopted by a government interfere

with the course of normal trade between us & other

countries.


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6. Different currencies

Another notable feature of international

trades is that it involves the use of differenttypes of currencies.

So, each country has its own policy in

regard to exchange rates and foreignexchange policies.

That is why there is the problem of

exchange rates & foreign exchange.

7 Problem of Balance of Payment


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7. Problem of Balance of Payment

Another important point which distinguishes

international trade from interregional trade is theproblem of BOP.

The problem of BOP is perpetual in international

trade, while regions within a country have no such

problem. This is because there is greater mobility of capital

within regions than between countries.

Further, the policies which a country chooses tocorrect its disequilibrium in the balance of

payments may give rise to a number of other

problems.

Advantages of international business


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Advantages of international business1. High Living Standards

2. Increased Socio-economic Welfare

3. Wider Market4. Reduced Effects of Business Cycles

5. Reduced Risks

6. Large-scale economies

7. Potential Untapped Markets

8. Provides the Opportunity for and challenge todomestic business

9. Division of labour and specialisation

10.Economic growth of the world

11.Optimum and proper utilization of world resources12.Cultural transformation

13.Knitting the world into a closely interactive traditionalvillage.

Disadvantages of international business


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Disadvantages of international business

1. Political Factors

2. Huge Foreign Indebtedness

3. Exchange Instability

4. Entry Requirements

5. Tariffs, Quotas and Trade Barriers

6. Corruption

7. Bureaucratic Practices of Government8. Technological Pirating

9. Quality Maintenance


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Theories of International TradeTheories of International Trade

International trade becomes possible forInternational trade becomes possible for

mutual benefit to the two countries due tomutual benefit to the two countries due to

the differences in opportunity costs.the differences in opportunity costs.

International trade between two countriesInternational trade between two countries

can benefit both countries if each countrycan benefit both countries if each countryexports the goods in which is has aexports the goods in which is has a

comparative advantage.comparative advantage.

A number of theories have beenA number of theories have beendeveloped by the international economistsdeveloped by the international economists

are -are -



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1.1. MercantilismMercantilism

2.2. Theory of Absolute Cost AdvantageTheory of Absolute Cost Advantage3.3. Comparative Cost Advantage TheoryComparative Cost Advantage Theory

4.4. Comparative Cost Advantage with MoneyComparative Cost Advantage with Money

5.5. Heckscher Ohlin TheoryHeckscher Ohlin Theory differences in differences infactors endowmentsfactors endowments

6.6. Country Similarity TheoryCountry Similarity Theory

7.7. Product Life Cycle TheoryProduct Life Cycle Theory

8.8. Global Strategic Rivalry TheoryGlobal Strategic Rivalry Theory

1 Mercantilism1 Mercantilism


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1. Mercantilism1. Mercantilism Mercantilism is the oldest international tradeMercantilism is the oldest international trade

theory during 1500 1800.theory during 1500 1800.

According to this theory the holdings of aAccording to this theory the holdings of acountrys treasure primarily in the form ofcountrys treasure primarily in the form of goldgoldconstituted its wealth.constituted its wealth.

This theory specifies that countries shouldThis theory specifies that countries shouldexport more than they importexport more than they import & receive the& receive thevalue of trade surplus in the form of gold fromvalue of trade surplus in the form of gold fromthose countries which experience trade deficits.those countries which experience trade deficits.

Government imposed restrictions on imports &Government imposed restrictions on imports &encouraged exports in order to prevent tradeencouraged exports in order to prevent tradedeficit & experience trade surplus.deficit & experience trade surplus.

Colonial powers like the British used toColonial powers like the British used to


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Colonial powers like the British used toColonial powers like the British used totrade with colonies like India, Srilanka etc.trade with colonies like India, Srilanka etc.

By importing the raw-materials from &By importing the raw-materials from &exporting the finished goods to colonies.exporting the finished goods to colonies.

The colonies had to export less valuedThe colonies had to export less valuedgoods & import more valued goods.goods & import more valued goods.

The theory benefited the colonial powersThe theory benefited the colonial powers& caused much discontent in the colonies.& caused much discontent in the colonies.

This theory was criticized by Adam SmithThis theory was criticized by Adam Smith

& developed new theory of absolute cost& developed new theory of absolute costadvantage different cost of productionadvantage different cost of productionleads the international trade.leads the international trade.

2 Theory of Absolute Cost Advantage2 Theory of Absolute Cost Advantage


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2. Theory of Absolute Cost Advantage2. Theory of Absolute Cost Advantage

Adam Smith proposedAdam Smith proposed Absolute Cost Absolute Cost

Advantage Theory of International TradeAdvantage Theory of International Trade in hisin hisPublication Publication An Enquiry into nature and causesAn Enquiry into nature and causes

of Wealth of Nation in 1776of Wealth of Nation in 1776..

He explain aboutHe explain about reason for international tradereason for international trade

between two countriesbetween two countries in terms of absolute costin terms of absolute costadvantage.advantage.

He assumed that the cost of the commoditiesHe assumed that the cost of the commodities

was determined by the relative amounts of labourwas determined by the relative amounts of labour

involved in their production.involved in their production.

Free trade promote international division ofFree trade promote international division of

labour and specialisationlabour and specialisation..

Assumptions of the law


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p1. 2 x 2 Model two countries and two commodities

A & B Countries X & Y commodities.

2. Labour is the only factors of production.3. A policy ofLaissez faire is advocated absence

of govt intervention.

4. Perfect competition existed in both commodity

and factor market.5. All labour were assumed to be homogenous equal skills and efficient.

6. Factors of Production are perfectly mobile

within the countrybut perfectly immobilebetween different countries.

7. Ignores transport costs.8. There is no trade cycles in the economy.

International trade would be beneficial for a


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country to exports products to thosecountries where these products could not be

produced at lower rates. The trade between the countries would result in

allocation of the resources in the world and henceproductivity will boost.

Trade between them will take place if each of thetwo countries has absolutely lower cost in theproduction one of these commodity.

A country will export that commodity in the

production of which it has an absolute costadvantage and import that commodity inwhich it has absolute cost disadvantage.

Table: 1 Absolute Costs Differences


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CountryCountry Commodity XCommodity X Commodity YCommodity Y

AA 1010 55

BB 55 1010

Table: 1 Absolute Costs Differences

A = 10X or 5 Y = 15

B = 5X or 10 Y = 15

(one unit of labour)


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A has an absolute advantage in theA has an absolute advantage in the

production of X i.e., 10X > 5Y.production of X i.e., 10X > 5Y.

B has an absolute advantage in theB has an absolute advantage in the

production of Y i.e., 10Y > 5Xproduction of Y i.e., 10Y > 5X

10 X of A10 X of A_____________ > 1 >5 X of B

5 Y of A______________

10 Y of B

After trade contractAfter trade contract


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After trade contractAfter trade contract Trade between the two countries will benefit bothTrade between the two countries will benefit both

if A specialise in the production of X & B in theif A specialise in the production of X & B in theproduction of Yproduction of Y

CountryCountry

ProductionProduction

before tradebefore trade

Production afterProduction after

tradetrade

Gains from tradeGains from trade

XX YY XX YY XX YY

AA 1010 55 2020 -- +10+10 -5-5

BB 55 1010 -- 2020 -5-5 +10+10TotalTotal

ProductionProduction1515 1515 2020 2020 +5+5 +5+5

Table: 2 Gain from trade

Th b t bl l th t b f t d b th


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The above table reveals that before trade both

countries produce only 15 units each of the two

commodities by applying one labour unit on eachcommodity.

A were to specialise in producing commodity X

and use both units of labour on it, its total

production will be 20 units of X.

Similarly, if B were to specialise in the production

of Y alone, its total production will be 20 units of

Y. The combined gain to both countries from trade

will be 5 units each of X and Y.

Chart: Absolute Cost Differences


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XB XA

YB

YA

YCommo

dit

y

X CommodityO X

Y

Chart: Absolute Cost Differences

OXA > OXB country A

OYB > OXA - country B

Before tradeBefore trade


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Before tradeBefore trade

Both countries produce only 15 units eachBoth countries produce only 15 units each

of the two commodity by using one unit onof the two commodity by using one unit oneach commodity.each commodity.

After tradeAfter trade

A country were specialise in producingA country were specialise in producingcommodity X with 20 unitscommodity X with 20 units

B country were specialise in the productionB country were specialise in the production

of Y with 20 units of Yof Y with 20 units of Y The combined gain to both countries fromThe combined gain to both countries from

trade will be 5 units each of X & Y.trade will be 5 units each of X & Y.

Criticism of the theory


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y

1. No Absolute Advantage One country shouldbe able to produce at least one product at a

comparatively low cost. But in reality most of thedeveloping countries do not have absoluteadvantage of producing any product at the lowestcost.

2. Country Size countries vary in size. Thistheory does not deal with country by countrydifferences in specialisation.

3. Variety of Resources though these areseveral resources like labour, technology andnatural resources, this theory deals with onlylabour and ignores all other resources.

4 Transport cost though the cost of


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4. Transport cost though the cost oftransportation plays a significant role in

international trade, this theory ignored thisaspect.

5. Large scale economies large scale

economies reduces the cost of production &form of part of the absolute advantage.

6. Absolute Advantage for many products

some countries may have absoluteadvantage for many products for example

Japan, USA, France & U.K. etc.

3 Theory of Comparative Cost Advantage3 Theory of Comparative Cost Advantage


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3. Theory of Comparative Cost Advantage3. Theory of Comparative Cost Advantage

The classical theory of the international trade, alsoThe classical theory of the international trade, also

known as theknown as the theory of comparative coststheory of comparative costs.. The Comparative Cost Theory was firstThe Comparative Cost Theory was first

systamatically formulated by the Englishsystamatically formulated by the English

economist David Ricardo in his Publicationeconomist David Ricardo in his Publication

entitledentitled Principles of Political Economy &Principles of Political Economy &Taxation 1817.Taxation 1817.

It was later refined byIt was later refined by J.S. Mill, Marshall,J.S. Mill, Marshall,

TaussingTaussing& Others.& Others. According to David Ricardo,According to David Ricardo, it is not the absoluteit is not the absolute

but the comparative differences in costbut the comparative differences in cost thatthat

determine trade relations between two countries.determine trade relations between two countries.

Ricardo states that the countries could beRicardo states that the countries could be


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Ricardo states that the countries could beRicardo states that the countries could bebenefited by trade even when a country couldbenefited by trade even when a country could

produce both the commodities at less labour produce both the commodities at less labour

cost than the other country.cost than the other country. Production costs differ in countries because ofProduction costs differ in countries because of

geographical condition, division of labour &geographical condition, division of labour &specialisation in production, climatespecialisation in production, climate

conditions, natural resources & efficiency ofconditions, natural resources & efficiency oflabour of a countrylabour of a country can produce one commoditycan produce one commodityat a lower cost than the other.at a lower cost than the other.

One country has a comparative advantage inOne country has a comparative advantage in

the production of both the commodities whilethe production of both the commodities whileother country has a comparative lessother country has a comparative lessdisadvantage in the production of onedisadvantage in the production of onecommoditycommodity..

As long as the cost ratios differ, both countriesAs long

as the cost ratios differ, both countries


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g ,ggain from trade, regardless of the fact that one ofgain from trade, regardless of the fact that one ofthe countries might have an absolutethe countries might have an absolute

disadvantage in the production of both thedisadvantage in the production of both thecommodities.commodities.

Therefore, when a country develop trade link withTherefore, when a country develop trade link withsome other country, it willsome other country, it will export thoseexport those

commodities in which their comparativecommodities in which their comparative productions costs are low, productions costs are low, && will import thosewill import thosecommodities in which its comparativecommodities in which its comparativeproduction cost are high.production cost are high.

This is theThis is the basis of international tradebasis of international trade.. He assumed Portugal and England as the twoHe assumed Portugal and England as the twocountries and Wine and Cloth as the twocountries and Wine and Cloth as the twocommodities they produced.commodities theyproduced.

Assumptions of the theoryAssumptions of the theory


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1.1. There are onlyThere are only two countriestwo countries A & B or A & B or

England & Portugal.England & Portugal.

2.2. They produce theThey produce the same two commoditiessame two commodities say,say,

Wine & Cloth X & Y commodities.Wine & Cloth X & Y commodities.

3.3. There areThere are similar tastessimilar tastes in both the countriesin both the countries

4.4. Labour is the onlyLabour is the only factor of productionfactor of production..5.5. TheThe supply of labour is unchangedsupply of labour is unchanged..

6.6. All units ofAll units oflabour are homogeneouslabour are homogeneous..

7.7. Prices of two commodities are determined byPrices of two commodities are determined bylabour cost.labour cost.



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8. Commodities are produced under the8. Commodities are produced under the law oflaw of

constant cost or returns.constant cost or returns.9.9. Technological knowledgeTechnological knowledge is unchanged.is unchanged.

10. Factors of production are10. Factors of production are perfectly mobile perfectly mobile

within each country,within each country, but are perfectlybut are perfectlyimmobile between countries.immobile between countries.

11.11. No transport costsNo transport costs are involved.are involved.

12. All the12. All the factors of production fully employedfactors of production fully employed

in both the countries.in both the countries.

Explanation of the theoryExplanation of the theory


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p yp y Ricardo shows that trade is possible betweenRicardo shows that trade is possible between

two countries when one country has antwo countries when one country has an

absolute advantage in the production of bothabsolute advantage in the production of both

commodities, but a comparative advantage incommodities, but a comparative advantage in

the production of one commodity than in thethe production of one commodity than in the

otherother

CountryCountry WineWine ClothCloth

EnglandEngland 120120 100100

PortugalPortugal 8080 9090

Table: 1 Man-Years of Labour Required forproducing one unit

The production of a unit of Wine in EnglandThe production of a unit of Wine in England


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The production of a unit of Wine in EnglandThe production of a unit of Wine in England

requires 120 men for a year, while a unit ofrequires 120 men for a year, while a unit of

Cloth requires 100 men for the sameCloth requires 100 men for the sameperiod.period.

On the other hand, the production of theOn the other hand, the production of the

same quantities of Wine & Cloth in Portugalsame quantities of Wine & Cloth in Portugalrequires 80 & 90 men respectively.requires 80 & 90 men respectively.

Thus, England uses more labour thanThus, England uses more labour than

Portugal in producing both wine & cloth.Portugal in producing both wine & cloth. In other words, the Portuguese labour isIn other words, the Portuguese labour is

more efficient than the English labour inmore efficient than the English labour in

producing both the products.producing both the products.

So Portugal possesses an absolute advantage inSo Portugal possesses an absolute advantage in


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both wine and cloth.both wine and cloth.

But Portugal would benefit more by producing wineBut Portugal would benefit more by producing wine

& exporting it to England because it possess greater& exporting it to England because it possess greatercomparative advantage in it (80/120 men).comparative advantage in it (80/120 men).

On the other hand, England interest to specialise inOn the other hand, England interest to specialise in

the production of cloth in which it has the leastthe production of cloth in which it has the least

comparative disadvantage.comparative disadvantage.

This is because the cost of production of cloth inThis is because the cost of production of cloth in

England in less (100/90 men) as compared withEngland in less (100/90 men) as compared with

wine (120/80 men).wine (120/80 men). Thus, trade is beneficial for both the countries. TheThus, trade is beneficial for both the countries. The

comparative advantage position of both the country.comparative advantage position of both the country.

Diagrammatically representation


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Wine

Cloth

E

G R L

P

g y p

O X

Y

ER parllel to PL

PL Production Possibility curve Portugal

EG - Production Possibility curve EnglandER Parllal to PL

PL is the production possibility curve of Portugal, & EG thatPL is the production possibility curve of Portugal, & EG thatf E l df E l d


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of England.of England.

Portugal enjoys an absolute advantage in the production ofPortugal enjoys an absolute advantage in the production of

both Wine & Cloth over England.both Wine & Cloth over England. It produces OL of Wine & OP of Cloth as against OG ofIt produces OL of Wine & OP of Cloth as against OG ofWine & OE of Cloth produced by England.Wine & OE of Cloth produced by England.

But the slope ER (parallel to PL) reveals that Portugal hasBut the slope ER (parallel to PL) reveals that Portugal hasgreater comparative advantage in the production of Winegreater comparative advantage in the production of Wine

because if it gives up the resources required to produce OEbecause if it gives up the resources required to produce OEof Cloth.of Cloth.

It can produce OR of Wine which is greater than OG ofIt can produce OR of Wine which is greater than OG ofWine of England.Wine of England.

On the other hand, England had the least comparativeOn the other hand, England had the least comparativedisadvantage in the production of OE Cloth.disadvantage in the production of OE Cloth.

Thus, Portugal will export OR of Wine to England inThus, Portugal will export OR of Wine to England inexchange for OE of Cloth from her.exchange for OE of Cloth from her.


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The table shows that the domestic exchangeThe table shows that the domestic exchange


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ratio in England is one unit of Cloth 0.83 unitsratio in England is one unit of Cloth 0.83 units

of Wine and in Portugal one unit of Wine 0.83of Wine and in Portugal one unit of Wine 0.83

units of cloth.units of cloth. If we assume the exchange ratio between theIf we assume the exchange ratio between the

two countries to be 1 unit of Cloth 1 unit oftwo countries to be 1 unit of Cloth 1 unit of

Wine.Wine. England would gain 0.17 (1 0.83 + 0.17) unit ofEngland would gain 0.17 (1 0.83 + 0.17) unit of

Wine by exporting one unit of Cloth to Portugal.Wine byexporting one unit of Cloth to Portugal.

Similarly the gain to Portugal by exporting oneSimilarlythe gain to Portugal by exporting one

unit of Wine to England will be 0.11 (1 0.89 +unit of Wine to England will be 0.11 (1 0.89 +0.11) unit of cloth.0.11) unit of cloth.

Thus trade is beneficial for both countriesThus trade is beneficial for both countries

Domestic Exchange Rate between Portugal and England


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C1

C2

O B

Y

Wine

Cloth

(0.83)W2 W1

(0.89)

C1W2 1 unit of cloth = 0.83

W1C2 1 unit of wine = 0.89

C1W1 1 unit cloth & 1 unit of wine

England Gain = W2W1 0.17 wine

Portugal Gain = C2C1 - 0.11 - cloth

The line C1W

2depicts the domestic


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1 2p

exchange ratio 1 unit of cloth = 0.83 unit

of Wine of England. The line W

1C

2that Portugal at the

domestic exchange ratio 1 unit of Wine= 0.89 unit of Cloth.

The line C1W

1shows the exchange rate

of trade of 1 unit of cloth = 1 unit of winebetween the two countries.

At this exchange rate, England gainW

2W

1(0.17 unit) of wine while Portugal

gains C2C

1(0.11 unit) of cloth.

Criticisms of comparative cost analysisCriticisms of comparative cost analysis


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p yp y

1.1. Unrealistic Assumption of Labour costUnrealistic Assumption of Labour cost

2.2. No similar tastesNo similar tastes3.3. Ignores transport costsIgnores transport costs

4.4. Factors are not perfectly mobile internallyFactors are not perfectly mobile internally

5.5. Unrealistic two country & two commodities modelUnrealistic two country & two commodities model

6.6. Assumption of free trade is not realisticAssumption of free trade is not realistic

7.7. Assumption of full employment is not realisticAssumption of full employment is not realistic

8.8. Ignores the role of technologyIgnores the role of technology

9.9. One sided theoryOne sided theory

10.10. Complete specialisation is impossible.Complete specialisation is impossible.

4. Modern Theory of International Trade4. Modern Theory of International Trade


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The Modern Theory of International TradeThe Modern Theory of International Tradewas advocated and developed by twowas advocated and developed by two

Swedish economists Swedish economists Heckscher and BertilHeckscher and BertilOhlin.Ohlin.

Bertin Ohlin in his famous bookBertin Ohlin in his famous book Inter-Inter-regional & International Traderegional & International Trade - (1933)- (1933)

criticised the classical theory of internationalcriticised the classical theory of internationaltrade and formulated the General Equilibriumtrade and formulated the General Equilibriumof International trade.of International trade.

Therefore, it is popularly known asTherefore, it is popularly known as Heckscher-Heckscher-Ohlin theory of trade (H.O. Therom)Ohlin theoryof trade (H.O. Therom)

It is also known asIt is also known as Factor Endowment orFactor Endowment orFactory Intensity Theory.FactoryIntensity Theory.

Factor Endowments means land, capital,Factor Endowments means land, capital,natural resources, labour, climate etc.natural resources, labour, climate etc.

For example Argentina and Australia have

l d I di d P ki t h


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more land, India and Pakistan have an

abundant supply of labour & USA and U.K

plenty of capital. Hence, Argentina and Australia produce more

of land intensive goods, India and Pakistan

more labour intensive goods & USA and UK produce more capital intensive goods.

According to Heckscher Ohlin differences

in the distribution of factor endowments are

responsible for differences in factor price andtherefore in the prices of goods and services

in different countries.

Trade results from differences in factor

d t i diff t t i l d t


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endowments in different countries leads to

differences in prices of commodities.

Some countries have much capital others

have much labour.

The theory says that countries that are rich in

capital will export capital intensive goods and Countries that have much labour will export

labour-intensive goods.

Thus, the main cause of trade between

regions is the difference in prices of

commodities based on relative factor

endowments and factors prices.



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1.1. It is 2 X 2 X 2 modelIt is 2 X 2 X 2 model - there are two countries- there are two countries

(A & B), two commodities (X & Y) & two factors(A & B), two commodities (X & Y) & two factorsof production (capital & labour).of production (capital & labour).

2.2. There isThere is perfect competition in commodityperfect competition in commodityasas

well aswell as factor marketsfactor markets..3.3. There isThere is full employment of resourcesfull employment of resources..

4.4. Country A is capital abundant & country B isCountry A is capital abundant & country B is

rich in labourrich in labour

5.5. There is perfect mobility of factors withinThere is perfect mobility of factors within

each region but internationally they areeach region but internationally they are

immobile.immobile.

Assumptions of the theory.Assumptions of the theory.


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p yp y

6. There are6. There are no transport costno transport cost..

7. There is7. There is free & unrestricted trade betweenfree & unrestricted trade betweenthe two countries.the two countries.

8. There are8. There are constant returns to scaleconstant returns to scale in thein the

production of each commodity in each region.production of each commodity in each region.9. There is9. There is no change in technologicalno change in technological

knowledgeknowledge..

10.10. Demand conditions are identicalDemand conditions are identical in bothin both

the countries.the countries.

Explanation of H.O. Therom


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Heckscher and Ohlin states that,

immediate cause of international tradeis the differences in relative commodityprices caused by differences in relativedemand and supply factors as a result

of differences in factor endowmentsbetween the two countries.

Fundamentally, the relative scarcity of

factors and unequally distributedbetween countries leads to differentrelative prices of commodities.

Production functions are different for


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different commodities capital intensive production function and labouintensive production function.

International trade responsible due todifferences in the relative prices of

commodities. Two main causes responsible for diversity

of production conditions

1. Differences in terms of distribution of factors ofproduction

2. Differences in the ratio of participation of thesefactors of production

Ohlin in his views General Equilibrium


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Theory of cost of the factors of productiondepends on conditions of supply andconditions of demand.

According to modern theory, theimmediate cause of international trade is

the differences in relative prices ofcommodities in the two countries.

Differences in commodity prices between

the countries due to differences infactors endowments of differentcountries.

Relative differences in the relative factor


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endowments of different countries and

different factor intensities for theproduction of different commodities.

The theory is usually formulated interms of two factor model labour and

capital are the two factor of production. The proposition is that capital rich

countries export capital - intensive

goods & Labour - rich countries export labour

intensive goods.

Factor abundance in terms of factor prices


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O X

Y

A

B

A1

B1

Labour

Cap

ital

K

K1

L

L1

In the figure xx and yy is the isoquants for two


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g yy q

goods X and Y respectively.

There are two types of factors intensity commodity X and Y represents capital and

labour intensity.

There are two types of countries A & B. A is the

relatively capital abundant & B is labourabundant countries.

The capital abundant country A will produced

with OA of capital & OB of labour. B country has labour abundant will produce OA

1

of capital and OB2of labour.

S i it f H O thS i it f H O th


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Superiority of H.O theory overSuperiority of H.O theory over

classical theoryclassical theory1.1. International trade a special caseInternational trade a special case

2.2. General equilibrium theory.General equilibrium theory.

3.3. Two factors of production 2 X 2 X 2Two factors of production 2 X 2 X 24.4. Differences in factor suppliesDifferences in factor supplies

5.5. Differences in factor endowmentsDifferences in factor endowments

6.6. Complete specialisation.Complete specialisation.


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6. International Product Life Cycle Theory International product life cycle theory developed by


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International product life cycle theory developed byRaymond Vernon & Lewis. T.Wells - 1966

PLC theory states that the development of a newproduct moves through a cycle or a series of stages inthe course of its development.

And also get comparative advantage changes as it

moves through the cycle. According to this theory of a new product is first

manufactured and marketed in a developed countrylike - USA.

Because, certain favourable factors such as largemarket, enterpreneurship, R & D etc.

The product is then exported to other developedcountries.


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INNOVATION

High IncomeCountries

Middle IncomeCountries

Low IncomeCountries


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Xerox origninally introduced photocopierinthe USA It later spread the manufacturing


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the USA. It later spread the manufacturing

facilities in Japan (Fuji-Xerox). Great Britain

(Rank Xerox) & India (Modi Xerox).

Xerox USA Japan UK India

PhotocopiesFiji

XeroxRankXerox

Modi

Xerox

According to Vernon, firms establish manufacturingfacilities in foreign countries, when the product

h i i h h Th


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reaches maturity stage in the home country. Theyinvest in low cost countries when cost becomes a

competitive edge. As competition increases in these markets,

manufacturing facilities are established there tocater to these markets & also to export to the

developing countries. As the product becomes standardised &competition further intensifies, manufacturingfacilities are established in developing countries tolower production costs & due to other reasons.

The developed country markets may also beserviced by exports form the production units in thedeveloping countries.


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INTERNATIONAL

PRODUCT LIFECYCLE

Stage I

StageII

Stage III

Stage IV

Introduction

Growth

Maturity

Decline

Chart : International Product Life Cycle (PLC) Theory


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About 95% of innovations take place in

i d t i ll d d t i


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industrially advanced countries.

This is mostly due to severe competition,customer demands, availability of R & D.

During this stage the firms sell most part of

their product in domestic country and a

limited part in other countries.

Microsoft sold most part of its innovated

software in the USA and the remaining part

in various countries including India.

2. Stage II Growth Increase in the sales of the new product attracts


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Increase in the sales of the new product attractsthe competitors.

At the same time, the increased awareness ofthe new product in various countriesparticularly in advanced countries increases thedemand for the product.

Further innovation in product, costreduction, market process etc.

There is mass production and distribution of

the new product. The innovating countries continues to have a

monopoly in producing and exporting theproduct.

3. Stage III Maturity Worldwide production increases during this


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Worldwide production increases during thisstage along with the demand for the product -

resulting in decline in exports. Increased competition results in increased

product standardization & cost reduction.

Producers start gaining the economies of scale

reducing the cost of production per unit. The lower per unit cost of production results in

exports to developing countries.

At this stage technology becomes standard.

Therefore, the producers start locating of theirplants in developing countries in order to takethe advantage of lower costs.


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Product Life-Cycle Theory


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Fig 4.5

Product life cycle theory


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Time

SalesVolum

e

Diagrammatically representation

The chart explains the possible international trade


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The chart explains the possible international trade

patterns in the life cycle of a new product.

OX and OY axis measures time and sales volume

respectively.

The figure shows three sets of curves The uppermost

set of curves relates to the innovating country, themiddle set to other advancedcountries, and the lowest

set to the less developed countries.

The uppermost set of curves relating to the innovating

country In the first stage, when the new product is

introduced, it is consumed in the domestic market, and

small portion exported to other advanced countries.

The middle set of curves shows that otheradvanced countries having started the


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g production of the new product continue toincrease its production upto the maturing

product stage and then become net exportersof the product in the standardised productstage.

The lowest set of curves relating to less

developed countries shows that suchcountries continue to import the productthroughout the three product stages. It is,however, in the maturing product stage thatthey start its production and become its netexporters very late in the last stage when the

product actually becomes old in advancedcountries.

Theories of International Investment


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1.Theory of Capital Movement

2.Market Imperfections Theory

3.Internationalisation Theory

4.Appropriability Theory5.Location Specific Advantage Theory

6.International Product Life Cycle Theory

7.Eclectic Theory

1. Theory of Capital Movement

Th l i l li t th ti i d l d


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The classical or earliest theoreticians, developed

theory of capital movement of international

investment.

The classical or tradition, assumes that, the

existence of a perfectly competitive market.

Foreign investment in the form factor movementto take advantage of the differential profit.

Charles Kindleberger, Stated that, under perfect

competition, foreign direct investment would notoccur & that would be unlikely to occusing world

where in the conditions were even approximately

competitive.

2. Market Imperfections Theory Th k t i f ti th f f i


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The market imperfections theory of foreigninvestment was advocated by Stephen in 1960,under monopolistic advantage theory.

According to this theory, foreign directinvestment occurred largely in oligopolisticindustries rather than industries operatingunder near perfect competition.

Hymer, suggested that, decision of firm to investin foreign markets was based on certainadvantages the firm possessed over the localfirms (foreign country).

Economies of scale, superior technology,production, marketing & finance.

3. Internationalisation Theory

According to the internationalisation theory


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According to the internationalisation theory

which is an extension of the market

imperfections theory.

Foreign investment results from the decision of a

firm to internalise the firm specific advantage like

a superior knowledge production, marketing,HRM.

Internationalisation include formal ways &

informal ways.

Formal ways patents & copy rights

Informal ways Secrecy & family networks

4. Appropriability Theory

According to the Appropriability Theory a


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According to the Appropriability Theory, afirm should be able to appropriate the

benefits resulting from a technology, it hasgenerated.

If this condition is not satisfied, the firm

would not be able to bear the cost oftechnology generation & therefore, wouldhave no incentive for Research &Development (R & D)..

MNCs tend to specialise in developing newtechnologies which are transmittedefficiently through their internal channe

Overview of Global Theory and Practice

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