Product Life Cycle

Theories of International Trade and Investment

McGraw-Hill/IrwinInternational Business, 11/e Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.

chapter three

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Learning Objectives

Explain the theories that attempt to explain why certain goods are traded internationally

Discuss the arguments for imposing trade restrictions

Explain two basic kinds of import restrictions: tariff and nontariff trade barriers

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Learning Objectives

Appreciate the relevance of changing status of tariff and nontariff barriers to managers

Explain some of the theories of foreign direct investment

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International Trade Theory

• Mercantilism– Economic philosophy based on belief that

• (1) a nation’s wealth depends on accumulated treasure, usually gold, and

• (2) to increase wealth, government policies should promote exports and discourage imports

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Theory of Absolute Advantage

• Absolute advantage– Theory that a nation has absolute

advantage when it can produce a larger amount of a good or service for the same amount of inputs as can another country or

– When it can produce the same amount of a good or service using fewer inputs than could another country

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Absolute Advantage

Each Country Specializes

Example

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Absolute Advantage

Terms of Trade (Ratio of International Prices)

Gains from Specialization and Trade

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Theory of Comparative Advantage

• Comparative Advantage– A nation having absolute disadvantages in

the production of two goods with respect to another nation has a comparative or relative advantage in the production of the good in which its absolute disadvantage is less

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Theory of Comparative Advantage

Example

Each Country Specializes

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Comparative Advantage

Terms of Trade – at a rate of ¾ bolt of cloth for 1 ton of soybeans

Terms of Trade – at a rate of 1 bolt of cloth for 1 ton of soybeans

Gains from Specialization and Trade

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Comparative Advantage

• Production Possibility Frontiers (figure 3.1)

Figure 3.1

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Heckscher-Ohlin Theory of Factor Endowment

• Factor Endowment – Heckscher-Ohlin theory that countries

export products requiring large amounts of their abundant production factors and import products requiring large amounts of their scarce production factors

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Heckscher-Ohlin Theory of Factor Endowment

• Leontief Paradox – The United States, one of the most capital-intensive

countries in the world, was exporting relatively labor-intensive products in exchange for relatively capital-intensive products

• Differences in Taste – A demand-side construct that is always difficult to

deal with in economic theory

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How Can Money Change The Direction of Trade?

Example

Exchange Rate – the price of one currency stated in terms of another currency

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How Can Money Change The Direction of Trade?

• Influences of Exchange Rate– Currency devaluation

• The lowering of a currency’s price in terms of other currencies

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Some Newer Explanations For The Direction Of Trade

• Linder Theory of Overlapping Demand

– Customers’ tastes are strongly affected by income levels; therefore a nation’s income per capita level determines the kinds of goods they will demand

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Some Newer Explanations For The Direction Of Trade

• International Product Life Cycle (IPLC) – Explains why a product that begins as

export eventually becomes import (figure 3.2) • U.S. exports• Foreign production begins• Foreign competition in export market• Import competition in the United States

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Figure 3.2 International Product Life Cycle

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Some Newer Explanations For The Direction Of Trade

• Technology Life Cycle – Production technology application of IPLC

• Economies of Scale and Experience Curve– As a plant gets larger and output increase, the

average cost of producing each unit of output decreases

– As firms produce more products, they learn ways to improve production efficiency

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Some Newer Explanations For The Direction Of Trade

• Imperfect Competition – Economies of scale with the existence of

differentiated products--Paul Krugman

• First-Mover Theory– Pattern of trade in goods subject to scale

economies may be determined by historical factors

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Some Newer Explanations For The Direction Of Trade

• National Competitive Advantage from Regional Clusters: Porter’s Diamond Model (figure 3.3)– National Competitiveness: a nation’s relative ability

to design, produce, distribute, or service products while earning increasing returns on resources

• Demand conditions• Factor Conditions• Related and supporting industries• Firm strategy, structure, and rivalry

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Figure 3.3 Variable Impacting Competitive Advantage: Porter’s Diamond

Source: Reprinted by permission of the Harvard Business Review. “The Competitive Advantage of Nations” by Michael E. Porter,March–April 1990, p. 77. Copyright © 1990 by The President and Fellows of Harvard College; all rights reserved.

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Trade Restrictions: Arguments For

• National Defense

• Sanctions to Punish Offending Nations

• Protect Infant (or Dying) Industry

• Protect Domestic Jobs from Cheap Foreign Labor

• Scientific Tariff or Fair Competition

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Trade Restrictions

• Retaliation– Dumping: selling a product abroad for less

than the cost of production, the price in the home market, or the price to third countries• Social dumping• Environmental dumping• Financial services dumping• Cultural dumping• Tax dumping

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Trade Restrictions

– Subsidies: Financial contributions, provided directly or indirectly by a government, which confer a benefit; include grants, preferential tax treatment, and government assumption of normal business expenses (figure 3.4)

– Countervailing duties: Additional import taxes levied on imports that have benefited from export subsidies

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Figure 3.4 Value of OECD Member Farm Subsidies

Source: “Agriculture: Support Estimates, 2004,” OECD in Figures: Statistics on the Member Countries. Accessed 7/2005 Link: http://dx.doi.org/10.1787/758034618756.

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Tariff Barriers

• Tariff – Taxes on imported goods for the purpose of raising

their price to reduce competition for local producers or stimulate local production

• Ad Valorem Duty – An import duty levied as a percentage of the invoice

value of imported goods

• Specific Duty – A fixed sum levied on a physical unit of an imported

good

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Tariff Barriers

• Compound Duty – A combination of specific and ad valorem

duties

• Official Prices

• Variable Levy – An import duty set at the difference between

world market prices and local government-supported prices

• Lower Duty for more local Input

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Nontariff Barriers

• Nontariff barriers (NTBs) – All forms of discrimination against imports

other than import duties

• Quantitative – Quotas: numerical limits placed on specific

classes of imports– Voluntary export restraints (VERs): Export

quotas imposed by exporting nation

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Nontariff Barriers

• Orderly Marketing Arrangements – Formal agreements between exporting and

importing countries that stipulate the import or export quotas each nation will have for a good

• Nonquantitative Nontariff Barriers – Direct government participation in trade– Customs and other administrative

procedures– Standards

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From Multinational to Globally Integrated Manufacturing Systems

• Close least efficient plants, and supply their markets with imports from other subsidiaries

• Change multidomestic manufacturing system to globally integrated system in which each plant performs the activities at which it is most efficient

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International Investment Theories

• Monopolistic Advantage Theory Theory that FDI is made by firms in oligopolisticindustries possessing technical and other advantagesover indigenous firms

• Product and Factor Market ImperfectionsSuperior knowledge leads to differentiated products, and they lead to firm control on price and advantage over indigenous firm (Hymer and Caves)

• Financial FactorsImperfections in the foreign exchange markets (Aliber)

• International Product Life Cycle

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International Investment Theories

• Follow The Leader• Cross Investment

– Foreign direct investment by oligopolistic firms in each other’s home countries as a defense measure

• Internalization Theory– An extension of the market imperfection theory: to

obtain a higher return on its investment, a firm will transfer its superior knowledge to a foreign subsidiary rather than sell it in the open market

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International Investment Theories

• Dynamic Capabilities – Theory that for a firm to successfully invest

overseas, it must have ownership of unique knowledge or resources and the ability to dynamically create and exploit these capabilities

• Dunning’s Eclectic Theory Of International Production– Theory that for a firm to invest overseas, it must

have three kinds of advantages: ownership-specific, internalization, and location-specific