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InternationalTradeTheory
Whatisinternationaltrade?
Exchangeofrawmaterialsandmanufacturedgoods
(andservices)acrossnationalborders

InternationalTradeTheory
Classicaltradetheories:
explainnationaleconomyconditionscountry
advantagesthatenablesuchexchangetohappen

Newtradetheories:
explainlinksamongnaturalcountryadvantages,
governmentaction,andindustrycharacteristicsthat
enablesuchexchangetohappen

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ClassicalTradeTheories
Mercantilism(pre16thcentury)
Takesanusversusthemviewoftrade
Othercountrysgainisourcountrysloss

FreeTradetheories
AbsoluteAdvantage(AdamSmith,1776)
ComparativeAdvantage(DavidRicardo,1817)
Specializationofproductionandfreeflowofgoods
benefitalltradingpartnerseconomies

FreeTraderefined
Factorproportions(HeckscherOhlin,191933)
Internationalproductlifecycle(RayVernon,1966)

Mercantilism
Fromthemid16th Centurytill19th Century
Anationswealthdependsonitsaccumulated
treasure,basicallyGold&Silver
Goldandsilverarethecurrencyoftrade.
Exportmoretostrangersthanweimportto
amasstreasure,expandkingdom
Tradeiswinorlose;azerosumgame.
TheinterestoftheStateisdominant

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Mercantilism
Governmentintervenestoachieveasurplusin
exports
Theorysaysyoushouldhaveatradesurplus.
Maximize exportsthroughsubsidies.
Minimize importsthroughtariffsandquotas.

King,exporters,domesticproducers:happy
Subjects:unhappybecausedomesticgoodsstay
expensiveandoflimitedvariety

Fitquitewellwithanageofexploration,colonialism,
imperialism,andcapitalism.(EastIndiaCompanies)

DavidHume 1752
Increasedexportsleadstoinflationandhigher
prices.
Increasedimportsleadtolowerprices.
Result:CountryAsellslessbecauseofhigh
pricesandCountryBsellsmorebecauseoflower
prices.
Inthelongrun,noonecankeepatradesurplus.

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FreeTradeTheory
FreeTrade occurswhenagovernmentdoesnot
attempttoinfluence,throughquotasorduties,what
itscitizenscanbuyfromanothercountryorwhat
theycanproduceandselltoanothercountry.

TheBenefitsofTrade allowacountrytospecializein
themanufactureandexportofproductsthatcanbe
producedmostefficientlyinthatcountry.

ThepatternofInternationalTradedisplayspatterns
thatareeasytounderstand(SaudiArabia/oilor
Bangladesh/laborintensivegoods).Othersarenotso
easytounderstand(Japanandcars).

TheoryofAbsoluteAdvantage
AdamSmith:WealthofNations(1776).
Capabilityofonecountrytoproducemoreofaproduct
withthesameamountofinputthananothercountry.
Acountry
Shouldspecializeinproductionofandexportproductsforwhichit
hasabsoluteadvantage;importotherproducts
Hasabsoluteadvantagewhenitismoreproductivethananother
countryinproducingaparticularproduct

Tradebetweencountriesis,therefore,beneficial.
Assumesthereisanabsoluteadvantagebalanceamong
nations.
Nolongerzerosum;everybodywins!
Ghana/cocoa.

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ComparativeAdvantage
DavidRicardo:PrinciplesofPolitical Economy,1817
Extendsfreetradeargument
Efficiencyofresourceutilizationleadstomoreproductivity.
Shouldimportevenifcountryismoreefficientintheproducts
productionthancountryfromwhichitisbuying.
Looktoseehowmuchmoreefficient.Ifonlycomparatively
efficient,thanimport.

Countryshouldspecializeintheproductionofthosegoods
inwhichitisrelatively moreproductive...evenifithas
absoluteadvantageinallgoodsitproduces
Makesbetteruseofresources
AbsoluteAdvantage isaspecialcaseofComparative
Advantage

FactorEndowmentsTradeTheory
Developed by Eli Heckscher (1919) Expanded by
Bertil Ohlin (1933)
FactorEndowmentsTradeTheoryoriginallyconsidered
twofactorsofProduction Labor&Capital
Factorsofproduction:labor,capital,land,human
resources,technology
Differencesinfactorendowmentsnotondifferencesin
productivitydeterminepatternsoftrade

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FactorEndowmentsTradeTheory
Acountryhasacomparativeadvantagein
producingproductsthatintensivelyusefactorsof
production(resources)ithasinabundance

Exportgoodsthatintensivelyusefactor
endowmentswhicharelocallyabundant.
Corollary:importgoodsmadefromlocallyscarce
factors.

Patternsoftradearedeterminedbydifferences
infactorendowments notproductivity.

Leontiefparadox
Acountrythatisrelativelylaborabundant(capitalabundant)
shouldspecializeintheproductionandexportofthatproduct
whichisrelativelylaborintensive(capitalintensive).
UShasrelativelymoreabundantcapitalyetimportsgoodsmore
capitalintensivethanthoseitexports
Thelaborcostishigh,butexportsmorelaborintensive
goods
Explanation(?):
UShasspecialadvantageonproducingnewproducts
madewithinnovativetechnologies
Thesemaybelesscapitalintensive,butmorelabor
intensivetilltheyreachmassproductionstate

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ProductLifeCycleTheory
(RaymondVernon,1966)
Asproductsmature,bothlocationofsalesand
optimalproductionchanges.
Affectsthedirectionandflowofimportsand
exports.
Globalizationandintegrationoftheeconomymakes
thistheorylessvalid.

ProductCycleTheory:
VernonsPremises
Technicalinnovationsleadingtonewand
profitableproductsrequirelargequantitiesof
capitalandskilledlabor
Theproductandthemethodsformanufacture
gothroughthreestagesofmaturation

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International Product Trade Cycle Model

production

HighIncomeCountries
Exports

Q
u
a
n
ti
t
y

Imports

10

11

12

13

14

MediumIncomeCountries

consumption

15

Exports

Imports
1

10

11

12

13

14

15

LowIncomeCountries
Exports
Imports
1

New Product

Maturing Product

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11

12

13

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Time

Standardized Product

Stages of Production Development

TheProductCycleandTradeImplications
Increasedemphasisontechnologysimpacton
productcost
Explainedinternationalinvestment
Limitations
Mostappropriatefortechnologybasedproducts
Someproductsnoteasilycharacterizedbystagesof
maturity
Mostrelevanttoproductsproducedthroughmass
production

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ClassicTheoryConclusion
FreeTradeexpandstheworldpieforgoods/services
TheoryLimitations:
Simpleworld(twocountries,twoproducts)
notransportationcosts
nopricedifferencesinresources
resourcesimmobileacrosscountries
constantreturnstoscale
eachcountryhasafixedstockofresourcesandnoefficiency
gainsinresourceusefromtrade
fullemployment

TheNewTradeTheory
Begantoberecognizedinthe1970s.
Dealswiththereturnsonspecialization
wheresubstantialeconomiesofscaleare
present.
Specializationincreasesoutput,abilityto
enhanceeconomiesofscaleincrease.

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ApplicationoftheNewTradeTheory
Typically,requiresindustrieswithhigh,fixed
costs.
Worlddemandwillsupportfewcompetitors.
Competitorsmayemergebecausetheygot
therefirst.
firstmoveradvantage.

Somearguethatitgeneratesgovernment
interventionandstrategictradepolicy.

FirstMoverAdvantage
Economiesofscalemayprecludenew
entrants.
Roleofthegovernment.
Boeing&Airbus

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PortersDiamond (1990)
TheCompetitiveAdvantageofNations.
Lookedat100industriesin10nations.
existingtheoriesdidntgofarenough.

Question:Whydoesanationachieve
internationalsuccessinaparticularindustry?

DeterminantsofNationalCompetitive
Advantage
Factorendowments:nationspositioninfactorsof
productionsuchasskilledlabororinfrastructurenecessary
tocompeteinagivenindustry.

Demandconditions:thenatureofhomedemandfor
theindustrysproductorservice.

Firmstrategy,structureandrivalry:theconditionsin
thenationgoverninghowcompaniesarecreated,
organized,andmanagedandthenatureofdomesticrivalry.

Relatedandsupportingindustries:thepresenceor
absenceinanationofsupplierindustriesorrelated
industriesthatarenationallycompetitive.

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PortersDiamond

FactorEndowments
Factorsofproduction:theinputsnecessaryto
competeinanyindustry
Basicfactorsnatural,capitalandlaborresources
(HeckscherOlin) arelargelyinherited
Advancedfactorssupportiveinfrastructure,
technology&communicationsystemsandan
educatedworkforce
Advancedfactorsleadtocompetitiveadvantage createdasa
resultofinvestmentbypeople,companies,government.
Porteralsomakesadistinctionbetween
Generalizedfactorscanbeusedinanumberofdifferentindustries
Specializedfactorstailoredforuseinspecificindustries

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FactorEndowments
Selectivedisadvantagesmayleadtoadvantagesin
factorsofproductionundercertainconditions
RelationshipofBasictoAdvancedFactors
Basiccanprovideaninitialadvantage.
Mustbesupportedbyadvancedfactorstomaintain
success.
Nobasics,thenmustinvestinadvancedfactors.

DeterminantsofNationalAdvantage
Demandconditions:characterizedbythenature
andsizeofbuyersneedsinthehomemarket
fortheindustrysgoodsorservices
Sizeofthemarketsegmentcanleadtoscale
efficientfacilities
Efficiencycanleadtodominationoftheindustry
inothercountries
Demandingconsumersmayleadtoefficient
product
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Relatedandsupportingindustries
Createsclustersofsupportingindustriesthatare
internationallycompetitive.

supportingservices,facilities,suppliersandso
on
Supportindesign
Supportindistribution
Relatedindustriesassuppliersandbuyers

Relatedandsupportingindustries
Supplyingindustriesinthehomebasehasseveral
advantagesindownstreamindustries
Efficient,early,rapid,andsometimespreferential
accesstothemostcosteffectiveinputs
Ongoingcoordination
Innovationandupgrading

Acompetitivedomesticsupplierindustryisbetter
thanrelyingonwellqualifiedforeignsuppliers

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Firmstrategy,structure,andrivalry
Onecountrydiffersfromanotherwithregardto
managerialsystemsandphilosophiesandwithregardto
capitalmarkets
Institutionalenvironmentsthatallowfirmstotakealong
termviewcontributepositivelytocompetitiveness
Presenceofalargenumberofcompetingfirmsorrivalsin
thedomesticindustry
Competitionamongfirmsisnecessaryforallocative efficiencyina
marketsystem,butdomesticrivalrycontributestodynamic,
technologicalefficiency

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PorterDiamondInteractions
MostimportantInteractionsallrelatedtorivalry
Domesticrivalsparticularlywhenclusteredina
geographicregioncontributetothecreationoffactors
Especiallyspecialized,advancedfactors

Agroupofdomesticrivalscontributetothepresenceof
specializedandsophisticatedsuppliers
Rivalryamongdomesticfirmsproducingdifferentiated
productsenlargeshomedemandandmakesitmore
sophisticated

Reinert/WindowsontheWorldEconomy,
2005

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SpatialClustersintheWorld
Economy
Flexibilityandhomebaseconceptsconvergeinspatial
clustering
Interlinkedfirms/activitiesthatexistinthesamelocalandregional
setting(intermsofeconomic,social,culturalandinstitutionalfactors)
AKAclusters,networks,centersofexcellence,andindustrialdistricts

FirstnoticedinSiliconValleyintheUnitedStates,inwhatis
nowknownastheThirdItaly,inSouthernGermany,andin
EastAsia
Muchproductiveknowledgecannotbecodifiedintoexplicit
forms
Rather,communicatedviaahighlysocialprocessoffacetoface
interactionoverarelativelylongperiodoftime
Consequently,innovationandlearningisaspatiallylocated,socialand
collectiveprocessamongagroupoffirms

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SpatialClustersintheWorld
Economy
Whydospatialclusterscontributetothe
productivityoffirms?
Concentratedcommunicationmadepossiblebya
clusterincreaseslearningandinnovation
Contributestothedynamic,technologicalefficiencyof
firmsinthecluster

Trustincreasesovertimewhichfacilitates
contractingandexchangeamongfirms
Commonbusinessculturedevelopswhichreduces
uncertainty
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EvaluatingPortersTheory
IfPorterisright,countryexportsshould
reflectthepresenceofthefourdiamond
components.Countrieswillimportgoods
fromindustrieswheresomeorallthe
componentsaremissing.
Toosoontotell.

ImplicationsforBusiness
Locationimplications:makessensetodisperse
productionactivitiestocountrieswheretheycanbe
performedmostefficiently.
Firstmoverimplications:Itpaystoinvest
substantialfinancialresourcesinbuildingafirst
mover,orearlymover,advantage.
Policyimplications:promotingfreetradeis
generallyinthebestinterestsofthehomecountry,
althoughnotalwaysinthebestinterestsofthefirm.
Eventhough,manyfirmspromoteopenmarkets.

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InternationalBusiness
Internationalbusinessconsistsofall
commercialtransactionsincludingsales,
investments,andtransportationthattake
placebetweentwoormorecountriesto
satisfytheprofitmotivesofindividuals,
companies,andorganizations

WhyfirmsengageinInternationalBusiness
ToExpandSales:pursuinginternationalsales
increasesthepotentialmarketandpotentialprofits
ToAcquireResources:maygivecompanieslower
costs,newandbetterproducts,additionaloperating
knowledge
ToDiversifyorReduceRisks:internationaloperations
mayreduceoperatingriskbysmoothingsalesand
profits,preventingcompetitorsfromgaining
advantage

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WhatsdifferentaboutInternational
Strategy
CorporateStrategy&InternationalStrategy
Heterogeneity
Scale
Volatility

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