The International Business Context

1. The International Business Context Mikkeli 2005 Compiled by Rulzion Rattray

2. International Business • Business activity that involves the transfer of resources across national boundaries. • International Trade occurs when a firm exports goods or services to buyers in another country. • International Business results from domestic business for market, economic or strategic motives

3. International Trade Theories • Mercantilism: • Mid 16th Century. Governments have 2 goals. • Increase national wealth by acquiring gold • Extract trade gains from foreign countries through regulation and control • Gold useful to hire mercenary armies • Limitations: • More gold higher local prices raising price of exports • Overlooks other sources of wealth, quantity of capital, skill or workforce, natural resources

4. Absolute AdvantageAdam Smith 1776 • Adam Smith suggested that countries could benefit from specialising in goods that they had an absolute advantage in (and trading any surpluses of them). • Absolute advantage - ability to produce those products at the lowest resource cost (less capital and labour) than other countries. • Countries should specialise where they have absolute advantage. • What if they don’t have any?

5. Comparative Advantage • Ricardo in 1817: • even if country has an absolute advantage in all goods it is still beneficial to specialise in the good in which it has the largest absolute advantage - Ie in which it has a comparative advantage. • Example: ________________________________________ Country Output CDS Output Videos ________________________________________ A 2,000 800 B 1,000 200 ________________________________________ Country A has an absolute advantage in both products (greater output for same resource) but a comparative advantage in videos: A is twice as efficient as B in CDs but four times as efficient as B in videos.

6. Comparative Advantage • Likewise, B has an absolute disadvantage in both products but a comparative advantage in CDs: B is only one quarter as efficient as A in videos it is only one half as efficient as A in CDs. B should therefore specialise in CDs and trade these for videos that A produces. • Can look at same comparative advantage idea in terms of OPPORTUNITY COST. • In Country A the production of an extra video has an opportunity cost of 2.5 CDs whereas for Country B the production of an extra video has an opportunity cost of 5 CDs. So, A has lower opportunity cost in videos than country B (and therefore has a comparative advantage in video production). • What is the opportunity cost for A and B of producing an extra CD?

7. Comparative Advantage • Answer:- • B has a lower opportunity cost (comparative advantage) in CD production.

8. Factor Endowment Theory (aka Heckscher-Ohlin [HO] theory). • Sources of Comparative and Competitive Advantage • HO suggest that those countries with an abundance of certain types of factor will be able to produce products which embody those abundant factors relatively more cheaply than other, less well endowed, countries. Simple, labour abundant countries export labour intensive products. Capital abundant countries export capital intensive products. • Nice idea! but little supporting empirical evidence for this being the major cause of patterns of trade!! E.g similar Factor endowed economies exporting to each other similar goods (Eg. Cars around Europe).

9. International Product Life Cycle(IPLC) - Vernon Domestic Consumption Exports Quantity Domestic Production Imports Product Cycle B C O A Growth Product New Product Mature Product Adapted from:Vernon, R. (1966), “International investment & international trade in the product life cycle,” Quarterly Journal of Economics, May, pp. 190-207.

10. Types of Trade Flow Inter-Industry Trade: where a country exports products which are fundamentally different in type from those that it imports. • Intra-Industry Trade: where a country exports certain items from a given product range while at the same time importing other items from the same product range. Example, UK exports cars to Germany and imports cars from Germany. Note - factor endowment theory often used to explain inter-industry trade whereas intra-industry trade needs to be explained with other theories such as International Product Life Cycle.

11. Critics of Free Trade • Drawbacks may not result in full benefit. • Assumes full employment domestic output may fall leading to unemployment. Welfare loss may be more than gain. • Also fails to asses how the gains will be distributed. Arguing in practice gains more likely to go the more powerful economy.

12. References • Griffiths, A., and Wall, S., (Eds), (1999), “Applied Economics”, Prentice Hall. • Heckscher, E. (1949), "The Effects of foreign trade on the distribution of income", reprinted in Ellis, H. & L., Metzler (eds), (1949) "Readings in the The Theory of International Trade", Homewood, IL: Irwin, Cited in Shenkar, O. and Luo, Y.(2004), International Business, John Wiley and Sons, Inc. pp 20. • Ohlin, B., (1933) International & Inter regional Trade, Cambridge, MA: Harvard Economic Studies, revised edition, 1967. Cited in Shenkar, O. and Luo, Y.(2004), International Business, John Wiley and Sons, Inc. pp 20. • Shenkar, O. and Luo, Y.(2004), “International Business”, John Wiley and Sons, Inc. • Tayeb, M., (2000), “International Management; Theories and Practice”, Prentice Hall.