section one: the nature of international business

Busi zionali 3 Affaires Internationales عمل دوليّة negócios internacionales Παγκοσμιο 國際事務 InternationalesGeschäft مل دوليّة zionali Bu международ GliAffa 事務 Los negóci Intern عمل διεθνής ä ft Business Παγκο Aff cionales Ый бизнес 國際事務 Busine section one: the nature of international business Chapter Three Theories of International Trade and Investment Chapter 3: Theories of International Trade & Investment

Chapter Objectives • Understand the theories of international trade. • Comprehend the arguments of imposing trade restrictions. • Explain the two basic kinds of import restrictions. • Appreciate the relevance of the changing status of tariff and non tariff barriers. • Recognize the weaknesses of GNP/capita as an economic indicator. • Understand the new definition of economic development. • Understand why governments change from import substitution to export promotion. • Explain some of the theories of foreign direct investment. Chapter 3: Theories of International Trade & Investment

International Trade Theory • Mercantilism • Believed nation’s welfare was in accumulation of stock of precious metals. • Trade surplus created by import restrictions and government subsidies to exporters. • Mercantilist era ended in 1700s. Chapter 3: Theories of International Trade & Investment

Modern Day Mercantilism • Economic Nationalism • Industrial policy based on state intervention • France nationalized key industries and banks to use the power of the state as • Stockholder and financier • Customer and marketer to revitalize the nation’s base • In 1986, little growth and high unemployment led government to reverse “mercantilist” policy • Japan called “fortress of mercantilism” by some • Nearly impenetrable market • Effort to maintain a cheap yen Chapter 3: Theories of International Trade & Investment

Theory of Absolute Advantage • “The capacity of one nation to produce more of a good with the same amount of input than another country.” • Adam Smith • Each nation should specialize in producing goods it could produce most efficiently • In absolute advantage, both nations would gain from trade. • Assumptions • Perfect competition and no transportation costs in a world of two countries and two products Chapter 3: Theories of International Trade & Investment

Theory of Comparative Advantage • “A nation having absolute disadvantages in the production of two goods compared to another nation, • has a comparative advantage in producing the good in which its absolute disadvantage is less.” • Theory of comparative advantage demonstrated by Ricardo in 1817. Chapter 3: Theories of International Trade & Investment

Production Possibility Frontiers • The following two graphs illustrate Chinese and U.S. production possibility frontiers using constant cost for simplicity. • These curves, in the absence of trade, also illustrate the possible combinations of goods for consumption. Chapter 3: Theories of International Trade & Investment

Offshoring Service Jobs to India • Approximately 1 Billion people • Comparative advantage in production of goods or services that require large amounts of labor • Citizens speak English • Low labor costs due to large workforce • Internet and telephone communications much less expensive • Industries offshoring include software engineering, telemarketing, banking, medical services, claims processing, IT jobs, financial services, insurance • Jobs created overseas generate jobs at home Chapter 3: Theories of International Trade & Investment

States that international and interregional differences in production costs occur because of differences in the supply of production factors. Therefore, Assumptions The price of factors depend only on the factor endowment. Given technology is universally available. Heckscher-Ohlin Theory of Factor Endowment Chapter 3: Theories of International Trade & Investment

Leontief Paradox • Study in 1953 by economist Wassily Leontief disputed the usefulness of the Heckscher-Ohlin Theory as a predictor of the direction of trade. • Found that the U.S., one of the most capital-intensive countries in the world, was exporting labor intensive products. Chapter 3: Theories of International Trade & Investment

Effect of Money on Trade • Exchange Rate • The price of one country’s currency stated in terms of the other. • Influence of Exchange Rates • European companies pressured to increase prices of exports to maintain Euro profits • Currency devaluation Chapter 3: Theories of International Trade & Investment

Economies of Scale and the Experience Curve As output increases cost per unit decreases Larger and more efficient equipment Volume discounts Fixed cost allocation Drop in learning curve First Mover Theory Gain market share Discourage foreign entrants The Linder Theory of Overlapping Demand Customers’ tastes determined by income levels Trade greater between nations with similar per capital incomes Newer Explanations of the Direction of Trade Chapter 3: Theories of International Trade & Investment

International Product Life Cycle (IPLC) • Four stages of the IPLC in the U.S. • U.S. exports • Foreign production begins • Foreign competition in export markets • Import competition in the U.S Chapter 3: Theories of International Trade & Investment

Exports Foreign production Foreign competition Import competition Stages of the International Product Life Cycle Chapter 3: Theories of International Trade & Investment

International Technology Life Cycle • Initial Stage • Development of new technology in an industrialized country • Subsequently exported to other developed countries • Increasing cost of labor make it no longer profitable to use in developed nation • Technology exported to developing nation • Technology produced abroad for domestic consumption Chapter 3: Theories of International Trade & Investment

Porter’s Competitive Advantage of Nations • Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage. • Demand conditions • Factor conditions • Related and supporting industries • Firm strategy, structure, rivalry Chapter 3: Theories of International Trade & Investment

Demand Conditions Nature of domestic demand. Factor Conditions Level and consumption of factors of production Lack of natural endowments has caused nations to invest in the creation of advanced factors Related and supporting industries Suppliers and industry support services tend to form a cluster in a given location Firm Strategy, Structure, Rivalry Extent of domestic competition, The existence of barriers to entry The firm’s management style and organization. Porter’s Competitive Advantage of Nations Chapter 3: Theories of International Trade & Investment

Trade Restrictions • Arguments for • National Defense • Sanctions to Punish Offending Nations • Protect Infant or Dying Industry Chapter 3: Theories of International Trade & Investment

Trade Restrictions • Arguments for • Protect Domestic Jobs from Cheap Foreign Labor • Scientific Tariff or Fair Competition • Retaliation Chapter 3: Theories of International Trade & Investment

Other Reasons for Retaliation • Dumping is the selling of a product abroad for less than • The average cost of production in the exporting nation • The market price in the exporting nation • The price to third countries • Result of • Excess production • Cyclical or seasonal factors • Attempt to force domestic producers out of business Chapter 3: Theories of International Trade & Investment

Sanctions Justified • Dumping for which sanctions are considered justified • Social dumping • Lower labor costs and poorer working conditions • Environmental dumping • Lax environmental standards • Financial services dumping • Low requirements for bank capital/asset ratios • Cultural dumping • Cultural barriers aid local firms • Tax dumping • Differences in corporate tax rates or special breaks Chapter 3: Theories of International Trade & Investment

Other Reasons for Retaliation • Subsidies • Government provides to domestic firm to encourage exports or protect from imports • Can be • Cash payment • Government participation in ownership • Low-cost loans • Preferential tax treatment • Countervailing Duties • Set by importing nation to offset effects of subsidy • Equal to the subsidy amount Chapter 3: Theories of International Trade & Investment

Ad Valorem Percentage of invoice value Specific Fixed sum of money per unit Compound duty Combination of the above Official Prices Minimum import duty regardless of invoice price Variable Levy Calculated daily based on world market price Lower Duties for Local Input Encourages some local production Types of Restrictions - Tariffs Chapter 3: Theories of International Trade & Investment

Types of Restrictions - Nontariff • Quantitative • Quotas • Voluntary Export Restraints • Orderly Marketing Arrangements • Nonquantitative Nontariff • Direct government participation in trade • Customs and other administrative procedures • Government and private standards Chapter 3: Theories of International Trade & Investment

Levels of Economic Development • Developed • Classification for all industrialized nations, which are mostly technologically developed. • Developing • Classification for world’s lower income nations, which are less technically developed. • Newly Industrialzing Countries (NICs) • Fast-growing, middle-income or higher economies • Heavy concentration of foreign investment • Exported large quantities of manufactured goods, including high-tech products Chapter 3: Theories of International Trade & Investment

Levels of Economic Development • Newly Industrialized Economies (NIEs) • Primarily used to refer to the four tigers • Taiwan, Hong Kong, Singapore, South Korea • IMF combines NIEs with Industrialized Nations to form “advanced economies • Emerging Market Economies • Chile, Malaysia, China, Thailand, Indonesia • Transition Countries or Eastern Europe • Former communist countries Chapter 3: Theories of International Trade & Investment

The World Bank Classification System • Based on GNP/capita • Low income($735 or less) • Lower middle income($736 - $2935) • Upper middle income($2,936 - $9,075) • High income($9,076 or more) Chapter 3: Theories of International Trade & Investment

GNP/Capita as an Indicator • Concerns • GNP/Capital data does not include Underground Economy • Currency conversion Chapter 3: Theories of International Trade & Investment

GNP/capital less than $9,075 Unequal distribution of income Technological dualism Regional dualism Majority of population working in agricultural sector Disguised unemployment or underemployment High population growth High rate of illiteracy and insufficient educational facilities Widespread malnutrition and health problems Political instability High dependence on a few products Inhospitable topography Low savings rates and inadequate banking facilities Characteristics of Developing Nations Chapter 3: Theories of International Trade & Investment

Human Needs Approach to Economic Development • Economic development: • the reduction of poverty, unemployment, and inequality in the distribution of income. • Human Development Index (HDI) based on • A long and healthy life • Ability to acquire knowledge • Access to resources for a decent standard of living • Measured by life expectancy, adult literacy, and GDP/capita adjusted for PPP Chapter 3: Theories of International Trade & Investment

Development Theory • No generally accepted theory • Economists concentrating on • Population growth • Income distribution • Unemployment • Transfer of technology • Role of government • Investment in human capital Chapter 3: Theories of International Trade & Investment

Contemporary Theories of FDI • Monopolistic Advantage Theory • Product and Factor Market Imperfections • International Product Life Cycle • Other Theories • Follow-the-leader theory • Cross investment • Internalization theory • Theory of International production Chapter 3: Theories of International Trade & Investment

section one: the nature of international business