Chap 003 Ppt 445

8/3/2019 Chap 003 Ppt 445

http://slidepdf.com/reader/full/chap-003-ppt-445 1/25

Theories of InternationalTheories of InternationalTrade and InvestmentTrade and Investment

Chapter Three

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

8/3/2019 Chap 003 Ppt 445


1-2

3-2

Review of Chapter 2Review of Chapter 2

Last week we discussed two primary waysof trading internationally…what are they?

Business can supply foreign marketsthrough both exporting and actually

manufacturing in them Where does trade take place

(developed v.s developing countries)? What are the seven global dimensions for

globalization “standardization”?

8/3/2019 Chap 003 Ppt 445


1-3

3-3

Learning ObjectivesLearning Objectives

Understand the theories that explain why certaingoods are traded internationally

Mercantilism

Theory of Absolute Advantage (Adam Smith)

Theory of Competitive Advantage (David Ricardo)

Theory of Factor Endowment (Heckscher-Ohlin)

International Product Life Cycle (Ray Vernon)

National Competitiveness (Michael Porter)

8/3/2019 Chap 003 Ppt 445


1-4

3-4

Learning ObjectivesLearning Objectives

Understand the various explanations for tradedirection shifts……

Economies of scale, learning curve, Imperfectcompetition, First-mover theory, Linder theory &technological life cycle

8/3/2019 Chap 003 Ppt 445


1-5

3-5

Theories of InternationalTheories of InternationalTrade/InvestmentTrade/Investment

Business managers MUST have agood understanding of “economictheory” to understand a nation’seconomic development strategy

-what are the beliefs and education of thegovernment’s economic planners

-Watch/listen to their actions/speeches

- Be Proactive: based on your understandingof the nations leaders

8/3/2019 Chap 003 Ppt 445


1-6

3-6

Some ExamplesSome Examples The Japanese Government has traditionally spent trillions of

Yen to push the Yen down vis-à-vis the US $ and the Euro.They keep the Yen artificially weak to reduce competitivepressures from Europe and USA..Hence, they can exportmore and import less

China has resisted all efforts to revalue their currency (Yuan).They simply have not allowed the Yuan to appreciate in

value, thus making/helping Chinese companies have strongcost-competitiveness.

-China has strong economic growth

- China has a large trade surplus Argentina pegged the Peso years ago to the US$. Financial

stability ensued but exports were too costly-recessionoccurred…. In 2002 they stopped the peg and devalued thePeso ( 1 US$ to .27cents) Imports were costly but exportsstarted to grow!

8/3/2019 Chap 003 Ppt 445


1-7

3-7

Consider also the Free-MarketConsider also the Free-Marketreforms in Chile………..reforms in Chile………..

Salvador Allende: President 1970-1973 Military coup(September) the economy was in shambles

-Inflation>1000% annually

-High national debt

-Government highly involved in economy

- high duties on imports- huge subsides to select industries New Government: Selected Group of New Economist from

the University of Chicago “The Chicago Boys” were freemarket advocates( influenced by Milton Friedman

“Chicago Boys” proposed programs based on the Theory of Comparative Advantage which immediately reduced importduties to 10% from 1000%. All other import barriers werecompletely eliminated. Capital equipment could now beimported which encouraged “business investment”

8/3/2019 Chap 003 Ppt 445


1-8

3-8

Continued…..Continued….. Select companies lost subsidy protection

Bottom line: A “big” correction in the economy andindustries followed

1. -Appliance Industry almost disappeared

2. -The electronics industry basically vanished

3. -Automobile Assembly plants closed

Those are products we should import. We have better opportunities for products based on our farm products, our timberlands, our fisheries and other natural resources thatwe should be making because they give us a “naturaladvantage” over other countries

It took time but by 2006 Annual growth >6% Inflation lowered and standard of living increased Chile has signed free trade arrangements with several

nations and the E.U, Mercosur, The USA and Canada Their Free market is now flourishing!!!!

8/3/2019 Chap 003 Ppt 445


1-9

3-9

To sum up…..To sum up…..

In Chile, prudent economic Policymaking has secured long termstability in a once very unstable

country! The Keystone of many countries

economic policies is “the law of comparative advantage”

8/3/2019 Chap 003 Ppt 445


1-10

3-10

International Trade Theory:International Trade Theory:MercantilismMercantilism

A nation’s wealth depends on accumulated treasure,usually gold A country that has no gold must import it

To increase wealth, government policies shouldpromote exports and discourage imports Importation of gold depends on exports of goods Importation of other goods tightly controlled

Economic competition is a “zero sum game”: if

country advances economically, another loses

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-11

3-11

Theory of Absolute Advantage:Theory of Absolute Advantage:Adam Smith (1723-1790)Adam Smith (1723-1790)

Market forces, not government controls, determinethe direction, volume and composition of internationaltrade

A country will export goods in which it has an

absolute advantage over other countries To have an absolute advantage a country must beable to produce a larger amount of a good or service for the same

amount of inputs as can another country

the same amount of a good or service using fewer inputs than can another country In classic economics a “unit of input” is measured in:

land, labor, capitalLO1LO1

8/3/2019 Chap 003 Ppt 445


1-12

3-12

Theory of Comparative Advantage:Theory of Comparative Advantage:David Ricardo 1817David Ricardo 1817

A nation may have absolute disadvantages in theproduction of two goods with respect to another nation

Yet this nation has a comparative advantage or relative advantage in the production of the good inwhich its absolute disadvantage is lower

By specializing in the production of the good inwhich the country has lower comparative

disadvantage, and importing other goods, the totalgoods available will increase

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-13

3-13

Comparative Advantage andComparative Advantage and“offshoring” of service jobs“offshoring” of service jobs

India has a comparative advantage in production of goods &

services requiring large amounts of labor and relatively littlecapital

Good opportunities to reduce cost in specific industries by“offshoring” parts of these service industries

INDIAINDIA1 billion people1 billion people

Citizens who speakCitizens who speakEnglishEnglish

Indian IT industryIndian IT industryIs growing rapidly!Is growing rapidly!

Tax, Financial services,Tax, Financial services,

Insurance, telemarketingInsurance, telemarketing

8/3/2019 Chap 003 Ppt 445


1-14

3-14

Heckscher-Ohlin TheoryHeckscher-Ohlin Theoryof Factor Endowmentsof Factor Endowments

Countries export products requiring large amounts of their abundant production factors Lower cost to produce; more attractive abroad Imported products have low relative cost as

producing locally would require large amounts of the importing country’s scarce production factors

For example….

--India: Has a large labor force (1 billion)

so they should concentrate on labor intensive goods.

--Germany: Has more capital than labor so they should concentrate on capital

intensive goods.

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-15

3-15

Heckscher-Ohlin TheoryHeckscher-Ohlin Theoryof Factor Endowmentsof Factor Endowments

Leontief Paradox- the US was one of the mostcapital-intensive countries in the world, wasexporting relatively labor-intensive products inexchange for relatively capital-intensive products

Differences in Taste

- A demand- side construct that is always difficult todeal with in economic theory

-Transportation cost can be toohigh

-Training skilled workers is critical- Some consumers simply will buyexpensive items (cars..perfumes..ect)

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-16

3-16

Currency Exchange Rates InfluenceCurrency Exchange Rates InfluenceThe Direction of TradeThe Direction of Trade

LO1LO1

Goods are valued in the currency of the country inwhich they are produced

An importer in another country must use theprevailing exchange rates to price the product about

to be imported The relative purchasing power of currencies is not

always reflected in official exchange rates Government policy can give an advantage to one

currency over another to induce exports

8/3/2019 Chap 003 Ppt 445


1-17

3-17

Some Newer ExplanationsSome Newer ExplanationsFor The Direction Of TradeFor The Direction Of Trade

1. International Product Life Cycle (IPLC) Most new products initially conceived and produced

in the U.S. in 20th century U.S. firms kept production close to the market

Aids decisions and minimizes risk of newproduct introductions

Demand not based on price yet so lowproduction cost not an issue

Limited initial demand in other advanced countries Initially, exports to these markets more

attractive than production

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-18

3-18

Some Newer ExplanationsSome Newer ExplanationsFor The Direction Of TradeFor The Direction Of Trade

With demand increase in advanced countriesProduction follows there from the U.S.

With demand expansion elsewhere

Product becomes standardizedProduction moves to low production cost areasProduct now imported to U.S. and to advanced

countries

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-19

3-19

International Product Life CycleInternational Product Life Cycle

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-20

3-20

Newer ExplanationsNewer ExplanationsFor The Direction Of TradeFor The Direction Of Trade

2. Linder Theory of Overlapping Demand Customers’ tastes are strongly affected by income levels

Income per capita determines the kinds of goods indemand

3. Technology Life Cycle Production technology application of the IPLC

Distinguishes between new products and newtechnologies used in the production of products

Technology follows the IPLC pattern

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-21

3-21


4. Economies of Scale and Learning Curve Economies of scale: as a plant gets larger, output

increases, per unit production cost decreases Learning curve: as firms produce more products, they

learn ways to improve production efficiency further

reducing costs A nation’s industries are now low cost producers andexporters

5. Imperfect Competition--Paul Krugman Economies of scale together with differentiated products

induces intraindustry foreign trade

6. First-Mover Theory Pattern of trade in goods subject to scale economies is

determined by historical factors that induce first movers

LO1LO1

8/3/2019 Chap 003 Ppt 445


1-22

3-22


7. National Competitive Advantage

Porter’s Diamond Model

National Competitiveness: a nation’s relative

ability to design, produce, distribute, or serviceproducts while earning increasing returns onresources

Four variables: factor endowments, demandconditions, related and supporting industries, andfirm strategy, structure, and rivalry

8/3/2019 Chap 003 Ppt 445


1-23

3-23


Factor endowments

land, labor, capital, workforce, infrastructure

Demand conditions

large, sophisticated domestic consumer base: offers an

innovation friendly environment and a testing ground Related and supporting industries

local suppliers cluster around producers and add toinnovation

Firm strategy, structure, rivalry

competition good

national governments can create conditions whichfacilitate and nurture such condition

8/3/2019 Chap 003 Ppt 445


1-24

3-24

Variables Impacting CompetitiveVariables Impacting CompetitiveAdvantage: Porter’s DiamondAdvantage: 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. LO1LO1

8/3/2019 Chap 003 Ppt 445


1-25

3-25

Synopsis: Trade TheorySynopsis: Trade Theory

Trade among countries results from relative pricedifferences that stem from different production costs Different production costs come from differences inEndowments of factors of production Levels of technology that determine the factor

intensities usedEfficiencies with which factor intensities are used Foreign exchange rates

Differences in tastes can reverse the direction of tradepredicted by theory

Nations attain a higher quality of life by specializing inthose products for which they have a comparativeadvantage and by importing the rest

Trade restrictions harm a nation’s welfare in the LRLO1LO1

Documents

Chap 003 Ppt 445