INTERNATIONAL BUSINESS

MANAGEMENT (BUSI 1346)

REVISION TOPICS

International TradeExports and FDI

Revision Week 2Dr Michael Wynn-Williams, wm97@gre.ac.uk

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INTERNATIONAL TRADE

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DIFFERENT THEORIES OF INTERNATIONAL TRADE Mercantilism Adam Smith and Absolute Advantage Comparative Advantage The Heckscher-Ohlin Framework The Stolper-Sameulson Approach

Factor Price Equalization Theorem Rybzcysky’s approach Bhagwati and Immiserising Growth

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MERCANTALISM

The Concept: Trade is a zero sum game: one country gains at the expense of others Theory drove the economic expansion in the 17th /18th

centuries Britain, France, Holland, Spain, etc

Imperialism was also in line with naval power Anglo Dutch wars

The Limitations: De-industrialization, brain drain, adverse movement of

factors of production

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ADAM SMITH AND ABSOLUTE ADVANTAGE

Proponent: Adam Smith- both nations can gain from trade

The concept : Theory of Absolute Advantage suggests that countries should specialize in producing those commodities in which they have a absolute advantage The UK has an advantage in producing “scotch”, while

France has an advantage in “champagne”

Limitations: how to handle situations when the distribution of resources in not equitable. The difference between UK and France on one hand and UK

and Lesotho on the other hand

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COMPARATIVE ADVANTAGE

Proponent: Ricardo (1817)

The concept : two countries should trade based on specialization in the areas in which they have not an absolute but a comparative advantage

Limitations: again, how to handle extreme situations, predominantly one product economy?

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HECKSCHER-OHLIN APPROACH

Proponent: Heckscher & Ohlin

The concept : a nation will have a comparative advantage in the production of that good that uses its abundant factor intensively Tries to move beyond efficiency to factor

endowment Are abundant factors necessarily more efficient?

The case of Indian Labour

Limitations:very difficult to handle technical progress over a period of time, the definition of comparative advantage can change

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THE STOLPER SAMEULSON THEOREM

Proponent: W Stopler & Paul Samuelson (1941)

The concept : an increase in the price of the traded good will increase the return to the factor that is abundant in its use Opening of trade will change the ratio of returns

between scarce and abundant factors of production Even with factor immobility relative price of factors of

production will equalize across countries Free trade is a substitute for factor mobility. Capital Vs

Labour

Limitations: assumption that both markets are clearing mechanisms. Developing countries, institutional constraints and rent seeking behaviour…

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RYBZCYNSKI’S APPROACH Proponent: Tadeusz Rybczynski (1923-1998).

The concept :The Rybczynski theorem proposes that when the endowment of one of two factors of production is increased there is a relative increase in the production of the good using more of that factor. This leads to a corresponding decline in that good's relative price. In the context of the H/O model, open trade between

regions means changes in relative factor supplies between regions can lead to an adjustment in quantities and types of outputs between regions that would return the system toward equality of production input prices like wages across countries

Limitations: what about primitive capitalist accumulation, that prevents factors from receiving their full share?

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BHAGWATI’S IMMESERIZING GROWTH Proponent: Jagdish Bhagwati (1958)

The concept : increased trade under some circumstances can lead to reduced welfare. If only one country is growing then the TOT can turn adverse The role of FDI Shifting of capacity on account of environment The role of institutions/ are markets really clearing

mechanisms

Limitations: has not found too much favour with the WTO !

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THE THEORETICAL FOUNDATIONS OF IB

Theories In brief

Theory Involves--

factor endow efficiency pricesgains from

trade

Mercantilism Trade is a zero sum game no absolute no no

Adam Smith/ Absolute Advantage

trade will benefit if I have absolute advantage

yes absolute no no

Ricardo / Comp Advantage

trade will benefit if I have comparative advantage yes relative no yes

Heckscher Ohlin

country will have comparative advantage in good that uses abundant

factor

yes relative no yes

Stolper Sameuleson

Increase in price of traded good will increase returns to

factor used abundantlyyes relative yes yes

Rybzcynski

increase in factor endowment will increase production of that good

using that factor

yes relative yes yes

Bhagwatinot all trade is good,

sometimes it can lead to lower social welfare

no relative yes sometimes

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THE GAINS FROM TRADE The limits to specialisation and trade The terms of trade

The import purchasing power of exports: PX/PM

Other reasons for gains from trade decreasing costs differences in demand increased competition trade as an ‘engine of growth’ non-economic advantages

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PORTER 1990: THE COMP ADVANTAGE OF NATIONS A nation’s competitiveness depends on its capacity

to innovate Much of the innovation is mundane and incremental; :

but important

Competitiveness must be defined in terms of productivity Sustained productivity growth requires that the

economy must continuously re-invent itself

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THE NATIONAL “DIAMOND”

Factor Conditions

Demand Related Conditions & supp.

industries

Firm strategyStructure and rivalry

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GOVERNMENT AGENDA….

Focus on specialized factor creation

Avoid intervening in factor and currency markets

Enforce strict product safety and environmental standards

sharply limit direct cooperation between industry rivals

Promote goals that lead to sustained investment

De-regulate competition

Enforce strong domestic anti trust policy

Reject managed trade

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KEY QUESTIONS: INTERNATIONAL TRADE

What do nations gain through international trade?

To what degree do different trade theories encourage nations to specialise in particular industries?

What are the advantages of industrial specialisation?

What are the disadvantages of industrial specialisation?

EXPORTS &FOREIGN DIRECT

INVESTMENT

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MODES OF FOREIGN ENTRY

Strategic alliances, equity, non-equity (Microsoft Windows and Vodafone)

Franchising (Pizza Hut)

Licensing (Pharma, SKB)

Exports, direct or indirect

FDI FDI- 100% ownership FDI < 100%, JV, different types [26%]

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PATTERNS OF FDI Product Life Cycle theory

Move overseas to low-labour cost region during the mature and decline phases

Uppsala stage theoryIncremental approachDepends on “psychic distance”

Strategic compulsionTaking the fight to the opposition’s

homelandSqueezed out of home market – Chrysler Following a rival’s lead – eg. Ford-Volvo,

GM-SaabSearch for foreign currency

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DECISION FRAMEWORK FOR FDI

Transportation costs and import barriers high?

Product as source of the competitive advantage?

Process as source of the competitive advantage?

Management as source of the competitive advantage?

Brownfield FDI

Greenfield FDI

Joint venture FDI

ExportNo

Yes

Yes

Yes

No

No

Yes

UPPSALA STAGE THEORY The strategic theory of FDI acknowledges that

corporate culture has a role Corporate culture can be understood through

behavioural theories The Uppsala Stage Theory illustrates the

manner in which companies progressively explore FDI Stage Commitment

Stage 1 No regular exportNo product adaptation

Stage 2 Exports through agentsSome superficial product adaptation

Stage 3 Overseas sales subsidiariesProduct structurally adapted to local market

Stage 4 Overseas productionLocal design, some reverse imports

CRITICISMS OF STAGE THEORIES They present a rather facile view of FDI – all

business expansions are incremental Stage theories lack sophistication – they do

not detail the mode of entry Operating from an established domestic base,

companies can enter a new market with a mode of entry based on their strongest asset Product led entry – a unique product, a high

technology product etc. Process led entry – production technology,

managerial talent, economies of scale

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FORMS OF EXPORTING Export Activity may take the following

formDirect exporting

Australian Apples Indirect exporting

Using an intermediary in the home country Arms trade (China-Pakistan-Palestine)

Inter corporate transfers Strategic trade Ford diesel engines Japanese reverse imports (imports from foreign

subsidiaries)

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Alternate modes of entry

Ownership Control

100%

Rolex Heinz

0% ? KFC Franchisee

100% Exports 100% Local

Exports Vs Local Production

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TYPES OF FDI Forms of FDI

Purchase of existing assets (brownfield) Quick entry Local market knowledge Eliminate competitor

New Investment (greenfield) No inherited problems Assurance of process quality Brand equity transference

Participation in an international joint venture Shared ownership Swift access to economies of scale Build on local knowledge and culture

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FOREIGN DIRECT INVESTMENT

First articulated by Stephen Hymer FDI happens when a firm invests directly in

facilities in a foreign country – implies a net capital increase in the country

The investing firm has control The commitment is relatively “long-term” A firm that engages in FDI becomes a multi

national enterprise Factors influencing FDI are strongly

correlated with factors influencing Trade eg. exploiting comparative advantage

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CHOOSING A MODE OF ENTRY Dunning’s eclectic OLI theory – FDI

when all the following are in placeOwnership advantages

Ownership of assets IPR Competitive advantage in the product

Location advantages Host country’s production facilities Local factor endowments Competitive advantage in the process

Internalisation advantages The minimisation of transaction costs Avoids dangers of opportunism Competitive advantage in management

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KEY QUESTIONS: EXPORTING AND FDI

Why do firms explore opportunities in overseas markets?

How would a firm choose to first explore overseas markets?

Given that a firm may export 100% or produce locally 100%, and may choose to retain 100% ownership or 0% ownership, give examples of four companies that are pursuing different ownership/export strategies?

What other means are there for entering overseas markets?

For each mode of entry, what are the related risks?