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The Theory of Trade and Investment
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Learning ObjectivesTo understand the traditional arguments of how and why international trade improves the welfare of all countriesTo review the history and compare the implications of trade theory from the original work of Adam Smith to the contemporary theories of Michael PorterTo examine the criticisms of classical trade theory and examine alternative viewpoints of which business and economic forces determine trade patterns between countriesTo explore the similarities and distinctions between international trade and international investment
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Evolution of Trade TheoryThe Age of MercantilismClassical Trade TheoryFactor Proportions Trade TheoryInternational Investment and Product Cycle TheoryThe New Trade Theory: Strategic TradeThe Theory of International Investment
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Mercantilism
Mixed exchange through trade with accumulation of wealthConducted under authority of governmentDemise of mercantilism inevitable
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Classical Trade TheoryThe Theory of Absolute Advantage
The ability of a country to produce a product with fewer inputs than another country
The Theory of Comparative Advantage
The notion that although a country may produce both products more cheaply than another country, it is relatively better at producing one product than the other
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Classical Trade Theory Contributions
Adam Smith—Division of LaborIndustrial societies increase output using same labor-hours as pre-industrial society
David Ricardo—Comparative Advantage
Countries with no obvious reason for trade can specialize in production, and trade for products they do not produce
Gains From TradeA nation can achieve consumption levels beyond what it could produce by itself
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Factor Proportions Trade Theory
Developed by Eli HeckscherDeveloped by Eli Heckscher
Expanded by Bertil OhlinExpanded by Bertil Ohlin
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Factor Proportions Trade TheoryConsiders Two Factors of Production
Labor
Capital
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Factor Proportions Trade Theory
A country that is relatively labor abundant (capital abundant) should specialize in the production and export of that product which is relatively labor intensive (capital intensive).
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Overlapping Product Ranges Theory:Staffan Burenstam Linder
Trade in manufactured goods dictated not by cost concerns, but by similarity in product demands across countries (overlapping product demands).
Work focused on preferences of consumer demand.
Today, product ranges termed market segments.
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Product Cycle Theory
Raymond Vernon
Focus on the product, not its factor proportions
Two technology-based premises
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Product Cycle Theory:Vernon’s Premises
Technical innovations leading to new and profitable products require large quantities of capital and skilled labor
The product and the methods for manufacture go through three stages of maturation, with competitive advantage shifting each time
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Stages of the Product Cycle
The New Product•Flexible production•Innovator Monopoly•concentration
The Maturing Product•Intl market & competition•More standardized production
The Standardized Product•Low-margin cost-based production•Highly competitive
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The Product Cycle and Trade Implications
Increased emphasis on technology’s impact on product cost
Explained international investment
LimitationsMost appropriate for technology-based productsSome products not easily characterized by stages of maturityMost relevant to products produced through mass production
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The New Trade Theory: Strategic Trade
Two New ContributionsPaul Krugman-How trade is altered when markets are not perfectly competitive
Michael Porter-Examined competitiveness of industries on a global basis
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Strategic Trade
Krugman’s Economics of Scale:
Internal Economies of ScaleInternal Economies of Scale
External Economies of ScaleExternal Economies of Scale
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Intra-Industry Trade
Trade within a market segmentProduct differentiationReciprocal dumping
Index of Intra-Industry Trade
comparative adv. (0) to fully intra-industry (1)
MX
MXIIT
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Strategic Trade
Can Government shift the balance in Imperfect
Competition?
PricePrice CostCost
RepetitionRepetition ExternalitiesExternalities
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Strategic TradePorter’s Diamond of National AdvantageInnovation is what drives and sustains competitivenessFour components of competition
Factor ConditionsDemand ConditionsRelated and Supporting IndustriesFirm Strategy, Structure, and Rivalry
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Michael Porter’s Competitive Clusters
Critical masses of unusual competitive success in particular fields, located in one place
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The Theory of International Investment
The movement of capital has allowed foreign direct investments across the globe
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The Theory of International Investment
Firms as Seekers Seeking ResourcesSeeking Factor AdvantagesSeeking KnowledgeSeeking SecuritySeeking Markets
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The Theory of International Investment
Firms as Exploiters of ImperfectionsImperfections in AccessImperfections in Factor MobilityImperfections in Management
Firms as InternalizersEstablish their own multinational operations-internalize productionCompetitive advantage due to confidentiality
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Conclusion
What can trade flows tell us about country advantage?
What can country advantage tell us about doing business in that country?