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					                       International Business
               Oded Shenkar and Yadong Luo


                                       Chapter 2

                   International Trade Theory and
                             Application



Chapter 2: International Trade Theory and Application
                                 Do You Know?

       • What are the major theories of
         international trade?
       • How do governments limit trade with
         other countries, and what are their
         reasons for doing so?
       • How do different technological levels
         define a country’s trade relationships?
       • Why do countries with similar levels of
         technology trade more than countries
         with disparate technology levels?
Chapter 2: International Trade Theory and Application
                International Trade Theories

       • International trade is the exchange of
         goods and services across borders.
       • Export structures vary across countries.
       • A number of international trade theories
         can explain these different structures.




Chapter 2: International Trade Theory and Application
                    The Mercantilist Doctrine
       • Mercantilism is a 16th Century doctrine
         stating that a nation should export more
         goods that it imports.
       • Government’s job is to create policy that
         promotes heavy exportation, collection of
         revenue, and industrial development
         internally.
       • In practice, it serves to make the State the
         stockholder, financier, customer, marketer,
         collector, and enforcer of contracts with
         other nations.

Chapter 2: International Trade Theory and Application
                Absolute Advantage Theory

       • In 1776, Adam Smith proposed that
         market forces rather than government
         desires were a better predictor of
         trade.
       • Laissez-Faire policy where
         government has no influence should
         promote trade better.
       • Nations will export to pay for goods
         they import.
Chapter 2: International Trade Theory and Application
                Absolute Advantage Theory

       • Nations could specialize in producing
         and exporting goods where they have
         a natural or acquired Absolute
         Advantage and import those goods
         they don’t produce as well.

       Exhibit 2-1: Labor hours required to product one unit of
       a good.




Chapter 2: International Trade Theory and Application
            Comparative Advantage Theory

       • David Ricardo indicated in 1817 there may
         be a better explanation since few States
         actually specialize like that.
       • Ricardo indicated that nations that are
         comparatively more efficient at production
         will make those goods even though they
         may not have an absolute advantage.
       • Comparative Advantage explains and
         predicts trade of goods where absolute
         advantages may not exist.

Chapter 2: International Trade Theory and Application
            Comparative Advantage Theory
       • Opportunity Cost – the amount of other goods
         which have to be given up to product one unit of a
         good.

  Exhibit 2-2: Labor hours required to produce one unit of a good.




   Exhibit 2-3: Opportunity costs for producing wine and cloth.




Chapter 2: International Trade Theory and Application
            Comparative Advantage Theory

       • Comparative Advantage must be
         explained by:
             – Comparative Production Cost – depends
               on the commodity’s production process.
             – Production Factors – such as labor, land,
               capital, and natural resources.




Chapter 2: International Trade Theory and Application
                  Heckscher-Ohlin Theorem

       • Countries export goods that make
         intensive use of the country’s abundant
         factor.
       • Countries import goods that make
         intensive use of the country’s scarce
         factor.
       • Differences in comparative advantage
         are attributed to differences in the
         structure of the economy.

Chapter 2: International Trade Theory and Application
                  Heckscher-Ohlin Theorem

       • Assumptions:
             – Countries vary in the availability of various
               factors of production.
             – The Production Function is identical
               anywhere in the world.
                  • The amount of output produced by using any
                    given amount of capital and labor.
             – Technology is constant in all trading
               countries.
             – Conditions of demand for production
               factors are the same in all countries.

Chapter 2: International Trade Theory and Application
                  Heckscher-Ohlin Theorem

       • Implications
             – Trade should be greatest between
               countries with the greatest differences in
               economic structure.
             – Trade should cause countries to specialize
               more.
             – Trade policy should take the form of trade
               restrictions.
             – Countries should export goods that make
               use of the abundant factors.

Chapter 2: International Trade Theory and Application
                  Heckscher-Ohlin Theorem

       • Implications
             – Free trade should equalize factor prices
               between countries with similar relative
               factor endowments.
             – Factor prices should be nearly equal
               between countries with more liberal mutual
               trade.
             – International investment should be
               stimulated by difference in factor
               endowments.

Chapter 2: International Trade Theory and Application
                         The Leontief Paradox

       • Leontief challenges Heckscher-Ohlin on a
         number of grounds.
             – The U.S (a capital intensive nation) exports labor-
               intensive goods.
             – The U.S also exports technically sophisticated
               goods that require skilled labor.
             – The U.S imports capital intensive goods made
               with unskilled labor.
      Exhibit 2-4: Capital position in U.S. exports and imports




Chapter 2: International Trade Theory and Application
                         The Leontief Paradox

       •       Stimulated a search for explanations.
              Demand bias for capital-investment
               goods.
              Existence of trade barriers.
              Importance of natural resources
              Prevalence of factor-intensity reversals.




Chapter 2: International Trade Theory and Application
     Human Skills and Technology-Based
                    View
       • Keesing indicated that trade direction
         and flow is predicted by gaps in
         human skills and technology.
       • Nations with higher levels of humans
         skills and technology will produce and
         export goods to nations with lower
         levels.


Chapter 2: International Trade Theory and Application
     Human Skills and Technology-Based
                    View
       • Human Skills are predicted by
             – Level of development in the scientific,
               technical, managerial, and skilled labor
               sectors.
       • Technology level is predicted by:
             – capital-intensive technology
               development
             – imitation lag that exists as technology
               innovations diffuse to developing areas.

Chapter 2: International Trade Theory and Application
              The Product Life-Cycle Model

       • Product innovation and initial use
         occurs first in higher income
         countries
       • Diffuses to middle and lower income
         countries as technology and skills
         gaps overcome and consumer
         preferences switch to the newer
         products.

Chapter 2: International Trade Theory and Application
              The Product Life-Cycle Model

       •       Several trends emerge in PLC:
             –     The export performance of the mature
                   innovating country is better than others.
             –     Technology is better in the mature
                   countries – as products diffuse production
                   tends to move from technology-intensive
                   to labor-intensive.
             –     Countries that were innovators can fall
                   from that place.
             –     Trade may increase in later stages of
                   product maturity as costs and prices
                   decline and production economies rise.
Chapter 2: International Trade Theory and Application
              The Product Life-Cycle Model
       Exhibit 2-5: Product cycle model of international trade
         – innovating country




Chapter 2: International Trade Theory and Application
              The Product Life-Cycle Model
       Exhibit 2-6: Product cycle model of international trade
         – imitating country




Chapter 2: International Trade Theory and Application
    Linder’s Income-Preference Similarity
                  Theory
       • Developed countries trade more than less
         developed countries (assumption)
       • Trade should take place between developed
         nations producing manufactured products
         and less developed nations producing
         primary products (e.g. natural resources)
         and labor-intensive goods.
       • According to Linder, the range of production
         is determined by internal demand.
       • Countries with similar internal demand
         conditions should therefore trade. This is
         called Preference Similarity.
Chapter 2: International Trade Theory and Application
                       The New Trade Theory

       •       Countries do not specialize and trade solely
               to take advantages of differences.
       •       They also trade because of increasing
               returns.
       •       Because of economies of scale, there are
               increasing returns to specialization.
       •       Economies of scale – reduction of
               manufacturing cost per unit as a result of
               increased production quantity during a
               given period.

Chapter 2: International Trade Theory and Application
                       The New Trade Theory

       • Inter-industry trade determined by
         Heckscher-Ohlin.
       • Intra-industry trade driven by
         increasing returns resulting from
         specialization within the industry.
       • Externality – when the actions of one
         agent directly affect the environment of
         another.


Chapter 2: International Trade Theory and Application
                          Theory Assessment

       • These theories provide insights in
         international trade.
       • No theorem can fully explain the range
         of motives for international trade.




Chapter 2: International Trade Theory and Application
  International Trade Volume and Growth

       • International trade continues to grow
         briskly
             – In 2000, global merchandise exports
               reached $6.2 trillion
                  • Increase of 12.5% over 1999
             – Global exports of commercial services
               reached $1.4 trillion
                  • Increase of 6% over 1999
             – Significant change in in the share of
               various world regions.

Chapter 2: International Trade Theory and Application
  International Trade Volume and Growth
       Exhibit 2-7: World merchandise trade by major product
         group, 1950 - 2000




Chapter 2: International Trade Theory and Application
  International Trade Volume and Growth
       Exhibit 2-8: World merchandise trade by region and
         selected economy




Chapter 2: International Trade Theory and Application
  International Trade Volume and Growth
       Exhibit 2-8: World merchandise trade by region and
         selected economy (cont)




Chapter 2: International Trade Theory and Application
                                  Service Trade

       • The import and export of:
             – Financial services
             – Information services
             – Education and training
             – Travel and tourism
             – Healthcare
             – Consulting and advisory services
       • Accounts for about one quarter of global
         trade, but rapidly growing.
Chapter 2: International Trade Theory and Application
                                  Service Trade
       Exhibit 2-9: Trade in commercial services of the U.S.




Chapter 2: International Trade Theory and Application
                          Trade Measurement

       • Trade measurement is generally a difficult
         exercise since nations do not use similar
         indexed systems.
       • Different trade data is collected for different
         purposes and aggregations may be biased.
       • Major sources of reliable data
             –   U.S Department of Commerce
             –   World Trade Organization
             –   Shippers Export Declarations
             –   World Bank


Chapter 2: International Trade Theory and Application
             Major Exporters and Importers

       • In merchandise trade, top exporters and
         importers are developed countries.
  Exhibit 2-10a: Top 10 leading exporters and importers in
  world merchandise trade, 2000




Chapter 2: International Trade Theory and Application
             Major Exporters and Importers

       • In commercial services, top exporters
         and importers are developed countries.
  Exhibit 2-10b: Top 10 leading exporters and importers in
  world trade in commercial services, 2000




Chapter 2: International Trade Theory and Application
                           U.S. Trade Partners

       • Canada is the largest trade partner
       • Followed by the EU, Mexico, and Japan
             – Developed economies
       • Canada and Mexico benefit from
         proximity and NAFTA membership.




Chapter 2: International Trade Theory and Application
                           U.S. Trade Partners
       Exhibit 2-11: Merchandise trade of the U.S. by region
         and economy, 2000




Chapter 2: International Trade Theory and Application
                           U.S. Trade Partners

       • Trade with Japan
             – Flow of foodstuff from U.S. to Japan
               explained by factor endowments
             – Japan exports 10 times more vehicles to
               the U.S. than vice versa.
                  • Trade barriers
                  • Currency exchange rates
                  • Rising fuel prices




Chapter 2: International Trade Theory and Application
                           U.S. Trade Partners
       Exhibit 2-12a: U.S. Exports to Japan (Top ten
         commodities)




Chapter 2: International Trade Theory and Application
                           U.S. Trade Partners
       Exhibit 2-12b: U.S. Imports from Japan (Top ten
         commodities)




Chapter 2: International Trade Theory and Application
                                 Trade Balance
• Balance of trade –
  exports minus
  imports of goods
  and services
• The U.S. has the
  largest trade deficit
• Low as a
  percentage of
  GDP.

    Exhibit 2-13:
    Balance of Trade
Chapter 2: International Trade Theory and Application
                    Opposition to Free Trade

       • Opponents of free trade in opposition to
         “globalization”.
       • Countries take the position that trade needs
         to protect the interests of their citizens.
       • In one survey, 48% of Americans said foreign
         trade is bad for the U.S.
       • Trade impacts at the micro level, as well as
         the macro.
       • People with lower incomes tend to be more
         negatively disposed to trade.

Chapter 2: International Trade Theory and Application
                  The Sovereignty Argument

       • Moving production to the most efficient
         location deprives a country’s economic
         viability.
       • Makes countries too dependent on
         other nations.
       • Particularly relevant to national security.
       • Threat to national culture and
         institutions.


Chapter 2: International Trade Theory and Application
        The Lowest Common Denominator
                   Argument
       • Product shifts to nations with the least
         protection.
       • Potentially adverse to the environment
         and safety.
       • Everyone will end up paying for the
         adverse effects.
       • One of the main complaints of the
         antiglobalization movement.


Chapter 2: International Trade Theory and Application
                             Trade Reciprocity

       • Benefits from trade can be not only
         economic but also political and social.
       • Passive reciprocity – a country
         refuses to lower or eliminate barriers to
         trade until the other does the same.
       • Active or aggressive reciprocity – the
         threat of retaliation.



Chapter 2: International Trade Theory and Application
                      Types of Trade Barriers

       • Tariff barriers – official constraints on
         the importation of certain goods or
         services.
             – Takes the form of a limitation or a special
               levy.
       • Non-tariff barriers – indirect measures
         that discriminate against foreign
         manufacturers.


Chapter 2: International Trade Theory and Application
                                           Tariffs

       • Surcharges that importer must pay above and
         beyond taxes leveled on domestic goods and
         services.
       • Transparent and based on the value of the
         product or service.
       • Optimal Tariff theory – governments can
         capture a portion of the manufactures profit
         margin.
       • Infant Industry theory – a industry new to a
         country can be protected against established
         global players.
Chapter 2: International Trade Theory and Application
                                           Tariffs
       Exhibit 2-14: Average import tariff rates




Chapter 2: International Trade Theory and Application
                                          Quotas

       • Quantitative limits on the importation of
         goods.
       • Definitive, quantifiable protection of the
         domestic producers.
       • Rule of origin – administration of tariffs
         and quotes based on the country origin.




Chapter 2: International Trade Theory and Application
                               Export Controls

       • Limitation of the type of products that
         can be exported to other countries.
             – National security risks
             – Dual purpose products
             – Goods vital to domestic industry
       • Companies often argue that countries
         will get the products from a competitor.



Chapter 2: International Trade Theory and Application
                Dumping and Anti-Dumping

       • Dumping - Selling a product at an
         unfairly low price.
       • Undermines the principles of
         comparative advantage.
       • WTO allows anti-dumping laws where
         there has been “material injury” to the
         domestic industry.



Chapter 2: International Trade Theory and Application
                            Non-Tariff Barriers
       • Administrative Barriers – used to block the
         entry of products while arguing that no
         barrier exists
       • Production Subsidies – payments provided
         by a government to domestic companies to
         make them more competitive.
       • Emergency Import Protection –
         implemented to protect against a surge in
         imports
       • Foreign Sales Corporations – offshore
         corporations that market products and
         services of firms in foreign countries.
Chapter 2: International Trade Theory and Application
                            Non-Tariff Barriers

       • Embargoes – the prohibition of exportation to
         a designated country.
       • Boycotts – the blank prohibition on
         importation of all or some goods from a
         designated country.
       • Technical Standards – requiring a company
         to demonstrate that their products meet the
         country’s domestic standards.
       • Corruption
       • Barriers to Service Trade

Chapter 2: International Trade Theory and Application

				
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