Chapter 06 International Trade a by benbenzhou

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									                        PART T HREE

                      CHAPTER SIX
                  INTERNATIONAL TRADE

•    To understand theories of why countries should trade
•    To comprehend how global efficiency can be increased through free trade
•    To become familiar with factors affecting countries’ trade patterns
•    To realize why countries’ export capabilities are dynamic
•    To discern why the production factors of labor and capital move internationally
•    To grasp the relationship between foreign trade and international factor mobility


Chapter Six provides a conceptual foundation for the exploration of the international
trade process. First, it examines the basic theories of mercantilism, absolute advantage,
and comparative advantage. Then it explores patterns of trade in light of the theories of
country size, factor proportions, and country similarity. It also considers the role of
distance and explains the relevance of Product Life Cycle Theory and Porter’s Diamond
of national competitive advantage. The chapter concludes with a discussion of factor
mobility and its relationship to the international trade process.


                       AND ECONOMIC TRANSFORMATION
                       [See Map 6.1.]
Costa Rica, a Central American country of barely 4 million people, has successfully
transformed its primarily agricultural economy to one that includes strong technology and
tourism sectors as well. Bordering both the Pacific Ocean and the Caribbean arm of the
Atlantic, Costa Rica used international trade and factor mobility policies to help achieve
its economic objectives. Although exports of coffee and bananas are still important,
high-tech manufactured products (electronics, software, and medical devices) are now the
backbone of Costa Rica’s economy and export earnings. As in all countries, Costa Rica’s
policies continually evolved, but generally fall into four periods and categories:

     •   1800s–1960: a liberal trade regime that promoted the exports of coffee and
     •   1960–1982: a more protectionist regime that promoted import substitution, i.e.,
         a policy of developing domestic industries to manufacture goods and provide
         services that would otherwise be imported (although results were mixed, the
         processing of coffee and cotton seeds increased the value of Costa Rican
         exports, and considerable substitution occurred in the pharmaceutical industry)
     •   1983–Early 1990s: a less protectionist regime that promoted the liberalization
         of imports, encouraged export promotion, and provided incentives to attract
         foreign capital and expertise
     •   Early 1990s-Present: a liberal trade regime that seeks the production of
         electronics, software, and medical devices via strategic trade policy, i.e., the
         identification and development of targeted domestic industries in order to
         improve their competitiveness at home and abroad

     TEACHING TIPS: Carefully review the PowerPoint slides for Chapter Six, as
     well as the opening case regarding Costa Rican Trade, which is cited throughout
     the chapter.

     Trade theory helps managers and government policymakers focus on three critical
     questions: What products should be imported and exported, how much should be
     traded, and with whom should they trade? While descriptive (free trade) theories
     suggest a laissez-faire treatment of trade, prescriptive (interventionist) theories
     suggest that governments should influence trade patterns. Trade in goods and
     services and the movement of production factors links countries internationally.
     [See Fig. 6.1.]

    Interventionist trade theories prescribe government action with respect to the
    international trade process.
    A. Mercantilism
         The concept of mercantilism (a zero-sum game) served as the foundation of
         economic thought for nearly three hundred years (1500–1800). It purports that a
         country’s wealth is measured by its holdings of treasure (usually gold). To
         amass a surplus (a favorable balance of trade), a country must export more
         than it imports and then collect gold and other forms of wealth from countries
         that run a deficit (an unfavorable balance of trade).
    B. Neomercantilism
         Neomercantilism represents the more recent strategy of countries that use
         protectionist trade policies in an attempt to run favorable balances of trade
         and/or accomplish particular social or political objectives.

    The explanatory power of the theories of absolute and comparative advantage is
    limited to the demonstration of how economic growth can occur via specialization
    and trade. The concept of free trade (a positive-sum game) purports that nations
    should neither artificially limit imports nor artificially promote exports. The
    invisible hand of the market will determine which competitors survive, as customers
    buy those products that best serve their needs. Free trade implies specialization—
    just as individuals and firms efficiently produce certain products that they then
    exchange for things they cannot produce efficiently, nations as a whole specialize in
    the production of certain products, some of which will be consumed domestically,
    and some of which may be exported; export earnings can then in turn be used to pay
    for imported goods and services.
    A. Theory of Absolute Advantage
         In 1776 Adam Smith asserted that the wealth of a nation consisted of the goods
         and services available to its citizens. His theory of absolute advantage holds
         that a country can maximize its own economic well being by specializing in the
         production of those goods and services that it can produce more efficiently than
         any other nation and enhance global efficiency through its participation in
         (unrestricted) free trade. Smith reasoned that: (i) workers become more skilled
         by repeating the same tasks; (ii) workers do not lose time in switching from the
         production of one kind of product to another; and (iii) long production runs
         provide greater incentives for the development of more effective working
         methods. Smith also asserted that country-specific advantages can either be
         natural or acquired.
         1. Natural Advantage. A country may have a natural advantage in the
              production of particular products because of given climatic conditions,
              access to particular resources, the availability of labor, etc. Variations in
              natural advantages among countries help to explain where particular
              products can be produced most efficiently.
         2. Acquired Advantage. An acquired advantage represents a distinct
              advantage in skills, technology, and/or capital assets that yields
              differentiated product offerings and/or cost-competitive homogeneous
              products. Technology, in particular, has created new products, displaced
              old products, and altered trading-partner relationships.
         3. Resource Efficiency Example. Real income depends on the output of
              products as compared to the resources used to produce them. By defining
              the cost of production in terms of the resources needed to produce a
              product, the production possibilities curve shows that through the use of
              specialization and trade, the output of two countries will be greater, thus
              optimizing global efficiency. [See Fig. 6.2.]
    B. Comparative Advantage
         In 1817 David Ricardo reasoned that there would still be gains from trade if
         a country specialized in the production of those things it can produce most
         efficiently, even if other countries can produce those same things even more
         efficiently. Put another way, Ricardo’s theory of comparative advantage holds
         that a country can maximize its own economic well-being by specializing in the

   production of those goods and services it can produce relatively efficiently and
   enhance global efficiency through its participation in (unrestricted) free trade.
   1. An Analogous Explanation. Would it make sense for the best
        physician in town, who also happens to be the most talented medical
        secretary, to handle all of the administrative duties of an office? No. The
        physician can maximize both output and income by working as a physician
        and employing a less skilled secretary. In the same manner, a country will
        gain if it concentrates its resources on the production of the goods and
        services it can produce most efficiently.
   2. Production Possibility Example. A country can simultaneously have a
        comparative advantage and an absolute advantage in the production of a
        given product. Assume that the United States is more efficient than Costa
        Rica in the production of both wheat and tea; however, the U.S. has a
        comparative ad-vantage in wheat production. By concentrating on the
        production of the product in which it has the greater advantage (wheat) and
        allowing Costa Rica to produce the product in which the United States is
        comparatively less efficient (coffee), global output can be increased, and
        specialization and trade will benefit both countries. [See Fig. 6.2.]
C. Some Assumptions and Limitations of the Theories of
   The theories of absolute and comparative advantage are based upon the
   economic gains from specialization, i.e., concentration on the production of a
   limited number of products. Each holds that specialization will maximize output
   and that subsequent trade will maximize consumer welfare. However, both
   theories make certain assumptions that may not always be valid.
   1. Full Employment. Both theories assume that resources are fully
        employed. When countries have many unemployed or underemployed
        resources, they may seek to restrict imports in order to employ their own
        available workers and other assets.
   2. Economic Efficiency Objective. Individuals and countries often
        pursue objectives other than economic efficiency. Individuals may prefer
        activities and/or occupations that are economically less productive, and
        nations may choose to avoid overspecialization because of the vulnerability
        created by potential changes in technology and price fluctuations.
   3. Division of Gains. Although specialization does maximize output, it is
        unclear how those gains will be divided. If one country believes that a
        trading partner is receiving too large a share of the benefits, it may choose
        to forego its relatively smaller gains in order to prevent the partner country
        from receiving larger gains.
   4. Two Countries, Two Commodities. The world is comprised of
        multiple countries and multiple commodities. Nonetheless, the theories are
        still useful; economists have applied the same reasoning and demonstrated
        the economic efficiency advantages in multi-product and multi-country
        production and trade relationships.
   5. Transport Costs. If it costs more to deliver products than can be saved
        via specialization, then the gains from trade are negated.

         6. Statics and Dynamics. Although the theories of absolute and
            comparative advantage consider gains at a given time (a static view), the
            relative conditions that surround a country’s particular advantage or
            disadvantage are dynamic (constantly changing). Thus, one cannot assume
            that future advantages will remain constant. (This idea will also be relevant
            to the discussion of the dynamics of the location of production and export
         7. Services. Although the theories of absolute and comparative advantage
            were developed from the perspective of trade in commodities, much of the
            same reasoning can be applied to trade in services.
         8. Mobility. Neither the assumption that resources can move domestically
            from the production of one good to another and at no cost, nor the
            assumption that resources cannot move internationally, is entirely valid.
            Nonetheless, domestic mobility is greater than the international mobility of
            resources. Clearly, the movement of resources such as capital and labor is a
            very real alternative to trade.

     The explanatory power of the theories of absolute and comparative advantage is
     limited to the demonstration of how economic growth can occur via specialization
     and trade. The theories of country size, factor proportions, and country similarity all
     contribute to the explanation of what types of products are traded and with which
     partner nations countries will primarily trade.
     A. How Much Does a Country Trade?
          Apart from nontradable products, i.e., goods and services that are impractical
          to export, country size helps to explain why some countries are more dependent
          on trade than others and why some account for larger portions of world trade
          than others.
          1. Theory of Country Size. The theory of country size holds that large
               countries tend to export a smaller portion of their output and import a
               smaller portion of their consumption. Large countries are more apt to have
               varied climates and a greater assortment of natural resources than smaller
               economies, thus making the large countries more self-sufficient. Further,
               given the same types of terrain and modes of transportation, the greater the
               distance, the higher the associated transport costs. Thus, firms in large
               countries often face higher transportation costs in terms of sourcing inputs
               from and delivering output to distant foreign markets than do their closer
               foreign competitors.
          2. Size of Economy. Counties can be compared on the basis of their
               economic size, using indicators that include the value and share of world
               trade. [See Table 6.2.] Ten of the world’s top trading nations are high-
               income countries. Despite its low per capita income, China also has a large
               economy because of its very large population. Together, the top ten nations
               account for more than one-half of all of the world’s trade.

B. What Types of Products Does a Country Trade?
   The composition of a country’s trade depends on both its natural and acquired
   advantages. With respect to the latter, both production and product technology
   can be very important.
   1. Factor-Proportions Theory. Developed by Eli Heckscher (1919) and
        Bertil Ohlin (1933), the factor-proportions theory holds that (i)
        differences in a country’s relative endowments of land, labor, and capital
        explain differences in the cost of production factors and (ii) a country will
        tend to export products that utilize relatively abundant factors of production
        because they are relatively cheaper than scarce factors; e.g., countries with
        rich and abundant land tend to be large exporters of agricultural products,
        whereas countries with capital-intensive production lines tend to be large
        exporters of manufactured goods. Nonetheless, production factors are not
        homogenous, and variations (particularly in labor) have led to international
        specialization by task; e.g., countries with less skilled and lower paid
        workers tend to export products that embody a higher intensity of labor.
   2. Production Technology. Factor proportions analysis becomes more
        complicated when the same product can be produced by different methods,
        such as different mixes of labor and capital. The optimum location will
        depend on comparisons of the production cost in each potential locale.
        Although larger nations tend to depend more on longer production runs,
        companies may locate long-run production facilities in small countries if
        export barriers to other markets are relatively low. In addition, firms tend to
        locate longer-run production facilities in just a few countries. However,
        when long runs are less important, there is a greater tendency to scatter
        production units around the world in a way that will minimize the
        transportation cost associated with exports.
   3. Product Technology. While manufacturing comprises the largest sector
        of world trade, commercial services is the fastest-growing sector. [See Fig.
        6.4.] Because manufacturing depends on acquired advantages (largely
        technology) plus large amounts of capital investment, most new products
        tends to be developed in high-income countries. On the other hand, lower-
        income countries depend more on the production of primary products,
        which in turn depend more on natural advantages.
C. With Whom Do Countries Trade?
   High-income countries trade primarily with each other, and emerging economies
   primarily export primary and labor-intensive products. Nonetheless, it is also
   true that economic and cultural similarities, political interests, and distance
   affect the determination of trading partners.
   1. Country-Similarity Theory. The country-similarity theory states that
        when a firm develops a new product in response to observed conditions in
        its home market, it is likely to turn to those foreign markets that are most
        similar to its domestic market when commencing its initial international
        expansion activities. So much trade takes place among industrialized
        countries because of the growing importance of acquired advantages, i.e.,

            skills and technology. In addition, markets in most industrialized countries
            are large enough to support new product introductions and the subsequent
            variants across the product life cycle. At the same time, trade in
            differentiated products occurs because over time firms in different countries
            develop product variants for particular market segments. Cultural similarity
            also facilitates trade. In particular, a common language and a common
            religion represent two major facilitators of the international trade and
            investment process. Historical and political relationships, as well as
            economic agreements, may encourage or discourage trade with particular
         2. Distance Among Countries. Countries that are near to one another
            enjoy relatively lower transportation costs than those that are more distant.
            While the disadvantages of distance can often be overcome through
            innovative technology and marketing methods, such gains are difficult to
            maintain in the long run.

                           DOES GEOGRAPHY MATTER?
                             Variety Is the Spice of Life

Geography plays a major role in many theories and decisions concerning international
trade. Part of a nation’s advantage is embedded in its natural advantages—climate,
terrain, arable land, and natural resources. Factor proportions theory helps explain where
certain goods and services may be more efficiently produced. Many small countries need
to trade relatively more than larger nations because small countries often lack a wide
variety of natural advantages and resources. In addition, distance, culture, and political/
economic relationships also play major roles in the process.

    Both the product life cycle theory and Porter’s Diamond of national competitive
    advantage help to explain how countries develop, maintain, and possibly lose their
    competitive advantages.
    A. Product Life Cycle (PLC) Theory
        Product life cycle theory states that the optimal location for the production of
        certain types of goods and services shifts over time as they pass through the
        stages of market introduction, growth, maturity, and decline. [See Table 6.3.]
        1. Changes Through the Cycle. A great majority of the new technology
             that results in new products and production methods originates in industrial
             • Introduction. Innovation, production, and sales occur in the domestic
                  (innovating) country. Because the product is not yet standardized, the
                  production process tends to be relatively labor-intensive, and
                  innovative customers tend to accept relatively high introductory prices.

         •   Growth. As demand grows, competitors enter the market. Foreign
             demand, competition, exports, and often direct investment activities
             also begin to accelerate.
        • Maturity. Global demand begins to peak, production processes are
             relatively standardized, and global price competition forces production
             site relocation to lower-cost developing countries.
        • Decline. Market factors and cost pressures dictate that almost all
             production occur in developing countries. The product is then imported
             by the country where it was initially developed—the importing firm
             may or may not be the innovating firm.
        2. Verification and Limitations of PLC Theory. Exceptions to the
             typical pattern of the product life cycle theory would include: products
             that have very short life cycles, luxury goods and services, products
             that require specialized labor, products that can be differentiated from
             direct competitors, and product for which transportation costs are
             relatively high.
B. The Porter Diamond
   Introduced by Michael Porter in 1990, the Diamond of National Competitive
   Advantage, i.e., the Porter Diamond, theorizes that national competitive
   advantage is embedded in four determinants: (i) demand conditions, (ii) factor
   conditions, (iii) related and supporting industries, and (iv) firm strategy,
   structure, and rivalry. All four determinants are interlinked and generally need
   to be favorable if a given national industry is going to attain global
   competitiveness. At times, determinants can be affected by the roles of chance
   and government.
   1. Explanation of the Porter Diamond
        • Demand Conditions. The nature and level of demand in the home
             market lead to the establishment of production facilities to meet that
        • Factor Conditions. Resource availability (inputs, labor, capital, and
             technology) contributes to the competitiveness of both firms and
             countries that compete in particular industries.
        • Related and Supporting Industries. The local presence of inter-
             nationally competitive suppliers and other related industries contributes
             to both the cost effectiveness and strategic competitiveness of firms.
        • Firm Strategy, Structure, and Rivalry. The creation and
             persistence of national competitive advantage requires leading-edge
             product and process technologies and business strategies.
   2. Limitations of the Porter Diamond. The existence of the four
        favorable conditions may represent a necessary but insufficient condition
        for the development of a particular national industry. Even when abundant,
        resources are ultimately limited; thus, firms must make choices regarding
        their pursuit of existing opportunities. Further, given the ability of firms to
        gain market information and production inputs from abroad, the absence of
        favorable conditions within a country may be overcome by their existence

         3. Using the Diamond for Transformation. Understanding and having
            the necessary conditions to be globally competitive are important, but these
            conditions are neither static nor purely domestic. As shown in the opening
            case regarding Costa Rica’s economic transformation, the Costa Rican
            government altered its educational system to tailor the country’s human
            resource development to fit the needs of targeted industries. Likewise, it
            developed local supplies and attracted sufficient numbers of foreign firm so
            that their combined presence assured a vibrant competitive environment.

               Should Countries Follow Strategic Trade Policies?

POINT: Given the importance of acquired advantage in world trade, a country must
develop and maintain industries that will grow and earn sufficient revenues so that its
domestic economy thrives and grows. Targeting industries has proven particularly
important for emerging economies such as Costa Rica, and small countries such as
Singapore. At the same time, there are numerous examples of the failure of laissez faire
trade policies in Africa—given all of their economic inadequacies, government guidance
and intervention is their best hope for better results.

COUNTERPOINT: There are few circumstances where targeting will work, and even if
governments are able to identify future growth industries in which their countries can
likely succeed, it does not follow that firms within those industries should receive
government assistance. A better policy would be to alter the conditions that affect a
country’s attractiveness to firms in general, rather than specific targeted industries. This
would improve the investment environment for all industries without the need for
government officials to choose which industries to support.

   Over time factor conditions change in both quality and quantity. Concomitantly, the
   mobility of capital, technology, and people also affects the relative capabilities of
   A. Why Production Factors Move
       Factor mobility concerns the free movement of factors of production, such as
       labor and capital, across national borders. While capital is the most
       internationally mobile factor, short-term capital is the most mobile of all.
       Capital is primarily transferred because of differences in expected returns,
       although firms may also respond to government incentives. People transfer
       internationally in order to work abroad, either on a temporary or a permanent
       basis. It may be difficult to distinguish between economic and political motives
       associated with international labor mobility, because poor economic conditions
       often accompany repressive and/or uncertain political conditions.

    B. Effects of Factor Movements
       Although capital and labor are in fact different production factors, they are
       intertwined. Further, neither international capital nor population movements are
       new occurrences. Immigrants bring human capital, thus adding to the base of a
       country’s skills and enabling competition in new areas. Likewise, inflows of
       capital to those same countries can be used to develop infrastructure and natural
       and other acquired advantages, thus enabling increased participation in the
       international trade arena. Countries lose potentially productive resources when
       educated people leave, a situation known as brain drain, but they may in turn
       gain from the remittances that citizens who are working abroad send home.
    C. The Relationship of Trade and Factor Mobility
       Factor movement is an alternative to trade that may or may not be a more
       efficient allocation of resources.
       1. Substitution. When factor proportions vary widely among countries,
            pressures exist for the most abundant factors to move to countries with
            greater scarcity. Thus, in countries where labor is relatively abundant
            compared to capital, workers tend to be poorly paid; many will attempt to
            go to countries that enjoy full employment and offer higher wages.
            Likewise, capital tends to move away from countries where it is abundant to
            those where it is relatively scarce. [See Fig. 6.6.] However, the inability to
            gain sufficient access to foreign production factors may stimulate efficient
            methods of domestic substitution, such as the development of alternatives
            for traditional production methods.
       2. Complementarity. Factor mobility via foreign direct investment may in
            fact stimulate foreign trade because of the need for equipment, components,
            and/or complementary products in the destination country. Alternatively,
            trade may be restricted by local content laws, or when foreign direct
            investment leads to import substitution.

       LOOKING TO THE FUTURE: Will Conditions for Trade Change?

Firms have greater opportunities to pursue global strategies and capture economies of
scale by serving markets in more than one country from a single base of production if
those countries have relatively few restrictions on foreign trade and investment activities.
However, uncertainties exist as to whether the current trend toward the freer movement
of trade and production factors will continue. Four factors that might cause merchandise
trade to become relatively less significant in the future are:
     • the growing tide of protectionist sentiment
     • the possibility of more efficient country-by-country production
     • increasingly flexible and efficient small-scale production methods
     • the rapid growth of services as a portion of production and consumption within
          the industrialized nations

                      CLOSING CASE: LUKoil [See Map 6.2.]

LUKoil was one of several firms created in 1991 out of Russia’s state-owned petroleum
monopoly. While both Russia and LUKoil must export to meet their economic
objectives, political relations within and outside of Russia could impair LUKoil’s future
ability to export. Thus, foreign investment and ties to Western oil companies are very
important to the firm’s ultimate success. Controlling 19 percent of Russia’s oil
production and refining capacity and employing more than 120,000 people in its
operations worldwide, LUKoil has become Russia’s largest oil company. It is also the
first Russian oil company to integrate from ―oil wells to filling stations.‖ High market
prices have enabled LUKoil to amass sufficient capital to make substantial foreign
investments. While much of its FDI has been directed to nearby countries, LUKoil has
also acquired 100 percent of Getty Petroleum in the United States, as well as 800 U.S.
stations from ConocoPhillips. Forward integration into filling stations will guarantee
LUKoil market access and enable the company to sell its crude oil during times of global
oversupply. Further, LUKoil sees its foreign acquisitions as a means of gaining
experienced personnel, technology, and competitive know-how to help it compete more
efficiently and effectively both at home and abroad.

1.   What theories of trade help to explain Russia’s position as an oil exporter? Which
     ones do not, and why?
     Both the theories of absolute and competitive advantage help to explain Russia’s
     position as an oil exporter. Prices in the global oil market are driven by the laws of
     supply and demand. Given the fact that Russia now has 15 more proven reserves
     than Saudi Arabia and its oil companies have become major global competitors, the
     country enjoys both natural and acquired advantages with respect to oil. Thus, factor
     proportions theory is applicable. The fact that a preponderance of its foreign
     expansion has been to countries of the former Soviet Union supports the country
     similarity theory. The Porter Diamond of national competitive advantage also helps
     to explain Russia’s position as an oil exporter. Global demand conditions are
     favorable; and Russian oil companies are making significant strides in the areas of
     factors conditions, related and supporting industries, and firm strategy, structure, and
     rivalry. Neither the interventionist theory of mercantilism nor the theories of country
     size apply. Further, product life cycle theory does not apply because petroleum is
     not an appropriate type of product for that model.

2.   How do global political and economic conditions affect world markets and prices of
     Global political and economic conditions affect world markets and prices because of
     their real and perceived effects on global supply. In spite of their general upward
     trend, oil prices have fluctuated widely in response to events during the twenty-first

     century. OPEC’s supply quotas, general economic uncertainty, China’s economic
     expansion, political unrest in Venezuela, and the war in Iraq have all contributed to
     the favorable market conditions that have led to record-setting prices and profits in
     the global oil industry.

3.   Discuss the following statement as it applies to Russia and LUKoil. “Regardless of
     the advantages a country may gain by trading, international trade will begin only if
     companies within that country have competitive advantages that enable them to be
     viable traders—and they must foresee profits in exporting and importing.”
     Given the globalization of the world’s oil industry on the one hand, and the massive
     capacity of Russia’s oil producers on the other, it is vital that Russia’s domestic
     companies have competitive advantages that enable them to operate profitably in
     global markets. Otherwise, foreign competitors that can do so would be in a position
     not just to serve the world’s markets, but to enter the Russian market via foreign
     direct investment, if such action were permissible. Thus, it is critical that both
     LUKoil and other Russian oil companies become as efficient as the major global
     competitors, either by developing or acquiring the latest petroleum technology,
     marketing skills, and operating efficiencies that will yield the efficiencies required to
     effectively compete at both the global and local levels.

4.   In LUKoil’s situation, what is the relationship between factor mobility and exports?
     Capital, technology, and skilled employees are all critical factors in the global oil
     industry. Even in Russia oil production and processing are capital-intensive
     activities that require massive amounts of highly valuable and highly specialized
     capital equipment manned by skilled laborers. Investment naturally flows to those
     sites where oil is abundant and production activities are the most efficient. Because
     oil is a limited resource and demand exists the world over, competitors such as
     LUKoil serve their global customers via production sites that are scattered across the
     world. Whereas LUKoil’s European customers will likely be served from its
     European reserves, other customers are more likely to be served by oil sourced from
     its holdings in other parts of the world.

5.   Compare the role of the Costa Rican government in the chapter’s opening case with
     the role of the Russian government in their use of trade to meet national economic
     The roles of the two governments are quite different in the sense that Costa Rica set
     about developing acquired advantages in targeted industries, while Russia chose to
     exploit its given natural resources in order to compete in global export markets as it
     transitioned to a market-based economy. Although exports of coffee and bananas are
     still important to Costa Rica, high-tech manufactured products (electronics, software,
     and medical devices) are now the backbone of that country’s economy and export
     earnings. On the other hand, as Russia moved through the transition from a
     centrally-planned to a market-based economy, it fashioned competitive enterprises
     such as LUKoil from its state-owned assets. Those firms have since had to rely on
     their earnings in order to develop or acquire needed products, processes, facilities,
     and/or employees.


    Teaching Tip: Visit for additional information and
    links relating to the topics presented in Chapter Six. Be sure to refer your students to
    the online study guide, as well as the Internet exercises for Chapter Six.


    strategic trade policy, p.201                     statics, p.210
    interventionist trade theories, p.203             dynamics, p.210
    mercantilism, p.203                               nontradable products, p.211
    favorable balance of trade, p.204                 theory of country size, p.211
    unfavorable balance of trade,p.204                factor proportions theory, p.212
    neomercantilism, p.204                            country similarity theory, p.215
    free trade, p.205                                 product life cycle theory, p.217
    invisible hand, p.205                             Porter diamond, p.219
    absolute advantage, p.205                         demand conditions, p.219
    natural advantage, p.205                          factor conditions, p.219
    acquired advantage, p.206                         factor mobility, p.223
    production possibilities curve, p.206             brain drain, p.224
    comparative advantage, p.207                      substitution, p.225
    complementarity, p.226

ADDITIONAL EXERCISES: International Trade and Factor Mobility

    Exercise 6.1. The theories of absolute and comparative advantage and the product
    life cycle all contribute to the explanation of the international trade process. Select
    two to three different types of products and ask students to discuss the likelihood that
    (a) an innovating country, (b) a rapidly developing country, and (c) an emerging
    country would enjoy an absolute advantage, a comparative advantage, or no
    particular advantage as each of the products moves through the four stages of the
    product life cycle. Be sure they cite examples and explain their reasoning.

    Exercise 6.2. The factor-proportions theory and the country-similarity theory both
    address patterns of trade, i.e., partner nations. Ask students to compare and contrast
    the two theories. In what ways are they complementary and in what ways do they
    differ? Then select two to five home countries of students in your class and ask the
    class to identify the natural and acquired advantages of those countries and to
    compare their various economic, cultural, and political similarities.

Exercise 6.3. Porter’s Diamond deals with the competitive advantages of nations.
Select two to five countries and lead the class in a comparative analysis of the four
points of the diamond, as well as the recent roles of government and chance, in those
nations. Conclude the discussion by exploring the associated competitive advantages
that may accrue to foreign firms that choose to operate in each of those countries.

Exercise 6.4. Select two large multinational enterprises that are known to the
students, one consumer-oriented (e.g., McDonald’s) and one industrial (e.g.,
Newmont Mining). Then ask students to discuss the concept of complementarity
within the context of the operations of those two firms. What equipment,
components, and/or complementary products are needed in host countries as a result
of their foreign operations that may stimulate foreign trade in both the short and the
long run?


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