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Chapter 6: International Trade and Investment Theory. International Business, 4 th Edition Griffin & Pustay. Chapter Objectives_1. Understand the motivation for international trade Summarize and discuss the differences among the classical country-based theories of international trade

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Chapter 6 international trade and investment theory

Chapter 6:International Trade and Investment Theory

International Business, 4th Edition

Griffin & Pustay

©2004 Prentice Hall


Chapter objectives 1
Chapter Objectives_1

  • Understand the motivation for international trade

  • Summarize and discuss the differences among the classical country-based theories of international trade

  • Use the modern firm-based theories of international trade to describe global strategies adopted by businesses

©2004 Prentice Hall


Chapter objectives 2
Chapter Objectives_2

  • Describe and categorize the different forms of international investment

  • Explain the reasons for foreign direct investment

  • Summarize how supply, demand, and political factors influence foreign direct investment

©2004 Prentice Hall


International trade
International Trade

  • Trade: voluntary exchange of goods, services, assets, or money between one person or organization and another

  • International trade: trade between residents of two countries

©2004 Prentice Hall



The largest component of the annual $1.5 trillion trade in 2001international services is travel and tourism

©2004 Prentice Hall


Classical country based trade theories
Classical Country-Based Trade Theories 2001

  • Mercantilism

  • Absolute Advantage

  • Comparative Advantage

  • Comparative Advantage with Money

  • Relative Factor Endowments

©2004 Prentice Hall


Mercantilism
Mercantilism 2001

  • A country’s wealth is measured by its holdings of gold and silver

  • A country’s goal should be to enlarge holdings of gold and silver by

    • Promoting exports

    • Discouraging imports

©2004 Prentice Hall


Modern mercantilism
Modern Mercantilism 2001

  • Neomercantilists or protectionists

    • American Federation of Labor-Congress of Industrial Organizations

    • Textile manufacturers

    • Steel companies

    • Sugar growers

    • Peanut farmers

©2004 Prentice Hall


Disadvantages of mercantilism
Disadvantages of Mercantilism 2001

  • Confuses the acquisition of treasure with the acquisition of wealth

  • Weakens the country because it robs individuals of the ability

    • To trade freely

    • To benefit from voluntary exchanges

  • Forces countries to produce products it would otherwise not in order to minimize imports

©2004 Prentice Hall


Absolute advantage
Absolute Advantage 2001

  • Export those goods and services for which a country is more productive than other countries

  • Import those goods and services for which other countries are more productive than it is

©2004 Prentice Hall


Table 6 1 the theory of absolute advantage an example
Table 6.1 The Theory of Absolute Advantage: An Example 2001

OUTPUT PER HOUR OF LABOR

France Japan

©2004 Prentice Hall


Absolute advantage s flaw
Absolute Advantage’s Flaw 2001

  • What happens to trade if one country has an absolute advantage in both products?

  • No trade would occur

©2004 Prentice Hall


Comparative advantage
Comparative Advantage 2001

  • Produce and export those goods and services for which it is relatively more productive than other countries

  • Import those goods and services for which other countries are relatively more productive than it is

©2004 Prentice Hall


Differences between comparative and absolute advantage
Differences between Comparative and Absolute Advantage 2001

  • Absolute versus relative productivity differences

  • Comparative advantage incorporates the concept of opportunity cost

    • Value of what is given up to get the good

©2004 Prentice Hall


Table 6 2 the theory of comparative advantage an example
Table 6.2 The Theory of Comparative Advantage: An Example 2001

OUTPUT PER HOUR OF LABOR

France Japan

©2004 Prentice Hall


Comparative advantage with money
Comparative Advantage with Money 2001

  • One is better off specializing in what one does relatively best

  • Produce and export those goods and services one is relatively best able to produce

  • Buy other goods and services from people who are better at producing them

©2004 Prentice Hall


Table 6 3 the theory of comparative advantage with money an example
Table 6.3 The Theory of Comparative Advantage with Money: An Example

Cost of Goods in France Cost of Goods in Japan

©2004 Prentice Hall


Relative factor endowments
Relative Factor Endowments Example

  • Heckscher-Ohlin Theory

  • What determines the products for which a country will have a comparative advantage?

    • Factor endowments vary among countries

    • Goods differ according to the types of factors that are used to produce them

©2004 Prentice Hall


Relative factor endowments 2
Relative Factor Endowments_2 Example

  • A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance

    • China: labor

    • Saudi Arabia: oil

    • Argentina: wheat

©2004 Prentice Hall



Modern firm based trade theories
Modern Firm-Based Trade Theories Paradox

  • Country Similarity Theory

  • Product Life Cycle Theory

  • Global Strategic Rivalry Theory

  • Porter’s National Competitive Advantage

©2004 Prentice Hall


Growth of firm based theories
Growth of Firm-Based Theories Paradox

  • Growing importance of MNCs

  • Inability of the country-based theories to explain and predict the existence and growth of intraindustry trade

  • Failure of Leontief and others to empirically validate country-based Heckscher-Ohlin Theory

©2004 Prentice Hall


Firm based trade theories
Firm-Based Trade Theories Paradox

  • Incorporate additional factors into explanations of trade flows

    • Quality

    • Technology

    • Brand names

    • Customer quality

©2004 Prentice Hall


Country similarity theory
Country Similarity Theory Paradox

  • Explains the phenomenon of intraindustry trade

    • Trade between two countries of goods produced by the same industry

      • Japan exports Toyotas to Germany

      • Germany exports BMWs to Japan

©2004 Prentice Hall


Country similarity theory 2
Country Similarity Theory_2 Paradox

  • Trade results from similarities of preferences among consumers in countries that are at the same stage of economic development

  • Most trade in manufactured goods should be between countries with similar per capita incomes

©2004 Prentice Hall


Product life cycle theory
Product Life Cycle Theory Paradox

  • Describes the evolution of marketing strategies

  • Stages

    • New product

    • Maturing product

    • Standardized product

©2004 Prentice Hall



Figure 6 4 the international product life cycle other industrialized countries
Figure 6.4 The International Product Life Cycle: Other Industrialized Countries

©2004 Prentice Hall


Figure 6 4 the international product life cycle less developed countries
Figure 6.4 The International Product Life Cycle: Less Developed Countries

©2004 Prentice Hall


Global strategic rivalry theory
Global Strategic Rivalry Theory Developed Countries

  • Firms struggle to develop sustainable competitive advantage

  • Advantage provides ability to dominate global marketplace

  • Focus: strategic decisions firms use to compete internationally

©2004 Prentice Hall


Sustaining competitive advantage
Sustaining Competitive Advantage Developed Countries

  • Owning intellectual property rights

  • Investing in research and development

  • Achieving economies of scale or scope

  • Exploiting the experience curve

©2004 Prentice Hall


Porter s national competitive advantage
Porter’s National Developed CountriesCompetitive Advantage

  • Success in trade comes from the interaction of four country and firm specific elements

    • Factor conditions

    • Demand conditions

    • Related and supporting industries

    • Firm strategy, structure, and rivalry

©2004 Prentice Hall


Figure 6 5 porter s diamond of national competitive advantage
Figure 6.5 Porter’s Diamond of Developed CountriesNational Competitive Advantage

Firm Strategy,

Structure,

and Rivalry

Factor

Conditions

Demand

Conditions

Related and

Supporting

Industries

©2004 Prentice Hall


The intense competitiveness Developed Countriesof Japanese market forces manufacturers to continually develop and fine-tune new products

©2004 Prentice Hall


Figure 6 6 theories of international trade

Country-Based Theories Developed Countries

Country is unit of analysis

Emerged prior to WWII

Developed by economists

Explain interindustry trade

Include

Mercantilism

Absolute advantage

Comparative advantage

Relative factor endowments

Firm-Based Theories

Firm is unit of analysis

Emerged after WWII

Developed by business school professors

Explain intraindustry trade

Include

Country similarity theory

Product life cycle

Global strategic rivalry

National competitive advantage

Figure 6.6 Theories of International Trade

©2004 Prentice Hall


Types of international investments
Types of International Investments Developed Countries

  • Does the investor seek an active management role in the firm r merely a return from a passive investment?

    • Foreign Direct Investment

    • Portfolio Investment

©2004 Prentice Hall


Figure 6 7 stock of foreign direct investment by recipient
Figure 6.7 Stock of Foreign Direct Investment, by recipient Developed Countries

©2004 Prentice Hall


Table 6 4 sources of fdi for the u s end of 2002
Table 6.4 Sources of FDI for the U.S., end of 2002 Developed Countries

©2004 Prentice Hall


Table 6 4 destinations of fdi for the u s end of 2002
Table 6.4 Destinations of FDI for the U.S., end of 2002 Developed Countries

©2004 Prentice Hall


International investment theories
International Investment Theories Developed Countries

  • Ownership Advantages

  • Internalization

  • Dunning’s Eclectic Theory

©2004 Prentice Hall


Ownership advantages
Ownership Advantages Developed Countries

  • A firm owning a valuable asset that creates a competitive advantage domestically can use that advantage to penetrate foreign markets through FDI

  • Why FDI and not other methods?

©2004 Prentice Hall


Internalization theory
Internalization Theory Developed Countries

  • FDI is more likely to occur when transaction costs with a second firm are high

  • Transaction costs: costs associated with negotiating, monitoring, and enforcing a contract

©2004 Prentice Hall


Dunning s eclectic theory
Dunning’s Eclectic Theory Developed Countries

  • FDI reflects both international business activity and business activity internal to the firm

  • 3 conditions for FDI

    • Ownership advantage

    • Location advantage

    • Internalization advantage

©2004 Prentice Hall


Table 6 5 factors affecting the fdi decision
Table 6.5 Factors Affecting Developed Countriesthe FDI Decision

©2004 Prentice Hall


Ikea aggressively exports its furniture to other countries
Ikea aggressively exports its furniture to other countries Developed Countries

©2004 Prentice Hall


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