Chapter 5 - PowerPoint PPT Presentation

Chapter 5

The Theory of Trade and Investment

• To understand the traditional arguments of how and why international trade improves the welfare of all countries
• To review the history and compare the implications of trade theory from the original work of Adam Smith to the contemporary theories of Michael Porter
• To examine the criticisms of classical trade theory and examine alternative viewpoints of which business and economic forces determine trade patterns between countries
• To explore the similarities and distinctions between international trade and international investment

• The Age of Mercantilism
• Classical Trade Theory
• Factor Proportions Trade Theory
• International Investment and Product Cycle Theory
• The New Trade Theory: Strategic Trade
• The Theory of International Investment

The evolution of trade into the form we see today reflects three events:

The Collapse of Feudal Society

The Emergence of the Mercantilist Philosophy

The Life Cycle of the Colonial Systems of the

European Nation-States

• Mixed exchange through trade with accumulation of wealth
• Conducted under authority of government
• Demise of mercantilism inevitable

• The 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

• Adam Smith—Division of Labor
• Industrial 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 Trade
• A nation can achieve consumption levels beyond what it could produce by itself

Developed by Eli Heckscher

Expanded by Bertil Ohlin

• Labor
• Capital

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).

The Test:

Could Factor Proportions Theory be used to explain the types of goods the United States imported and exported?

The Method:

Input-output analysis

The Findings:

The U.S. exported labor-intensive products and imported capital-intensive products.

The Controversy:

Findings were the opposite of what was generally believed to be true!

• Trade in manufactured goods dictated not by cost concerns, but by similarity in product demands across countries.
• Work focused on preferences of consumer demand.
• Today, termed market segments.

• Raymond Vernon
• Focus on the product, not its factor proportions
• Two technology-based 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

The New Product

The Maturing Product

The Standardized Product

• Increased emphasis on technology’s impact on product cost
• Explained international investment
• Limitations
• Most appropriate for technology-based products
• Some products not easily characterized by stages of maturity
• Most relevant to products produced through mass production

Two New Contributions

• Paul Krugman-How trade is altered when markets are not perfectly competitive
• Michael Porter-Examined competitiveness of industries on a global basis

Krugman’s Economics of Scale:

Internal Economies of Scale

External Economies of Scale

• Government can play a beneficial role when markets are not purely competitive
• Theory expands to government’s role in international trade
• Four circumstances exist that involve imperfect competition in which strategic trade may apply

The Four Circumstances Involving Imperfect Competition:

Price

Cost

Externalities

Repetition

Porter’s Diamond of National Advantage

• Innovation is what drives and sustains competitiveness
• Four components of competition
• Factor Conditions
• Demand Conditions
• Related and Supporting Industries
• Firm Strategy, Structure, and Rivalry

• Critical masses of unusual competitive success in particular fields, located in one place

• The movement of capital has allowed foreign direct investments across the globe

• Firms as Seekers
• Seeking Resources
• Seeking Factor Advantages
• Seeking Knowledge
• Seeking Security
• Seeking Markets

• Firms as Exploiters of Imperfections
• Imperfections in Access
• Imperfections in Factor Mobility
• Imperfections in Management
• Firms as Internalizers
• Establish their own multinational operations-internalize production
• Competitive advantage due to confidentiality