Gbm unit-02 (global trade & theory)

07/06/10 1

By :

Prof. Amit Kumar

07/06/10 2

“A student pursuing management education from IILM-

Graduate School of Management, for example may find

himself or herself placed in a firm located in a totally

different country. Knowledge about international

business keeps the youngster mentally prepared to

accept assignment in an alien environment. Forewarning

is definitely forearming, for the fresh management

graduate”.

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Importance of this course

Global Business Management

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Course: Global Business Management

1. Globalization

2. Global Trade & Theory

3. Global Technological Environment

4. Global Economic Environment

5. Global Political-Legal Environment

6. Foreign Direct Investments

7. Regional Economic Integration

8. Strategy and Structure of International Business

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Global Business Management

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Global Business Management Global Trade & Theory

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Contents

• Benefits of Foreign Trade• Foreign Trade Policies• Barriers to Trade• Trade Theories

Theory of Absolute Advantage Theory of Comparative Advantage International Product Life Cycle National Competitive Advantage

• Usefulness of Trade Theories• Case Study: What was good for GM is not so for Others

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• Trade is the voluntary exchange of goods, services, or both. Trade is also called commerce.

• A mechanism that allows trade is called a market. • The original form of trade was barter, the direct

exchange of goods and services. Later one side of the barter were the metals, precious metals (poles, coins), bill, paper money.

Introduction

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• Modern traders instead generally negotiate through a medium of exchange, such as money.

• Trade between two traders is called bilateral trade, while trade between more than two traders is called multilateral trade.

Introduction

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Benefits of Foreign Trade

1. Natural resources of the earth are unevenly distributed. One country possesses product X in surplus and lacks in respect of product Y. In other country the reverse may be true.

2. Countries also differ in their preferences and technologies, economics and social, and capabilities for growth and development.

3. Foreign trade is significant for the economic development of the countries, particularly the developing one.

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Suppose an economy has decided to embark on a

programme of development is required to extend its

productive capacity at a fast rate.

– For this, imports of machinery and equipment, which cannot be produced in the initial stages at home, are essential. Such imports which either help create new capacity in some lines of production or enlarge capacity in the other lines of production are called developmental imports. e.g. imports required for the setting up of steel

plant, hydro-electric projects are developmental imports.

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Suppose an economy has decided to embark on a

programme of development is required to extend its

productive capacity at a fast rate.

– A developing country which sets in motion the process of industrialization at home requires the imports of raw materials and intermediate goods so as to properly utilize the capacity created in the country. Imports which are made in order to make full use of the productive capacity are called ‘maintenance imports’.

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Trade policies can be free trade, fair trade, inward

trade or outward trade.

Free Trade:

– Free trade implies that the government of the land exerts minimal influence on decisions relating to exports or imports made by private individuals and businesses. Promotion of free trade is the main plank of the WTO.

Foreign Trade Policies

To connect or combine precisely or harmoniously

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Free Trade:

– According to the law of comparative advantage the policy permits trading partners mutual gains from trade of goods and services.

– Under a free trade policy, prices are a reflection of true supply and demand.

– Free trade agreements are a key element of customs unions and free trade areas.



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Fair Trade:

– Fair trade, also called managed trade, suggests that the government of the land should actively intervene and ensure that exports from the own country receive a fair share in the global trade and that imports are controlled so as to minimize losses of domestic jobs and market share in specific industries. Fair trade orientation corresponds with the inward trade policy.



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Outward-oriented Policies:It is supported on the following grounds:

– Free Trade Promotes World Trade– Uneven Distribution of Resources makes Trade

Inevitable– World Trade Encourages Efficient use of Global

Resources– Global Competition Forces Companies to become more

efficient and Innovative– World trade has Created Awareness– The Economic Interdependence among Countries

makes Countries Engage Less in Conflicts



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Inward-oriented Policies:

An inward-oriented strategy, usually, means over protection. What is less obvious is that sheltering

domestic industries puts exports at a great disadvantage because it raises the cost of the

foreign inputs used in their production. Moreover, an increase in the relative costs of domestic

inputs may also occur through inflation or because of appreciation of the exchange rate as

import restrictions are introduced.



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An inward-looking trade policies advocates that a country should not trade with other nations,

whereas an outward trade policies calls for easy movement of goods and services among

nations.

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Barriers to Trade

Some countries use several barriers to protect domestic industries from competition from

foreign firms. These barriers generally include tariff and non-tariff strategies.

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Barriers to Trade

Barriers

Non-TariffTariff

Transit Tariff

Import TariffExport Tariff

Others

SubsidiesQuotas

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Tariffs

A tariff is a tax imposed on goods involved in

international trade. – Tariffs are imposed on goods imported, in which

case they are called import duties. – Taxes are imposed on goods when they leave the

country (export tariff) or – As they pass through one country bound for

another (transit tariff).

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Barriers to Trade

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Tariffs– Tariffs may be either ad valorem or specific. Ad valorem tariffs are imposed as percentages on

values of goods imported. Sometimes these are problematic, as when the international price of the good falls.

Specific tariffs relate to some specific attributes of the goods- weight, quantity, that does not vary with the price of the goods.

A compound tariff is also calculated partly as a percentage on value and partly as a rate per unit or weight.

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Barriers to Trade

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Tariffs– In the past, tariffs formed a much larger part of

government revenue than they do today.– When shipments of goods arrive at a border

crossing or port, customs officers inspect the contents and charge a tax according to the tariff formula. Since the goods cannot continue on their way until the duty is paid, it is the easiest duty to collect, and the cost of collection is small.

– Traders seeking to evade tariffs are known as smugglers.

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Barriers to Trade

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Non-Tariffs

– Any government regulation, policy, or procedure other than a tariff that has effect of restricting international trade, or affecting overseas investment, becomes a non-tariff barrier.

– These are Quotas, Subsidies and Others.

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Barriers to Trade

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Barriers

Non-TariffTariff

Others

SubsidiesQuotas

Product & TestingStandards

Embargoes

CurrencyControl

Local ContentRequirements

AdministrativeDelay

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Barriers to Trade

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Quotas: (Non-Tariff) It refers to numerical limits on the quantity of goods

that may be imported into a country during a specified period.

The quantity of goods that may be imported is stated in a license issued to a group of individuals or firms.

Most countries use quotas to protect powerful industries as agriculture, textile or motor vehicles, from the threat of foreign competition.

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Barriers to Trade

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Quotas: (MFA)• With regard to textiles, countries placed quotas on

imports under what is called Multi-Fiber Arrangement which is a part of the GATT agreements.

• Countries affected by this arrangement accounted for over 80% of the world trade in textiles and clothing each year.

• It has been continuously revised and extended. However, all quotas in this industry are expected to phase out completely by 2014.

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Barriers to Trade

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Quotas: (VER)

• A variant on the import quota is the Voluntary Export Restraint (VER).

• A VER is a quota on trade imposed by the exporting country, typically at the request of the importing country.

A classic example of the use of VER is the automobile industry in 1980s.

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Barriers to Trade

Quotas: (VER)

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Barriers to Trade

The closing of US auto manufacturing facilities was creating in the US, a volatile anti-Japan sentiments

among the people and the US Congress.

Fearing punitive legislation in Congress if Japan did not limit its exports to the US, the Japanese government

and its car makers self-imposed a VER on cars meant for exports to the US.

Japanese car markets were making significant inroads into the US car market.

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Subsidies:(Non-Tariffs)• A subsidy is a government payment to a domestic

producer.• Subsidies take several forms including cash grants,

low-interest loans, tax breaks and government equity participation in local firm.

• By lowering costs, subsidies help domestic producers in two ways:

1. They help them compete against low-cost foreign imports.

2. Gain excess to export markets.

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Barriers to Trade

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Embargo: (Non-Tariffs)

• An embargo refers to a complete ban on trade (imports and exports) in one or more products with a particular country.

For example, import of beef in any form and import of products containing beef in any form into India is prohibited because Hindus, who form majority in

the total population, shun beef.

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Barriers to Trade

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Local Content Requirement: (Non-Tariffs)

• These refer to the legal stipulation that a specified amount of a good or service be supplied by producers in the domestic market.

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Barriers to Trade

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Administrative Delay: (Non-Tariffs)• Regulatory controls or bureaucratic rules designed to

impair the flow of imports into a country.• Includes a wide range of government actions such as

1. requiring international air carriers to land at inconvenient airports

2. requiring product inspection (health & safety inspection) that damage the product itself

3. purposely understaffing customs offices to cause unusual delays and

4. requiring special license that take a long time to obtain.

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Barriers to Trade

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Currency Control: (Non-Tariffs)• This refer to restrictions on the convertibility of a

currency into other currencies. Any domestic company (that wishes to import) must obtain foreign currency from its nation’s domestic banking system.

• Government can declare that companies desiring such a currency apply for a license to obtain it. Thus, a country’s government can discourage imports by restricting currency.

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Barriers to Trade

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Product & Testing Standards: (Non-Tariffs)

• This non-tariff barrier requires that foreign goods meet a country’s domestic product or testing standards before they can be offered for sale in that country.

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Barriers to Trade

China, for example, requires extensive and expensive testing of foreign motors vehicles

machinery, electric goods and pesticides before they enter its market.

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Trade Theories

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Trade Theories

Year

1500 1600 1700 1800 1900 2000

MercantilismAbsolute Advantage

Comparative Advantage

Factor Proportions Theory

International product Life Cycle

New Trade Theory

National Competitive Advantage (Porter’s Diamond)

TIME LINE OF TRADE THEORIES

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1. Mercantilism

• First theory, emerged in England in the mid-16th century.• The hypothesis is that gold & silver are the mainstays of

national wealth and essentials to vigorous commerce.• Gold & silver were currency of trade between countries;

a country could earn gold & silver by exporting goods. • To surplus, govt. is expected to discourage imports by

imposing tariffs & quotas and subsidizing exports.

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Trade Theories

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1. Mercantilism

• Colonizing resource rich, less developed countries was yet another source of mercantilism.

• Mercantilists Doctrine (policy) is being criticized on the ground that it believes in a zero-sum game.

However, exporters welcome mercantilism because of the subsidies and incentives they receive from the

government. Local manufacturer welcome the policy as it would protect them from competition from imports.

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Trade Theories

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2. Theory of Absolute Advantage

The theory has been propounded by Adam Smith, generally considered to be the father of economics. In his book, Smith argued that countries differ in their ability to produce goods efficiently.

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Trade Theories

In his time, the English (UK), by virtue of their superior manufacturing processes, were the world’s most efficient textile manufacturer.

Due to the combination of favorable climate, good soils, and accumulated expertise, the French has the world’s most efficient wine industry.

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ENGLAND(Absolute Advantage in Textiles)

FRANCE(Absolute Advantage in Wines)

ExportWines

ImportTextile

ImportWines

ExportTextile

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Trade Theories

The English had an absolute advantage in the production of textiles.

The French has the absolute advantage in the production of wine.

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2. Theory of Absolute Advantage: Numerical Examples• The efficiency of each country in the production of the two products is

measured in terms of the labor hours required to produce one unit of each product.

1. Obviously, Spain has an absolute advantage in production of olive oil (it takes only 2 hours to produce one unit),

2. whereas Italy has absolute advantage to produce shoes (it takes just 2 hours per unit of shoes).

COUNTRY Olive OilShoesSpain 2 4

Italy 4 2

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Trade Theories

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• Tata Steel, Hero Honda & Hero Cycles, each of these companies has acquired absolute advantage over the rest of the world.

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Trade Theories

A more complicated picture emerges when one of the trading partners has an absolute advantage in the

production of both the goods, namely, oil and shoes.

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3.Theory of Comparative Advantage

In his book, Ricardo argued that it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce itself efficiently.

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Trade Theories

Theory holds that nations should produce those goods for which they have the greatest relative advantage.

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• Obviously, for every unit of resource used, Spain can produce more oil and shoes than Italy. Spain has absolute advantage in the production of both the goods, but it has comparative advantage in shoes.

• Italy is unable to produce oil/shoes more efficiently than Spain but able to produce shoes more efficiently than oil.

In Spain, 1 Unit of Resources = 1 Unit of Oil or ½ Unit of Shoes.In Italy, 1 Unit of Resources = 1/6 Unit of Oil or 1/3 Unit of Shoes.

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Trade Theories

COUNTRY Olive OilShoesSpain 1 2

Italy 6 3

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• The difference between the theory of absolute advantage and the theory of comparative advantage is subtle.

• Absolute advantage looks at absolute productivity differences; comparative advantage looks at relative productivity differences.

What are the limitation of these two theories ?

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Trade Theories

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Trade Theories

Year

1500 1600 1700 1800 1900 2000

MercantilismAbsolute Advantage

Comparative Advantage

Factor Proportions Theory

International product Life Cycle

New Trade Theory

National Competitive Advantage (Porter’s Diamond)

TIME LINE OF TRADE THEORIES

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4. Factor Proportions/Endowments Theory

• Ricardo’s theory stresses that comparative advantage arises from differences in productivity. He emphasized that differences in labor productivity between nations underlie the nature of comparative advantage.

• Swedish economist Eli Heckscher (1919) put forward a different explanation of comparative advantage. He argued that comparative advantage arises from difference in national factor endowments.

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Trade Theories

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4. Factor Proportions/Endowments Theory

• The theory says that a country with capital abundance will export capital-intensive goods while the labor-abundant countries will export labor-intensive products.

TISCO in India is now ranked the first among the top world-class steel makers because of

the factors favorable to it.

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Trade Theories

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5. International Product Life Cycle

• IPLC theory, propounded in 1960s by Raymond Vernon of Harvard Business School, has two lessons: why trade takes place and why investment occurs.

• Theory explain how a company will begin by exporting its products and eventually undertake foreign direct investment, as the product moves through its life cycle.

• Theory has identified 3 stages in the life of a product:

1. New Product Stage

2. Maturing Product Stage

3. Standardized Product Stage

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Trade Theories

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5. International product Life Cycle

1. New Product Stage• In this stage a firm introduces an innovative product in

response to felt need in the domestic market. • As the fortunes of the product are not known, it is

produced in a limited quantity and is sold mainly in the domestic market.

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Trade Theories

Exports are either non-existent or take place in a limited way, gradually growing late in the new

product stage.

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2. Maturing Product Stage• As the product picks up in consumer acceptance and

popularity, demand for it rises both domestic as well as in foreign markets.

• The innovating firm sets up manufacturing facilities abroad to expand production capacity, and to meet growing demand from domestic & foreign consumers.

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Trade Theories

Near the end of maturity stage, attempts are made to produce the product in the

developing countries.

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3. Standardized Product Stage• This is the last stage in PLC.

Here, the market for the product stabilizes. The product becomes a commodity.

Market becomes price sensitive and the manufacturers are motivated to search for low cost producing countries in order to bring down the cost of production.

As a result, the production begins to be imported into the innovating firm’s home country.

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Trade Theories

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3. Standardized Product Stage• This is the last stage in PLC.

IPLC approach possesses versatility as it can be applied to a variety of products, such as

synthetic fibers, electronics goods, radio and television, computer.

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Trade Theories

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Trade Theories: International PLC

• PLC theory can be illustrated by taking photocopiers.

• The photocopiers was first developed in the early 1960s by Xerox in the US and sold initially to the users in that country. Originally Xerox exported photocopiers from the US to Japan and to the advanced countries of western Europe.

• As demand began to grow in those countries, Xerox entered into joint ventures to set up production in

Japan (Fuji-Xerox) and Great Britain (Rank Xerox). In addition, once Xerox’s patents on the photocopier process expired, other foreign competitors began to enter the market (Canon in Japan, Olivetti in Italy).

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3. Standardized Product Stage

• As a consequence, exports from the US declined and users in the US began to buy photocopiers.

• More recently, Japanese companies have found that manufacturing costs are too high in their own country, so they have begun to switch production to developing countries such as Singapore and Thailand.

• As a result, the US and several other advanced countries (e.g. Japan, Great Britain) have switched from being exporters to being importers of photocopiers.

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Trade Theories: International PLC

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6. New Trade Theory

A new trade theory to explain foreign trade emerged during 1970s and 1980s.The new trade theory states that:

1. There are gains to be made from specialization and economics of scale.

2. The first movers into any market can create entry barriers to others.

3. Governments may have a role to play in assisting its home based firms.

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Trade Theories

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7. National Competitive Advantage

• Michael Porter, Professor at Harvard, explained how a firm can become competitive.

• According to Porter, a firm’s competitive advantage stems from:

Strategy & Rivalry

Related & Supporting Industries

Factor Conditions

Demand Conditions

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Trade Theories: Porter’s Diamond

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Factor Conditions:

• It includes land, labor and natural resources. These factors will give initial competitive advantage to a nation.

• But a sustained competitive advantage comes from advanced and specialized factors. Such as skilled labor, capital and infrastructure.

• Specialized factors are difficult to duplicate and a firm that possesses these enjoys competitive advantage because others can not easily replicate them.

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Demand Conditions:• It includes the size and sophistication of its market and

the appropriateness of product standards.• Sophisticated local customers enhance the country’s

competitiveness by providing firms with insight into emerging customer needs.

• Example is the French wine industry. The French are discernible wine consumers. Those consumer force, help & expect French wineries to produce high quality wines.

• Because of the exacting demands of Italian buyers, producers are producing high quality leather products.

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Related and Supporting Industries:

• Extant related and supporting industries enhance competitive advantage of a firm through close working relationships, joint research and problem-solving, close proximity and sharing of knowledge and experience.

• While it is possible to outsource some of these facilities to distant suppliers, using nearby vendors is better.

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Strategy, Structure and Rivalry:

• The ability of a firm to compete successfully in global markets depends on its strategy, its structure and domestic rivalry.

• National policies tend to affect the firm’s international strategies. Policies that encourage investment, protect IPR, open local market for overseas trade and reduce corruption make firms strong.

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Usefulness of Trade Theory

Assignments:

Write down a short notes on the usefulness/practical aspect of Trade theories. Which theory is having important insights &

practical application in Globalizations.

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Gbm unit-02 (global trade & theory)

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