session 5th

8/7/2019 session 5th

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1

Theories of International Trade and Investment



2

FOUNDA TION CONCEPTS

Comparative advantage

Superior features of a country that provide it

with unique benefits in global competition ²

derived from either national endowments ordeliberate national policies

Competitive advantage

Distinctive assets or competencies of a firm ²

derived from cost, size, or innovation strengthsthat are difficult for competitors to replicate or

imitate



3

EXAMPLES OF NATIONAL COMPARATIVE A DVA NTAGE

A bundant, low-cost labor in China

Mass of IT workers in India

Huge reserves of bauxite in A ustralia

A bundant agricultural land in the USA

Oil in Saudi A rabia



4

EXAMPLES OF FIRM COMPETITIVE A DVA NTAGE

Dell·s prowess in global supply chain management

Procter & Gamble·s skill in marketing

Samsung·s leadership in flat-panel TV

A pple·s design leadership in cell phones and personalmusic players





6

WHY NATIONS TRA DE: CLA SSICAL THEORIES

Mercantilism: the belief that national

prosperity is the result of a positive balance of

trade ² maximize exports and minimize imports

Absolute advantage principle: a countryshould produce only those products in which it

has absolute advantage or can produce using

fewer resources than another country





8

WHY NATIONS TRA DE: CLA SSICAL THEORIES

Comparative advantage principle: it isbeneficial for two countries to trade even if onehas absolute advantage in the production of allproducts; what matters is not the absolute cost of

production but the relative efficiency with whichit can produce the product.



One ton of Cloth Wheat

---------------------------------------------

France 30 40

Germany 10 20

----------------------------------------------Example of Comparative A dvantage (labor cost

in days of production for one ton)



10

LIMITATIONS OF EARLY TRA DE THEORIES

Do not take into account the cost of internationaltransportation

Tariffs and import restrictions can distort tradeflows

Scale economies can bring about additionalefficiencies

When governments selectively target certainindustries for strategic investment, this may

cause trade patterns contrary to theoreticalexplanations

Today, countries can access needed low-costcapital in global markets

Some services cannot be traded internationally



11

CLA SSICAL THEORIES: FACTOR PROPORTIONS THEORY

Factor proportions (endowments) theory: each country should produce and export productsthat intensively use relatively abundant factorsof production, and import goods that intensively

use relatively scarce factors of production Examples:

y China and labor

y USA and pharmaceuticals

y Canada and electric power



12

CLA SSICAL THEORIES:

INTERNATIONAL PRODUCT CY CLE THEORY

International product cycle theory: each productand its associated manufacturing technologies gothrough three stages of evolution: introduction,g rowth, and maturity. Think of cars, TVs.

In the introduction stage, the inventor country enjoys

a monopoly both in manufacturing and exports A s the product·s manufacturing becomes more

standard, other countries will enter the globalmarketplace

When the product reaches maturity, the originalinnovator country will become a net importer of the

product A pplicability to the contemporary global economy: Today, the cycle from innovation to maturity is muchshorter making it harder for the innovator country tosustain its lead in a particular product



13

HOW NATIONS ENHA NCE COMPETITIVE A DVA NTAGE

The contemporary view suggests thatgovernments can proactively implement policiesto enhance a nation·s competitive advantage,beyond the natural endowments the country

possesses Governments can create national economic

advantage by: stimulating innovation, targetingindustries for development, providing low-costcapital, minimizing taxes, investing in IT, etc.





15

MICHAEL PORTER·S DIA MONDMODEL:

SOURCES OF NA TIONAL COMPETITIV E A DV ANTA GE

1. Firm strategy, structure, and rivalry ² the presenceof strong competitors at home serves as a nationalcompetitive advantage

2. Factor conditions ² labor, natural resources, capital,technology, entrepreneurship, and know how

3. Demand conditions at home ² the strengths andsophistication of customer demand

4. Related and supporting industries ² availability of

clusters of suppliers and complementary firms withdistinctive competences





17

INDUSTRIAL CLUSTERS

A concentration of suppliers and supporting firmsfrom the same industry located within the samegeographic area

Examples include: the Silicon Valley, fashioncluster in northern Italy, pharma cluster inSwitzerland, footwear industry in Pusan, SouthKorea, and the IT industry in Bangalore, India

Can serve as a nation·s export platform



18

NATIONAL INDUSTRIAL POLICY

Proactive economic development plan enacted by the government tonurture or support promising industries sectors.

Typical initiatives:

y Tax incentives

y Investment incentives

y Monetary and fiscal policiesy Rigorous educational systems

y Investment in national infrastructure

y Strong legal and regulatory systems

(Examples: Japan, Dubai, and Ireland)





20

DOMINA NCE OF FDI-BA SED EXPLA NATIONS OF THE INTERNATIONAL FIRM

Most IB theories about the firm emphasize theMNE, since it was long the major player ininternational business.

Foreign direct investment (FDI) is the mainstrategy used by MNEs in internationalexpansion; thus, earlier theories emphasizedmotives for, and patterns of, FDI







23

FDI BA SED EXPLANA TIONS:

MONOPOLISTIC A DV ANTA GE THEORY

Suggests that FDI is preferred by MNEs because

it provides the firm with control over resources

and capabilities in the foreign market, and a

degree of monopoly power relative to foreign

competitors

Key sources of monopolistic advantage include

proprietary knowledge, patents, unique know-

how, and sole ownership of other assets



24

FDI BA SED EXPLA NATIONS:

INTERNALIZATION THEORY

Explains the process by which firms acquire and

retain one or more value-chain activities inside

the firm ² retaining control over foreign

operations and avoiding the disadvantages of

dealing with external partners.

In contrast to arm·s-length entry strategies (such

as exporting and licensing) which imply

developing contractual relationships withexternal business partners, FDI provides the firm

with control and ownership of resources



25

FDI BA SED EXPLA NATIONS:

DUNNING·S ECLECTIC PARA DIGM

Three conditions determine whether or not a company will

internalize via FDI:

1. Ownership-specific advantages ² knowledge, skills,

capabilities, relationships, or physical assets that form

the basis for the firm·s competitive advantage2 . Location-specific advantages ² advantages associated

with the country in which the MNE is invested,

including natural resources, skilled or low cost labor,

and inexpensive capital

3 . I nternalization advantages ² control derived frominternalizing foreign-based manufacturing, distribution,

or other value chain activities



26

NON-FDI BA SED EXPLA NATIONS:

INTERNATIONAL COLLA BORATIVE VENTURES

While FDI-based internationalization is still common,

beginning in the 1980s firms have emphasized non-

equity, flexible collaborative ventures to

internationalize.

Collaborative venture: a form of cooperation betweentwo or more firms. Through collaboration, a firm can

gain access to foreign partner·s know-how, capital,

distribution channels, and marketing assets, and

overcome government imposed obstacles.

Venture partners share the risk of their joint efforts,and pool resources and capabilities to create synergy.



27

TWO TY PES OF

INTERNATIONALCOLLA BORATIVE VENTURES

1. Equity-based joint ventures result in the formation

of a new legal entity. Here, the firm collaborates with

local partner(s) to reduce risk and commitment of

capital.

2. Project-based alliances involve cooperation in R&D,

manufacturing, design, or any other value-adding

activity, a partnership aimed at a narrowly defined

scope of activities and timeline



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