International Business

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Chapter 2 The Evolution of International Business

Introduction to Global Business

Briefly explain why trade and foreign investment are good for society as a whole.

Describe the major international trade theories and how they operate.

Evaluate trade policy, the main instruments of trade policy, and their impact on business, consumers, and governments.

Explain the rationale behind a country’s choice of managing trade.

After studying this chapter, you should be able to:

Terms

International business

All commercial transactions, both private and public between nations of the world

Trade

The two-way flow of exports and imports of goods (merchandise trade) and services (service trade)

Foreign direct investment

Inflows of capital from abroad for investing in domestic plant and equipment for the production of goods and/or services and for buying domestic firms

EXHIBIT 2.1 WORLD’S TEN LARGEST ECONOMIES: PURCHASING POWER PARITY (PPP) BASIS* (U.S. $ 2012)

*PPP conversion factor is the number of units of a country’s currency that is required to buy the same amount of goods and services in the domestic market that a U.S. dollar would buy in the United States.

**GNI is the total value of goods and services produced by a country plus net receipts of employee compensation and property income from abroad.

Benefits of International Trade

A greater amount of choice in the availability of goods and services

Competition results in lower prices for goods and services consumed

Increased quality of life and higher living standards

EXHIBIT 2.2 WORLD TRADE PATTERNS: TOP TEN EXPORTING NATIONS IN 2012 (PERCENTAGE OF TOTAL WORLD EXPORTS)

EXHIBIT 2.3 NET INFLOWS OF FOREIGN DIRECT INVESTMENT BY REGION AND INDUSTRIALIZATION

EXHIBIT 2.3 NET INFLOWS OF FOREIGN DIRECT INVESTMENT BY REGION AND INDUSTRIALIZATION (continued)

Major Theories of International Trade

Mercantilism

The premise that a nation could only gain from external trading if it had a trade surplus

Specialization

Free trade en-courages countries to specialize in the production of those goods and services that they most efficiently produce

Factor Endowments

Nations primarily export goods and services that intensely use their abundant factors of production

Trade Theory Terms

Factors of production

Endowments used to produce goods and services:

Land (quantity, quality, and mineral resources beneath it)

Labor (quantity and skills)

Capital (cost)

Technology (quality)

Trade surplus

When the value of exports exceeds the value of imports; the opposite of a trade deficit

Wealth Accumulation as a Basis for Trade Theory: Mercantilism

Mercantilism is the oldest form of trade theory.

Practiced during the 1500–1750 period as Europe moved toward nationalism

Wealth—both personal and national—largely determined by the amount of precious metal owned

Mercantilists believed that for a nation to be wealthy, it must export as much as possible and import as little as possible so that the country would have a trade surplus.

Mercantilists did not want to see the big picture:

If all nations increased exports and decreased imports, there would be a surplus of exports that would lead to unpleasant results.

Specialization as a Basis for Trade Theory: Absolute and Comparative Advantage

Absolute advantage

The ability of one country to produce a good or service more efficiently than another

Comparative advantage

The ability of one country that has an absolute advantage in the production of two or more goods (or services) to produce one of them relatively more efficiently than the other

Factor Endowments as a Basis for Trade Theory

The Heckscher–Ohlin (H–O) theory

Attributes the comparative advantage of a nation to its factor endowments: land (quantity, quality, and mineral resources beneath it), labor (quantity and skills), capital (cost), and technology (quality)

Key assumptions of the H–O theory:

Perfect competition in the marketplace

Perfect immobility of factors of production among countries

Factor Endowments as a Basis for Trade Theory (continued)

Factor price equalization theory

When factors are allowed to move freely among trading nations, efficiency increases, which leads to superior allocation of production of goods and services among countries.

Free mobility of factors will lead to efficient reallocation of resources (factors of production) until price equilibrium is reached.

Porter’s “Diamond” Model of National Competitive Advantage

Chance

Demand conditions

Factor conditions

Government

Firm strategy, structure, and rivalry

Related and supporting industries

The Practice of Trade Policy

Trade policy

All government actions that seek to alter the size of merchandise and/or service flows from and to a country

Instruments of trade policy

Tariffs (custom duties)

Preferential duties

Most favored nation status

Nontariff barriers

Inbound Goods: Taxes on Imports

Tariffs

Customs duties on imports that are collected by a designated government agency responsible for regulating imports

Specific Tariff

An import tax that assigns a fixed dollar amount per physical unit

Ad Valorem Tariff

A tax on imports levied as a constant percentage of the monetary value of one unit of the imported good

Preferential Duties

Generalized System of Preferences (GSP)

An import tariff established by a nation for goods of certain countries and not applied to the same goods of other countries

An agreement where a large number of developed countries permit duty-free imports of a selected list of products that originate from specific countries

Outbound Goods: Taxes on Exports

A negative tariff or tax break aimed at boosting exports

Export Subsidy

Taxes meant to raise export cost and divert production for home consumption

Export Taxes

International Trade Organizations

International Monetary Fund (IMF)

World Bank

Bretton Woods

General Agreement on Tariffs and Trade (GATT)

World Trade Organization (WTO)

Nontariff Barriers

Import Quotas

Quantitative Restrictions (QRs) limit the amount or number of units of products that can be imported to a country

Voluntary Export Restraint (VER)

An arrangement under which an efficient exporting nation agrees to limit exports of a product to another country for a temporary period

Domestic Content Provisions

Regulations requiring that a certain percentage of the value of import be sourced domestically

Current Practice of “Managed” Trade

Socioeconomic Rationale

Countertrade

Export cartels

Protection of infant industries

Questionable labor practices

Environmental considerations

Health and safety

Geopolitical Rationale

National security

Protection of critical (strategic) industries

Embargoes

international business

trade

foreign direct investment

outsourcing

mercantilism

factors of production

trade surplus

absolute advantage

comparative advantage

factor price equalization theory

Heckscher–Olin (H–O) theory

trade policy

tariffs

custom duties

specific tariff

ad valorem tariff

preferential duties

generalized system of preferences (GSP)

export subsidy

export taxes

Key Terms

most favored nation (MFN)

import quotas

voluntary export restraint (VER)

domestic content provisions

managed trade

countertrade

export cartels

infant industry argument

embargoes

Key Terms (continued)