Global Trade Operations
rockshan19977
Week2LectureSlidesupdated-OMGT2243.pptx
—
OMGT 2243:
Global Trade Operations
Week: 2
Theories of International Trade
Learning objectives
Be familiar with the different theories explaining trade flows between nations.
Understand why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system.
Be familiar with the arguments of those who maintain that government can play a proactive role in promoting national competitive advantage in certain industries.
Understand the important implications that international trade theory holds for business practice
The pattern of international trade
5-‐3
Some patterns of trade are fairly easy to explain—it is obvious why Ghana exports cocoa, Brazil exports coffee, Saudi Arabia exports oil, and Australia exports fuels and minerals.
But: Why does Japan export automobiles, consumer electronics and machine tools? Why does Switzerland export chemicals, pharmaceuticals, watches and jewellery?
An overview of trade theory
5-‐4
International trade allows a country:
to specialise in the manufacture and export of products that it can produce efficiently.
import products that can be produced more efficiently in other countries.
Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country
Summary; Theory Time-line
1500
1600
1700
2000
Mercantilism pre (16th C)
Absolute Adv (1776)
Comparative Adv (1817)
International Product cycle (1966)
1800 1900
New Trade Theory (70s & 80s)
Factor Endowment (1919)
National Competitive Adv (1990)
Source: Wild et al 2003. International Business. New Jersey: Prentice Hall, pp. 145
5
Year
Mercantilism
5-‐6
Mercantilism suggests that it is in a country’s best interest to maintain a trade surplus—to export more than it imports.
Mercantilism advocates government intervention to achieve a surplus in the balance of trade.
It views trade as a zero-sum game: one in which a gain by one country results in a loss by another.
Absolute advantage
5-‐7
Postulated by Adam Smith, 1776
Country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.
Countries should specialise in the production of goods for which they have an absolute advantage and then trade these goods for goods produced by other countries.
Absolute advantage
5-‐8
Both countries gained from trade due to their specialisation - Positive Sum Game !
What happens…. If a country has an absolute advantage in producing everything?
Comparative advantage
5-‐9
David Ricardo asked what might happen when one country has an absolute advantage in the production of all goods.
Should the country trade with others?
Should the country just cease trading altogether?
What happens if a comparison is made between the relative efficiency for producing different products within the same country (when an Absolute Advantage exists for all products)?
A country should then focus on producing a product that it is most efficient in producing, compared to other products, even though the country enjoys an Absolute Advantage for producing all products.
Comparative advantage
5-‐10
If each country specialises in the production of the good in which it has a comparative advantage and trades for the other, both countries gain.
Comparative advantage theory provides a strong rationale for encouraging free trade because it suggests that the potential world production is greater with unrestricted free trade than it is with restricted trade.
Trade is a positive-sum game in which all countries
that participate realise economic gains.
Comparative advantage
Are resources immobile?
Resources do not always move freely from one economic activity to another, and job losses may occur.
Are returns constant, or diminishing?
What are dynamic effects? How will economic growth be affected?
Unrestricted free trade is beneficial, but because of diminishing returns, the gains may not be as great as the simple model would suggest.
Extensions of the Ricardian model
5-‐12
Opening a country to trade:
might increase a country's stock of resources as increased supplies become available from abroad.
might increase the efficiency of resource utilisation and free up resources for other uses.
might increase economic growth.
Dynamic gains from trade may not always be beneficial.
The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the countries with capital, where wages would then fall.
5-13
The Samuelson critique
Paul Samuelson argues that dynamic gains from trade may not always be beneficial.
The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages would then fall.
13
Heckscher-Ohlin theory
5-‐14
Ricardo’s theory suggests that comparative advantage arises from differences in productivity.
Eli Heckscher and Bertil Ohlin argued that comparative advantage arises from differences in national factor endowments—the extent to which a country is endowed with resources like land, labour and capital.
The Heckscher-Ohlin theory predicts that countries will export goods that make intensive use of those factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce.
A commonsense approach. Australia exports mineral commodities. China exports labour-intensive manufactured products.
5-15
The Leontief paradox
Wassily Leontief theorised that since the U.S. was relatively abundant in capital compared to other nations, the U.S. would be an exporter of capital intensive goods and an importer of labour-intensive goods.
However, he found that U.S. exports were less capital intensive than U.S. imports.
Since this result was at variance with the predictions of the theory, it became known as the Leontief paradox.
15
Trade theory and government policy
5-‐16
Mercantilism makes a crude case for government involvement in promoting exports and limiting imports.
Smith, Ricardo and Heckscher-Ohlin promote unrestricted free trade.
New trade theory and Porter’s theory of national competitive advantage justify limited and selective government intervention to support the development of certain export-oriented industries.
Classical Theories of International Trade
Some of the limitations of the theories become obvious when they are applied to real life observations.
All theories have assumptions. Some of the assumptions do not hold true all the time.
Is one theory better than another for explaining empirical observations?
What is the gap between theory and practice?
Contemporary Theories of International Trade
The Product Life Cycle Theory
New Trade Theory
Porter’s Diamond (National Competitive Advantage)
Product Life Cycle Theory
Proposed by Raymond Vernon
• mid-1960s
Based primarily on USA-invented products
Products undergo different life cycle phases.
At the “new product phase” the product is produced in the USA for the USA, to keep production close to the market.
At the “maturity phase” the product is introduced to other markets in developed countries. The production may also be moved to other developed countries to be close to the market.
Product Life Cycle Theory
At the “Standardised Product phase” the product is introduced to markets in developing countries. Production may be moved to developing countries to be close to the market.
In its home market, the product is now competing heavily on price. Hence there is a bigger push for production cost to be lower, the move to shift production to developing countries is well justified. The product is then re-exported back to the USA from a developing country.
Once the patent protecting the product expires, competitors will introduce competing products, often produced from plants in developing countries. The rival products mainly compete on price.
5-21
5-21
Figure 5.5 The product life-cycle theory
21
Product Life Cycle Theory
Problems with the Product Life Cycle Theory
Very US-centric. More and more innovative products are produced by European and Asian companies. Would the theory be applicable?
What if a product is introduced globally at the same time? The life cycles would be “synchronised” then…
What about a product that is produced simultaneously in developed and developing countries, for developed and developing countries?
How about a product that is heavily reliant to its components that are produced globally? Is there still a “lag”?
Product Life Cycle Theory
Product Life Cycle Theory may be useful for explaining international trade generated from the shifting of production location.
Limited to explaining USA-produced products or innovation, from a particular period in time?
Xerox Copier
New Trade Theory
• 1970s
Economists note that businesses seek to achieve cost reduction through economies of scale.
Economies of scale = unit cost reduction due to a large volume of output.
If a product does not have a big enough market, then it may not be produced because economies of scale cannot be achieved.
New Trade Theory predicts that
product variety will increase as a result.
if the output required to achieve economies of scale is a big proportion of total world demand, then the market may only support a limited number of players, usually the first-movers.
New Trade Theory
Problems with New Trade Theory…
At odds with Heckscher-Ohlin Theory.
USA is a major exporter of a product because it is the first mover. Not because it is better endowed.
To become a first mover… the government has a big role to play. Now, this is at odds with the push towards minimal government intervention and free trade… What roles do governments play in promoting initiatives such as the Silicon Valley and Space Exploration
National Competitive Advantage: Porter’s Diamond
Proposed by Michael Porter in 1990.
Why are some countries simply more successful than others in a particular industry?
Japan and Korea with electronics
Germany and Japan with cars
Heskscher-Ohlin Theory and Comparative Advantage theory only offer partial explanations…
What’s missing then?
National Competitive Advantage: Porter’s Diamond
Four attributes promote/impede the creation of competitive advantage
i. Factor endowments
ii. Demand conditions
iii. Related and supporting industries
iv. Firm strategy, structure and rivalry
The four points of the diamond (four attributes) are mutually reinforcing. The effect of one attribute influences one another.
Two additional factors determine success: chance and
government
5-28
5-28
Determinants of national competitive advantage: Potter’s diamond
28
National Competitive Advantage: Porter’s Diamond
Problems with Porter’s Diamond
Are all four attributes always achievable for a country?
How big is the effect of “chance” and “government”?
More empirical testing may be required.
Contemporary Theories on International Trade
Consider the importance of
1. Location
2. First-mover advantages
3. Government policy
4. Competitive capabilities
Summary
We have covered contemporary trade theories. In contrast to classical theories, the assumptions
made, and the predictions generated, are often contradictory to those from classical theories.
Understand and appreciate the importance of theories, both classical and contemporary, in particular their implication on practice
—
Questions ???
