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International Trade

CHAPTER SIX

INTERNATIONAL

BUSINESS

The Challenges of Globalization

Canadian Edition

Wild • Wild • Valladares Montemayor

Chapter Objectives

Describe the relation between international trade volume and world output and identify overall trade patterns.

Describe the political, economic, and cultural motives behind governmental intervention in trade.

List and explain the methods governments use to promote and restrict international trade.

Describe mercantilism and explain its impact on world powers and their colonies.

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In this chapter, you will explore global patterns of international trade.

You will also:

Learn about mercantilism—the earliest theory of international trade.
Explore the theories of absolute and comparative advantage.
And understand more recent trade theories and their implications for international business.

Chapter Objectives

Explain the theories of absolute advantage and comparative advantage.

Explain the factor proportions and international product life cycle theories.

Explain the new trade and national competitive advantage theories.

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International Trade

Purchase, sale, or exchange of goods and services across national borders

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People have larger selection of products
Important engine for job creation

International trade is the purchase, sale, or exchange of goods and services across national borders.

We can measure the importance of trade to a nation by examining its trade volume relative to its total output.

The main benefits of international trade are that:

It provides a country’s people with a greater choice of goods and services.
and It creates new entrepreneurial opportunities and creates jobs.

Trade and World Output

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World trade
80% merchandise
20% services

World output impacts trade
Growing output = growing trade
Sluggish output = sluggish trade

World trade grows faster

than world output

Today, world merchandise exports are valued at more than $16 trillion and service exports total nearly $3.8 trillion.
Trade in merchandise is around 80% of total world trade, whereas services account for around 20%.
And while higher world economic output encourages international trade, lower output slows trade.
Over time, we see that world trade expands at a rate that is faster than growth in world output.

Canada in the World

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20 percent of all jobs in Canada are directly or indirectly derived from exports.

Over 150,000 business establishments were engaged in goods importing in 2009. These businesses hired over 33 percent of the Canadian labour force.

Canadians traveling

to other countries for business and pleasure

Photo: Gerry Taft Mount Royal University

20 percent of all jobs in Canada

are directly or indirectly derived from exports. According to Statistics Canada, over 150 000

business establishments were engaged in goods importing in 2009. These businesses hired over

33 percent of the Canadian labour force.

World’s Top Exporters

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This table shows the world’s largest exporters of merchandise and services. Perhaps not surprisingly, the United States ranks third in merchandise exports (behind Germany and China).

Trade Patterns

Merchandise trade among:

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Low- and middle-income nations

High-income nations

High-income and low- and middle-income nations

Trade volume and world output data provide insights into the international trade environment, but do not disclose who are a nation’s trading partners.

There is a persistent pattern of merchandise trade among nations.
Trade between the world’s high-income economies accounts for roughly 60 percent of total world merchandise trade.
Trade between high-income countries and low- and middle-income nations accounts for around 34 percent of world merchandise trade.
And Trade between low- and middle-income nations accounts for only about 6 percent of world merchandise trade.

Chart3

High income nations

High-income and low- and middle-income nations

Low- and middle-income nations

Sheet1

High income nations	High-income and low- and middle-income nations	Low- and middle-income nations
60	34	6

Sheet1

Sheet2

Sheet3

Who Trades with Whom?

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Map 6.2 shows intra-regional and extra-regional trade data (in percentages and billion dollars)

for the major regions of the world’s economy. What immediately stands out is the number representing

intra-regional trade for Asia. This number tells us that 52 percent of Asia’s exports are

destined for other Asian nations. The percentage has not increased much, however, in the last

decade. But if we analyze the amount in billions of dollars, Asian intra-regional trade has more

than doubled. Asian’s extra-regional trade has also increased significantly in billions of dollars.

As these nations’ economies grow, it will become increasingly important for managers to fully

understand how to do business in Asia. For some pointers on doing business in Pacific Rim

nations, see this chapter’s Global Manager’s Briefcase, titled “ Doing Business in the Pacific Rim .”

In contrast, intra-regional exports account for only 12 percent of all exports in Africa and

15 percent of intra-regional exports in Middle East. Another important observation is that

Trade Dependence and Independence

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Potential effects of dependence:

Infuses needed capital
Creates jobs and raises wages
Imports technology and skills

Economic problems transferred
Political turmoil can spill over

Total

dependence

Total

independence

Countries range from total trade dependence at one extreme and total independence at the other extreme.

The trade of developing and transition nations often depends on their developed neighbors with whom they share borders. For example, Germany is the single most important trading partner of several central and eastern European nations.
Dependency on trade with another nation is similar to other dependency situations:
When times are good in the nation depended upon, times are often good for the dependent nation.
But hard times in a nation depended upon (such as periods of economic recession or political turmoil) often spells trouble for a dependent nation.

Discussion Question

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What are the patterns of global and regional trade flows that we see among nations?

Photo: Gerry Taft, Mount Royal University

A typical street in downtown Manila, The Philippines

What are the patterns of global and regional trade flows that we see among nations?

Answer to Discussion Question

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Trade among high-income economies accounts for roughly 60 percent of total world merchandise trade. Trade between high-income countries and low- and middle-income nations accounts for about 34 percent of world merchandise trade.

Intra-regional trade accounts for nearly 70 percent of Europe’s exports, 56 percent of Asia’s exports, and 38 percent of North America’s exports.

Some economists call this the “Pacific century,” referring to the expected future growth of Asian economies and expected shift in trade flows from the Atlantic to the Pacific Ocean

Answer:

Trade among high-income economies accounts for roughly 60 percent of total world merchandise trade. Trade between high-income countries and low- and middle-income nations accounts for about 34 percent of world merchandise trade.
Intra-regional trade accounts for nearly 70 percent of Europe’s exports, 56 percent of Asia’s exports, and 38 percent of North America’s exports.
Some economists call this the “Pacific century,” referring to the expected future growth of Asian economies and expected shift in trade flows from the Atlantic to the Pacific Ocean.

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Why Do Governments Intervene in Trade?

Political Motives

Protect Jobs

Preserve National Security

Respond To “Unfair” Trade

Gain Influence

Photo: Gerry Taft, Mount Royal University

If one government thinks another nation is not “playing fair,” it will often threaten to retaliate unless certain concessions are made.

China is often accused of “taking away” American jobs

Why Do Governments Intervene in Trade?

In general, they do so for reasons that are political, economic, or cultural—or some combination of the three.

Political Motives

The main political motives behind government intervention in trade include protecting jobs, preserving national security, responding to other nations’ unfair trade practices, and gaining influence over other nations

Protect Jobs

Short of an unpopular war, nothing will oust a government faster than high rates of unemployment.

Preserve National Security

National Security and Imports Certain imports are often restricted in the name of preserving national security. In the event that a war would restrict their availability, governments must have access to a domestic supply of certain items such as weapons; fuel; and air, land, and sea transportation

National Security and Exports Governments also have national security motives for banning certain defence-related goods from export to other nations. Most industrialized nations have agencies that review requests to export technologies or products that are said to have dual uses — meaning they have both industrial and military applications. Products designated as dual use are classified as such and require special governmental approval before export can take place. Products on the dual-use lists of most nations include nuclear materials; technological equipment; certain chemicals and toxins; some sensors and lasers; and specific devices related to weapons, navigation, aerospace, and propulsion.

Respond To “Unfair” Trade

if one government thinks another nation is not “playing fair,” it will often threaten to retaliate unless certain concessions are made.

Gain Influence

The United States goes to great lengths to gain and maintain control over events in all of Central, North, and South America, and the Caribbean basin.

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Why Do Governments Intervene in Trade?

Economic Motives

Protect Infant Industries

Pursue Strategic Trade Policy

Cultural Motives

The upper picture is a store in Siberia.

The lower picture is of products on sale in the store.

Should a local Siberian candy producer be granted protection from these multinational brands?

Photos: Gerry Taft, Mount Royal University.

Economic Motives

The most common economic reasons for nations’ attempts to influence international trade are the protection of young industries from competition and the promotion of a strategic trade policy.

Protect Infant Industries

First, the argument requires governments to distinguish between industries that are worth protecting and those that are not.

Second, protection from international competition can cause domestic companies to become complacent toward innovation.

Third, protection can do more economic harm than good.

Pursue Strategic Trade Policy

Benefits of Strategic Trade Policy Advocates claim that strategic trade policies helped South Korea build global conglomerates (called chaebol ) that dwarf competitors

Drawbacks of Strategic Trade Policy Although it sounds as if strategic trade policy has only benefits, there can be drawbacks as well. Lavish government assistance to domestic companies in the past caused inefficiency and high costs for both South Korean and Japanese companies. Large government concessions to local labour unions hiked wages and forced Korea’s chaebol to accept low profit margins. In addition, when governments decide to support specific industries, their choice is often subject to political lobbying by the groups seeking government assistance. It is possible that special interest groups could capture all the gains from assistance with no benefit for consumers. If this were to occur, consumers could end up paying more for lower-quality goods than they could otherwise obtain.

Cultural Motives

Nations often restrict trade in goods and services to achieve cultural objectives, the most common being protection of national identity.

Methods of Promoting and Restricting Trade

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The most common instruments that governments use are shown

in Table 6.2 .

There are two general categories of trade barriers available to governments. A tariff is a government tax levied on a product as it enters or leaves a country. A restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time is called a quota. After tariffs, quotas are the second most common type of trade barrier.

Trade Promotion

Subsidies

Export financing

Foreign trade zones

Special government

agencies

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Photo: Gerry Taft, Mount Royal University

A hydrofoil races through the harbour in Hong Kong.

Hong Kong is a free port which thrives on free trade. It has become one of the world's largest trading economies and an international financial and commercial centre.

Methods of Promoting Trade

Subsidies

Financial assistance to domestic producers in the form of cash payments, low-interest loans, tax breaks, product price supports, or other forms is called a subsidy

Drawbacks Of Subsidies

Critics say that subsidies encourage inefficiency and complacency by covering costs that truly competitive industries should be able to absorb on their own.

Export Financing

Governments often promote exports by helping companies finance their export activities

Foreign Trade Zones

A designated geographic region through which merchandise is allowed to pass with lower customs duties (taxes) and/or fewer customs procedures

Special Government Agencies

The governments of most nations have special agencies responsible for promoting exports. Such agencies can be particularly helpful to small and medium-sized businesses that have limited financial resources

Trade Restrictions

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Tariffs

Quotas

Embargoes

Local content requirements

Administrative

Delays

Currency controls

As a tourist, it is very

difficult to exchange foreign currency for Belarusian Rubles, even at banks!

Photos: Gerry Taft, Mount Royal University

Methods of Restricting Trade

Tariffs

Protect Domestic Producers an import tariff raises the cost of an imported good and increases the appeal of domestically produced goods

Generate Revenue

Tariffs are also a source of government revenue, but mostly among developing nations.

Quotas

Restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time.

Reason For Import Quotas

A government may impose an import quota to protect its domestic producers by placing a limit on the amount of goods allowed to enter the country.

Reasons For Export Quotas

There are at least two reasons why a country imposes export quotas on its domestic producers. First, it may wish to maintain adequate supplies of a product in the home market. This motive is most common among countries that export natural resources that are essential to domestic business or the long-term survival of a nation. Second, a country may limit the export of a good to restrict its supply on world markets, thereby increasing the international price of the good.

voluntary export restraint (VER)

Unique version of export quota that a nation imposes on its own exports,

usually at the request of an importing nation.

Tariff-Quotas

A hybrid form of trade restriction is called a tariff-quota —a lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota.

Embargoes

Complete ban on trade (imports and exports) in one or more products with a particular country.

Local Content Requirements

The purpose of local content requirements is to force companies from other nations to use local resources in their production processes—particularly labour.

Administrative Delays

Regulatory controls or bureaucratic rules designed to impair the flow of imports into a country.

Currency Controls

Restrictions on the convertibility of a currency into other currencies.

Think – Pair - Share

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Across Vietnam, hundreds of small clothing factories have thrived following removal of worldwide import quotas allowed under the Multi-Fibre Agreement. Under the MFA, wealthy nations guaranteed imports of textiles and garments from poor countries under a quota system.

Under what conditions do you think nations should be allowed to impose import quotas?

Slide 19 is the first “Think-Pair-Share” in this chapter. These slides are intended to stimulate discussion between students. The activity requires students to consider the question individually, and then share their thoughts with one classmate or a small group. The goals of these slides are to 1) improve students’ conceptual understanding of the material, 2) hone critical thinking skills, and 3) improve problem solving.

Vietnamese women manufacture woven rugs at a craft centre in Hoi An, Vietnam. Across Vietnam, hundreds of small clothing factories have thrived following removal of worldwide import quotas allowed under the Multi-Fibre Agreement. Under the MFA, wealthy nations guaranteed imports of textiles and garments from poor countries under a quota system. Under what conditions do you think nations should be allowed to impose import quotas?

We can examine the material in this chapter on “Why Government’s intervene in Trade” to look for some possible answers.

Trade Theory Timeline

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It was not until the fifteenth century that people first put forth formal explanations for why trade occurs.
Today, trade experts continue to refine existing trade theories and develop new ones.
Let’s now explore some of these main theories.

Foundations of Mercantilism

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Nations accumulate financial wealth by encouraging exports and discouraging imports

Three pillars:

▪ Maintain trade surplus

▪ Government intervention

▪ Exploit colonies

The trade theory of mercantilism argues that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports.

European sea-faring nations practiced mercantilism from around 1500 to the late 1700s.
These countries acquired colonies in Africa, Asia, and the Americas as sources of inexpensive raw materials and as markets for higher-priced finished goods.
Mercantilist nations used profits from this trade to create armies and navies to control colonies and protect their shipping.

Flaws of Mercantilism

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World trade is a zero-sum game
Limits colonies’ market potential
Constrains output and consumption

There are several main problems inherent in mercantilism:

One flaw is that it views international trade as a zero-sum game. This is the idea that a nation benefits from trade only at the expense of other nations.
Also, market potential in the colonies was less than it could have been had people there received higher prices for their resources.
These actions, in turn, constrained the potential output and consumption for both the colonies and the mercantilist nations.

Absolute Advantage

Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources)

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Specialization and trade allows each to produce and consume more

1 resource unit = 1/6 ton rice or

1/3 ton tea

Tealand

Riceland

1 resource unit = 1 ton rice or

1/5 ton tea

Absolute advantage is the ability of a nation to produce a good more efficiently than any other nation.
This means that the nation can produce a greater amount of output using the same amount of, or fewer, resources.
Assume a world of two countries (Riceland and Tealand), two products (rice and tea), where transporting goods costs nothing, and each nation produces and consumes its own rice and tea.
In Riceland, one resource unit produces one ton of rice or one-fifth of a ton of tea.
In Tealand, one resource unit produces one-sixth ton of rice or one-third ton of tea.
Therefore, Riceland has an absolute advantage in rice production and Tealand has an absolute advantage in tea production.

Trade Gains:
Absolute Advantage

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Specialization and trade:

Riceland gets five times more tea than it would have produced itself

Tealand gets two times more rice than it would have produced itself

Assume that Riceland and Tealand expend additional resource units to produce extra rice and tea, respectively, and then trades its additional output with the other nation on a one-to-one basis.
This means that Riceland expends an additional resource unit to produce one extra ton of rice that it then trades with Tealand to obtain one ton of tea. Riceland gets four-fifths of a ton more tea than the one-fifth of a ton it would have produced itself with one additional resource unit.
Likewise, Tealand expends an additional resource unit to produce an extra one-third of a ton of tea that it then trades with Riceland to obtain one-third of a ton of rice. Tealand gets one-sixth of a ton more rice than the one-sixth of a ton it would have produced itself with one additional resource unit.
Specialization and trade gives Riceland five times more tea than it would have produced itself, and gives Tealand two times more rice than it would have produced itself.
Therefore, if each country specializes in the area in which it has an absolute advantage, world output (and consumption) of both goods increases. In other words, each nation benefits from specialization and trade.

Comparative Advantage

Inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good

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Specialization and trade allow each to produce and consume more

1 resource unit = 1/6 ton rice or

1/3 ton tea

Tealand

Riceland

1 resource unit = 1 ton rice or

1/5 ton tea

Comparative advantage is the inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good.
This means that a country is less efficient in the production of all goods, but it is less inefficient in the production of one good.
Again, assume a world of two countries, two products, and where transporting goods costs nothing.
In Riceland, one resource unit produces one ton of rice or one-half of a ton of tea.
In Tealand, one resource unit produces one-sixth of a ton of rice or one-third of a ton of tea.
Therefore, Riceland has absolute advantages in both goods because it is more efficient at producing each one.
However, Tealand has a comparative advantage in tea production because it produces tea more efficiently than it produces rice.

Trade Gains:
Comparative Advantage

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Specialization and trade:

Riceland gets two times more tea than it would have produced itself

Tealand gets two times more rice than it would have produced itself

Again, assume that Riceland and Tealand expend additional resource units to produce extra rice and tea, respectively, and then trades its additional output with the other nation on a one-to-one basis.
This means that Riceland expends an additional resource unit to produce one extra ton of rice that it then trades with Tealand to obtain one ton of tea. Riceland gets one-half of a ton more tea than the one-half of a ton it would have produced itself with one additional resource unit.
Likewise, Tealand expends an additional resource unit to produce an extra one-third of a ton of tea that it then trades with Riceland to obtain one-third of a ton of rice. Tealand gets one-sixth of a ton more rice than the one-sixth of a ton it would have produced itself with one additional resource unit.
Specialization and trade gives Riceland two times more tea than it would have produced itself, and gives Tealand two times more rice than it would have produced itself.
Therefore, if Riceland holds an absolute advantage in the production of each good and Tealand holds a comparative advantage in the production of one good, world output (and consumption) of both goods increases. In other words, each nation can still benefit from specialization and trade.

Assumptions and Limitations

Nations strive only to maximize production and consumption

Only two countries produce and consume just two goods

No transportation costs of traded goods

Labor is the only resource used to produce goods

Ignores efficiency and improvement gains from producing just one good

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The theories of absolute and comparative advantage focus on production efficiency, or productivity.

Despite their powerful predictive capabilities, these are limited by their assumptions that:

Nations are only driven to maximize their production and consumption; when governments get involved in trade for many reasons, including a concern for workers’ jobs.
Only two nations are engaged in the production and consumption of two goods; when more than 180 countries and countless products are produced, traded, and consumed.
It costs nothing to transport goods; when transportation costs are a major expense of international trade.
Labor is the only resource in production and cannot cross national borders; when production clearly needs additional resources and labor is increasingly mobile.
And that specialization does not result in efficiency gains; when specialization actually increases knowledge of a task and causes future improvements.

Discussion Question

6 - *

When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________.

a. Absolute advantage

b. Comparative advantage

c. Mercantilism

When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________.

a. Absolute advantage

b. Comparative advantage

c. Mercantilism

Answer to Discussion Question

6 - *

When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________.

a. Absolute advantage

b. Comparative advantage

c. Mercantilism

The correct answer is b. Comparative advantage

Factor Proportions Theory

Countries produce and export goods that require resources (factors) in abundance, and import goods

that require resources in short supply

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Two factor types

Labour

Land

And

Capital

Whereas the absolute and comparative advantage theories focus on productivity, factor proportions theory concentrates on factors of production.

Factor proportions theory says that countries produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply.
It predicts that a country will specialize in products that require labor if its cost is low relative to that of land and capital, and vice versa.
The theory seems common sense—Australia has abundant land and a small population, and its exports consist of products that require land while its imports consist of manufactured and consumer goods.

Leontief Paradox

Research found evidence opposite of that predicted by the factor proportions theory:

U.S. exports are more labor-intensive than U.S. imports

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Possible explanations:

Theory assumes nation’s production factors to be homogeneous
Theory is better predictor when expenditures on labor are considered

But a researcher named Wassily Leontief explored whether the United States, as predicted by the theory, exports goods requiring capital-intensive production and imports goods requiring labor-intensive production.
He found that the United States exports require more, not less, labor-intensive production than its imports. This apparent contradiction became known as the Leontief Paradox.
A possible explanation is that the theory considers a country’s production factors to be homogeneous—particularly labor—although labor skills vary greatly within a country.

International Product Life Cycle

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A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle

Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.

The international product life cycle theory states that a company will begin exporting its product and later undertake foreign direct investment as the product moves through its life cycle. This means that a country’s export will eventually become its import.

The product life cycle theory is broken into three stages:

In stage 1, the new product stage, high purchasing power and buyer demand encourage a company to design and introduce a new product concept. Although there is virtually no export market initially, exports increase late in this stage.
In stage 2, the maturing product stage, the domestic market and markets abroad become fully aware of the existence of the product and its benefits. Demand rises and is sustained over a fairly lengthy period of time. Near the end of this stage, sales begin in developing nations and manufacturing is established there.
In stage 3, the standardized product stage, competition from companies selling similar products pressures companies to lower prices to maintain sales levels. An aggressive search for low-cost production bases abroad begins and the home market may begin importing the product.

New Trade Theory

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Fundamentals

Gains from specialization and economies of scale
Companies first to market create barriers to entry
Government may help by assisting home companies

First-mover advantage

Economic and strategic advantage of being first to enter an industry
May create a formidable barrier to market entry for potential rivals

New trade theory says that:

There are gains to be made from specialization and increasing economies of scale.
Companies first to market can create barriers to entry.
And Government may play a role in assisting its home-based companies.

According to the theory, as a firm specializes and its output grows, it realizes economies of scale and its unit cost of production declines. The company can then expand, lower prices, and force competitors to produce a similar level of output if they are to remain competitive.

A major part of the theory is the first-mover advantage—which is the economic and strategic advantage gained by being the first company to enter an industry.
This advantage creates a barrier to entry for potential rivals and may allow a country to dominate in a product.
This leads some supporters to make the case that governments should work with home-based companies to help them become first movers in their industries.

Discussion Question

6 - *

Briefly describe the new trade theory. Does its focus on productivity put it at odds with the theory of comparative advantage and factor proportions theory?

Answer to Discussion Question

6 - *

New trade theory says that:

There are gains to be made from specialization and increasing economies of scale.

A company that is first to the market and achieves a first-mover advantage can create barriers to entry.

And Government may play a role in assisting its home-based companies.

Because new trade theory emphasizes productivity rather than a nation’s resources, it is in line with the theory of comparative advantage but at odds with factor proportions theory.

Answer:

New trade theory says that:

There are gains to be made from specialization and increasing economies of scale.
A company that is first to the market and achieves a first-mover advantage can create barriers to entry.
And government may play a role in assisting its home-based companies.

Because new trade theory emphasizes productivity rather than a nation’s resources, it is in line with the theory of comparative advantage but at odds with factor proportions theory.

National Competitive Advantage

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Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants

(plus government and chance)

Factor conditions

Demand conditions

Firm strategy, structure, and rivalry

Related and supporting industries

National competitive advantage theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.

The theory attempts to explain why some nations are more competitive in certain industries.
It argues that four elements are the basis of national competitiveness: factor conditions; demand conditions; related and supporting industries; and firm strategy, structure, and rivalry.
Let’s now examine each of these elements more closely.

Factor Conditions

6 - *

Basic Factors

Advanced Factors

Natural endowments of resources, such as a large population, natural resources, climate, and land features.

Result from a nation’s innovation and education, including the skill levels of different segments of its workforce and the quality of its technological infrastructure.

National competitive advantage theory recognizes two types of factors in any nation:

Basic factors are natural endowments of resources, such as a large population, natural resources, climate, and land features.
Advanced factors result from a nation’s innovation and education, including the skill levels of different segments of its workforce and the quality of its technological infrastructure.

The theory says that basic factors can spark initial production, but advanced factors account for a nation’s sustained competitive advantage in a product.

Demand Conditions

6 - *

Sophisticated home-market buyers drive companies to improve existing products and develop entirely new products and technologies

This should improve the competitiveness of the entire group of companies in a market

National competitive advantage theory acknowledges the importance of demand conditions—which refers to the sophistication of buyers in the home market.
Sophisticated demand conditions in the domestic market drives companies to modify existing products to create new design features, and to develop new products and technologies to better satisfy customers.

Related and Supporting Industries

6 - *

Companies in an internationally competitive industry do not exist in isolation

Supporting industries form “clusters” of economic activity in the geographic area

Each industry reinforces the competitiveness of every other industry in the cluster

Related and supporting industries also feature prominently in national competitive advantage theory.

Companies in internationally competitive industries do not exist in isolation.
Rather, supporting industries arise to provide inputs and form regional clusters of related activities that reinforce productivity and competitiveness.
Exporting clusters—those that export products or invest outside a region—can become a region’s source of long-term prosperity.

Firm Strategy, Structure,
and Rivalry

Highly skilled managers are essential because strategy has lasting effects on firm competitiveness

Domestic industry whose structure and rivalry create an intense struggle to survive strengthens competitiveness

6 - *

Firm strategy, structure, and rivalry also play roles in national competitive advantage theory.

Strategic decisions have lasting effects on future competitiveness, as do industry structure and rivalry between companies.
In general, the more intense the rivalry between domestic companies, the greater is their global competitiveness. Heightened competitiveness at home helps businesses to compete against imports and against foreign companies trying to develop a presence in the domestic market.

Discussion Question

6 - *

National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.

a. Product life cycle

b. First-mover

c. Competitive advantage

National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.

a. Product life cycle

b. First-mover

c. Competitive advantage

Answer to Discussion Question

6 - *

National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.

a. Product life cycle

b. First-mover

c. Competitive advantage

The correct answer is c. Competitive advantage

Think – Pair - Share

6 - *

For decades, trade with the United States brought well-paying jobs to ordinary Mexicans, like the man forming athletic shoes shown here. But some of Mexico’s garment producers (among others) are moving production to cheaper locations such as China. When this happens, Mexico experiences the negative effects of its dependence on US trade.

Why is a nation’s level of trade dependence or independence important?

Slide 43 is the second “Think-Pair-Share” in this chapter. These slides are intended to stimulate discussion between students. The activity requires students to consider the question individually, and then share their thoughts with one classmate or a small group. The goals of these slides are to 1) improve students’ conceptual understanding of the material, 2) hone critical thinking skills, and 3) improve problem solving.

Q: Why is a nation’s level of trade dependence or independence important?

A: Developing and transition nations that share borders with developed countries are often dependent upon their wealthier neighbors. A nation’s level of trade dependence is important because recession or political turmoil in the dominant nation can cause problems for the dependent nation. Countries try to reduce their dependence on other nations. The level of interdependency between pairs of countries is often reflected by the amount of trade that occurs between a company’s subsidiaries in the two nations.

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