INTERNATIONAL BUSINESS THEORY AND POLICY
ARIZONA STATE UNIVERSITY
OMT 440 - INTERNATIONAL BUSINESS
WEEK 2
LEARNING OBJECTIVES:
1.
Understand the theory that explains why certain goods are traded internationally
2.
Can explain some theories of foreign direct investment (FDI)
INTRODUCTION:
Since the importance of international business to a country's economy was first
realized, various theories have been put forward to try to explain the occurrence of
international trade. With globalization, international direct investment activities also
increased rapidly, so various theories were also put forward to explain the occurrence of
international direct investment.
International trade theory itself can be categorized into two groups, those that use the
state as the unit of analysis, and those that use the firm as the unit of analysis. Because the
first group was put forward in the past in which the role of the state was decisive in
international trade, this group is known as the classical international trade theory group. The
modern international trade theory group emerged in the mid-20th century, which has a more
realistic view of international trade, namely that the state is no longer directly active in
international trade.
International investment is also explained by various theories. The attempt to explain
international investment is centered on the theory of international direct investment. The
explanation of portfolio investment, which is an investment that is very easy to get in and out
of a foreign country, does not differ much from domestic portfolio investment.
Since its inception, the concept of free trade has generated much debate that continues
to this day. While there are many arguments in favor of the concept of free trade for its
economic development and growth benefits, there are also many arguments against the
concept, especially from developing countries. Developing countries generally argue that free
trade is detrimental to them and only benefits relatively more developed countries. This is
especially voiced by countries whose economies and industries have not advanced or even
regressed due to free trade. However, many developing countries support the concept of free
trade, especially those developing countries that have benefited in terms of economic growth
and development through free trade.
Since the mid-20th century, countries around the world have increasingly faced free
trade and international direct investment. International business theory has influenced many
agreements and the emergence of world trade organizations and economic cooperation
between countries, which aim to encourage international business between countries in the
world. Therefore, it is very important to study the theories that underlie these international
business activities. Similarly, it is necessary to Understand the policies of countries that
affect international trade and international direct investment.
CLASSICAL INTERNATIONAL TRADE THEORY:
International trade theories attempt to explain the motivations for international trade
and explain why international trade occurs, and can be classified into classical country-based
theories and modern-firm-based theories: classical country-based theories and modern-firm
based theories.
Classical theories include: mercantilism, absolute advantage theory, comparative
advantage theory, relative factor endowments theory. Modern theories include: country
similarity theory, product life cycle theory, global strategic rivalry theory, and Porter's
national competitive advantage theory. The classical theory uses the state as the foundation,
while the modern theory realizes that it is the firm that does the business, not the state, so the
theory is based on an understanding of the firm's or industry's activities.
This group of classical international trade theories was developed by economists before
World War 2, and tries to explain national economic conditions, especially the advantages of
a country that allows the exchange of goods, or international trade. These theories were
developed during the rise of European countries in international trade. Country-based
theories, in particular useful in describing trade in commodities, i.e. standardized,
undifferentiated products, such as agricultural and mining products, such as sugar, wheat,
rice, which are typically purchased based on price rather than brand. The theories in this
classification are: mercantilism, absolute advantage, comparative advantage, factor
proportion. These theories are still relevant to know, because although they are often
criticized as outdated and incorrect, they are still the basis of many countries' policies.
While all these classical theories agree that international trade benefits a country, there
are basic differences in the recommendations for government policy. Mercantilism argues
that a country's government should actively promote exports and discourage imports. In
contrast, absolute advantage theory, comparative advantage, factor proportion theory either
directly or indirectly promote free trade, both exports and imports.
MERCANTILISM:
The concept of mercantilism developed in the 16th century. Mercantilism is an
economic ideology or philosophy based on the idea that the wealth of a country depends on
the treasure it manages to accumulate, usually in the form of gold, and to increase wealth,
government policy should increase gold holdings through promoting exports and reducing
imports. The practice of mercantilism was supported by trade surpluses, government
intervention and colonialism.
A trade surplus is obtained when the value of exports is greater than the country's
imports. A trade deficit, which is when imports are greater than exports must be avoided,
therefore government intervention is needed so that a trade surplus can occur. In this case the
government will, among other things, try or prohibit or limit imports in various ways, as well
as provide subsidies to domestic industries to increase exports. Governments at the time often
also prohibited the shipment of gold and other precious materials abroad. Furthermore,
mercantilist countries colonized as many countries as possible in order to provide a source of
cheap raw materials and a market for their expensive finished products.
European countries, such as Britain, France, the Netherlands, Spain and Portugal have
practiced this, so that today most countries in Asia, Africa, America, Australia and Oceania
are former colonies of these European countries. This policy has made European countries
wealthy, enabling them to have strong armies at that time, which further strengthened their
control over their colonies. Therefore, the political power of a country is said to depend on
how much economic power it has.
This policy has benefited many parties in European countries at that time, including
employees and businesses. On the other hand, this policy was detrimental to society at large,
as government subsidies had to be financed from government revenues, i.e. through taxes,
and consumers had to pay more for various products due to protection policies. At the time,
many of these burdens were then placed on the colonized country. For example, when
Indonesia was a colony The Dutch implemented policies to make plantation products cheaper
to export, taxed all products for Indonesian consumption, and limited government services,
such as education and health care for Indonesians. However, it is possible to control another
country without making it a colony, and this is often referred to as neo-colonialism.
Economic, financial, political, military and technological power has enabled the practice of
neo-colonialism until now for the continued suffering of developing countries.
The criticism of this theory is mainly on the concept of equating the notion of property
ownership with wealth ownership. In addition, it is thought that the application of this theory
by a country will actually weaken the country by eliminating the ability to produce because it
wants to reduce imports. Another criticism is that in the long run, no country can actually
maintain its international trade surplus, so no country can maintain its wealth. Another
weakness of this theory is that it is based on a zero-sum game, where a surplus for one
country is a loss for another. Another criticism of mercantilism is that it cannot be viewed as
an economic theory, as the concept is primarily driven by the political and economic interests
of a country, and its implementation requires the active role of the state.
Although mercantilist policies only benefited some people, and did more harm,
mercantilism remains popular today. Almost all countries in the world apply the philosophy
of mercantilism in their respective government policies. Because of the link between political
power and economic power, and economic power and economic wealth, and economic
wealth and international trade surpluses, mercantilism is still widely adopted by countries in
the world. Countries that strive to maintain their international trade surpluses are often
referred to as countries that practice neo-mercantilism.
The fact shows that even though they no longer use gold as a measure of wealth, many
countries can actually become developed countries because they apply the concept of neo-
mercantilism in their international trade. The concept of neo-mercantilism has been applied
by various developing countries that have successfully increased the prosperity of their
countries. In Tables 2 and 3 in Chapter I, we have shown the success of China, Taiwan,
Singapore, Malaysia, Thailand with their trade surplus over time. Indonesia and the
Philippines are two countries that often experience trade deficits and are less prosperous than
their Asian counterparts, partly due to their inability to maintain trade surpluses. Thus,
although not entirely true, nor can it be said to be an economic theory, the application of the
concept of neo-mercantilism has been proven to be able to increase the prosperity of the
countries that apply it.
ABSOLUTE ADVANTAGE THEORY:
The philosophy of mercantilism was criticized by Adam Smith (1776) who argued that
mercantilism blurred the notion of property acquisition with that of wealth acquisition. With
the concept of mercantilism, it is detrimental to the country as individuals cannot trade freely
and gain the benefits of free trade. In addition, with protection, a country will be inefficient in
producing goods that are not worth producing. This inefficiency makes mercantilism reduce
the wealth of the country, even though some members of society benefit. Therefore, Adam
Smith introduced free trade between countries, as this allows a country to efficiently produce
the goods it is worth producing and source other goods from other countries.
The issue then becomes what goods does a country produce, and what goods does it
import? The theory of absolute advantage answers this question. The theory of absolute
advantage introduced by Adam Smith (1776) refers to an attempt to explain why a country
conducts international trade, and how it can do so. In economic principles, absolute
advantage is the ability of a country to produce more goods than other countries, given the
same amount of inputs. This theory includes the free trade supporting theory, which argues
that specialization of production and the free flow of goods will grow the economies of all
trading countries.
Adam Smith argued that it was an impossibility that all countries in the world would
become rich simultaneously by following mercantilism, as one country's exports were
imported by other countries, and this meant that there were countries that did not become
rich. In contrast, free trade and specialization based on each country's absolute surplus would
allow all countries to become rich. Moreover, the prosperity of a country depends not on its
wealth or gold reserves, but on the availability of goods and services needed by its
population. With specialization, each country benefits from the trade, so international trade is
not a zero-sum game, but a positive-sum game.
The main criticism of this theory is that there are likely to be many countries that have
no, or limited, absolute surplus. There may be countries that cannot trade at all, as they do not
have any absolute surplus. Furthermore, for countries with limited absolute surplus, there will
indeed be gains for all trading parties, but those gains may not be equal. This means that in a
world where the concept of absolute surplus applies, there will be prosperous countries, less
prosperous countries, and failed countries.
An example of trade possibilities based on absolute advantages between two countries
(as measured by labor productivity) is as follows;
Labor Productivity (Output per Hour)
Country/Product
Indonesia
Japan
Shoes
20
10
Watches
10
50
Under these conditions, Indonesia will produce shoes, and Japan will produce watches,
and trade will occur. Indonesia produces and exports shoes to Japan, and Japan produces and
exports watches to Indonesia. On the other hand, according to this theory, if a country has an
absolute surplus in both products, there will be no trade.
COMPARATIVE ADVANTAGE THEORY.
Adam Smith's absolute surplus theory implies that if a country has an absolute surplus
in all goods, then there is no benefit for that country to trade internationally. Likewise, if a
country does not have an absolute surplus in a good, it will not be able to trade
internationally. David Ricardo (1817) introduced the theory of comparative advantage, which
states that each country will benefit from international trade by specializing in the production
of the goods it most efficiently produces.
The theory of comparative advantage is based on the notion that a country can have a
comparative or relative advantage in the production of a good even though its absolute
advantage is lower than other countries. The comparative advantage is obtained because the
country is able to produce a good products at a lower opportunity cost than other countries, or
the ability to produce a good with the highest relative efficiency compared to all other
products.
With this comparative advantage, a country will produce and export goods and services
that it is relatively more productive in producing than other countries. It will import goods
and services in which the other country is relatively more productive. The theory of
comparative advantage explains how trade can create value for both parties even if one party
can produce the entire product more productively than the other party. The net benefits of all
trade outcomes are called gains from trade, the benefits of trade. The existence of these gains
from trade is the central concept of international trade theory.
The difference between absolute and comparative advantage is the difference between
absolute productivity and relative productivity. The theory of comparative advantage uses the
concept of opportunity cost, the value of what is given up to obtain a good.
To demonstrate the possibility of trade using the theory of comparative advantage, the
example of two countries, Indonesia and Australia, which both produce and consume two
products: textiles and beef, is used. The capacity and efficiency of the two countries are such
that if each country uses all its resources to produce beef, the output will be as follows:
Indonesia produces 100 tons, Australia 400 tons. If all resources are used to produce textiles,
then output will be as follows Indonesia produces 100 tons, Australia 200 tons.
Country/Product
Indonesia
Australia
Textiles
100 tons
200 tons
Beef
100 tons
400 tons
Using the theory of absolute surplus, no trade would occur, as Australia has an absolute
surplus of both products, so no one benefits from international trade. The opportunity cost
concept shows that trade can occur. Indonesia's opportunity cost for 1 ton of beef is 1 ton of
textiles. Australia's opportunity cost for 1 ton of beef is 0.5 tons of textiles. Australia's
opportunity cost for 1 ton of textiles is 2 tons of beef. Australia has a comparative advantage
in beef production, as it has a lower opportunity cost than Indonesia. On the other hand,
Indonesia has a comparative advantage over Australia in textile production, because
Australia's opportunity cost for textiles is higher than Indonesia's. If there is no trade, then
Australia has a comparative advantage in textile production. If no trade occurs, it is assumed
that each country produces and consumes both products in its own country:
For trade to occur, Indonesia needs at least 1 ton of beef as the price for 1 ton of
textiles, and Australia needs at least 1 ton of textiles in exchange for 2 tons of beef.
Supposing the exchange price is somewhere in between, i.e. exchange occurs when 1 ton of
beef is exchanged for 2/3 ton of textiles, then if both countries specialize in products with
comparative advantage, production and consumption will be as follows:
Production After Trade
After-Trade Consumption
Beef
Textiles
Beef
Textiles
Indonesia
0
100
75
50
Australia
300
50
225
100
Total
300
150
300
150
Both countries benefit from international trade because by specializing in production,
as well as trading it, they gain the benefit of being able to consume more of those products
than they could before trade.
Although the theory of comparative advantage is better able to explain the occurrence
of international trade, as with the theory of absolute advantage, many unrealistic assumptions
have been used in both theories. The first assumption is that countries only need to maximize
production and consumption. This is not true, as governments often engage in international
trade in the interests of consumers and workers. Second, In reality, international trade
involves many countries, each of which has its own advantages and disadvantages. Third,
international trade always involves transportation costs and issues, so these cannot be ignored
in the explanation of international trade. Fourth, it is assumed that labor is the only resource
used, and that labor mobility can easily occur between countries. In reality, today labor is not
the only resource that is important in the production of a product, and in many cases it is
often negligible. Moreover, it is not common for labor to move easily from one country to
another. Finally, the assumption that production specialization will not change the efficiency
of product production. In fact, economies of scale and learning curves greatly affect the
efficiency of product production.
The usefulness of the theory of comparative advantage has also been questioned,
including its impact on the economy. Conditions that maximize comparative advantage do
not automatically resolve trade deficits. In fact, in many real-world examples, comparative
advantage is achieved through trade deficits. Criticism relating to the merits of applying the
theory of comparative advantage is also based on the theory of developing a country's
economy through import substitution strategies. The argument is based on the concept that a
country may lack comparative advantage in an industry, but this can be changed by economic
development or investment policies, so that the country succeeds in achieving competitive
advantage in that industry. Therefore, the competitive advantage theory does not provides
guidelines for the economic development of a country, especially in the industrialization
efforts of developing countries.
ENDOWMENT FACTOR THEORY:
The theory of comparative advantage raises the question of what determines the
products that a country has a comparative advantage? The Heckscher-Ohlin theory (1919)
answers the question of what determines a country's products will have comparative
advantage. The factors of production endowed to each country are different, while goods
differ based on the type of factors used to produce them. The differences in the factors of
production (land, labor, capital) endowed to each country determine a country's comparative
advantage. A country will have a comparative advantage in products that require factors of
production that are abundantly available in the country. This is because the profitability of the
product is determined by the cost of inputs to the product. Products that require inputs that
are abundantly available in a country will be produced at a lower cost than products that
require inputs that are scarce in the country. For example: Indonesia with its abundance of
labor will export products from labor-intensive industries; Saudi Arabia with its abundance
of petroleum will export such products.
Just like all economic theories, the Hecskscher-Ohlin theory is based on many
assumptions that are often unrealistic, and aims only to facilitate explanation. It therefore also
has its shortcomings As with many economic theories, it is useful for explanation, but cannot
be directly applied as a way to implement a country's economic policy. These assumptions
include: the assumption that both countries have identical production technology; production
output has constant returns to scale, the technology used to produce the two goods is
different, labor and capital are free to move within a country, labor and capital cannot move
between countries, products have the same price everywhere, and so on.
Leontief (1950) tested the Heckscher-Ohlin theory with USA import-export data. The
results of his research showed the opposite fact to the endowment factors theory, known as
the Leontief paradox. The USA, which has large capital and human resources that are not
cheap, exports products that require a lot of labor, and imports more capital intensive goods.
Leontief's research was criticized because he only considered two factors of production,
namely capital and labor, while every good requires many other factors of production. Many
products are produced in a capital-intensive manner with factors of production not taken into
account, such as capital-intensive agricultural products, human-capital intensive computers,
and other technology-intensive products. Thus, the factor endowments theory may be correct
if other factors of production that are not gifts, such as technology, are also taken into
account. However, for exported products, there may be differences in tastes and the role of
monetary (exchange rates) that can cause the Leontief paradox.
MODERN INTERNATIONAL TRADE THEORY:
International trade theories in this group developed due to the increasingly important
role of multinational corporations, as well as the inability of country-based theories to
explain and predict the existence of trade between countries and its growth as the original
purpose of these theories. The modern theory of international trade was developed after
World War 2 by business experts who argued that the unit of analysis should be firms rather
than countries. This theory explains international trade based on productivity rather than the
resources of a country.
This theory is based on the concept: (1) that there are benefits from specialization and
high economies of scale, (2). Firms that enter the market first may form entry barriers for
other businesses, and (3). The government may have a role to play in protecting domestic
firms. A firm that specializes in producing a product will increase its output due to efficiency
gains. The increase in output will allow the firm to benefit from economies of scale, further
lowering the cost of the product. The first firm to enter the market will gain competitive
ability in price and other strategic capabilities will create high barriers for other firms to enter
the market.
This group of theories is called firm-based trade theories, because the development of
the world shows that if previously the role of government was so great for the prosperity of a
country, then in modern times, the actors of the trade trade theories have become more
important business plays a greater role. The government can no longer directly prosper a
country, because the prosperity of a country is now determined by the progress or failure of
business companies in that country. Modern theories use various factors to explain trade,
including: quality, technology, brand names, consumers, and so on. Theories in this
classification include: country similarity theory; product life cycle theory; global strategic
rivalry theory; Porter's national competitive advantage theory. Firm-based theories are
particularly useful for explaining international trade in differentiated products, e.g.,
automobiles, electronic goods, and other consumer products, in which brands are a major
component of consumers' buying decisions.
COUNTRY SIMILARITY THEORY:
Classical international trade theory describes interindustry trade, which is trade
between countries from different industries. In reality, much of the trade in goods between
countries takes place in the form of intraindustry trade, i.e. trade in goods within the same
industry. Classical international trade theory cannot explain this phenomenon. Country
similarity theory can explain the phenomenon of trade by the same industry between
countries. For example, why Japan exports cars produced in Japan to Germany, while
Germany also exports its cars to Japan, and so on between various countries in the car
industry. Trade occurs due to the similarity of preferences for cars between consumers in
countries that are located in the same country. Similar stages of economic development and
different tastes among individuals make trade possible.
More general is The Linder theory of overlapping demand which argues that
international trade in manufactured products will be greater between countries with similar
levels of income per capita than with other countries that are not at the same level of income
per capita. This is shown by the data that a much larger percentage of a developed country's
trade is with another developed country than with a developing country. While this is the case
for developed countries, it is not the case for developing countries, as exports of developing
countries' products are generally more to developed countries than between developing
countries.
INTERNATIONAL PRODUCT LIFE CYCLE THEORY:
The failure of Heckscher-Ohlin to explain the pattern of international trade prompted
Raymond Vernon (1960) to introduce an economic theory that became known as the
international product life cycle theory. His observations in the USA showed that most of the
goods that began to be produced in the 20th century originated from the USA and were also
initially sold in the USA (cars, televisions, personal computers, etc.). This situation was
explained because the technological and production capabilities of the USA made product
development carried out in the USA. Sales were also made to the USA market because the
wealth and size of the USA market made these products sold for the first time in the USA.
Further observation shows that the products The goods are then also sold overseas, and
produced overseas as well. Subsequently, the USA imported these goods from these overseas
production facilities.
This theory suggests that international trade follows a product life cycle, hence the
name international product life cycle theory. Initially, all products are marketed in the
country where they were originally developed. After that, the product is introduced to the rest
of the world, and production slowly moves away from the country of origin. In some cases,
the product is imported by the country of origin. This model shows the dynamics of
comparative advantage. Countries that have a comparative advantage in producing a product
will move from the inventor country (which is usually a developed country) to developing
countries.
From the company's point of view, this theory shows the evolution of marketing
strategies with respect to products, namely through the stages: new product, maturing
product, and standardized product. The international product life cycle theory was developed
at a time when the USA was still the center of new product development and the largest
market for any product. This theory was very appropriate to explain international trade at that
time.
The explanation for the occurrence of international trade by this theory is that there are
generally four stages in the product life cycle: (a). Introduction, (b). Growth, (c). Maturity,
and (d). Decline. In the introduction stage, a new product is introduced to meet local needs,
and then begins to be exported to countries that have characteristics that are not the same
different from the inventor's country (e.g. in its needs, preferences, and income). In the
growth stage, the demand for the product increases rapidly in various countries, and this
encourages production in other countries in order to meet the speed of demand growth. In the
maturity stage, demand stagnates, so the industry begins to contract, production is carried out
only in countries with the lowest cost ability to produce it. Each product will then experience
a period of decline, demand will decrease, and the market will be limited to less developed
countries. A country or company in that country will only be able to survive if it can adapt
products to suit the needs of the small market.
GLOBAL STRATEGIC RIVALRY THEORY:
Companies will export products if they have competitive advantages compared to
companies in other countries, even though companies from countries that do not have
abundant production factors. Competitive advantage can be obtained from various sources,
including economies of scale and experience curve. These advantages can usually be obtained
by firms facing a large domestic market that allows them to produce in large quantities, thus
achieving competitive advantages in economies of scale and experience curve.
Competitive advantages can also be gained by companies that, through investment in
research and development, acquire intellectual property rights that are not owned by other
companies in the target market country. Advantages can also be gained A company that
implements a first mover strategy, which is the first company to enter a market, and can
dominate the market through the economies of scale it gains.
A company's success in international trade will depend on its ability to develop a
sustainable competitive advantage strategy. Such advantages will enable the company to
dominate the global market.
Porter's Competitive Advantage of Nations (Theory of Competitive Advantage of
Nations):
This theory was developed by Michael Porter who put forward a model that there are
various variables that determine the ability of a company in a country to gain competitive
advantages compared to companies in other countries. These variables include: demand
conditions, conditions of production factors, industrial structure and competition, related
industries and supporting industries.
The size and nature of a country's domestic demand for a product provides a factor that
can support a firm's production of that product, so that competitive advantages can be gained
through economies of scale and scope, and experience curves for overseas competition.
Likewise, the availability of factors of production in a country in abundance will support a
firm's ability to produce at a more competitive cost than its competitors in other countries.
The availability of efficient industries related or associated with the company's industry in a
country will be able to streamline the industrial supply chain process, so that the company
can gain a competitive advantage in this regard. Similarly, industry structure and competitive
conditions will determine whether the company can gain competitive advantages from the
characteristics of the industry and competition in the country.
INTERNATIONAL DIRECT INVESTMENT THEORY:
Various theories have also been developed to explain why a company makes direct
investment abroad. These theories use the unit of analysis of the firm rather than the country.
Some of the theories that will be discussed include: monopolistic advantage theory; product
and factor market imperfection; international product life cycle; the internalization theory,
and Dunning's eclectic theory.
MONOPOLISTIC ADVANTAGE THEORY:
According to the theory of monopolistic advantages proposed by Stephen Hymer,
investment into another country is made by companies in oligopolistic industries. In
oligopolistic industries, companies that are able to invest in other countries are companies
that have absolute advantages in technology or others compared to companies in the target
country so that they can overcome the disadvantages of being an overseas company,
including lack of knowledge of local market conditions, increased costs due to having to
operate in a place with differences in culture, language, laws and regulations.
Direct investment in another country can only be made by a company that has valuable
assets that give it a competitive advantage that it can use to enter the foreign market. Such
advantages may include economies of scale, advanced technology, or greater capabilities in
marketing, management, and finance. Foreign direct investment can occur due to
imperfections in product and market factors, which allow foreign firms to operate more
profitably in foreign markets compared to local firms.
PRODUCT AND FACTOR MARKET IMPERFECTIONS:
Caves developed Hymer's theory to show that ownership knowledge that more more
sophisticated knowledge allows firms from abroad that make investments can produce
products products that are so that consumers will prefer the product over the same product
from a local company. Superior knowledge allows products to be differentiated, thus making
the market imperfect. This is shown by the fact that companies that invest abroad are
companies that do a lot of research and development of products and strategic marketing.
Another theory develops Hymer's theory based on financial factors. Imperfections in the
currency exchange market lead to foreign direct investment. Companies from countries with
overvalued currencies will be attracted to invest in countries with undervalued currencies.
Another argument suggests that overseas operations allow companies to diversify risk, thus
maximizing return on investment.
INTERNATIONAL PRODUCT LIFE CYCLE:
This theory has been discussed to explain international trade, but there is actually a
relationship that There is a close relationship between trade and international investment. In
this theory, overseas investment is the natural next step of international trade.
To avoid losing an export market, companies are often forced to invest in production
facilities abroad. This may be due to increased competition from other overseas companies in
that market, or due to compulsion by the government of that country. Overseas production
typically increases in the maturity and decline stages, as the firm needs to remain
competitive, both in its export markets, and in its home market. This can be achieved by
producing products in countries with cheaper production factors.
THE INTERNALIZATION THEORY:
This theory is an extension of the market imperfection theory. A firm may have
superior knowledge, but due to the inefficiency of external markets, it can make greater
profits by using that knowledge itself, rather than selling it to other firms. By investing in
overseas subsidiaries for activities such as supply, production, or distribution, rather than by
licensing to other firms, a firm can still own its own knowledge by using it abroad. The
company can earn a high return on its investment by transferring its superior know-how to an
overseas subsidiary rather than selling it on the free market.
According to this theory, direct investment will occur when transaction costs with other
firms are high. Transaction costs are costs associated with negotiating, monitoring, and
executing contracts and maintaining knowledge ownership.
DUNNING'S ECLECTIC THEORY:
Dunning's eclectic theory combines elements of several previously discussed theories.
This theory seeks to provide a comprehensive framework to explain why firms choose to
make direct investment over other modes, such as exporting, licensing, and so on. Dunning
argues that if a firm invests directly in overseas production facilities, it must have three forms
of advantages: ownership specific, location specific, and internalization.
Ownership specific is the degree to which a firm has or can develop specific advantages
through ownership of tangible or intangible assets that are not available to other firms, and
these assets can be transferred abroad. These specific ownership advantages are knowledge or
technology, economies of scale or scope, and monopolistic advantages associated with
unique access to important inputs or outputs. Such advantages will lead to lower costs or
higher revenues that will exceed the additional costs of operating abroad.
Location specific is the special characteristics of a foreign market in the form of
economic, social or political characteristics, which can allow companies to gain by exploiting
its location-specific advantages.
Each company has various alternatives to enter into foreign markets, by export, or
direct investment with full ownership of the subsidiary in the country. The firm will invest
directly through internalization because this mode is the most profitable way for the firm to
exploit excess specific ownership. This occurs when the market is not yet established, or
functions inefficiently, causing the transaction cost of using other modes to be too high.
The OLI (Ownership, Location, Internalization) theory provides an explanation for a
firm's choice to invest in overseas production facilities. A firm must have ownership and
location advantages to invest in an overseas plant. The firm will invest where it is most
profitable to internalize its monopolistic advantages. This investment can be done proactively
with a strategic plan or reactively as a reaction to market imperfections.
INTERNATIONAL BUSINESS POLICY
INTERNATIONAL TRADE BARRIERS:
International trade occurs mainly because there are relative price differences between
countries. Such differences arise from differences in the cost of production, which can occur
due to: differences in the factors of production that are the bounty for a country, differences
in the level of technology that determines the intensity of factors used, differences in the
efficiency with which factor intensities are used, and the value of currency exchange.
However, various factors can change the course of trade, such as different tastes, demand
conditions, and so on.
International trade theory suggests that a country can achieve a higher level of living by
specializing in products in which it has a comparative advantage and importing products in
which it has a comparative disadvantage. In general, this means that trade restrictions are
detrimental to a country's welfare.
Although there are many benefits of international free trade, in practice, many countries
apply trade barriers for various reasons. These barriers are not only applied by developing
countries, but also by developed countries.
One of the main reasons is national defense. A country that is weak in its economy
relative to other countries will experience international trade on terms of trade that are less
favorable to them. Similarly, if a country's level of industrialization is lower than that of other
countries, then international trade will cripple the national industry, and often make the
country's industry and consumption dependent on products imported from other countries.
This means that the country will be weaker in its political and economic power compared to
other countries, which can jeopardize the country's national defense. Trade barriers for this
reason are most commonly applied to industries that are strategic to the country.
Another most widely used reason is the infant industry argument. Under any pretext,
the prosperity and progress of a country depends on the progress and prosperity of its
industrialization. Developing countries are generally trying to transition from agrarian to
industrialized countries. Many of the industries established are still among the newly
established industries, so they are termed infant industries. If such industries have to compete
freely with industries in other countries, it is certain that the industry will collapse, due to the
inability to compete. For this reason, various trade barriers are imposed to protect these infant
industries, at least temporarily, so that the industry has the opportunity to develop and
improve its competitive ability.
Another reason most developed countries use trade barriers is to protect domestic
employment against cheaper foreign labor. With relatively low wage levels in developing
countries, many companies move their product supply to other countries. This means that
supply can be obtained from any country in the world, especially developing countries with
relatively cheap labor. This means the closure of the product's industry in developed
countries, and the loss of jobs.
Many countries strive to promote their domestic industries, which is often done with
government policies, for example by providing subsidies and various other facilities. In
developed countries, many companies have successfully developed so that they have
competitive advantages that are difficult for other companies to match, especially in the
advantages of company size, technology, and world brands. Companies with government
assistance, or that already have very high competitive advantages, make them unrivaled when
entering other countries. This often forces the government of another country to impose trade
barriers to ensure that competition is fair, at least according to the government's definition of
fairness.
Trade barriers are often put in place as a way of retaliating against another country that
was previously thought to have put in place trade barriers. The consequence of this kind of
reasoning is that a trade war between two countries through trade barriers is likely to occur.
Many companies employ a strategy of concentrating on their core business. This is not
by choice, but often an unavoidable strategy. Companies often find it difficult to diversify
their products or businesses because the market for those products or businesses is already
dominated by foreign companies. In this case the government may issue policies to
discourage international trade in order to allow domestic firms to diversify their businesses or
products.
DUMPING:
Dumping is defined by the W.T.O. as an action by a firm to sell a product into a foreign
market at a price lower than the cost of production or the price in the country, or the price in a
third country. A company dumping for a variety of reasons, including as a way to sell excess
production without damaging the domestic market, or as a reaction to seasonal or cyclical
market factors. Dumping is predatory dumping, when the aim is to force domestic producers
in the country to be unable to sell within their country.
Various types of dumping are proposed to be banned in W.T.O. as well, namely :
1.
Social dumping: unfair competition, as producers in developing countries can sell at low
prices, due to cheap labor costs, and inhumane working conditions, which means the
social system in the country is not viable, and this keeps production costs low. This can
often happen even if the selling price to a country is still higher than the selling price
domestically.
2.
Environmental dumping: unfair competition because many developing countries have
lower environmental regulations or standards. Producers in these countries will be able to
produce products at a much lower cost than producers in developed countries that must
comply with very high environmental standards.
3.
Financial services dumping: unfair competition caused by lower lending rates, due to
very lenient requirements on banks in capital-asset ratios.
4.
Cultural dumping: unfair competition caused by cultural barriers helps local companies.
5.
Tax cumping: unfair competition caused by differences in corporate tax rates within a
country.
SUBSIDY
Subsidies are financial assistance provided by the government of a country directly or
indirectly, which creates benefits for companies or industries, including direct cash transfers,
more lenient and lower taxes, government participation in company ownership, lower interest
rates.
Subsidies are often practiced by many countries, both developed and developing, for a
variety of purposes. In general, subsidies are among the behaviors that are often retaliated
against by the affected countries.
TARIFF CONSTRAINTS:
A tariff is a tax imposed on goods imported into a country with the primary purpose of
raising the price of those goods so as to reduce competition with domestic producers. Some
countries apply tariffs to generate revenue for both imported and exported products. Tariffs
on exported products are usually applied to reduce the amount of products sold abroad so as
to ensure their availability in the country.
Import duties can be Ad Valorem, Specific, or Compound Duties. Ad valorem duty is a
duty applied as a percentage of the invoice value of the product. Specific duty is a duty that is
applied as a fixed amount of money to a physical unit of the product. Compound duty is the
combined import duty of ad valorem and specific duty. The European Union imposes a
Variable levy, which is an import duty applied specifically to agricultural products, to ensure
that the price of imported agricultural products will not be lower than the price of agricultural
products from the European Union's own countries.
NON-TARIFF BARRIERS:
These barriers are all forms of discrimination against imported products that do not
constitute import duties. In the name of free trade, many developed countries have tried to
reduce the amount of import duties, but various ways have been put forward to impede trade.
These include quantitative and qualitative policies, as well as various surcharges imposed on
producers and exporters to impede international trade.
Quantitative barriers are in the form of quotas, which are numerical limits on specific
imports. Quotas can be general quotas, which apply to all other countries, or allocation
quotas, which allocate quotas to individual countries. In addition to quotas, there are what are
known as Voluntary Export Constraints, which are export quotas imposed by exporting
countries to limit the amount of products they export. There are also so-called Orderly
Marketing Arrangements, which are formal agreements between exporting and importing
countries that determine the amount of import and export quotas for a product.
The most important barriers to international trade are non-quantitative barriers. There
are many qualitative ways to impede trade, of which can be classified in three forms, namely:
(1). Direct government participation in trade, (2). Customs and other administrative
procedures, and (3). Standards.
Direct government participation in trade includes subsidies. Another way is through
government spending policies, which among other things prioritize the procurement of goods
and services from domestic producers, or by discriminating in prices, and other procedures.
In many developing countries the government even establishes state enterprises that are given
special rights to conduct international trade.
Barriers can also be imposed by governments through customs and administrative
procedures for export and import activities in a country. Local companies may get tax breaks
and reductions in conducting their international business activities.
Quality, health and safety standards should apply to all products. But in international
business, many governments apply strict standards to imported products, but not to domestic
producers.
PRACTICE QUESTIONS:
1.
The classical theories of international trade attempt to explain the motivations for
international trade. Explain each of these theories.
2.
What is The linder theory of overlapping demand? and give an example that occurs
between developing countries and developed countries.
3.
In product life cycle theory, international trade occurs because it follows a product life
cycle. Explain why this is so using a real product example!
4.
Describe Porter's Diamond of National competitive Advantage and explain it in your
own language!
5.
Various theories have also been developed to explain why companies make direct
investments abroad. What do you know about theories of international direct
investment?
6.
What are the barriers that often occur to business people in Indonesia who try to trade
internationally?
7.
What policies has the Indonesian government made regarding International Trade?
