FACTOR PROPORTIONS THEORY OF INTERNATIONAL TRADE
Explaining Trade Through Factor Abundance
The factor proportions theory proposes that nations will export goods
requiring abundant and thus cheaper factors of production, and import
goods requiring scarcer and more expensive factors.
Main Principles
Focuses on a country's supply of factors (resources) rather than
efficiency at producing specific goods.
Divides factors into labor versus land and capital equipment.
Predicts countries will export goods requiring their abundant factor,
and import goods requiring their scarce factor.
Examples
Land-rich Australia exports minerals, grains, meats that require
much land. Imports manufactured goods needing capital.
Labor-abundant China exports labor-intensive goods like apparel and
toys. Imports more capital-intensive goods.
The Leontief Paradox
Studies found US with abundant capital exported labor-intensive
goods and imported capital-intensive goods.
Paradox emerged as trade flows did not match theory's predictions.
Possible Explanations
Theory considers labor as homogeneous, but skills actually vary
greatly within countries.
When labor quality accounted for, theory aligned more closely with
actual trade flows.
Illustrates challenges in neatly explaining causes of trade flows. New
theories continue to emerge.
TRADE FLOWS AND THE PRODUCT LIFE CYCLE
The international product life cycle theory examines how trade flows shift
as a product matures.
Main Stages
Stage 1 New Product: Produced and sold domestically. Exports begin
toward end of stage.
Stage 2 Maturing Product: Exports rise to meet foreign demand.
Some foreign production starts.
Stage 3 Standardized Product: Imports replace domestic supply.
Production shifts to low-cost countries.
Examples
In 1960s-70s, aligned with US innovating new products and
exporting, then importing as they matured.
Worked when US dominated global innovation. Harder to apply
today with innovation worldwide.
Boeing sources aircraft parts globally based on productivity. iPhone
assembled in China from global components.
Limitations
Innovation now dispersed globally, not centered in one country.
Frequent upgrades and new products shorten life cycles. Must
launch simultaneously in many markets.
Teaming with foreign partners from outset common for
entrepreneurs accessing global markets.
Still useful for broad patterns but new theories needed to capture
complexity of modern trade flows.
NATIONAL COMPETITIVE ADVANTAGE ANALYSIS
National competitive advantage is one of the most important trade
theories put forth by Michael Porter in 1990 to explain why certain
countries excel in specific industries. Let us unpack Porter's national
competitive advantage theory and the Porter Diamond model in detail.
The Porter Diamond and National Competitve Advantage
Porter identified four primary factors known as the Porter Diamond that
influence a nation's competitiveness in certain industries. These
interlinked factors are factor conditions, demand conditions, related and
supporting industries, and firm strategy, structure and rivalry. In addition,
the roles of chance and government also shape competitiveness.
Factor Conditions
Factor conditions refer to both basic factors like natural resources, climate
etc and advanced factors involving workforce skills and technological
infrastructure. While basic factors drive initial competitiveness, sustained
advantage stems from advanced factors through education, innovation
and R&D. For example, though lacking natural resources, nations like
Japan and Korea invested in automotive R&D to gain dominance in that
industry.
Demand Conditions
The sophistication of domestic demand is important as companies
catering to sophisticated local buyers are compelled to innovate and
develop new products/technologies. For instance, the advanced US AI
market bolsters American companies' global AI leadership.
Related and Supporting Industries
Competitive industries thrive within supportive industrial clusters as
related businesses provide required inputs. Semiconductor fabrication
clusters in Phoenix benefits firms like Intel and suppliers alike. Tesla's
Texas Gigafactory is attracting electric vehicle component makers.
Firm Strategy, Structure and Rivalry
Managers' commitments to quality, market share and returns alongside
intense domestic rivalry spur continuous upgrading of competitive
strengths.
Government and Chance
While chance impacts can threaten competitive positions, governments
can foster advantages through policies developing diamond attributes
instead of protecting inefficient firms.
