1 INTERNATIONAL TRADE AND FOREIGN DIRECT INVESTMENT

2 General Types of Trade Theories Descriptive: the natural order of trade Tolerant conditions Which products, how much, and with whom a country will trade in the absence of restrictions Prescriptive: questions whether governments should interfere with the free movement of goods and services 2

3 Mercantilism Initial trade theory that formed the foundation of economic thought from 1500 – 1800 Based on concept that a nations wealth is measured by its holding of treasure (gold) Nations often imposed restrictions on imports since they did not want “their” treasure moving to another country to pay for the imports It was also advantageous to run a trade surplus with “colonies” 3

4 Mercantilism Terms Favorable balance of trade: country is exporting more than it is importing Unfavorable balance of trade: country is importing more than it is exporting, i.e. a trade deficit Neomercantilism: current term to describe the approach of countries that try to run favorable balances of trade to achieve some social or political gains 4

5 Absolute Advantage Absolute advantage holds that different countries produce some goods more efficiently than other countries Thus, global efficiency can be increased through international free trade 5

6 Comparative Advantage There are still global gains to be made if a country specializes in products it produces more efficiently than other products Regardless of whether other countries can produce those same products even more efficiently. Comparative Advantage: - A country can maximize its own economic well-being by specializing in the production of those goods and services it can produce relatively efficiently and enhance global efficiency through its participation in unrestricted free trade. Analogous Explanation Production Possibility example 6

7 Factor Proportions The composition of a country’s trade depends on both its natural and acquired advantages. Acquired advantage “Factor-Proportions Theory”: Differences in a country’s relative endowments of land, labor, and capital explain differences in the cost of production factors. A country will tend to export products that utilize relatively abundant factors of production because they are relatively cheaper than scarce resources. 7

8 Forms of Protectionism: 1- Tariffs: Taxes or duties typically levied on imports as they enter the country. 2- Import quotas: restrictions on the quantity of a good which may be imported, perhaps from specific countries. 3- Embargoes- An official ban on trade or other commercial activity with a particular country. 4- Export subsidies- Export subsidy is a government policy to encourage export of goods and discourage sale of goods on the domestic market through low-cost. 5- Foreign exchange controls- Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents. 6- Non-tariff barriers: such as laws and regulations e.g. product specifications or professional qualifications.

9 General Agreement on Tariffs and Trade (GATT) Formed in 1947 by 23 countries to abolish quotas and reduce tariffs Laid the foundation to liberalize world trade Required members to open markets equally to every other member However, it could not enforce compliance WTO- World Trade Organization (1 st January 1995), 153 member countries (2010)

10 World Trade Organization (WTO) 140 current members (90% of trade) Adopted the principles and trade agreements of GATT Expanded to cover trade in Services Investment Intellectual property Governments bring charges of unfair trade practices to the WTO WTO rulings are binding

11 GATT and the World Trade Organization (WTO): Then extended to include 100 countries. GATT’s aim was to promote trade and reduce/eliminate tariffs. GATT three major rounds: 1- The Kennedy Round in the mid-1960s. 2- The Tokyo Round in the mid-1970s. 3- The Uruguay Round in 1993: which concluded seven years of difficult negotiation. Initiated further cuts in import duties and other tariffs world-wide.

12 Key Trading Principles under GATT and WTO 1- Restrictions on the use of quotas. 2- Allowing of retaliation against ‘unfair’ trading practices. 3- A requirement to grant ‘most favored nation’ concessions to all member countries. 4- Members not allowed to treat imported goods less favorably than domestic production (except GATS).

13 WORLD BANK (5 Banks) Washington D.C. IBRD- International Bank for Reconstruction and Development – 187 Countries Member (1944) IDA- International Development Association, (1960) MIGA- Multilateral Investment Guarantee Agency (1988) IFC- International Financial Corporation, (1956) ICSID- International Centre for the Settlement of Investment Disputes (1966) IMF- International Monetary Fund (1944), 187 member countries

14 Foreign Direct Investment (FDI) Introduction: International trade and foreign direct investment (FDI) are closely interlinked. The common factor in both instances is the international / transnational corporation (TNC), because exporting / importing or investing overseas are: Simply alternative ways of internationalizing business.

15 Foreign Direct Investment (FDI) Definition: The transnational corporation is defined as: Comprising parent enterprises and their foreign affiliates. A parent enterprise controls assets of another entity on other country usually via ownership of an equity stake. UNCTAD assumes a minimum equity stake of 10% as the threshold for control.

16 Reasons for FDI: 1- Increased profit. 2- New markets. 3- Protectionism. 4- Extending the product life cycle.

17 Product Life Cycle (PLC) Theory The optimal location for the production of certain types of goods and services shifts over time as they pass through the stages of market introduction, growth, maturity, and decline. 1. Introduction: Innovation, production, and sales occur in the domestic (innovating) country. Innovative customers tend to accept relatively high introductory prices. 2. Growth: As demand grows, competitors enter the market. Foreign demand, competition, exports, and investment activities also begin to accelerate. 3. Maturity: Global demand begins to peak, production processes are relatively standardized, and global price competition forces production site relocation to lower-cost developing countries. 4. Decline: Market factors and cost pressures dictate that almost all production occur in developing countries. 17

18 The Porter Diamond National competitive advantage is embedded in four determinants: a) Demand conditions b) Factor conditions c) Related and supporting industries d) Firm strategy, structure, and rivalry. 18