LEARNING OBJECTIVES After studying this chapter you should be able to: 1.Use the resource- and institution-based views to explain why nations trade 2.Understand classical and modern theories of international trade 3.Realize the importance of political and economic realities governing international trade 4.Participate in two leading debates on international trade 5.Draw implications for action

Trade terms exporting - Selling abroad importing - Buying from abroad merchandise – physical goods/tangible products services - acts, efforts, or performances exchanged from producer to user without ownership rights, intangible services

Trade Balance trade deficit - An economic condition in which a nation imports more than it exports trade surplus - An economic condition in which a nation exports more than it imports balance of trade - The aggregation of buying (importing) and selling (exporting) by both sides leads to the country-level trade surplus or deficit.

Trade Theories classical trade theories - major theories typically studied consist of mercantilism, absolute advantage, and comparative advantage modern trade theories - major theories typically studied consist of product life cycle, strategic trade, and national competitive advantage

Classical Trade Theories Theory of mercantilism - belief that held that the wealth of the world (measured in gold and silver) was fixed, and that a nation that exported more and imported less would enjoy the net inflows of gold and silver and thus become richer Protectionism - idea that governments should actively protect domestic industries from imports and vigorously promote exports

Classical Trade Theories free trade - idea that free market forces should determine how much to trade with little (or no) government intervention theory of absolute advantage - economic advantage one nation enjoys that is absolutely superior to other nations theory of comparative advantage - relative (not absolute) advantage in one economic activity that one nation enjoys in comparison with other nations opportunity cost - given the alternatives, the cost of pursuing one activity at the expense of another activity

Classical Trade Theories factor endowments - extent to which different countries possess various factors, such as labor, land, and technology factor endowment theory (Heckscher-Ohlin theory) - The proposition that nations will develop comparative advantage based on their locally abundant factors

FACTORS OF PRODUCTION natural resources – things that are useful in their natural state, such as land, forests, minerals, and water human resources – anyone (from company presidents to grocery clerks) who works to produce goods and services capital – resources (such as money, computers, machines, tools, and buildings)that a business needs to produce goods and services entrepreneurs – innovative businesspeople who are willing to take the risks involved in creating and operating new businesses knowledge – the collective intelligence of an organization

Modern Trade Theories product life cycle theory - economic theory that accounts for changes in the patterns of trade over time strategic trade theory - theory that suggests that strategic intervention by governments in certain industries can enhance their odds for international success first-mover advantages - Advantages that first entrants enjoy and do not share with late entrants strategic trade policy - Economic policies that provide companies a strategic advantage through government subsidies

Modern Trade Theories Theory of national competitive advantage of industries (or diamond theory) The theory that the competitive advantage of certain industries in different nations depends on four aspects that form a “diamond”

Evaluating Theories of International Trade Resource Mobility The assumption that a resource removed from one industry can be moved to another.

REALITIES OF INTERNATIONAL TRADE tariff barrier - Trade barriers that rely on tariffs to discourage imports. import tariff - A tax imposed on imports nontariff barriers (NTBs) – restrict imports but are not in the usual form of a tariff: subsidies, import quotas, export restraints, local content requirements, administrative policies, antidumping duties, over-elaborate or inadequate infrastructure, “buy national" policy, bribery and corruption, unfair customs procedures, restrictive licenses, etc. deadweight costs - Net losses that occur in an economy as the result of tariffs

REALITIES OF INTERNATIONAL TRADE subsidy – Government payments to domestic firms import quotas - Restrictions on the quantity of imports for specific period of time voluntary export restraints (VRAs) - superficial policy to show that exporting countries voluntarily agree to restrict their exports local content requirements - A requirement that a certain - proportion of the value of the goods made in one country originate from that country.

REALITIES OF INTERNATIONAL TRADE administrative policy – Bureaucratic rules that make it harder to import foreign goods antidumping duties - Costs levied on imports that have been “dumped” (selling below costs or below exporter’s home market price to “unfairly” drive domestic firms out of business)

Economic Arguments Against Free Trade Prominent among economic arguments against free trade include: 1. The need to protect domestic industries - The oldest and most frequently used economic argument against free trade is the urge to protect domestic industries, firms, and jobs from “unfair” foreign competition - in short, protectionism 2. The necessity to shield infant industries - belief that if domestic firms are as young as “infants,” in the absence of government intervention, they stand no chance of surviving and will be crushed by mature foreign rivals

Political Arguments against Free Trade Political arguments against free trade advance a nation’s political, social, and environmental agenda regardless of possible economic gains from trade These arguments include: (1) national security (2) consumer protection (3) foreign policy (4) environmental and social responsibility Trade Embargo - Politically motivated trade sanctions against foreign countries to signal displeasure.

Trade Deficit versus Trade Surplus Trade Deficit OK – Trading partners mutually benefit by developing a deeper division of labor based on comparative advantage. “Trade is not about competition, it is about mutually beneficial exchange... Imports, not exports, are the purpose of trade.” Trade Deficit Bad – International Trade is about competition—about markets, jobs, and incomes.

Classical Theories versus New Realities Classical theorists and their modern-day disciples argue that the United States and India trade by tapping into each other’s comparative advantage. India leverages its abundant, high-skill, and low-wage labor. Americans will channel their energy and resources to higher skill, higher paying jobs. Regrettably, certain Americans will lose jobs, but the nation as a whole benefits. Are the theories still valid?