1. Chapter 6: International Trade and Investment Theory
International Business
Griffin & Pustay

2. Chapter Objectives Why should we study Trade Theories?
Types of Trade Theories
Overview of International Investment
International Investment theory
Factors influencing investments

3. International Trade
Trade: voluntary exchange of goods, services, assets, or money between one person or organization and another.
International trade: trade between residents of two countries.

4. Significance of Trade Theories
Governments use these theories when they design policies they hope will benefit their industries and citizens.
Managers use them to identify the promising markets and profitable internationalization strategies.

5. Classical Country-Based Trade Theories
Modern Firm-Based Trade Theories

6. Classical Country-Based Trade Theories
Developed in sixteenth century, focused on the individual country in examining pattern of export and import.
These theories are particularly useful for describing trade in commodities , which are standardized, undifferentiated goods, that are typically bought on the basis of price rather than brand name.

7. Classical Country-Based Trade Theories
Mercantilism
Absolute Advantage
Comparative Advantage
Relative Factor Endowments

8. Mercantilism
A country’s wealth is measured by its holdings of gold and silver
A country’s goal should be to enlarge holdings of gold and silver by
Promoting exports
Discouraging imports

9. Disadvantages of Mercantilism
Weakens the country because it robs individuals of the ability
To trade freely
To benefit from voluntary exchanges
Forces countries to produce products it would otherwise not in order to minimize imports

10. Absolute Advantage Proposed by Adam Smith.
Export those goods and services for which a country is more productive than other countries
Import those goods and services for which other countries are more productive than it is

11. The Theory of Absolute Advantage: An Example
OUTPUT PER HOUR OF LABOR
France Japan
Wine 2 1
Clock radios 3 5

12. Comparative Advantage
Developed by David Ricardo in 1817.
Produce and export those goods and services for which it is relatively more productive than other countries
Import those goods and services for which other countries are relatively more productive than it is

13. The Theory of Comparative Advantage: An Example
OUTPUT PER HOUR OF LABOR
France Japan
Wine 4 1
Clock radios 6 5

14. Relative Factor Endowments
Heckscher-Ohlin Theory
What determines the products for which a country will have a comparative advantage?
Factor endowments vary among countries
Goods differ according to the types of factors that are used to produce them

15. Relative Factor Endowments
A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance
China: labor
Saudi Arabia: oil
Argentina: wheat

16. Modern Firm-Based Trade Theories
Firm based were developed after World War II and are used to describe trade patterns of differentiated goods, for which brand name is an important component of the customer’s purchase decision.

17. Modern Firm-Based Trade Theories
Country Similarity Theory
Product Life Cycle Theory
Global Strategic Rivalry Theory
Porter’s National Competitive Advantage

18. Country Similarity Theory
Country similarity theory is particularly useful in explaining trade in differentiated goods for which brand names and product reputation play an important role in consumer decision making.
Explains the phenomenon of intraindustry trade
Trade between two countries of goods produced by the same industry
Japan exports Toyotas to Germany
Germany exports BMWs to Japan

19. Country Similarity Theory
Trade results from similarities of preferences among consumers in countries that are at the same stage of economic development
Most trade in manufactured goods should be between countries with similar per capita incomes.
Firms initially manufacture goods to satisfy the domestic market. As they explore exporting opportunities, they discover that the most promising foreign markets are in countries where consumer preferences resembles to their own domestic market.

20. Product Life Cycle Theory
Product life cycle theory, which originated in the marketing field to describe the evolution of marketing strategies as a product matures.
This theory states that location of production of certain kinds of products shifts as they go through their stages of life cycle, which consists of-
New product
Maturing product
Standardized product

21. Product Life Cycle Theory
New Product Stage:
Innovation in response to observed needs in the domestic market.
Limited export by the innovating country.
Maturing Product stage:
Demand for the product expands dramatically as consumers recognize its value.
So, increase in production to satisfy both domestic and foreign market.
Domestic and foreign competition begins to emerge.

22. Product Life Cycle Theory
Standardized Product Stage:
The market for the product stabilizes.
Firms are pressured to lower their manufacturing costs as much as possible by shifting to countries where labour costs are lower.
Product begins to be imported in the innovative country.

23. Global Strategic Rivalry Theory
Firms struggle to develop sustainable competitive advantage
Advantage provides ability to dominate global marketplace
Focus: strategic decisions firms use to compete internationally

24. Global Strategic Rivalry Theory
Owning intellectual property rights
Investing in research and development
Achieving economies of scale or scope
Exploiting the experience curve

25. Porter’s National Competitive Advantage
Success in trade comes from the interaction of four country and firm specific elements
Factor conditions
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry

26. Porter’s Diamond of National Competitive Advantage
Firm Strategy,
Structure,
and Rivalry
Factor
Conditions
Demand
Conditions
Related and
Supporting
Industries

27. Theories of International Trade
Country-Based Theories
Country is unit of analysis
Emerged prior to WWII
Developed by economists
Explain interindustry trade
Include
Mercantilism
Absolute advantage
Comparative advantage
Relative factor endowments
Firm-Based Theories
Firm is unit of analysis
Emerged after WWII
Developed by business school professors
Explain intraindustry trade
Include
Country similarity theory
Product life cycle
Global strategic rivalry
National competitive advantage

28. International Investment Theories
Ownership Advantages
Internalization
Dunning’s Eclectic Theory

29. Ownership Advantages
A firm owning a valuable asset that creates a competitive advantage domestically can use that advantage to penetrate foreign markets through FDI
Why FDI and not other methods?

30. Internalization Theory
FDI is more likely to occur when transaction costs with a second firm are high
Transaction costs: costs associated with negotiating, monitoring, and enforcing a contract

31. Dunning’s Eclectic Theory
FDI reflects both international business activity and business activity internal to the firm
3 conditions for FDI
Ownership advantage
Location advantage
Internalization advantage