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International Trade and Investment Theory
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Chapter Objectives_1 Understand the motivation for international trade
Summarize and discuss the differences among the classical country-based theories of international trade Use the modern firm-based theories of international trade to describe global strategies adopted by businesses
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Chapter Objectives_2 Describe and categorize the different forms of international investment Explain the reasons for foreign direct investment Summarize how supply, demand, and political factors influence foreign direct investment
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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
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Figure 6.2 Sources of the World’s Merchandise Exports, 2001
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The largest component of the annual $1
The largest component of the annual $1.5 trillion trade in international services is travel and tourism
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Classical Country-Based Trade Theories
Mercantilism Absolute Advantage Comparative Advantage Relative Factor Endowments
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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
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Modern Mercantilism Neomercantilists or protectionists
American Federation of Labor-Congress of Industrial Organizations Textile manufacturers Steel companies Sugar growers Peanut farmers
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Disadvantages of Mercantilism
Confuses the acquisition of treasure with the acquisition of wealth 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
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Absolute Advantage 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
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Table 6.1 The Theory of Absolute Advantage: An Example
OUTPUT PER HOUR OF LABOR France Japan Wine 2 1 Clock radios 3 5
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Absolute Advantage’s Flaw
What happens to trade if one country has an absolute advantage in both products? No trade would occur
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Comparative Advantage
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
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Differences between Comparative and Absolute Advantage
Absolute versus relative productivity differences Comparative advantage incorporates the concept of opportunity cost Value of what is given up to get the good
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Table 6.2 The Theory of Comparative Advantage: An Example
OUTPUT PER HOUR OF LABOR France Japan Wine 4 1 Clock radios 6 5
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Comparative Advantage with Money
One is better off specializing in what one does relatively best Produce and export those goods and services one is relatively best able to produce Buy other goods and services from people who are better at producing them
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Table 6.3 The Theory of Comparative Advantage with Money: An Example
Cost of Goods in France Cost of Goods in Japan French Made Japanese Made Wine €3 €8 ¥375 ¥1,000 Clock Radios €1.6 ¥250 ¥200
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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
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Relative Factor Endowments_2
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
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Figure 6.3 U.S. Imports and Exports, 1947: The Leontief Paradox
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Modern Firm-Based Trade Theories
Country Similarity Theory Product Life Cycle Theory Global Strategic Rivalry Theory Porter’s National Competitive Advantage
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Growth of Firm-Based Theories
Growing importance of MNCs Inability of the country-based theories to explain and predict the existence and growth of intraindustry trade Failure of Leontief and others to empirically validate country-based Heckscher-Ohlin Theory
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Firm-Based Trade Theories
Incorporate additional factors into explanations of trade flows Quality Technology Brand names Customer quality
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Country Similarity Theory
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
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Country Similarity Theory_2
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
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Product Life Cycle Theory
Describes the evolution of marketing strategies Stages New product Maturing product Standardized product
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Figure 6.4 The International Product Life Cycle: Innovating Firm’s Country
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Figure 6.4 The International Product Life Cycle: Other Industrialized Countries
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Figure 6.4 The International Product Life Cycle: Less Developed Countries
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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
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Sustaining Competitive Advantage
Owning intellectual property rights Investing in research and development Achieving economies of scale or scope Exploiting the experience curve
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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
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Figure 6.5 Porter’s Diamond of National Competitive Advantage
Firm Strategy, Structure, and Rivalry Factor Conditions Demand Conditions Related and Supporting Industries
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The intense competitiveness of Japanese market forces manufacturers to continually develop and fine-tune new products
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Figure 6.6 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
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Types of International Investments
Does the investor seek an active management role in the firm r merely a return from a passive investment? Foreign Direct Investment Portfolio Investment
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Figure 6.7 Stock of Foreign Direct Investment, by recipient
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Table 6.4 Sources of FDI for the U.S., end of 2002
United Kingdom 283.3 France 170.6 Netherlands 154.8 Japan 152. Germany 137.0 Switzerland 113.2 Canada 92.0 Luxembourg 34.3 Bermuda, Bahamas, Caribbean islands 32.5 Other European countries 113.3 All other countries 65.0 Total 1,348.0
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Table 6.4 Destinations of FDI for the U.S., end of 2002
United Kingdom 255.4 Canada 152.5 Netherlands 145.5 Bermuda, Bahamas, Caribbean islands 98.1 Switzerland 70.1 Japan 65.7 Germany 64.7 Mexico 58.1 France 44.0 Other European countries 217.2 All other countries 349.7 Total 1,521.0
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International Investment Theories
Ownership Advantages Internalization Dunning’s Eclectic Theory
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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?
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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
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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
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Table 6.5 Factors Affecting the FDI Decision
Supply Factors Demand Factors Political Factors Production costs Customer access Avoidance of trade barriers Logistics Marketing advantages Economic development incentives Resource availability Exploitation of competitive advantages Access to technology Customer mobility
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Ikea aggressively exports its furniture to other countries
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