1. Int’l Bus Strategy Lecture 3: The Global Business Environment
© Ram Mudambi, Temple University, 2007

2. Learning Objectives
Understanding the historical evolution of the international trade theories
Understanding the politics and economics underlying the international business environment
© Ram Mudambi, Temple University, 2007

3. International Trade Theory
Introduction and illustrations
Theories of international trade
Mercantilism
Absolute Advantage
Comparative Advantage
Heckscher-Ohlin Theory
Product Life Cycle Theory
New Trade Theory
Porter’s Diamond
Through 1700s
1776, Smith
1817, Ricardo
1920s
1966, Vernon
1980s
1990s
 Ram Mudambi, Temple University, 2001

4. Definitions Output per capita = GDP divided by population
Standard of living depends on (among other things) the evolution of output per capita.
Purchasing power parity (PPP) = adjustment when comparing output figures across countries.
The Penn World Tables
© Ram Mudambi, Temple University, 2007

5. A Growth History of the World
Large-scale ocean-borne
Trade
Output per capita
Industrial revolution
Technology
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6. Relatively good infrastructure
1st British African colony to win independence and richest country in Sub-Saharan Africa
Relatively good infrastructure
Education, judicial institutions
Developed resources – cocoa, gold
Nkrumah espoused pan-African socialism
High tariffs, anti-exporting policy
© Ram Mudambi, Temple University, 2007

7. Outward oriented, but not a totally free market economy
1950s – import substitution; education, infrastructure
1960s – heavy govt. intervention
1970s – H-C-I period
1980s – gradual reduction of quotas and subsidies
1950s
1990s
Employment in agriculture
77%
20%
Manufacturing share of GNP
10%
30%
HCI – ‘heavy and chemical industry’ period
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8. The Impact of Trade Policies
Ghana
1970
GNP/capita
$250
1997
GNP/per capita
$370
GNP Growth/year
1.5% (1997)
Shift from comparative advantage uses (cocoa) to non-comparative advantage uses (subsistence agriculture).
Korea
1970
GNP/per capita
$260
1997
$10,550
GNP Growth/year
5.1% (1997)
Shift from non-comparative advantage uses (agriculture) to comparative advantage uses (labor-intensive manufacturing).
South Korea – 2003 GDP per capita (PPP) - $17,700; Growth rate = 2.8%
Ghana – 2003 GDP per capita (PPP) - $1,861; Growth rate = 5.8%
However: per capita GDP in Ghana was lower in 1998 than in 1975.
© Ram Mudambi, Temple University, 2007

9. The Impact of Trade Policies
Brazil
1970
GNP/per capita
$1,145
1997
$4,720
GNP Growth/year
1.1% (1997)
Blanket policies for the entire economy
Policy characterized by crisis management
Korea
1970
GNP/per capita
$260
1997
$10,550
GNP Growth/year
5.1% (1997)
Specific policies for export sector.
Strategic policy continuity
South Korea – 2003 GDP per capita - $17,700; Growth rate = 2.8%
Brazil – 2003 GDP per capita - $7,600; Growth rate = 1%
© Ram Mudambi, Temple University, 2007

10. Growth in Modern Times
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11. An Overview of Trade Theory
Free Trade occurs when a government does not attempt to influence, through quotas or duties, what its citizens can buy from another country or what they can produce and sell to another country.
The Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country.
Some patterns of international trade are easy to understand (Saudi Arabia / oil or Mexico / labor intensive goods). Others are not so easy to understand (Japan / cars).
© Ram Mudambi, Temple University, 2007

12. Mercantilism: mid-16th century
A nation’s wealth depends on accumulated internationally valued assets - gold and silver
To maximize its wealth, a
nation should
Maximize exports through subsidies.
Minimize imports through tariffs and quotas.
Trade is a “Zero-sum game”
 Implement ‘beggar thy neighbor’ policies
Mercantilism distilled virtually all pre-existing trade theory
Makes sense in an autarkic world one-shot games
© Ram Mudambi, Temple University, 2007

13. Theory of Absolute Advantage
Adam Smith: Wealth of Nations (1776).
Production efficiencies vary across countries.
Produce only goods where you are most efficient, trade for those where you are not efficient.
Trade between countries is, therefore, beneficial.
Ghana / cocoa.
© Ram Mudambi, Temple University, 2007

14. Theory of Comparative Advantage
David Ricardo: Principles of Political Economy (1817).
Countries specialize in products where they have the largest comparative advantage.
Implication: Trade can be beneficial even between countries where one has an absolute advantage in ALL goods.
© Ram Mudambi, Temple University, 2007

15. The Production Possibility Frontier*
Production point = Consumption point
PPF2
PPF1
Cocoa
PPF1 is the production possibility frontier under autarky.
*Diminishing
returns mean
that the PPF
is curved
Rice
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16. The Influence of Free Trade on the PPF
Production point
PPF2
Cocoa
Consumption point
PPF1
Export
Import
Rice
© Ram Mudambi, Temple University, 2007

17. Is the mercantilist theory still valid?
A qualified Yes.
Equate political power with economic power and economic power with a trade surplus.
Japan, China
© Ram Mudambi, Temple University, 2007

18. Product Life-Cycle Theory (Raymond Vernon, 1966)
Article in the Quarterly Journal of Economics.
As products mature, both location of sales and optimal production changes.
Affects the direction and flow of imports and exports.
Globalization and integration of the economy makes this theory less valid.
© Ram Mudambi, Temple University, 2007

19. International Product Trade Cycle Model
High Income Countries
production
Exports
Imports
consumption
Quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Medium Income Countries
Exports
Imports 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Low Income Countries
Exports
Imports 1
Time 2 3 4 5 6 7 8 9 10 11 12 13 14 15
New Product
Maturing Product
Standardized Product
Stages of Production Development

20. The New Trade Theory
Typically, in industries with high fixed costs, world demand will support few competitors
Competitors may emerge because “they got there first” – first mover advantages
economies of scale and experience curve effects
Some argue that it creates a role for govt. intervention and strategic trade policy
© Ram Mudambi, Temple University, 2007

21. First-Mover Advantage
Founded 1915 by William Boeing
Largest commercial airplane manufacturer
Over 9,000 commercial jetliners in service
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22. Government-supported entry
Established 1967
Western Europe buying 25% of aircraft ,but selling only 10%.
France, Germany, Great Britain, Spain, Italy
By 2002: 4,632 orders - 3,127 deliveries
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23. Boeing vs. Airbus Net plane orders
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24. Porter’s Diamond The Competitive Advantage of Nations.
Looked at 100 industries in 10 nations.
Thought existing theories didn’t go far enough.
Question: “Why does a nation achieve international success in a particular industry?”
© Ram Mudambi, Temple University, 2007

25. Porter’s Diamond Determinants of National Competitive Advantage
Demand Conditions
Economies of
scale
Discerning
customers
Firm Strategy,
Structure and
Rivalry
Creation and
organization
of firms
Antitrust
Factor Endowments
Key items:
Skilled labor
Technology
Related and
Supporting
Industries

26. Policy and Luck Chance Government
Company Strategy,
Structure,
and Rivalry
Demand
Conditions
Related
and Supporting
Industries
Factor
Chance
Two external factors that influence the four determinants.
© Ram Mudambi, Temple University, 2007

27. New Trade Theory vs. the Diamond
New trade theory provides a role for government in supporting ‘national champions’
Porter’s diamond argues that such support is counter-productive
Airbus seems to provide evidence for New Trade theory
The computer industry seems to provide evidence for Porter’s diamond
Groupe Bull (France), Siemens (Germany),
Olivetti (Italy), ICL (The UK)
World Trade

28. The Political Economy of Trade
The role of politics in trade policy
Trade wars
Policy tools through which political factors impact international trade
Instruments of trade policy
© Ram Mudambi, Temple University, 2007

29. EU-US and GMO 1989 - EU bars growth hormone treated beef.
US exports decline form $231m in 1988 to $98m
in US exports of GM corn targeted in 1998.
With other countries, US files complaint to WTO.
WTO Panel declares ban
to be illegal.
EU reluctant to comply and
appeals, but loses the appeal.
US threatens to raise
tariffs on hundreds of EU products.
WTO rules in favor of US again, allowing
punitive tariffs of hundreds of millions of euros
Jan 22, 2003 WSJ article by Nobel Laureate Norman Borlaug, architect of the Green Revolution, argues that there is no science behind concerns regarding GM foods.
© Ram Mudambi, Temple University, 2007

30. US Targets EU Beef Pork Sausages Corned Beef Roquefort Cheese
Chocolate Products
Mustards
Chewing Gum
Soups and Broths
Truffles
Mineral Water
Cut Flowers
Yarn
Electric Hair Clippers
Motorcycles and Mopeds
© Ram Mudambi, Temple University, 2007

31. Trade Policy and Politics
Protecting jobs and industries:
emerging industries.
Increasing exports.
National security.
Retaliation.
International product domination:
New trade theory and subsidies.
© Ram Mudambi, Temple University, 2007

32. Instruments of Trade Policy
Tariffs
Subsidies
Quotas and voluntary export restraints (VERs)
Local content requirements (LCRs)
Anti-dumping policies
Administrative policies
© Ram Mudambi, Temple University, 2007

33. Instruments of Trade Policy Tariffs
Tariffs - oldest form of trade policy
Specific
ad valorem
Good for government
Good for producers
But reduces efficiency
Bad for consumers
© Ram Mudambi, Temple University, 2007

34. Instruments of Trade Policy Subsidies
A payment to a domestic producer.
Cash grants
low-interest loans
tax breaks
government equity participation in the company
Airbus
Subsidy revenues generated from taxes.
© Ram Mudambi, Temple University, 2007

35. Instruments of Trade Policy Import Quotas and Voluntary Export Restraints (VERs)
Restriction on the quantity of some good imported into a country.
Voluntary Export Restraint (VER):
Quota on trade imposed by exporting country, typically at the request of the importing country.
© Ram Mudambi, Temple University, 2007

36. Instruments of Trade Policy Local Content Requirements - LCRs
Requires some specific fraction of a good to be produced domestically.
Percent of component parts.
Percent of the value of the good.
Initially used by developing countries to help shift from assembly to production of goods.
Developed countries (US) beginning to implement.
For component part manufacturer, LCR acts the same as an import quota.
Benefits producers, not consumers.
© Ram Mudambi, Temple University, 2007

37. Instruments of Trade Policy Anti-dumping Policies
Defined variously as:
Selling goods in a foreign market below production costs.
Selling goods in a foreign market below fair market value.
Result of:
Unloading excess production.
Predatory behavior.
Remedy: seek imposition of tariffs.
© Ram Mudambi, Temple University, 2007

38. Dumping: GATT and the U.S.
GATT:Sale of an imported product at ‘less than fair value’ and causes ‘material injury to a domestic industry’.
US: An unfair trade practice that results in injury, destruction, or the prevention of the establishment of an American industry.
© Ram Mudambi, Temple University, 2007

39. Instruments of Trade Policy Administrative Policies
Bureaucratic rules designed to make it difficult for imports to enter a country.
Japanese ‘masters’ in imposing rules.
Unit inspections
Tulip bulbs
Cars
© Ram Mudambi, Temple University, 2007

40. Summary
Both theory and practice indicate that international trade and engaging with the world economy have enormous wealth creating potential
Industries are internationally mobile and generally this mobility creates efficiency
National politics has a powerful influence on trade policies and generally leads to the erection of trade barriers of various kinds
These barriers generally create inefficiencies
© Ram Mudambi, Temple University, 2007