1. International Trade and Investment
Unit: III

2. Trade Theory Timeline

3. Foundations of Mercantilism
Nations accumulate financial wealth by encouraging exports and discouraging imports
Three pillars
Maintain trade surplus
Government intervention
Exploit colonies

4. Flaws of Mercantilism World trade is zero-sum game
Limits colonies’ market potential
Constrains output and consumption

5. Absolute Advantage
Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources)
Riceland:
1 resource unit = 1 ton rice or 1/5 ton tea
Tealand:
1 resource unit = 1/6 ton rice or 1/3 ton tea
Specialization and trade allows each to produce and consume more

6. Trade Gains: Absolute Advantage
Specialization and trade:
Riceland gets five times more tea than it would have produced itself
Tealand gets two times more rice than it would have produced itself

7. Comparative Advantage
Inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good
Riceland:
1 resource unit = 1 ton rice or 1/2 ton tea
Tealand:
1 resource unit = 1/6 ton rice or 1/3 ton tea
Specialization and trade allows each to produce and consume more

8. Trade Gains: Comparative Advantage
Specialization and trade:
Riceland gets two times more tea than it would have produced itself
Tealand gets two times more rice than it would have produced itself

9. Assumptions and Limitations
Nations strive only to maximize production and consumption
Only two countries produce and consume just two goods
No transportation costs of trading goods
Labor is the only resource used to produce goods
Ignores efficiency and improvement gains from producing just one good

10. Discussion Question
When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________.
a. Absolute advantage
b. Comparative advantage
c. Mercantilism

11. Answer to Discussion Question
When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________.
a. Absolute advantage
*b. Comparative advantage
c. Mercantilism

12. Factor Proportions Theory
Countries produce and export goods that require resources (factors) in abundance, and import goods that require resources in short supply
Two factor types
Labor
Land and Capital

13. Leontief Paradox
Research found evidence opposite of that predicted by the factor proportions theory
U.S. exports are more labor-intensive than U.S. imports
Possible explanations
Theory assumes nation’s production factors to be homogeneous
Theory is better predictor when expenditures on labor are considered

14. International Product Life Cycle
A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle
Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.

15. New Trade Theory Fundamentals First-mover advantage
Gains from specialization and economies of scale
Companies first to market create barriers to entry
Government may help by assisting home companies
First-mover advantage
Economic and strategic advantage of being first to enter an industry
May create a formidable barrier to market entry for potential rivals

16. Discussion Question
Briefly describe the new trade theory. Does its focus on productivity put it at odds with the theory of comparative advantage and factor proportions theory?

17. Answer to Discussion Question
New trade theory says that:
There are gains to be made from specialization and increasing economies of scale.
A company that is first to the market and achieves a first-mover advantage can create barriers to entry.
And government may play a role in assisting its home-based companies.
Because new trade theory emphasizes productivity rather than a nation’s resources, it is in line with the theory of comparative advantage but at odds with factor proportions theory.

18. National Competitive Advantage
Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants (plus government and chance)
Factor conditions
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry

19. Factor Conditions Basic factors Advanced factors Nation’s resources
Result of investing in education and innovation
For example, Japan is a small nation that lacks enough land fit for agriculture; in order to make up for this and become more competitive in the international markets, however, Japan has exploited its wealth of human resources to become a global leader in technology.

20. Demand Conditions
Sophisticated home-market buyers drive companies to improve existing products and develop entirely new products and technologies
This should improve the competitiveness of the entire group of companies in a market
For example, if there is a high demand for the iPhone in the U.S., Apple will be more willing to work on improving its design and thus do better in not only the U.S. market, but the international market as well.

21. Related and Supporting Industries
Companies in an internationally competitive industry do not exist in isolation
Supporting industries form “clusters” of economic activity in the geographic area
Each industry reinforces the competitiveness of every other industry in the cluster
For example, the success of the automobile industry not only benefits the industries of its suppliers (e.g. metal, leather, rubber), but also industries that are directly linked to automobiles (e.g. car insurance).

22. Firm Strategy, Structure and Rivalry
Highly skilled managers are essential because strategy has lasting effects on firm competitiveness
Domestic industry whose structure and rivalry create an intense struggle to survive strengthens its competitiveness
For example, the rivalry between iPhones and Androids in the smartphone market is healthy because this incites innovation on either side and makes both companies key players in providing the U.S. with a high-ranking NCA.

23. Discussion Question
National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.
a. Product life cycle
b. First-mover
c. Competitive advantage

24. Answer to Discussion Question
National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.
a. Product life cycle
b. First-mover
*c. Competitive advantage

25. FOREIGN DIRECT INVESTMENT
(FDI)

27. What is foreign direct investment
It is a direct investment into production/ business by company of country A into country B either by:
Buying a company
Expanding operations in exiting business operations
Simply defines as an investment made by a company in one country, into a company of the another country.
Usually involves participation in management, joint-venture, transfer of technology and expertise.

28. IMPORTANCE OF FDI Resource for economic growth
Money inflow from overseas
Business grows in several countries
FDI & Economic development
Opportunities
Competitive requirement
Corporative Activities
Branch plant or subsidiary company operations
Rise in National Income

29. BARRIERS TO FDI
Formal restrictions on FDI include limits on foreign ownership
Screening and approval procedures
Informal barriers may also be important
Barriers to investment access, operations, areas, products, ownership and land use
Barriers on labour, policy, institutional and control variables
Political controversial

30. ADVANTAGES OF FDI New jobs are created New technology are implemented
Availability of scarce of factory of productions, products and raw materials
Improving the balance of payment though import and export substitution
Revenue to the government through taxation
Improved political relations
To get additional expertise
Increase in the number of competition
Expand local business
Stimulate the local economy and thus increasing in GDP

31. DISADVANTAGES OF FDI Political changes leads to “Expropriation”
Cultural and political indifference
Investing is more expansive than exporting
FDI always at risk
Threat to local product
Takes away employment opportunities
It brings harm to the environment
Foreign market recession
Inequality of income distribution

32. What Are The Patterns Of FDI?
Both the flow and stock of FDI have increased over the last 30 years
Most FDI is still targeted towards developed nations
United States, Japan, and the EU
but, other destinations are emerging
South, East, and South East Asia especially China
Latin America
Country Focus: Foreign Direct Investment in China explores investment opportunities in China. In the late 1970s, China opened its doors to foreign investors. By the mid 2000s, China attracted $60 billion of FDI annually. China’s large population is a magnet for many companies and because high tariffs make it difficult to export to the Chinese market, firms frequently turn to foreign direct investment. However, many companies have found it difficult to conduct business in China, and in recent years investment rates have slowed. In response, the Chinese government, hoping to continue to attract foreign companies has established a number of incentives for would-be investors.

33. What Are The Patterns Of FDI?
FDI Outflows ($ billions)

34. What Are The Patterns Of FDI?
FDI Inflows by Region ($ billion)

35. What Are The Patterns Of FDI?
The growth of FDI is a result of
a fear of protectionism
want to circumvent trade barriers
political and economic changes
deregulation, privatization, fewer restrictions on FDI
new bilateral investment treaties
designed to facilitate investment
the globalization of the world economy
many companies now view the world as their market
need to be closer to their customers

36. What Are The Patterns Of FDI?
Gross fixed capital formation - the total amount of capital invested in factories, stores, office buildings, and the like
the greater the capital investment in an economy, the more favorable its future prospects are likely to be
So, FDI is an important source of capital investment and a determinant of the future growth rate of an economy

37. What Are The Patterns Of FDI?
Inward FDI as a % of Gross Fixed Capital Formation
This Figure suggests that FDI has become increasingly important as a source of investment in the world’s economies.

38. What Is The Source Of FDI?
Since World War II, the U.S. has been the largest source country for FDI
the United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries
together, these countries account for 60% of all FDI outflows from

39. What Is The Source Of FDI?
Cumulative FDI Outflows ($ billions)

40. Ups and Downs of Foreign Direct Investment
International Business 5e

41. International Business 5e
Drivers of FDI
Increasing
globalization
mergers
and acquisitions
International Business 5e

42. Worldwide Flow of FDI
Driving FDI growth are more than 82,000 multinational companies with more than 810,000 affiliates abroad, roughly half of which are in developing countries.
Developed nations remain the prime destinations for FDI.
Developed countries account for around 57 % ($962 billion) of Global FDI.

43. STRATEGIC ASSETS SEEKING

44. Foreign Horizontal Direct Investment
An investment made by a multinational company in different nations.
It is the investment made for conducting similar business operations.
For example: Apple Inc. factory in Brunei
Horizontal FDI results in expansion of the parent company and brings FDI in the other economy

45. Vertical Foreign Direct Investment
Backward Vertical = It is when an industry abroad provides inputs for a firm's domestic production process
For example: Brunei Shell Petroleum with Royal Dutch Shell
Forward Vertical = industry abroad sells the outputs of a firm's domestic production process.
For example: when Volkswagen entered the United States market it acquired a large number of dealers rather than distribute its cars through independent United States dealers

46. Explanations of Foreign Direct Investment
Why FDI occurs? (four theories)
International Product Life Cycle
Market Imperfections (internationalization)
Eclectic Theory
Market power

47. Management issues in the FDI Decision
Control
Partnership requirements
Benefits of cooperation
Purchase or build decision
3. Production Costs
Rationalized production
Cost of Research and Development
Customer Knowledge
Following Clients
Following Rivals

48. Government Intervention in Foreign Direct Investment
Balance of Payment
Balance of payment is the systematic record of all the economic transactions between the residents of a reporting country and the residents of the foreign country during the given period of time.
Current account
Capital account

49. Government Intervention in Foreign Direct Investment
Reason for intervention by the host country
Control Balance of Payment
Obtain Resources and Benefits
Access to Technology
Management Skills and Employment

50. Government Intervention in Foreign Direct Investment
Reasons for Intervention by the Home Country
Investing in other Nations sends resources out of the home country
Outgoing FDI may ultimately damage a nation’s balance of payment by taking the place of its exports
Jobs resulting from outgoing investment may replace jobs at home
Outcome FDI can increase long term competitiveness.
Nations may encourage FDI in industries identified as “sunset” industries.

51. Government Policy Instruments and FDI
HOST Countries: Promotion
Financial Incentives
Infrastructure Improvements
Host Countries: Restriction
Ownership Restrictions
Performance Demands

52. Government Policy Instruments and FDI
Home Countries: Promotion
Insurance
Loans
Political pressure
Home Countries: Restriction
Different tax rates
Restrictions to certain nations

53. THE END OF CHAPTER: III