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Lecture 2

Second lecture

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ahmed.ameen
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International

Trade Theory
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
Lecture-2
International Trade Theory
 What is international trade?
 Exchange of raw materials and manufactured goods
(and services) across national borders
 Classical trade theories:
 explain national economy conditions--country
advantages--that enable such exchange to happen
 New trade theories:
 explain links among natural country advantages,
government action, and industry characteristics that
enable such exchange to happen
 Implications for International Business
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
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.
 The Pattern of International Trade displays
patterns that are are easy to understand (Saudi
Arabia/oil or Mexico/labor intensive goods). Others
are not so easy to understand (Japan and cars).

© McGraw Hill Companies, Inc.,2000 4-5


Classical Trade Theories
 Mercantilism (pre-16th century)
 Takes an us-versus-them view of trade
 Other country’s gain is our country’s loss
 Free Trade theories
 Absolute Advantage (Adam Smith, 1776)
 Comparative Advantage (David Ricardo, 1817)
 Specialization of production and free flow of goods benefit all
trading partners’ economies
 Free Trade refined
 Factor-proportions (Heckscher-Ohlin, 1919)
 International product life cycle (Ray Vernon, 1966)
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
The New Trade Theory
 As output expands with specialization, an
industry’s ability to realize economies of scale
increases and unit costs decrease
 Because of scale economies, world demand
supports only a few firms in such industries (e.g.,
commercial aircraft, automobiles)
 Countries that had an early entrant to such an
industry have an advantage:
 Fist-mover advantage
 Barrier to entry

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


New Trade Theory

 Global Strategic Rivalry


 Firms gain competitive advantage trough:
intellectual property, R&D, economies of scale
and scope, experience
 National Competitive Advantage (Porter,
1990)

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


Mercantilism/Neomercantilism
 Prevailed in 1500 - 1800
 Export more to “strangers” than we import to amass
treasure, expand kingdom
 Zero-sum vs positive-sum game view of trade
 Government intervenes to achieve a surplus in
exports
 King, exporters, domestic producers: happy
 Subjects: unhappy because domestic goods stay
expensive and of limited variety
 Today neo-mercantilists = protectionists: some
segments of society shielded short term
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
Absolute Advantage
 Adam Smith: The Wealth of Nations, 1776
 Mercantilism weakens country in long run; enriches only a few
 A country
 Should specialize in production of and export products for which it has
absolute advantage; import other products
 Has absolute advantage when it is more productive than another
country in producing a particular product

G Cocoa
G: Ghana
K: S. Korea

K'
Rice
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020 G'
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
Comparative Advantage
 David Ricardo: Principles of Political Economy,
1817
 Country should specialize in the production of those
goods in which it is relatively more productive...
even if it has absolute advantage in all goods it
produces
 Absolute Advantage is a special case of
Comparative Advantage
G
Cocoa
G: Ghana
K: S. Korea

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


K' G'
Rice
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
Heckscher (1919)-Ohlin (1933)

 Differences in factor endowments not on differences


in productivity determine patterns of trade
 Absolute amounts of factor endowments matter
 Leontief paradox:
 US has relatively more abundant capital yet
imports goods more capital intensive than those
it exports
 Explanation(?):
 US has special advantage on producing new products made with innovative technologies
 These may be less capital intensive till they reach mass-production state

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


Theory of Relative Factor Endowments
(Heckscher-Ohlin)
 Factor endowments vary among countries
 Products differ according to the types of factors that
they need as inputs
 A country has a comparative advantage in producing
products that intensively use factors of production
(resources) it has in abundance
 Factors of production: labor, capital, land, human
resources, technology

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


International Product Life-Cycle
(Vernon)
 Most new products conceived / produced in the US in 20th century
 US firms kept production close to their market initially
 Aid decisions; minimize risk of new product introductions
 Demand not based on price; low product cost not an issue

 Limited initial demand in other advanced countries initially


 Exports more attractive than overseas production

 When demand increases in advanced countries, production follows


 With demand expansion in secondary markets
 Product becomes standardized
 production moves to low production cost areas
 Product now imported to US and to advanced countries

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
Classic Theory Conclusion
 Free Trade expands the world “pie” for goods/services
Theory Limitations:
 Simple world (two countries, two products)
 no transportation costs
 no price differences in resources
 resources immobile across countries
 constant returns to scale
 each country has a fixed stock of resources and no efficiency
gains in resource use from trade
 full employment
Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020
New Trade Theories

 Increasing returns of specialization due to economies


of scale (unit costs of production decrease)

 First mover advantages (economies of scale such that


barrier to entry crated for second or third company)

 Luck... first mover may be simply lucky.

 Government intervention: strategic trade policy

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


National Competitive Advantage
(Porter, 1990)
 Factor endowments
 land, labor, capital, workforce, infrastructure
(some factors can be created...)
 Demand conditions
 large, sophisticated domestic consumer base: offers an
innovation friendly environment and a testing ground
 Related and supporting industries
 local suppliers cluster around producers and add to
innovation
 Firm strategy, structure, rivalry
 competition good, national governments can create
conditions which facilitate and nurture such conditions

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


Porter’s Diamond

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


“So What” for business?
 First mover implications

 Location Implications

 Foreign Investment Decisions

 Government Policy implications

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020


The END

Prepared by Ing. Ahmed Ameen Mohamed, Mandhu College 2020

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