INTERNATIONAL BUSINESS 2
SESSION 1: INTERNATIONAL TRADE THEORIES, BARRIERS
& GOVERNMENT ROLE
Lecturer:
Mail:
1. Overview Of International Trade
a. Definition of International Trade
CONTENT b. Balance of Trade
2. Theories Of International Trade
a. Mercantilism
b. Neo-Mercantilism
c. Theory of Absolute Advantage
d. Theory of Comparative Advantage
e. Factor Endowment Theory
f. Vernon’s Product Life Cycle Theory
3. Barriers To Trade
a. Reasons
b. Types of Tariff
c. Non-Tariff Barriers
i. Effect of quota & subsidy
ii. Embargo
iii. Product & Testing Standards
iv. Local content requirements (LCR)
v. Currency control
vi. Administrative policies
d. The Role of Government
1a. DEFINITION OF INTERNATIONAL TRADE
Definition: The branch of economics concerned with the exchange of goods
and services with foreign countries
FDI
Joint
venture
export
M&A
International
TRADE
International import
BUSINESS
Licensing/
franchising
1a. DEFINITION OF INTERNATIONAL TRADE
1b. BALANCE OF TRADE
● Balance of trade: difference between the
value of a country's exports and the value
of a country's imports for a given period
🡪 indicator of economic health of a country
1b. BALANCE OF TRADE
Trade surplus Trade deficit
Import
Export
Export
Import
2. THEORIES OF INTERNATIONAL TRADE
Main Features of Mercantilism
Examples of Mercantilism
England
- The aim of the British government
was to control colonial trade and
make sure that wealth flowed back
to England.
France
- The aim was to increase exports in
order to generate reserves of gold.
Spain
- The aim was to exert maximum
control over resources in order to
build wealth and power.
CRITICISM OF MERCANTILISM
● Trade Restrictions
○ country put high trade barriers in place to restrict imports
in the form of tariffs and quotas.
● Misunderstanding of Wealth
○ the source of national wealth was considered to be
accumulating precious metals such as gold and silver
● Zero-sum View of Trade
○ one country could benefit from the gains of international
trade only at the expense, loss, or cost of another country
2b. NEO-MERCANTILISM
● Definition: Neo-mercantilism is the modern version of traditional
outdated mercantilism.
● Objectives:
○ protect domestic industries,
○ promote exports,
○ limit imports
○ keep the balance of trade surplus.
=> Many countries protect domestic industries through trade barriers
to promote self-sufficiency, protect domestic jobs and avoid balance
of trade deficits.
2c. ABSOLUTE ADVANTAGE
• Theory of “Absolute Advantage”: from the
book “The Wealth of Nations” by Adam Smith,
1776
○ “because some countries can produce certain
goods more efficiently than other countries,
they should specialize in and export those
products that they can produce more
efficiently and trade for other products that
ADAM SMITH (1723-1790)
they need”
• Countries should focus on the production of
goods which they are the best at and then trade
these for goods produced by other countries.
2c. ABSOLUTE ADVANTAGE
HOURS/PRODUCT JAPAN VIETNAM Assumptions:
- Labor is the only element
(1 unit of ) Steel 2 8 - All other things are the same
and unchanged.
(1 unit of) Cloth 5 3
● Japan has an absolute advantage in manufacturing steel
● Vietnam has an absolute advantage in manufacturing cloth
🡪 Adam Smith: Japan produce steel – Vietnam produce cloth & exchange to each other to get
benefits both
2d. COMPARATIVE ADVANTAGE
“Principles of political economy” - David Ricardo, 1817
“ those who produce certain goods and services relatively
more efficiently should specialize in their production and
export, while importing those goods and services in which
they have a comparative cost disadvantage”.
2d. COMPARATIVE ADVANTAGE
HOURS/PRODUCT JAPAN VIETNAM Assumptions:
- Labor is the only element
STEEL 2 8 - All other things are the same
and unchanged.
CLOTH 5 6
Japan has absolute advantages in manufacturing both steel AND cloth ”OPPORTUNITY COST”
Labor cost of 1 unit of steel in Japan 2
= = 0.4 🡪 1S = 0.4C Japan: steel
Labor cost of 1 unit of cloth in Japan 5
COMPARATIVE ADVANTAGE
Labor cost of 1 unit of steel in VN 8
= = 1.3 🡪 1S = 1.3C Vietnam: cloth
Labor cost of 1 unit of cloth in VN 6
2d. COMPARATIVE ADVANTAGE
Table 1: Manufacturing labor costs
Product Hours in Britain Hours in Spain
(1 unit of) wheat 15 10
(1 unit of) wine 30 15
Labor cost of 1 unit of wheat in Britain 15
= = 0.5 🡪 1 wheat = 0.5 wine Britain: …?
Labor cost of 1 unit of wine in Britain 30
COMPARATIVE ADVANTAGE
Labor cost of 1 unit of wheat in Spain 10
= = 0.7 🡪 1 wheat = 0.7 wine Spain:…?
Labor cost of 1 unit of wine in Spain 15
2d. COMPARATIVE ADVANTAGE
Assume: Table 1: Manufacturing labor costs
- Labor source in Britain: 270 hours
Product Hours in Britain Hours in Spain
- Labor source in Spain: 180 hours
1 unit of wheat 15 10
1 unit of wine 30 15
Table 2: Before trade
Country Units of wheat Units of wine
Britain 8 5
Spain 9 6
Total 17 11
2d. COMPARATIVE ADVANTAGE
Table 1: Manufacturing labor costs
Assume:
Product Hours in Britain Hours in Spain
- Labor source in Britain: 270 hours
- Labor source in Spain: 180 hours 1 unit of wheat 15 10
- Britain only produces wheat & Spain only 1 unit of wine 30 15
produces wine
Table 3: After trade
“SPECIALIZATION”
Country Units of wheat Units of wine
Britain 18 0
Spain 0 12
Gain from Trade Total 18 12
https://www.youtube.com/watch?v=Meo0s54s1sw
COMPARISONS
Absolute advantage Comparative advantage
- Stress the role of international trade
Similarities - All nations can get benefits from trade
- Recognize the superiority of specialization
Based on Opportunity costs
Based on Manufacturing costs
to compare the
Difference to compare the
competitiveness among
competitiveness among nations
nations
2e. FACTOR ENDOWMENT THEORY
● Heckscher-Ohlin model (1919 - 1933)
“differences in a country’s proportionate holdings of factors
of production (land, labor, and capital) explain differences
in the costs of the factors and that export advantages lie in
the production of goods that use the most abundant factors”
● Example:
❑ Certain countries have extensive oil reserves but
have very little iron ore.
❑ other countries can easily access and store precious
metals, but they have little in the way of agriculture.
2f. Vernon’s Product Life Cycle Theory
FREE TRADE
Pros Cons
● Allows consumers to access the cheapest ● Competition with foreign exports may cause
goods on the world market. local unemployment and business failures.
● Allows countries with relatively cheap labor ● Industries may relocate to jurisdictions with
or resources to benefit from foreign exports. lax regulations, causing environmental
● Under Ricardo's theory, countries can produce damage or abusive labor practices.
more goods collectively by trading on their ● Countries may become reliant on the global
respective advantages. market for key goods, leaving them at a
strategic disadvantage in times of crisis.
PROTECTIONISM
● Protectionism: The theory or practice of shielding domestic industries from
foreign competition, often through trade barriers adopted by the government
3. BARRIERS TO TRADE - REASONS
● Protect local jobs by shielding home-country business from foreign competition
● Encourage local production to replace imports
● Protect infant industries that are just getting started
● Reduce reliance on foreign suppliers
● Encourage local and foreign direct investment
● Promote export activity
● Prevent foreign firms from selling goods below cost in order to achieve market share
● Promote political objectives such as refusing to trade with countries that practice
apartheid or deny civil liberties to their citizens
3. BARRIERS TO TRADE
Barriers
Tariff Non-tariff
Export Import Transit Quotas Subsidies Others
Tariff Tariff Tariff
Production & Local Content Currency Administrative
Embargoes
Testing Requirements Controls Policies
Standards
3b. TYPES OF TARIFFS
● Import and export tariffs: a tax levied on imports or exports of a
country
● Transit tariff: a tax levied on goods passing through the country
● Specific duty: a tariff based on the number of items being
imported
● Ad valorem duty: a tariff based on a percentage of the value of
imported goods
● Compound duty: a tariff consisting of both a specific and ad
valorem duty
3c. NON-TARIFF BARRIERS
The UN Conference on Trade and
Development classifies 16 types of
non-tariff barrier, ranging from
measures favouring domestic industries
to intellectual property to measures on
plant and animal health.
Source:
https://www.instituteforgovernment.org
.uk/article/explainer/non-tariff-barriers
3c. NON-TARIFF BARRIERS
Quotas will reduce imports, and help domestic suppliers. However, they will
lead to higher prices for consumers, a decline in economic welfare and could
lead to retaliation with other countries placing tariffs on our exports.
3c. NON-TARIFF BARRIERS
● Embargo: Government bans trade of particular product(s) with a
specific country.
• In the late 50s, US had a
strong influence on Cuba
• In 1960, all US businesses
in Cuba were nationalized
without compensation
• The US retaliated by putting
an embargo against Cuba
3c. NON-TARIFF BARRIERS
● Product & Testing Standards: criteria that ensures foreign products
perform in certain way to achieve a level of quality required by the
government
“chili sauce bottles contained
benzoic acid while this
additive is not allowed in
preserving of chili sauce in
Japan” – Osaka website
3c. NON-TARIFF BARRIERS
● Local content requirements (LCR): policies imposed by governments requiring
firms to use domestically-manufactured goods/services to operate in an economy
Nigerian incorporated Increased local employment,
companies with no less better training, higher
than 51% equity shares foreign investment
by Nigerians
- follow provisions of
Companies and Allied
Matters Act (CAMA)
3c. NON-TARIFF BARRIERS
● Currency controls (foreign exchange controls or currency exchange
controls): set of government restrictions to ban or limit the sale or purchase
of foreign currencies by nationals and that of local currency by foreigners.
• Exchange rate
A higher-valued currency makes a country's imports less expensive
at home and its exports more expensive in foreign markets.
3c. NON-TARIFF BARRIERS
Administrative policies: regulatory
control designed to slow the flow of
import into a country; includes wide
range of government action:
▪ Inconvenient ports for imports
▪ Product-damaging inspections “bureaucratic
▪ Understaffed customs offices rules”
▪ Lengthy licensing procedures
3d. THE ROLE OF GOVERNMENT
Governments are motivated to control trade for the following reasons:
● Financial issues (BOP): restricting the buying in foreign countries
to reduce money spending overseas.
● Security issues: sale of chemicals for weapons or explosives
● Safety issues: importing defecting equipment or parts
● Health issues: avoiding contaminated food or material hazardous to
health or environment
● Protectionist issues: safeguarding domestic industry from import
competition
