Chapter 2: International Trade Theory and Application

Chapter 2
International Trade Theory and
Application
International Business
Oded Shenkar and Yadong Luo
Chapter 2: International Trade Theory and Application
Do You Know?
What are the major theories of
international trade?
How do governments limit trade with
other countries, and what are their
reasons for doing so?
How do different technological levels
define a countrys trade relationships?
Why do countries with similar levels of
technology trade more than countries
with disparate technology levels?
Chapter 2: International Trade Theory and Application
International Trade Theories
International trade is the exchange of
goods and services across borders.
Export structures vary across countries.
A number of international trade theories
can explain these different structures.
Chapter 2: International Trade Theory and Application
The Mercantilist Doctrine
Mercantilism is a 16
th
Century doctrine
stating that a nation should export more
goods that it imports.
Governments job is to create policy that
promotes heavy exportation, collection of
revenue, and industrial development
internally.
In practice, it serves to make the State the
stockholder, financier, customer, marketer,
collector, and enforcer of contracts with
other nations.
Chapter 2: International Trade Theory and Application
Absolute Advantage Theory
In 1776, Adam Smith proposed that
market forces rather than government
desires were a better predictor of
trade.
Laissez-Faire policy where
government has no influence should
promote trade better.
Nations will export to pay for goods
they import.
Chapter 2: International Trade Theory and Application
Absolute Advantage Theory
Nations could specialize in producing
and exporting goods where they have
a natural or acquired Absolute
Advantage and import those goods
they dont produce as well.
Exhibit 2-1: Labor hours required to product one unit of
a good.
Chapter 2: International Trade Theory and Application
Comparative Advantage Theory
David Ricardo indicated in 1817 there may
be a better explanation since few States
actually specialize like that.
Ricardo indicated that nations that are
comparatively more efficient at production
will make those goods even though they
may not have an absolute advantage.
Comparative Advantage explains and
predicts trade of goods where absolute
advantages may not exist.
Chapter 2: International Trade Theory and Application
Comparative Advantage Theory
Opportunity Cost the amount of other goods
which have to be given up to product one unit of a
good.
Exhibit 2-3: Opportunity costs for producing wine and cloth.
Exhibit 2-2: Labor hours required to produce one unit of a good.
Chapter 2: International Trade Theory and Application
Comparative Advantage Theory
Comparative Advantage must be
explained by:
Comparative Production Cost depends
on the commoditys production process.
Production Factors such as labor, land,
capital, and natural resources.
Chapter 2: International Trade Theory and Application
Heckscher-Ohlin Theorem
Countries export goods that make
intensive use of the countrys abundant
factor.
Countries import goods that make
intensive use of the countrys scarce
factor.
Differences in comparative advantage
are attributed to differences in the
structure of the economy.
Chapter 2: International Trade Theory and Application
Heckscher-Ohlin Theorem
Assumptions:
Countries vary in the availability of various
factors of production.
The Production Function is identical
anywhere in the world.
The amount of output produced by using any
given amount of capital and labor.
Technology is constant in all trading
countries.
Conditions of demand for production
factors are the same in all countries.
Chapter 2: International Trade Theory and Application
Heckscher-Ohlin Theorem
Implications
Trade should be greatest between
countries with the greatest differences in
economic structure.
Trade should cause countries to specialize
more.
Trade policy should take the form of trade
restrictions.
Countries should export goods that make
use of the abundant factors.
Chapter 2: International Trade Theory and Application
Heckscher-Ohlin Theorem
Implications
Free trade should equalize factor prices
between countries with similar relative
factor endowments.
Factor prices should be nearly equal
between countries with more liberal mutual
trade.
International investment should be
stimulated by difference in factor
endowments.
Chapter 2: International Trade Theory and Application
The Leontief Paradox
Leontief challenges Heckscher-Ohlin on a
number of grounds.
The U.S (a capital intensive nation) exports labor-
intensive goods.
The U.S also exports technically sophisticated
goods that require skilled labor.
The U.S imports capital intensive goods made
with unskilled labor.
Exhibit 2-4: Capital position in U.S. exports and imports
Chapter 2: International Trade Theory and Application
The Leontief Paradox
Stimulated a search for explanations.
Demand bias for capital-investment
goods.
Existence of trade barriers.
Importance of natural resources
Prevalence of factor-intensity reversals.
Chapter 2: International Trade Theory and Application
Human Skills and Technology-Based
View
Keesing indicated that trade direction
and flow is predicted by gaps in
human skills and technology.
Nations with higher levels of humans
skills and technology will produce and
export goods to nations with lower
levels.
Chapter 2: International Trade Theory and Application
Human Skills and Technology-Based
View
Human Skills are predicted by
Level of development in the scientific,
technical, managerial, and skilled labor
sectors.
Technology level is predicted by:
capital-intensive technology
development
imitation lag that exists as technology
innovations diffuse to developing areas.
Chapter 2: International Trade Theory and Application
The Product Life-Cycle Model
Product innovation and initial use
occurs first in higher income
countries
Diffuses to middle and lower income
countries as technology and skills
gaps overcome and consumer
preferences switch to the newer
products.
Chapter 2: International Trade Theory and Application
The Product Life-Cycle Model
Several trends emerge in PLC:
The export performance of the mature
innovating country is better than others.
Technology is better in the mature
countries as products diffuse production
tends to move from technology-intensive
to labor-intensive.
Countries that were innovators can fall
from that place.
Trade may increase in later stages of
product maturity as costs and prices
decline and production economies rise.
Chapter 2: International Trade Theory and Application
The Product Life-Cycle Model
Exhibit 2-5: Product cycle model of international trade
innovating country
Chapter 2: International Trade Theory and Application
The Product Life-Cycle Model
Exhibit 2-6: Product cycle model of international trade
imitating country
Chapter 2: International Trade Theory and Application
Linders Income-Preference Similarity
Theory
Developed countries trade more than less
developed countries (assumption)
Trade should take place between developed
nations producing manufactured products
and less developed nations producing
primary products (e.g. natural resources)
and labor-intensive goods.
According to Linder, the range of production
is determined by internal demand.
Countries with similar internal demand
conditions should therefore trade. This is
called Preference Similarity.
Chapter 2: International Trade Theory and Application
The New Trade Theory
Countries do not specialize and trade solely
to take advantages of differences.
They also trade because of increasing
returns.
Because of economies of scale, there are
increasing returns to specialization.
Economies of scale reduction of
manufacturing cost per unit as a result of
increased production quantity during a
given period.
Chapter 2: International Trade Theory and Application
The New Trade Theory
Inter-industry trade determined by
Heckscher-Ohlin.
Intra-industry trade driven by
increasing returns resulting from
specialization within the industry.
Externality when the actions of one
agent directly affect the environment of
another.
Chapter 2: International Trade Theory and Application
Theory Assessment
These theories provide insights in
international trade.
No theorem can fully explain the range
of motives for international trade.
Chapter 2: International Trade Theory and Application
International Trade Volume and Growth
International trade continues to grow
briskly
In 2000, global merchandise exports
reached $6.2 trillion
Increase of 12.5% over 1999
Global exports of commercial services
reached $1.4 trillion
Increase of 6% over 1999
Significant change in in the share of
various world regions.
Chapter 2: International Trade Theory and Application
International Trade Volume and Growth
Exhibit 2-7: World merchandise trade by major product
group, 1950 - 2000
Chapter 2: International Trade Theory and Application
International Trade Volume and Growth
Exhibit 2-8: World merchandise trade by region and
selected economy
Chapter 2: International Trade Theory and Application
International Trade Volume and Growth
Exhibit 2-8: World merchandise trade by region and
selected economy (cont)
Chapter 2: International Trade Theory and Application
Service Trade
The import and export of:
Financial services
Information services
Education and training
Travel and tourism
Healthcare
Consulting and advisory services
Accounts for about one quarter of global
trade, but rapidly growing.
Chapter 2: International Trade Theory and Application
Service Trade
Exhibit 2-9: Trade in commercial services of the U.S.
Chapter 2: International Trade Theory and Application
Trade Measurement
Trade measurement is generally a difficult
exercise since nations do not use similar
indexed systems.
Different trade data is collected for different
purposes and aggregations may be biased.
Major sources of reliable data
U.S Department of Commerce
World Trade Organization
Shippers Export Declarations
World Bank
Chapter 2: International Trade Theory and Application
Major Exporters and Importers
In merchandise trade, top exporters and
importers are developed countries.
Exhibit 2-10a: Top 10 leading exporters and importers in
world merchandise trade, 2000
Chapter 2: International Trade Theory and Application
Major Exporters and Importers
In commercial services, top exporters
and importers are developed countries.
Exhibit 2-10b: Top 10 leading exporters and importers in
world trade in commercial services, 2000
Chapter 2: International Trade Theory and Application
U.S. Trade Partners
Canada is the largest trade partner
Followed by the EU, Mexico, and Japan
Developed economies
Canada and Mexico benefit from
proximity and NAFTA membership.
Chapter 2: International Trade Theory and Application
U.S. Trade Partners
Exhibit 2-11: Merchandise trade of the U.S. by region
and economy, 2000
Chapter 2: International Trade Theory and Application
U.S. Trade Partners
Trade with Japan
Flow of foodstuff from U.S. to Japan
explained by factor endowments
Japan exports 10 times more vehicles to
the U.S. than vice versa.
Trade barriers
Currency exchange rates
Rising fuel prices
Chapter 2: International Trade Theory and Application
U.S. Trade Partners
Exhibit 2-12a: U.S. Exports to Japan (Top ten
commodities)
Chapter 2: International Trade Theory and Application
U.S. Trade Partners
Exhibit 2-12b: U.S. Imports from Japan (Top ten
commodities)
Chapter 2: International Trade Theory and Application
Trade Balance
Balance of trade
exports minus
imports of goods
and services
The U.S. has the
largest trade deficit
Low as a
percentage of
GDP.
Exhibit 2-13:
Balance of Trade
Chapter 2: International Trade Theory and Application
Opposition to Free Trade
Opponents of free trade in opposition to
globalization.
Countries take the position that trade needs
to protect the interests of their citizens.
In one survey, 48% of Americans said foreign
trade is bad for the U.S.
Trade impacts at the micro level, as well as
the macro.
People with lower incomes tend to be more
negatively disposed to trade.
Chapter 2: International Trade Theory and Application
The Sovereignty Argument
Moving production to the most efficient
location deprives a countrys economic
viability.
Makes countries too dependent on
other nations.
Particularly relevant to national security.
Threat to national culture and
institutions.
Chapter 2: International Trade Theory and Application
The Lowest Common Denominator
Argument
Product shifts to nations with the least
protection.
Potentially adverse to the environment
and safety.
Everyone will end up paying for the
adverse effects.
One of the main complaints of the
antiglobalization movement.
Chapter 2: International Trade Theory and Application
Trade Reciprocity
Benefits from trade can be not only
economic but also political and social.
Passive reciprocity a country
refuses to lower or eliminate barriers to
trade until the other does the same.
Active or aggressive reciprocity the
threat of retaliation.
Chapter 2: International Trade Theory and Application
Types of Trade Barriers
Tariff barriers official constraints on
the importation of certain goods or
services.
Takes the form of a limitation or a special
levy.
Non-tariff barriers indirect measures
that discriminate against foreign
manufacturers.
Chapter 2: International Trade Theory and Application
Tariffs
Surcharges that importer must pay above and
beyond taxes leveled on domestic goods and
services.
Transparent and based on the value of the
product or service.
Optimal Tariff theory governments can
capture a portion of the manufactures profit
margin.
Infant Industry theory a industry new to a
country can be protected against established
global players.
Chapter 2: International Trade Theory and Application
Tariffs
Exhibit 2-14: Average import tariff rates
Chapter 2: International Trade Theory and Application
Quotas
Quantitative limits on the importation of
goods.
Definitive, quantifiable protection of the
domestic producers.
Rule of origin administration of tariffs
and quotes based on the country origin.
Chapter 2: International Trade Theory and Application
Export Controls
Limitation of the type of products that
can be exported to other countries.
National security risks
Dual purpose products
Goods vital to domestic industry
Companies often argue that countries
will get the products from a competitor.
Chapter 2: International Trade Theory and Application
Dumping and Anti-Dumping
Dumping - Selling a product at an
unfairly low price.
Undermines the principles of
comparative advantage.
WTO allows anti-dumping laws where
there has been material injury to the
domestic industry.

Chapter 2: International Trade Theory and Application
Non-Tariff Barriers
Administrative Barriers used to block the
entry of products while arguing that no
barrier exists
Production Subsidies payments provided
by a government to domestic companies to
make them more competitive.
Emergency Import Protection
implemented to protect against a surge in
imports
Foreign Sales Corporations offshore
corporations that market products and
services of firms in foreign countries.
Chapter 2: International Trade Theory and Application
Non-Tariff Barriers
Embargoes the prohibition of exportation to
a designated country.
Boycotts the blank prohibition on
importation of all or some goods from a
designated country.
Technical Standards requiring a company
to demonstrate that their products meet the
countrys domestic standards.
Corruption
Barriers to Service Trade