5 Theories of Trade

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THEORIESOFTRADE1

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Theories of InternationalTrade and Investment

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Learning Objectives

1.Theories of international trade andinvestment

2.Why nations trade

3.How nations enhance their competitiveadvantage: contemporary theories

4.Why and how firms internationalize

5.How firms gain and sustain internationalcompetitive advantage


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FOUNDATIONCONCEPTS

Comparat ive advantage

Superior features of a country that provideit with unique benefits in global

competitionderived from either nationalendowments or deliberate nationalpolicies

Compet i tive advantage

Distinctive assets or competencies of a firm derived from cost, size, or innovationstrengths that are difficult for competitorsto replicate or imitate 4

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PERSPECTIVESOFTHENATIONANDTHEFIRM

Comparat ive advantage

Is the concept that helps answer the questionof all nations can gain and sustain national

economic superiorityCompet i t ive advantage

Is the concept that helps explain howindividual firms can gain and sustain

distinctive competence vis--vis competitors

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EXAMPLESOFNATIONALCOMPARATIVE

ADVANTAGE

China is a low labor cost production base

Indias Bangalore region offers a critical mass of IT

workers

Irelands repositioning enabled a sophisticatedservice economy

Dubai, a previously obscure Emirate, has been

transformed into a knowledge-based economy

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EXAMPLESOFFIRMCOMPETITIVEADVANTAGE

Dells prowess in global supply chain management

Nokias design and technology leadership in

telecommunications

Samsungs leadership in flat-panel TV Herman Millers design leadership

in office furniture

(e.g., Aeron chairs)

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WHYNATIONSTRADE: CLASSICAL

THEORIES

Mercantilism: the belief that national prosperity is

the result of a positive balance of trademaximize

exports and minimize imports

Absolute advantage principle: a country should

produce only those products in which it has

absolute advantage or can produce using fewer

resources than another country

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EXAMPLE


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WHYNATIONSTRADE: CLASSICAL

THEORIES

Comparative advantage principle: it is beneficialfor two countries to trade even if one has absoluteadvantage in the production of all products; whatmatters is not the absolute cost of production but

the relative efficiency with which it can produce theproduct

By specializing in what they produce best and tradefor the rest, countries can use scarce resourcesmore efficiently

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LIMITATIONSOFEARLYTRADETHEORIES

Do not take into account the cost of internationaltransportation

Tariffs and import restrictions can distort tradeflows

Scale economies can bring about additionalefficiencies

When governments selectively target certainindustries for strategic investment, this maycause trade patterns contrary to theoretical

explanations Today, countries can access needed low-cost

capital on global markets

Some services do not lend themselves to cross-border trade

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CLASSICALTHEORIES: FACTORPROPORTIONSTHEORY

Factor proportions (endowments) theory: eachcountry should produce and export products thatintensively use relatively abundant factors ofproduction, and import goods that intensively use

relatively scarce factors of production Leontief paradoxsuggested that countries can

be successful in the export of products thatrequire a less abundant resource (e.g., the U.S.with its labor-intensive exports)

The Leontief paradox implies that internationaltrade is complex and cannot be fully explained bya single theory, e.g., the abundance of a certainproduction input

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CLASSICALTHEORIES:

INTERNATIONALPRODUCTCYCLETHEORY

International product cycle theory: each product

and its associated manufacturing technologies gothrough three stages of evolution: introduction,growth, and maturity

In the introduction stage, the inventor country enjoysa monopoly both in manufacturing and exports

As the products manufacturing becomes morestandard, other countries will enter the globalmarketplace

When the product reaches maturity, the originalinnovator country will become a net importer of the

productApplicability to the contemporary global economy:

Today, the cycle from innovation to maturity is muchshorter making it harder for the innovator country tosustain its lead in a particular product

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HOWNATIONSENHANCECOMPETITIVEADVANTAGE

The contemporary view suggests that governmentscan proactively implement policies to enhance anations competitive advantage, beyond the naturalendowments the country possesses

Governments can create national economicadvantage by: stimulating innovation, targetingindustries for development, providing low-costcapital, and through other incentives

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MICHAELPORTERSDIAMONDMODEL:

SOURCESOFNATIONALCOMPETITIVEADVANTAGE

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Firm strategy, structure, and rivalrythepresence of strong competitors at homeserves as a national competitive advantage

2. Factor conditionslabor, natural resources,

capital, technology, entrepreneurship, andknow how

3. Demand conditions at homethe strengthsand sophistication of customer demand

4. Related and supporting industriesavailability of clusters of suppliers andcomplementary firms with distinctivecompetences

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5 Theories of Trade

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