International Business - Chapter 6: International Trade and Investment Theory

Chapter 6: International Trade and Investment Theory

International Business, 4th Edition Griffin & Pustay

Chapter Objectives_1

 Understand the motivation for international

trade

 Summarize and discuss the differences

among the classical country-based theories of international trade

 Use the modern firm-based theories of international trade to describe global strategies adopted by businesses

Chapter Objectives_2

 Describe and categorize the different forms of international investment  Explain the reasons for foreign direct

investment

 Summarize how supply, demand, and

political factors influence foreign direct investment

International Trade

 Trade: voluntary exchange of goods,

services, assets, or money between one person or organization and another  International trade: trade between

residents of two countries

Figure 6.2 Sources of the World’s Merchandise Exports, 2001

37%

40%

European Union United States Japan Canada Other countries

4%

12%

7%

The largest component of the annual $1.5 trillion trade in international services is travel and tourism

Classical Country-Based Trade Theories

 Mercantilism  Absolute Advantage  Comparative Advantage  Comparative Advantage with Money  Relative Factor Endowments

Mercantilism

 A country’s wealth is measured by its

holdings of gold and silver

 A country’s goal should be to enlarge

holdings of gold and silver by – Promoting exports – Discouraging imports

Modern Mercantilism

 Neomercantilists or protectionists

– American Federation of Labor-Congress

of Industrial Organizations

– Textile manufacturers – Steel companies – Sugar growers – Peanut farmers

Disadvantages of Mercantilism

 Confuses the acquisition of treasure with

the acquisition of wealth

 Weakens the country because it robs

individuals of the ability – To trade freely – To benefit from voluntary exchanges  Forces countries to produce products it

would otherwise not in order to minimize imports

Absolute Advantage

 Export those goods and services for

which a country is more productive than other countries

 Import those goods and services for which other countries are more productive than it is

Table 6.1 The Theory of Absolute Advantage: An Example

OUTPUT PER HOUR OF LABOR France Japan

Wine

Clock radios

Absolute Advantage’s Flaw

 What happens to trade if one country has an absolute advantage in both products?

 No trade would occur

Comparative Advantage

 Produce and export those goods and

services for which it is relatively more productive than other countries

 Import those goods and services for which other countries are relatively more productive than it is

Differences between Comparative and Absolute Advantage

 Absolute versus relative productivity

differences

 Comparative advantage incorporates the

concept of opportunity cost – Value of what is given up to get the good

Table 6.2 The Theory of Comparative Advantage: An Example

OUTPUT PER HOUR OF LABOR France Japan

Wine

Clock radios

Comparative Advantage with Money

 One is better off specializing in what one

does relatively best

 Produce and export those goods and services one is relatively best able to produce

 Buy other goods and services from people

who are better at producing them

Table 6.3 The Theory of Comparative Advantage with Money: An Example

Cost of Goods in France Cost of Goods in Japan

French Made

Japanese Made

French Made

Japanese Made

€8

¥375

¥1,000

€3

Wine

€1.6

¥250

¥200

€3

Clock Radios

Relative Factor Endowments

 Heckscher-Ohlin Theory  What determines the products for which

a country will have a comparative advantage? – Factor endowments vary among countries – Goods differ according to the types of factors that are used to produce them

Relative Factor Endowments_2

 A country will have a comparative

advantage in producing products that intensively use resources (factors of production) it has in abundance – China: labor – Saudi Arabia: oil – Argentina: wheat

Figure 6.3 U.S. Imports and Exports, 1947: The Leontief Paradox

Modern Firm-Based Trade Theories

 Country Similarity Theory  Product Life Cycle Theory  Global Strategic Rivalry Theory  Porter’s National Competitive

Advantage

Growth of Firm-Based Theories

 Growing importance of MNCs  Inability of the country-based theories to explain and predict the existence and growth of intraindustry trade  Failure of Leontief and others to

empirically validate country-based Heckscher-Ohlin Theory

Firm-Based Trade Theories

 Incorporate additional factors into

explanations of trade flows – Quality – Technology – Brand names – Customer quality

Country Similarity Theory

 Explains the phenomenon of

intraindustry trade – Trade between two countries of goods

produced by the same industry • Japan exports Toyotas to Germany • Germany exports BMWs to Japan

Country Similarity Theory_2

 Trade results from similarities of preferences among consumers in countries that are at the same stage of economic development

 Most trade in manufactured goods should be between countries with similar per capita incomes

Product Life Cycle Theory

 Describes the evolution of marketing

strategies

 Stages

– New product – Maturing product – Standardized product

Figure 6.4 The International Product Life Cycle: Innovating Firm’s Country

Figure 6.4 The International Product Life Cycle: Other Industrialized Countries

Figure 6.4 The International Product Life Cycle: Less Developed Countries

Global Strategic Rivalry Theory

 Firms struggle to develop sustainable

competitive advantage

 Advantage provides ability to dominate

global marketplace

 Focus: strategic decisions firms use to

compete internationally

Sustaining Competitive Advantage

 Owning intellectual property rights  Investing in research and development  Achieving economies of scale or scope  Exploiting the experience curve

Porter’s National Competitive Advantage

 Success in trade comes from the

interaction of four country and firm specific elements – Factor conditions – Demand conditions – Related and supporting industries – Firm strategy, structure, and rivalry

Figure 6.5 Porter’s Diamond of National Competitive Advantage

Firm Strategy, Structure, and Rivalry

Factor Conditions

Demand Conditions

Related and Supporting Industries

The intense competitiveness of Japanese market forces manufacturers to continually develop and fine- tune new products

Figure 6.6 Theories of International Trade

Firm-Based Theories  Firm is unit of analysis  Emerged after WWII  Developed by business school

professors

Country-Based Theories  Country is unit of analysis  Emerged prior to WWII  Developed by economists  Explain interindustry trade  Include

 Explain intraindustry trade  Include

– Mercantilism – Absolute advantage – Comparative advantage – Relative factor endowments

– Country similarity theory – Product life cycle – Global strategic rivalry – National competitive

advantage

Types of International Investments

 Does the investor seek an active

management role in the firm r merely a return from a passive investment? – Foreign Direct Investment – Portfolio Investment

Figure 6.7 Stock of Foreign Direct Investment, by recipient

Table 6.4 Sources of FDI for the U.S., end of 2002

United Kingdom

283.3

France

170.6

Netherlands

154.8

Japan

152.

Germany

137.0

Switzerland

113.2

Canada

92.0

Luxembourg

34.3

Bermuda, Bahamas, Caribbean islands

32.5

Other European countries

113.3

All other countries

65.0

Total 6-39

Table 6.4 Destinations of FDI for the U.S., end of 2002

United Kingdom

255.4

Canada

152.5

Netherlands

145.5

Bermuda, Bahamas, Caribbean islands

98.1

Switzerland

70.1

Japan

65.7

Germany

64.7

Mexico

58.1

France

44.0

Other European countries

217.2

All other countries

349.7

Total 6-40

International Investment Theories

 Ownership Advantages  Internalization  Dunning’s Eclectic Theory

Ownership Advantages

 A firm owning a valuable asset that creates a competitive advantage domestically can use that advantage to penetrate foreign markets through FDI

 Why FDI and not other methods?

Internalization Theory

 FDI is more likely to occur when

transaction costs with a second firm are high

 Transaction costs: costs associated with negotiating, monitoring, and enforcing a contract

Dunning’s Eclectic Theory

 FDI reflects both international business activity and business activity internal to the firm

 3 conditions for FDI – Ownership advantage – Location advantage – Internalization advantage

Table 6.5 Factors Affecting the FDI Decision

Supply Factors

Demand Factors

Political Factors

Production costs

Customer access

Avoidance of trade barriers

Logistics

Marketing advantages

Economic development incentives

Resource availability

Exploitation of competitive advantages

Access to technology

Customer mobility

Ikea aggressively exports its furniture to other countries