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INTERNATIONAL BUSINESS

MANAGEMENTTopic 1.2: The Theoretical Foundations of International Business, Trade

Course Leader: Dr Michael Wynn-Williamswm97@gre.ac.uk

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STRATEGY AND ECONOMICS Firms exist in order to organize the

production of goods and services

The extent to which the firm internalizes any of its transactions depends on Its ability to achieve economies of scale in

production and distribution, andAnalysis of the transaction costs

Dangers of opportunism Search costs

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DIFFERENT THEORIES OF INTERNATIONAL TRADE

Mercantilism Adam Smith and Absolute Advantage Comparative Advantage The Heckscher-Ohlin Framework The Stolper-Sameulson Approach

Factor Price Equalization Theorem Rybzcysky’s approach Bhagwati and Immiserising Growth

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MERCANTALISM Principal: wealth based on holdings of gold

The Concept: Trade is a zero sum game: one country gains at the expense of others Drove the economic expansion in the 17th /18th

centuries Imperialism was also in line with military power Colonies forced to export commodities and import

manufactured products

The Limitations: De-industrialization, brain drain, adverse movement

of factors of production from colonies Inefficient production Rising inflation

Current usage: neo-mercantilism is politically attractive

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ADAM SMITH AND ABSOLUTE ADVANTAGE Principle: Adam Smith – both nations can gain from

trade

The concept : countries should specialize in producing those commodities in which they have an absolute advantage The UK has an advantage in producing “scotch”, while

France has an advantage in “champagne” Brings specialisation benefits – economies of scale, learning Can derive from natural or acquired advantages

Limitations: some countries have no absolute advantage, natural or acquired

Current usage: applicable to some industries, particularly strategic

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COMPARATIVE ADVANTAGE Principle: Ricardo (1817) – even a country with all

absolute advantages is comparatively better at some things

The concept : two countries specialise in the areas in which they

have a comparative advantage (and possible an absolute disadvantage)

Opens trade to developing entrants

Limitations: Assumes factors of production are only mobile within

countries

Current usage: basic theory of trade

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HECKSCHER-OHLIN APPROACH

Principle: Heckscher & Ohlin – comparative advantage based on factor endowments of capital, land and labour

The concept : a nation will have a comparative advantage in the production of that good that uses its abundant factor intensively Tries to move beyond efficiency to factor

endowment Explains production expansions in low labour cost

developing regions

Limitations: implies trade equilibrium

Current usage: outsourcing benefits

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THE STOLPER SAMEULSON THEOREM Principle: W Stopler & Paul Samuelson (1941) –

derived from OH model but describes the effect of market price changes on returns

The concept : an increase in the price of the traded good will increase the return to the factor that is abundant in its use For a capital intensive industry, rising prices for the

product will lead to an expansion in machinery at the expense of labour

Related to the factor price equalisation theory Free trade is a substitute for factor mobility. Capital Vs

Labour

Limitations: assumes trade equalisation, lack of empirical evidence

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RYBZCYNSKI’S APPROACH Proponent: Tadeusz Rybczynski (1923-1998).

The concept :The Rybczynski theorem proposes that when the endowment of one factor of production is increased there is a relative increase in the production of the good using more of that factor, at the expense of production using another factor. This leads to a corresponding decline in that good's relative price. Shows how the OH model can be affected by changes in the

endowments through investment, immigration etc.

Limitations: what about primitive capitalist accumulation, that prevents factors from receiving their full share?

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BHAGWATI’S IMMESERIZING GROWTH

Principle: Jagdish Bhagwati (1958) – massive export growth leading to a fall in the terms of trade

The concept : increased trade under some circumstances can lead to reduced welfare. If only one country is growing then the TOT can turn adverse The role of FDI Shifting of capacity on account of environment The role of institutions/ are markets really clearing

mechanisms

Limitations: is contrary to push for free-trade

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THE GAINS FROM TRADE Two main gains from trade:

Specialisation – economies of scale, learning Welfare increase – cheaper goods, more to

spend The terms of trade

The import purchasing power of exports: PX/PM

Other reasons for gains from trade decreasing costs increased competition trade as an ‘engine of growth’ non-economic advantages

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THE RESTRICTION OF TRADE

Methods of restricting tradeTariffsNon-tariff barriers (NTBs)

quotasadministrative barriers

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ARGUMENTS FOR RESTRICTING TRADE

infant industry argument changing comparative advantage/technology to prevent dumping to prevent establishment of a foreign-based

monopoly to spread risks To limit externalities (pollution) pursuing national interests (but against world

interests) exploiting monopoly power protecting declining industries

non-economic arguments (politics!)

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CLASS TASK You are an investor looking at the

following four industries Cotton farming Rare earth metal mining (lithium for batteries) Banking

You want to lobby your government to pursue the trade policy that will be most supportive for your investment

Which trade theories fit which industries and provide your investment with the most benefit?

What will be the long-term effects?

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UNDERSTANDING COMPETITIVE ADVANTAGE

What is the competitive advantage of a nation?

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UNDERSTANDING COMPETITIVE ADVANTAGE

What is the competitive advantage of a nation?Some suggestions

Exchange rates, interest rates Natural resources Policy framework Management practices

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UNDERSTANDING COMPETITIVE ADVANTAGE

What is the competitive advantage of a nation?Some suggestions

Exchange rates, interest rates Natural resources Policy framework Management practices

The only meaningful concept: productivity Human resources – wages Capital – roce?

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PORTER 1990: THE COMPETITIVE ADVANTAGE OF NATIONS

A nation’s competitiveness depends on its capacity to innovateMuch of the innovation is mundane and

incremental, but important

Competitiveness must be defined in terms of productivitySustained productivity growth requires

that the economy must continuously re-invent itself

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PORTER 1990, CONTD. Innovation can be anywhere

Lower end : cost leadershipUpper end : product differentiation

Nations are not competitive Industry clusters are sources of

competition

National Diamond : one way of capturing the tightness of the cluster Is there a similarity to web structure ?

Role of the state is defined in terms of creation and assimilation of knowledge

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PORTER’S DIAMOND MODEL

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COMPANY AGENDA : STRATEGIC THRUST AREAS

Create pressures for innovation

Seek out capable competitors and motivators

Establish early warning systems

Improve and tighten the industry diamond

Welcome the domestic rivalry

Globalize to tap the advantages of other nations

Use alliances only selectively

Home base is important to support competitive advantage

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GOVERNMENT AGENDA…. Focus on specialized factor creation

Avoid intervening in factor and currency markets

Enforce strict product safety and environmental standards

sharply limit direct cooperation between industry rivals

Promote goals that lead to sustained investment

De-regulate competition

Enforce strong domestic anti trust policy

Reject managed trade

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SEMINAR QUESTION FOR WEEK 2 Break the tutorial Groups into four. Group A to look at Japan Group B to look at China Group C to look at USA Group D to look at UK

Consider the application of the Porter’s national diamond to the allocated country. Does this model explain competitiveness?