International Business and Trade PDF

INTERNATIONAL BUSINESS AND TRADE Evolution of International Trade What is the Concept of IBT? Revolves around the exchange of Goods, Services, and Capital across International Borders. International Business and Trade Refers to the commercial ACTIVITIES and TRANSACTIONS that occur between...

INTERNATIONAL BUSINESS AND TRADE Evolution of International Trade What is the Concept of IBT? Revolves around the exchange of Goods, Services, and Capital across International Borders. International Business and Trade Refers to the commercial ACTIVITIES and TRANSACTIONS that occur between businesses or entities ACROSS national borders. International Trade Theory The evolution of International Trade Theory is a manifestation on how nations address basic economic problems. ▪ When we say BASIC ECONOMIC PROBLEMS, it is attributed to UNEQUAL distribution of natural resources or DIFFERENCE in geographical locations. Timeline of the Development of International Trade Theory 16th - 18th Century: Mercantilism → It posited that a nation\'s wealth was measured by its stock of precious metals (gold and silver), which could be increased by maintaining a positive balance of trade (exporting more than importing). o This led to protectionist policies, including tariffs and restrictions on imports, as countries aimed to accumulate wealth through trade surpluses. ECONOMIC POLICIES OF GREAT BRITAIN IN THE 17TH AND 18TH ▪ The Navigation Acts were a set of rules enacted by the British government with the intention of controlling colonial trade and advancing British shipping. ▪ According to these laws, cargo coming into England, or its colonies had to be transported on either English or native ships. 1776: Adam Smith's Theory of Absolute Advantage ▪ Adam Smith argued that countries should specialize in producing goods where they have an absolute advantage---where they can produce more efficiently than other countries. Example of Absolute Advantage: Consider two countries, Country A and Country B, both producing Oil and Corn. Country A can produce 1M barrel of oil or 1M sacks of corn with the same amount of resources. Country B can produce 400k barrels of oil or 400k sacks of corn with the same amount of resources. ▪ According to the theory of absolute advantage, Country A should specialize in producing oil, and Country B should focus on producing corn (even though it does not have an absolute advantage in corn, this allows for specialization). Both countries can then trade, allowing each to benefit from the other\'s efficiency. 1817: David Ricardo's Theory of Comparative Advantage ▪ Ricardo expanded on Smith's ideas by introducing the concept of COMPARATIVE ADVANTAGE. He argued that even if a country does not have an absolute advantage in any product, it can still benefit from trade by specializing in the goods where it has the lowest opportunity cost. ▪ OPPORTUNITY COST refers to the cost of forgoing the next best alternative when making a decision. In the context of international trade, it represents the benefits that a country misses out on when it chooses to allocate resources to produce one good over another. ▪ Ricardo argued that even if one country has an absolute advantage in producing all goods compared to another country, both countries can still benefit from trade if they specialize according to their comparative advantage. Comparative advantage is determined by the opportunity cost of producing goods. Example: Imagine two countries, Country X and Country Y, both capable of producing wine and cloth. Country X can produce 10 units of wine or 5 units of cloth with the same resources. Country Y can produce 6 units of wine or 4 units of cloth with the same resources. For Country X, the opportunity cost of producing 1 unit of wine is 0.5 units of cloth (since producing 10 units of wine means giving up 5 units of cloth). For Country Y, the opportunity cost of producing 1 unit of wine is 0.67 units of cloth (since producing 6 units of wine means giving up 4 units of cloth). ▪ Even though Country X is more efficient in producing both goods, it has a lower opportunity cost in producing wine a(0.5 units of cloth compared to 0.67 units in Country Y). Country Y has a lower opportunity cost in producing cloth (1.5 units of wine compared to 2 units in Country X). ▪ According to Ricardo, Country X should specialize in producing wine, where it has a comparative advantage, and Country Y should specialize in producing cloth, where it has a comparative advantage. Both countries can then trade, allowing each to benefit from the other's specialization and resulting in more efficient global production. ▪ This trade leads to an increase in the overall wealth of both countries, as they both end up with more goods than they could have produced on their own without trade. 1930s: Heckscher-Ohlin Theory (Factor Endowment Theory) ▪ Developed by Eli Heckscher and Bertil Ohlin, this theory suggested that countries EXPORT goods that use their ABUNDANT AND CHEAP factors of production (e.g., labor, capital) and import goods that require factors that are scarce. ▪ The Heckscher-Ohlin model explains the patterns of trade based on the differences in countries\' factor endowments and has been used to understand the role of resources in trade. o It explains why countries trade with each other. It focuses on the idea that different countries have different amounts of resources (like land, labor, and capital), and these differences influence what they produce and trade. Country A has a lot of land but not many workers. This means it's easy for Country A to grow crops like wheat or corn because they have plenty of space to do it. Country B has a lot of workers but not much land. This means it's good at making things that need a lot of people to produce, like clothes or electronics. ✓ Country A will specialize in growing crops because it has lots of land. It can produce more crops at a lower cost because land is abundant there. ✓ Country B will specialize in making clothes or electronics because it has a lot of workers. It can produce these goods more efficiently because it has a lot of people to work in factories. ▪ Now, instead of trying to produce both crops and clothes, these countries can trade with each other. ▪ By focusing on what they're best at, both countries can produce more and then trade to get the other goods they need. o The reason this works well is because each country uses its resources (land, labor) most efficiently. ▪ In summary, the Heckscher-Ohlin model shows that countries trade based on what they have a lot of, using their resources to make the things they can produce most efficiently. Then, they trade to get the other things they need. 1950s: Leontief Paradox o Wassily Leontief's → empirical study contradicted the Heckscher-Ohlin theory when he found that the U.S., a capital-abundant country, exported labor-intensive goods and imported capital-intensive goods, which was unexpected according to the theory. o Under the Heckscher-Ohlin model suggests that a country will export goods that use its abundant resources intensively and import goods that use its scarce resources intensively. For example: A country with a lot of capital (like the U.S.) should export capital-intensive goods (like machinery). A country with a lot of labor (like Bangladesh) should export labor-intensive goods (like textiles). ▪ However, when Leontief analyzed the actual trade patterns of the United States, he found something surprising: ▪ The U.S., which was considered to be a capital-abundant country, was exporting labor-intensive goods. ▪ At the same time, it was importing capitalintensive goods. ✓ This result was the opposite of what the Heckscher-Ohlin model would predict, hence the term \"Leontief Paradox.\" ▪ Think of it like this: If you have a friend who is really good at art and has all the best art supplies, you would expect them to sell amazing paintings. But instead, they're selling hand-made bracelets that don't need many supplies, and they're buying expensive sculptures from someone else. That's unexpected, right? ▪ In the same way, the U.S. was expected to sell high-tech, machine-made goods and buy simpler, labor-made products. But the opposite was happening, which was surprising to economists. 1990s: New Economic Geography and Gravity Models These ideas helped to explain patterns of trade, the distribution of economic activity, and the forces shaping where businesses and people are located. ▪ The New Economic Geography is a theory that explains how and why economic activity (like businesses and industries) is distributed in certain locations. ▪ NEG focuses on the idea that businesses and industries tend to cluster together in certain regions, creating economic \"hubs\" or \"centers.\" This clustering happens because companies benefit from being close to each other---they can share resources, access a larger pool of workers, and reduce costs by being near suppliers and customers. ▪ Gravity Models in economics are used to predict and explain trade flows between two countries. The Gravity Model suggests that: Larger economies (those with a higher GDP) will have more trade between them. Countries that are closer together geographically will also trade more with each other. ▪ New Economic Geography helps us understand why cities and regions develop into economic powerhouses and how the location of industries affects the economy. ▪ Gravity Models provide a way to predict and analyze trade patterns between countries, helping economists understand why certain countries trade more with each other than others. BARTER SYSTEM →BARTER/BARTERING is the process of trading GOODS or SERVICES between two parties WITHOUT using money in the transaction. →It involves a direct trade or exchange of goods or services. →This system has been in practice for centuries facilitating the exchange of goods and services before the advent of the monetary system. Key Features of Barter Direct Exchange: Barter involves a direct swap between two parties, such as trading a basket of apples for a handmade shirt. No Money Involved: Unlike modern transactions where money is used as a medium of exchange, barter relies purely on the exchange of goods or services. Double Coincidence of Wants: For a barter transaction to occur, both parties must want what the other has. For instance, if a fisherman wants grain, they need to find a farmer who wants fish. The Development of Barter: From Basic Exchanges to Organized Trade. 1\. Early Beginnings of Barter Survival Needs: In ancient times, people had basic needs---food, shelter, and clothing. Early humans began trading with each other to get the things they couldn\'t produce themselves. For example, a hunter who had extra meat might trade with a farmer who had extra meat might trade with a farmer who had more grain than needed. This was the simplest form of barter Direct Exchange: Barter started as a direct exchange of goods or services between people. It was simple, but it required a \"double coincidence of wants\"---meaning both parties had to have something the other wanted. 2\. Barter in Small Communities Community Barter Systems: As human societies became more settled and started forming small communities, barter became more common. Villages and small towns often relied on bartering because there was no money. Specialization of Skills: People began to specialize in certain skills---some became potters, others became weavers or blacksmiths. This specialization increased the need for barter, as people needed to trade their specific goods or services for other things they couldn\'t produce themselves. 3\. Barter and the Rise of Trade Routes Expansion of Barter Networks: As villages grew into towns and towns into cities, people started trading over longer distances. Barter wasn't just local anymore; it became regional. Traders would carry goods like spices, silk, salt, and precious stones to barter with people in other regions. Trade Routes: Major trade routes like the Silk Road (connecting Asia and Europe) and the Trans-Saharan trade routes (connecting North Africa to Sub-Saharan Africa) emerged. These routes were used by traders who bartered goods across vast distances, leading to cultural exchanges and the spread of ideas, technologies, and religions. 4\. The Limitations of Barter Challenges of Barter: Although barter allowed people to trade goods, it had limitations: Double Coincidence of Wants: Finding someone who wants what you have and has what you want was often difficult. Indivisibility of Goods: Some goods could not be easily divided. For example, how would you barter half a cow for a few apples? Lack of Standard Value: Different people valued goods differently, making it hard to agree on a fair trade. 5\. Development of Money from Barter Need for a Standard Medium: Due to these limitations, people realized the need for a common medium of exchange that everyone could agree upon. This led to the development of early forms of money like shells, beads, and eventually coins made of precious metals like gold and silver. Shift to Money-Based Economies: As the use of money spread, it made trade easier and more efficient. Money allowed people to buy and sell goods without needing a direct exchange, which greatly expanded the possibilities for trade. 6\. Barter in the Modern World Modern Examples of Barter: While money has replaced barter in most situations, barter still exists today in some forms: Local Exchange Trading Systems (LETS): Communities sometimes use systems where people trade services, like babysitting or gardening, without using money. Bartering Online: There are websites and apps where people can exchange goods or services directly, such as trading furniture or skills like web design. Advantages of a Barter System 1\. Simplicity and Direct Exchange ✓ Easy to Understand: A barter system is straightforward---people trade goods or services directly. There's no need to understand complex financial concepts or deal with money. Imagine you want a new skateboard, and your friend wants your extra set of headphones. You simply swap! ✓ No Need for Money: In a barter system, people don't have to worry about having money. They can still get what they need by exchanging something they already have. 2\. Flexibility in Negotiation ✓ Flexible Deals: In a barter system, the value of items can be negotiated. For example, if you think your bike is worth two of your friend's video games, and they agree, the trade happens. This flexibility allows people to strike deals based on their needs and the value they see in the items or services being exchanged. ✓ Personalized Trade: Barter can be more personal and tailored to the situation. People can trade items based on what they genuinely need or want, rather than fixed prices. 3\. Utilizes Surplus Goods and Services ✓ Reduces Waste: Bartering helps people make use of surplus goods they don't need. For example, if a farmer has too many apples, they can trade them for other things like vegetables, eggs, or tools. This ensures nothing goes to waste and everyone benefits. ✓ Maximizes Resources: People can use their skills or extra items effectively. If someone is good at fixing things but needs food, they can barter their repair skills with a neighbor for meals. 4\. Builds Community and Relationships ✓ Encourages Trust and Cooperation: Barter systems often happen in close-knit communities where people know each other. This system promotes trust and cooperation, as people directly interact to exchange goods or services. ✓ Strengthens Social Ties: When people barter, they communicate and build relationships. It brings a sense of community, as everyone works together to meet their needs. 5\. Useful in Situations with No Currency ✓ Works in Emergencies: In situations where money is scarce or unavailable---like in remote areas or during natural disasters--- bartering allows people to still get the essentials they need to survive. ✓ Adapts to Non-Monetary Economies: In some traditional societies or local markets, barter is still common because it's adapted to their way of life, where formal currency is not used or trusted. 6\. Avoids Currency Fluctuations and Inflation ✓ Stable Value: In a barter system, the value of goods or services isn't affected by inflation or currency exchange rates. If your family's chickens lay too many eggs, you can trade them for vegetables from a neighbor without worrying about the changing value of money. ORIGIN OF MONEY Some problems of Barter System. 1\. The Seller must have the specific good the buyer needs and vice versa. 2\. Lack of common value to measure the value of the goods. 3\. Indivisibility of goods. As a result, people started to: Stacking certain valuable things that were acceptable for the majority. \- SALT \- METAL \- FARM ANIMALS This was made possible after they agreed upon specific value/s for these materials. ▪ Traders wanted something that is NOT PERISHABLE and EASY to carry as medium of exchange. This led to the use of METAL pieces as money. ▪ The transition from barter to money can be traced back to the need for a more efficient system of trade. Economic theorists like Adam Smith, William Stanley Jevons, and Carl Menger have posited that money developed to alleviate the inconveniences associated with bartering, such as the lack of divisibility and the difficulty in assessing the value of goods. Money is something we use to exchange goods and services, but it hasn't always existed in the form of coins, bills, or digital currency Barter System (Before Money Existed) What is bartering? Bartering is the direct exchange of goods and services without using money. Challenges of bartering Double coincidence of wants: Both parties had to want what the other person had. Indivisibility: Some items can't be easily divided. For example, how would you trade half a cow? Lack of a standard value: Different people may value items differently, making it hard to determine how much of one good is worth another. The Emergence of Commodity Money What is commodity money? People eventually started using goods that had inherent value (something valuable in themselves) as a medium of exchange. This could be things like cattle, grain, salt, or precious metals like gold and silver. These items became early forms of money because they were widely desired and could be traded for almost anything. ▪ Why did people start using commodities? These items were easier to trade, store, and transport. They also had value recognized by many people, which made exchanges smoother Introduction of Coins and Metal Money ▪ When did coins first appear? Around 600 BCE, the first standardized coins made from precious metals like gold, silver, and bronze appeared in ancient civilizations like Lydia (in modern-Turkey). These coins had a set value based on their metal content, making trade easier and more reliable ▪ Why were coins important? Coins solved many problems of the barter system: Standard value: The value of the coin was universally recognized based on its metal content. Divisibility: Coins could be divided into smaller units for smaller transactions. Durability: Metal coins were durable and could be used multiple times. PAPER MONEY How did paper money start? Over time, carrying heavy metals like gold became inconvenient. In China around the 7th century, people began using paper as a form of money. The government would issue a note that promised the bearer a certain amount of precious metal (like gold or silver) if they brought the note to a bank or government official. Why use paper instead of metal? Paper is easier to carry, and over time, people trusted that the paper represented real value. Eventually, paper money became more common, especially as governments started controlling how much money was printed and used MODERN MONEY Today, money exists in many forms: Coins and banknotes: What we commonly use for everyday purchases. Bank deposits and electronic money: Most money today exists digitally, as numbers in bank accounts. People use credit cards, debit cards, and online transactions to make purchases without physically exchanging cash. Cryptocurrency: Newer digital currencies, like Bitcoin, are examples of money that don't rely on any government or physical currency. These are purely digital and decentralized. Why Was Money Invented? Money was created to make trade easier. It solved the problems of the barter system, creating a reliable, standardized way to exchange goods and services. With money, people could save, invest, and plan for the future, which contributed to the growth of civilizations and economies