International Trade Theories PDF

INTERNATIONAL BUSINESS IMGT 3232 International Trade Theories B. S Habaragoda (PhD, HUST) Department of Industrial M...

INTERNATIONAL BUSINESS IMGT 3232 International Trade Theories B. S Habaragoda (PhD, HUST) Department of Industrial Management Faculty of Applied Sciences Wayamba University of Sri Lanka WUSL Email: [email protected] 29 Phone: 0779902064 Years 3/22/2024 1  Lesson ILOs At the end of this lesson, you should be able to 1. Understand how different approaches to international trade theories help policy makers achieve economic objectives 2. Comprehend the historical and current rationale for interventionist trade theories 3. Explain how free trade improves global efficiency 4. Distinguish factors affecting national trade patterns 5. Recognize why a country’s export capabilities are dynamic 6. Detect why production factors, especially labour and capital, move internationally 7. Describe the relationship between foreign trade and international factor mobility 8. Grasp scenarios of possible changes in trade patterns WUSL 29 Years 3/22/2024 2  Why We Need to Discuss Trade Theories? What products should we import and export? How much should we trade? With whom should we trade? WUSL 29 Years 3/22/2024 3  Why Do Nations Trade? Whenever a buyer and a seller come together, each A nation trades because it expects to gain expects to gain something from something from its trading partner the other. The 1 same expectation applies to nations that trade with It is virtually impossible for a each other country to be completely self- sufficient without incurring 2 undue costs Differences in factor endowments Differences in demand Cost advantage WUSL Patterns of specialization 29 Years Diversification of sources and markets 3/22/2024 4  Why Do Nations Trade? International trade allows a country To specialize in the manufacture and export of products and services that it can produce efficiently Import products and services that can be produced more efficiently in other countries WUSL 29 Years 3/22/2024 5  Laissez-Faire Vs Interventionist Approaches to International Trade Laissez-Faire Interventionist Allows market forces to determine Mercantilism which trading relations. prescribe a great deal Free-trade theories (absolute advantage of government and comparative advantage) take a intervention in trade. complete laissez-faire approach because they prescribe that governments should not intervene directly to affect trade WUSL 29 Years 3/22/2024 6  International Trade Theories Description of Prescription of trade natural trade relationships With whom does trade What products should How much should be How much is traded Should government With whom should What products are trade take place? control trade be traded? take place traded? traded Theory Mercantilism √ Yes √ √ √ Absolute Advantage √ No √ Comparative Advantage √ No √ Factor Proportion √ √ Country Size √ Country Similarity √ √ WUSL Product Life Cycle √ √ 29 Years Diamond of national √ 3/22/2024 7 competitive advantage  Interventionist Theories Mercantilism (mid-16th century in Poland ) suggests that it is in a country’s best interest to maintain a trade surplus -to export more than it imports. Advocates government intervention to achieve a surplus in the balance of trade Mercantilism views trade as a zero-sum game ,one in which a gain by one country results in a loss by another. The primary objective of Mercantilism was to increase the power of the nation state wealth which measured by its holdings of treasure (usually gold) WUSL 29 Years 3/22/2024 8  Mercantilism Do you think mercantilism theory lead to the starting of colonialism? European countries competed for world power and needed colonies to provide necessary raw materials so mother country does not have to import from other nations and markets for exports Mercantilist policies are politically attractive to some firms and their workers, as mercantilism benefits certain members of society. Modern supporters of these policies are known as neo-mercantilists, or protectionists. Protectionism" is often seen as a primary characteristic of Mercantilism Do you think it benefit nation or…………….? WUSL 29 What do you think? Years 3/22/2024 9  Free Trade Theories Why can’t Sri Lanka (or any other country) Why do be content with countries need the goods and to trade at all? services it Nations have been reducing produces? barriers to the movement of trade and production factors because competition spurs efficiency and consumers want a greater variety of goods and services at lower prices. WUSL 29 Years 3/22/2024 10  Theory of Absolute Advantage Holds that different countries produce some goods more efficiently than others Why the citizens of any country should have to buy domestically produced goods when they can buy them more cheaply from abroad? Unrestricted trade would lead a country to specialize in those products that gives it a competitive advantage A country’s resources would shift to the efficient industries because it could not WUSL compete in the inefficient ones 29 Years 3/22/2024 11  Theory of Absolute Advantage A country can increase its efficiency through Labour could become more skilled by repeating the same tasks specialization; Labour would not loose time in switching production from one kind of product to another Long production runs would provide incentives for developing more effective working methods WUSL 29 Years 3/22/2024 12  Natural Advantage A country’s natural advantage in creating a product or service comes from climatic conditions, access to certain natural resources, or availability of certain labour forces. Costa Rica’s climate Variations among and soil support the The more the two countries in natural production of countries natural advantages also help bananas, pineapples advantages differ, the explain where certain and coffee, while its more likely they will manufactured or biodiversity supports a favour trade with one processed might best thriving ecotourism another be produced industry WUSL 29 Years 3/22/2024 13  Acquired Advantage Countries that are competitive in manufactured goods have an acquired advantage, usually in either product or process technology. Process technology is Product technology Acquired advantage enables a country to enables a country to through technology efficiently produce a produce a unique has created new homogeneous product or one that is products, displaced product (one not easily distinguished old ones, and altered easily distinguished from those of trading-partner from that of competitors relationships competitors). WUSL 29 Years 3/22/2024 14  Absolute Advantage Specialization Greater efficiency Higher global output WUSL 29 Years 3/22/2024 15  How Does Specialization Increase Output? Say that Taiwan and the United States are the only two countries and each has the same amount of resources (land, labor, and capital) to produce either tea or wheat (refer the figure in next slide). Let us assume that 100 units of resources are available in each country. In Taiwan, assume that it takes four units to produce a ton of tea and 10 units per ton of wheat. The purple Taiwan production possibility line shows that Taiwan can produce 25 tons of tea and no wheat, 10 tons of wheat and no tea, or some combination of the two. In the United States, it takes 20 units per ton of tea and five units per ton of wheat. The green U.S. production possibility line indicates that the country can produce five tons of tea and no wheat, 20 tons of wheat and no tea, or some combination of the two. Taiwan is more efficient (that is, takes fewer resources to produce tea), while the United States is more efficient in wheat production. WUSL 29 Years 3/22/2024 16 WUSL 29 Years 3/22/2024 17 How can Production be Increased through Specialization and Trade? Resources required to produce one ton of coffee and wheat Tea Wheat Taiwan 4 10 United States 20 5 Production and consumption without trade Taiwan 12.5 5 United States 2.5 10 Total Production 15 15 Production with specialization Taiwan 25 - United States WUSL - 20 29Total Production 25 20 Years 3/22/2024 18  Theory of Comparative Advantage What happens when one country can produce all products at an absolute advantage?? Theory of comparative advantage holds that global efficiency gains may still result from trade if a country specializes in what it can produce most effectively – regardless of other countries’ absolute advantage Imagine that the best physician in a town also happens to be the best medical administrator. It would not make economic sense for the physician to handle all the administrative duties of the office, because of earning more money by concentrating on medical duties, even though that means having to employ a less-skilled WUSL office administrator. 29 Years 3/22/2024 19  Comparative Advantage It takes Taiwan 10 units of resources to produce either a ton of tea or a ton of wheat, whereas it takes the United States only five units to produce a ton of tea and four for a ton of wheat. Taiwan can produce five tons of tea and five tons of wheat (point A on the purple line), and the United States can produce 10 tons of tea and 12.5 tons of wheat (point B on the green line). Without trade, neither country can increase its tea production without sacrificing some wheat production, or vice versa. WUSL Production Possibilities under Conditions of 29 Comparative Advantage Years 3/22/2024 20  Comparative Advantage WUSL 29 Years 3/22/2024 21  Resources required to produce one ton of coffee and wheat Tea Wheat Taiwan 10 10 United States 5 4 Production and consumption without trade Taiwan 5 5 United States 10 12.5 Total Production 15 17.5 With trade (increasing tea production) Taiwan 10 - United States 6 17.5 Total Production 16 17.5 With trade (increasing wheat production) Taiwan 10 - WUSL 29 United States 5 18.75 Years Total Production 3/22/2024 15 18.75 22  Some Assumptions and Limitations Both theories assume that resources are fully employed Full Employment Countries with many unemployed or unused resources may seek to restrict imports to employ or use idle resources Countries purse objectives other than output efficiency They may avoid overspecialization because of the Economic Efficiency vulnerability created by changes in technology and by price fluctuations or not trusting foreign countries to always supply them with essential goods If countries perceive that a trading partner is gaining too large share of benefits, they may prefer to forgo Division of Gain absolute gains for themselves so as to prevent others from a relative advantage WUSL 29 Years 3/22/2024 23  Some Assumptions and Limitations Both theories assume no transportation cost between countries Transport Costs If it costs more to transport the goods than the savings from specialization, no advantage of trading Both theories address countries statically – by looking at them at one point of time Statics and Relative conditions that give countries production Dynamics advantages and disadvantages change we should not assume that future absolute or comparative advantages will remain as they are today. Both theories deal with products rather than services Today, a growing portion of world trade made up of Services services and resources must also go into service production WUSL 29 Years 3/22/2024 24  Some Assumptions and Limitations Both theories deal with trading one Production product for another Networks Today, a product may be made in different countries Both theories assume that resources can move easily from the production of one good to another and at no cost which is completely invalid. Mobility Also both theories assume that resources cannot move internationally, however they do and such movements affect countries’ production capabilities WUSL 29 Years 3/22/2024 25  Theories Explaining Patterns of Trade Theory of Country Size How much a country trade Factor Who will be its trading partners? Proportions Country Similarity WUSL 29 Years 3/22/2024 26  How Much Does a Country Trade? Theory of Country Size: Countries with larger land masses usually depend less on trade than smaller ones Tend to export a smaller portion of output and import a smaller part of consumption Have higher average transport costs for foreign trade WUSL 29 Years 3/22/2024 27  What Types of Products Does a Country Trade? Capital intensive goods Factor Proportions Theory (Eli Heckscher and Bertil Ohlin) Patterns of trade are determined Capital Labour by differences in factor abundant abundant endowments - not productivity country country Factors in relative abundance are cheaper than factors in relative scarcity Labour intensive goods These relative factor costs would lead countries to excel in the production and export of products that used their abundant (therefore WUSL 29cheaper) production factors. Years 3/22/2024 28  Factor Proportions Theory Land and People Countries with many people relative to the amount of land, land price is very high such as Hong Kong and Netherlands Countries with abundance of land relative to people produce products that require large amount of land such as Australia and Canada Neither of these countries excels in the production of goods that intensively use lands such as wool or WUSL wheat 29 Years 3/22/2024 29  Factor Proportions Theory Capital, Labour Rates and Specialization Labour skills, in fact, vary within and among Production factors, especially labour, are not countries because homogeneous of training and education differences Factor endowment theory accounting for differences in labour groups and the capital invested to train them, helps explaining many trade patterns Developed countries depend on their abundant resources (higher proportion of professionals) in the production that they export, while low income countries depend on less-skilled labours in their exports A MNC may locate R&D and management functions in countries with a highly educated WUSLpopulation, while locating labour-intensive production work in countries where it can employ 29 less educated and less expensive workers Years 3/22/2024 30  Factor Proportions Theory Process Technology Companies may substitute capital for labour, depending on the cost of each. Some products require huge amounts of fixed capital and long production runs to spread the fixed capital costs over more output units, usually resulting in development in large countries with large markets If long production runs are important locate production in WUSL only a few countries, otherwise locate production units 29 around the world to minimize transportation costs Years 3/22/2024 31  Rice harvesting is capital intensive in Italy, such that labour rates are high. They tend to use mechanized methods require few workers Rice harvesting in Indonesia, where many manual labourers are employed since it is labour intensive in Indonesia such that labour rates are low WUSL 29 Years 32  Factor Proportions Theory Product Technology As a percentage of total world trade, manufactured products are more important than products in any other category. Services, however, constitute the fastest-growing category Worldwide Trade by Major Sectors WUSL Source: Based on World Trade Organization, Annual Report 29 (Geneva, various years). Years 3/22/2024 33  With Whom Do Countries Trade? Country-Similarity Theory Produce and consume Companies create products in response Developed more to home country market conditions. countries trade Emphasize technical Then they turn to similar foreign primarily with innovations in markets each other different industrial sectors. Political relationships and Cultural Similarity May encourage or discourage economic trade between countries agreements Perceptions of greater ease is in doing business Historic colonial relationships WUSL 29 Years 3/22/2024 34  With Whom Do Countries Trade? Companies in a given country spend Germany -machinery and Specialization more on R&D in some sectors than equipment Switzerland – and acquired in others, thus leading to countries’ pharmaceutical products advantage specialization and acquired Denmark – Food products advantage Bangladesh- garments Product Causes countries to conduct two-way trade Air bus vs. Boeing Differentiation in seemingly similar products Greater distance means higher transportation cost Distance Distance is more important for homogenous products than for differentiated products WUSL 29 Years 3/22/2024 35  The Dynamics of Export Capabilities Product Life Cycle Theory (PLC) Explain how countries develop, maintain, and lose their competitive Diamond of advantages. National Advantage WUSL 29 Years 3/22/2024 36  Product Life Cycle Theory The production location for many products moves from one country to another depending on the stage in the product’s life cycle A US company Companies develop new products develops a new primarily because they observe product for the US nearby needs for them market New technology that results in new products and production methods originates in developed countries, which have most of the resources to develop new products and most of the income to buy them WUSL 29 Years 3/22/2024 37  PLC Theory Introduction Growth Innovation in response to observed need Increases in exports by the Exporting by the innovative innovating country country More competition Evolving product Increased capital intensity characteristics. Some foreign production. Maturity A decline in exports from the Decline innovating country More product Production in developing standardization countries More capital intensity Increased competitiveness of An innovating country price becoming a net importer WUSL Production start-ups in 29 emerging economies. Years 3/22/2024 38  Variations and Limitations of PLC Theory Products with high transport costs that may have to be produced close to the market, thus never becoming significant exports Products with extremely short life cycles (due to very rapid innovation), making it impossible to reduce costs by moving production from one country to another. Luxury products for which cost is of little concern to the consumer. Production in a developing country may cause consumers to perceive the product as less luxurious Products that require specialized technical personnel to be located near production so as to move the production into their next generation models. Ex: U.S. dominance in medical equipment production and German dominance in rotary printing presses WUSL 29 Years 3/22/2024 39  Diamond of National Competitive Advantage Companies’ development and maintenance of internationally competitive products depends on favourable; Demand conditions Factor conditions Related and supporting industries Firm strategy, structure and rivalry WUSL 29 Years 3/22/2024 40  Diamond of National Competitive Advantage Basic factors Advanced factors WUSL 29 Years 3/22/2024 41  Diamond of National Competitive Advantage Are sufficient quantities and combinations of the quality of labour, capital, and raw materials Factor Conditions available at acceptable prices? Development Are consumers likely to buy what we can produce with the factor conditions above and at the price Demand Conditions we can deliver to them? Can we outsource production of sufficient Related and components and services to allow us to Supported concentrate our efforts on what we can do best? Industries Sustainability Will competitive conditions and our reactions to Firm Strategy, them enable us to evolve our operations to Structure and sustain and improve our market position? Rivalry WUSL 29 Years 3/22/2024 42  Diamond of National Competitive Advantage Italian Ceramic Tile Industry: The availability of most New products arise from production factors (skilled companies’ observation of labour, capital, technology and need/demand which has equipment) within the country traditionally been in their on favourable terms home country, where they influenced the choice of Italy start up production – recall as the production location – PLC and country similarity recall absolute advantage and theories. factor endowment theories WUSL 29 Years 3/22/2024 43  Diamond of National Competitive Advantage The existence of nearby Intensified rivalry forced related breakthroughs in both and supporting industries product and process (enamels and glazes)—was technologies, which gave the also favourable Italian producers advantages over foreign firms and enables them to gain the largest global share of tile exports WUSL 29 Years 3/22/2024 44  Factor Mobility Theory Why production factors move? The effects of those movements on transforming factor endowments The impact of international factor mobility (Especially people) on world trade WUSL 29 Years 3/22/2024 45  Why Production Factors Move? Capital: Especially short-term capital, is the most internationally mobile production factor. Companies and private individuals primarily transfer capital because of differences in expected return (accounting for risk). Political and economic conditions affect investors’ perceptions of risk and where they prefer to put their capital. Companies invest abroad for the long term to tap markets, improve quality, and lower operating costs. Besides businesses, governments, not-for-profit organizations and individuals make international capital movements. WUSL 29 Years 3/22/2024 46  Why Production Factors Move? People: Less mobile than capital High transportation costs, immigration issues, difficulties in adjusting to different cultures People do endure hardships and risk of entering to other countries to gain more income and to flee adverse political situations in their home countries Major engine of globalization. Nearly 3% of the of the world’s population (over 200 million people) has migrated to another country (Hong Kong, Singapore) Permeant migrations – allow people to become citizens of a country and reside there for the rest of their lives Temporary migrations - allow workers to enter into a country on temporary work WUSL permits, usually for short periods. Ex: most workers in the United Arab Emirates 29 are there on temporary work permits Years 3/22/2024 47  Effects of Factor Endowments Factor Factor movements endowments alter Immigrants bring human capital with them, adding to the base of skills that enabled countries to be newly competitive in an array of products they might otherwise have imported WUSL 29 Years 3/22/2024 48  Major Net Migrations (2005-2010) WUSL 29 Years 3/22/2024 49  Effects of People Move The United States, an example of a country whose recent immigration is largely concentrated at the high and low ends of human skills. Over a third of all people with doctoral degrees in the United States are foreign-born. At the other extreme, much recent U.S. immigration has been made up of low- skilled workers. At both extremes, the United States has had shortages of native-born workers, which has been partially alleviated through immigration. Effect of outward migration – brain drain Loosing people with substantial work skills (especially for developing countries) WUSL 29 Remittance flow Years 3/22/2024 50  The Relationship between Trade and Factor Mobility Factor movement may substitute or stimulate trade Pressures exist for the most abundant factors to move to countries with greater scarcity If no restrictions for moving finished goods and Substitution production factors internationally, the comparative costs of transferring goods and factors would determine production location Lowest cost occur when trade and production factors are both mobile Companies’ investments abroad often stimulate exports from their home countries. Complementarity Many of the exports would not occur without foreign investments, partly because a company may export equipment as part of its foreign investment WUSL 29 Years 3/22/2024 51  Review Question 1. How can a country with high labor costs improve its national competitiveness? WUSL 29 Years 3/22/2024 52  References https://www.youtube.com/watch?v=gMYo07DESRs https://www.youtube.com/watch?v=T9ALTVXawNk WUSL 29 Years 3/22/2024 53