Chap003.ppt

Review of Chapter 2
Last week we discussed two primary ways of trading internationally…what are they?
Business can supply foreign markets through both exporting and actually manufacturing in them
Where does trade take place
(developed v.s developing countries)?
What are the seven global dimensions for globalization “standardization”?

Learning Objectives
Understand the theories that explain why certain goods are traded internationally
Mercantilism
Theory of Absolute Advantage (Adam Smith)
Theory of Competitive Advantage (David Ricardo)
Theory of Factor Endowment (Heckscher-Ohlin)
International Product Life Cycle (Ray Vernon)
National Competitiveness (Michael Porter)

Learning Objectives
Understand the various explanations for trade direction shifts……
Economies of scale, learning curve, Imperfect competition, First-mover theory, Linder theory & technological life cycle

Theories of International Trade/Investment
Business managers MUST have a good understanding of “economic theory” to understand a nation’s economic development strategy
- what are the beliefs and education of the government’s economic planners
-Watch/listen to their actions/speeches
- Be Proactive: based on your understanding of the nations leaders

Some Examples
The Japanese Government has traditionally spent trillions of Yen to push the Yen down vis-à-vis the US $ and the Euro. They keep the Yen artificially weak to reduce competitive pressures from Europe and USA..Hence, they can export more and import less
China has resisted all efforts to revalue their currency (Yuan). They simply have not allowed the Yuan to appreciate in value, thus making/helping Chinese companies have strong cost-competitiveness.
-China has strong economic growth
- China has a large trade surplus
Argentina pegged the Peso years ago to the US$. Financial stability ensued but exports were too costly-recession occurred…. In 2002 they stopped the peg and devalued the Peso ( 1 US$ to .27cents) Imports were costly but exports started to grow!

Consider also the Free-Market reforms in Chile………..
Salvador Allende: President 1970-1973 Military coup (September) the economy was in shambles
-Inflation>1000% annually
-High national debt
-Government highly involved in economy
- high duties on imports
- huge subsides to select industries
New Government: Selected Group of New Economist from the University of Chicago “The Chicago Boys” were free market advocates( influenced by Milton Friedman
“ Chicago Boys” proposed programs based on the Theory of Comparative Advantage which immediately reduced import duties to 10% from 1000%. All other import barriers were completely eliminated. Capital equipment could now be imported which encouraged “business investment”

Continued…..
Select companies lost subsidy protection
Bottom line: A “big” correction in the economy and industries followed
-Appliance Industry almost disappeared
-The electronics industry basically vanished
-Automobile Assembly plants closed
Those are products we should import. We have better opportunities for products based on our farm products, our timberlands, our fisheries and other natural resources that we should be making because they give us a “natural advantage” over other countries
It took time but by 2006 Annual growth >6%
Inflation lowered and standard of living increased
Chile has signed free trade arrangements with several nations and the E.U, Mercosur, The USA and Canada
Their Free market is now flourishing!!!!

To sum up…..
In Chile, prudent economic Policy making has secured long term stability in a once very unstable country!
The Keystone of many countries economic policies is “the law of comparative advantage”

International Trade Theory: Mercantilism
A nation’s wealth depends on accumulated treasure, usually gold
A country that has no gold must import it
To increase wealth, government policies should promote exports and discourage imports
Importation of gold depends on exports of goods
Importation of other goods tightly controlled
Economic competition is a “zero sum game”: if country advances economically, another loses
LO1

Theory of Absolute Advantage: Adam Smith (1723-1790)
Market forces, not government controls, determine the direction, volume and composition of international trade
A country will export goods in which it has an absolute advantage over other countries
To have an absolute advantage a country must be able to produce
a larger amount of a good or service for the same amount of inputs as can another country
the same amount of a good or service using fewer inputs than can another country
In classic economics a “unit of input” is measured in: land, labor, capital
LO1

Theory of Comparative Advantage: David Ricardo 1817
A nation may have absolute disadvantages in the production of two goods with respect to another nation
Yet this nation has a comparative advantage or relative advantage in the production of the good in which its absolute disadvantage is lower
By specializing in the production of the good in which the country has lower comparative disadvantage, and importing other goods, the total goods available will increase
LO1

Comparative Advantage and “offshoring” of service jobs
India has a comparative advantage in production of goods & services requiring large amounts of labor and relatively little capital
Good opportunities to reduce cost in specific industries by “offshoring” parts of these service industries
INDIA 1 billion people Citizens who speak English Indian IT industry Is growing rapidly! Tax, Financial services, Insurance, telemarketing

Heckscher-Ohlin Theory of Factor Endowments
Countries export products requiring large amounts of their abundant production factors
Lower cost to produce; more attractive abroad
Imported products have low relative cost as producing locally would require large amounts of the importing country’s scarce production factors
For example….
--India: Has a large labor force (1 billion) so they should concentrate on labor intensive goods.
--Germany: Has more capital than labor so they should concentrate on capital intensive goods.
LO1

Heckscher-Ohlin Theory of Factor Endowments
Leontief Paradox- the US was one of the most capital-intensive countries in the world, was exporting relatively labor-intensive products in exchange for relatively capital-intensive products
Differences in Taste
- A demand- side construct that is always difficult to deal with in economic theory
-Transportation cost can be too high
-Training skilled workers is critical
- Some consumers simply will buy expensive items (cars..perfumes..ect)
LO1

Currency Exchange Rates Influence The Direction of Trade
Goods are valued in the currency of the country in which they are produced
An importer in another country must use the prevailing exchange rates to price the product about to be imported
The relative purchasing power of currencies is not always reflected in official exchange rates
Government policy can give an advantage to one currency over another to induce exports
LO1

Some Newer Explanations For The Direction Of Trade
International Product Life Cycle (IPLC)
Most new products initially conceived and produced in the U.S. in 20th century
U.S. firms kept production close to the market
Aids decisions and minimizes risk of new product introductions
Demand not based on price yet so low production cost not an issue
Limited initial demand in other advanced countries
Initially, exports to these markets more attractive than production
LO1

Some Newer Explanations For The Direction Of Trade
With demand increase in advanced countries
Production follows there from the U.S.
With demand expansion elsewhere
Product becomes standardized
Production moves to low production cost areas
Product now imported to U.S. and to advanced countries
LO1

International Product Life Cycle LO1

Newer Explanations For The Direction Of Trade
Linder Theory of Overlapping Demand
Customers’ tastes are strongly affected by income levels
Income per capita determines the kinds of goods in demand
Technology Life Cycle
Production technology application of the IPLC
Distinguishes between new products and new technologies used in the production of products
Technology follows the IPLC pattern
LO1

Economies of Scale and Learning Curve
Economies of scale : as a plant gets larger, output increases, per unit production cost decreases
Learning curve : as firms produce more products, they learn ways to improve production efficiency further reducing costs
A nation’s industries are now low cost producers and exporters
Imperfect Competition- -Paul Krugman
Economies of scale together with differentiated products induces intraindustry foreign trade
First-Mover Theory
Pattern of trade in goods subject to scale economies is determined by historical factors that induce first movers
LO1

National Competitive Advantage
Porter’s Diamond Model
National Competitiveness: a nation’s relative ability to design, produce, distribute, or service products while earning increasing returns on resources
Four variables: factor endowments, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry

Factor endowments
land, labor, capital, workforce, infrastructure
Demand conditions
large, sophisticated domestic consumer base: offers an innovation friendly environment and a testing ground
Related and supporting industries
local suppliers cluster around producers and add to innovation
Firm strategy, structure, rivalry
competition good
national governments can create conditions which facilitate and nurture such condition

Variables Impacting Competitive Advantage: Porter’s Diamond Source: Reprinted by permission of the Harvard Business Review . “The Competitive Advantage of Nations” by Michael E. Porter, March–April 1990, p. 77. Copyright © 1990 by The President and Fellows of Harvard College; all rights reserved. LO1

Synopsis: Trade Theory
Trade among countries results from relative price differences that stem from different production costs
Different production costs come from differences in
Endowments of factors of production
Levels of technology that determine the factor intensities used
Efficiencies with which factor intensities are used
Foreign exchange rates
Differences in tastes can reverse the direction of trade predicted by theory
Nations attain a higher quality of life by specializing in those products for which they have a comparative advantage and by importing the rest
Trade restrictions harm a nation’s welfare in the LR
LO1

Chap003.ppt

by Shelly38 on May 12, 2010

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Chap003.ppt — Presentation Transcript