Gbm unit-02 (global trade & theory)

07/06/10 1
By :
Prof. Amit Kumar

07/06/10 2
“A student pursuing management education from IILM-
Graduate School of Management, for example may find
himself or herself placed in a firm located in a totally
different country. Knowledge about international
business keeps the youngster mentally prepared to
accept assignment in an alien environment. Forewarning
is definitely forearming, for the fresh management
graduate”.
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Importance of this course
Global Business Management

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Course: Global Business Management
1. Globalization
2. Global Trade & Theory
3. Global Technological Environment
4. Global Economic Environment
5. Global Political-Legal Environment
6. Foreign Direct Investments
7. Regional Economic Integration
8. Strategy and Structure of International Business
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Global Business Management

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Global Business Management Global Trade & Theory
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Contents
• Benefits of Foreign Trade
• Foreign Trade Policies
• Barriers to Trade
• Trade Theories
 Theory of Absolute Advantage
 Theory of Comparative Advantage
 International Product Life Cycle
 National Competitive Advantage
• Usefulness of Trade Theories
• Case Study: What was good for GM is not so for Others
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• Trade is the voluntary exchange of goods, services,
or both. Trade is also called commerce.
• A mechanism that allows trade is called a market.
• The original form of trade was barter, the direct
exchange of goods and services. Later one side of the
barter were the metals, precious metals (poles, coins),
bill, paper money.
Introduction
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• Modern traders instead generally negotiate through a
medium of exchange, such as money.
• Trade between two traders is called bilateral trade,
while trade between more than two traders is called
multilateral trade.
Introduction
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Benefits of Foreign Trade
1. Natural resources of the earth are unevenly distributed.
One country possesses product X in surplus and lacks in
respect of product Y. In other country the reverse may be
true.
2. Countries also differ in their preferences and technologies,
economics and social, and capabilities for growth and
development.
3. Foreign trade is significant for the economic development
of the countries, particularly the developing one.
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Suppose an economy has decided to embark on a
programme of development is required to extend its
productive capacity at a fast rate.
– For this, imports of machinery and equipment, which
cannot be produced in the initial stages at home, are
essential. Such imports which either help create new
capacity in some lines of production or enlarge capacity in
the other lines of production are called developmental
imports. e.g. imports required for the setting up of steel
plant, hydro-electric projects are developmental imports.
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Suppose an economy has decided to embark on a
programme of development is required to extend its
productive capacity at a fast rate.
– A developing country which sets in motion the process of
industrialization at home requires the imports of raw
materials and intermediate goods so as to properly utilize
the capacity created in the country. Imports which are
made in order to make full use of the productive capacity
are called ‘maintenance imports’.
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Trade policies can be free trade, fair trade, inward
trade or outward trade.
Free Trade:
– Free trade implies that the government of the land
exerts minimal influence on decisions relating to
exports or imports made by private individuals and
businesses. Promotion of free trade is the main
plank of the WTO.
Foreign Trade Policies
To connect or combine precisely or harmoniously
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Free Trade:
– According to the law of comparative advantage the
policy permits trading partners mutual gains from trade
of goods and services.
– Under a free trade policy, prices are a reflection of true
supply and demand.
– Free trade agreements are a key element of customs
unions and free trade areas.
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Fair Trade:
– Fair trade, also called managed trade, suggests that
the government of the land should actively intervene
and ensure that exports from the own country receive a
fair share in the global trade and that imports are
controlled so as to minimize losses of domestic jobs
and market share in specific industries. Fair trade
orientation corresponds with the inward trade policy.
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Outward-oriented Policies:
It is supported on the following grounds:
– Free Trade Promotes World Trade
– Uneven Distribution of Resources makes Trade
Inevitable
– World Trade Encourages Efficient use of Global
Resources
– Global Competition Forces Companies to become more
efficient and Innovative
– World trade has Created Awareness
– The Economic Interdependence among Countries
makes Countries Engage Less in Conflicts
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Inward-oriented Policies:
An inward-oriented strategy, usually, means over
protection. What is less obvious is that sheltering
domestic industries puts exports at a great
disadvantage because it raises the cost of the
foreign inputs used in their production. Moreover,
an increase in the relative costs of domestic
inputs may also occur through inflation or
because of appreciation of the exchange rate as
import restrictions are introduced.
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An inward-looking trade policies advocates that a
country should not trade with other nations,
whereas an outward trade policies calls for easy
movement of goods and services among
nations.
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Barriers to Trade
Some countries use several barriers to protect
domestic industries from competition from
foreign firms. These barriers generally include
tariff and non-tariff strategies.
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Barriers to Trade
Barriers
Non-TariffTariff
Transit Tariff
Import TariffExport Tariff
Others
SubsidiesQuotas
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Tariffs
A tariff is a tax imposed on goods involved in
international trade.
– Tariffs are imposed on goods imported, in which
case they are called import duties.
– Taxes are imposed on goods when they leave the
country (export tariff) or
– As they pass through one country bound for
another (transit tariff).
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Barriers to Trade

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Tariffs
– Tariffs may be either ad valorem or specific.
Ad valorem tariffs are imposed as percentages on
values of goods imported. Sometimes these are
problematic, as when the international price of the
good falls.
Specific tariffs relate to some specific attributes of
the goods- weight, quantity, that does not vary with
the price of the goods.
A compound tariff is also calculated partly as a
percentage on value and partly as a rate per unit or
weight.
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Barriers to Trade

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Tariffs
– In the past, tariffs formed a much larger part of
government revenue than they do today.
– When shipments of goods arrive at a border
crossing or port, customs officers inspect the
contents and charge a tax according to the tariff
formula. Since the goods cannot continue on their
way until the duty is paid, it is the easiest duty to
collect, and the cost of collection is small.
– Traders seeking to evade tariffs are known as
smugglers.
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Barriers to Trade

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Non-Tariffs
– Any government regulation, policy, or
procedure other than a tariff that has effect of
restricting international trade, or affecting
overseas investment, becomes a non-tariff
barrier.
– These are Quotas, Subsidies and Others.
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Barriers to Trade

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Barriers
Non-TariffTariff
Others
SubsidiesQuotas
Product & Testing
Standards
Embargoes
Currency
Control
Local Content
Requirements
Administrative
Delay
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Barriers to Trade

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Quotas: (Non-Tariff)
 It refers to numerical limits on the quantity of goods
that may be imported into a country during a specified
period.
 The quantity of goods that may be imported is stated
in a license issued to a group of individuals or firms.
 Most countries use quotas to protect powerful
industries as agriculture, textile or motor vehicles,
from the threat of foreign competition.
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Barriers to Trade

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Quotas: (MFA)
• With regard to textiles, countries placed quotas on
imports under what is called Multi-Fiber Arrangement
which is a part of the GATT agreements.
• Countries affected by this arrangement accounted for
over 80% of the world trade in textiles and clothing
each year.
• It has been continuously revised and extended.
However, all quotas in this industry are expected to
phase out completely by 2014.
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Barriers to Trade

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Quotas: (VER)
• A variant on the import quota is the Voluntary Export
Restraint (VER).
• A VER is a quota on trade imposed by the exporting
country, typically at the request of the importing
country.
A classic example of the use of VER is the
automobile industry in 1980s.
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Barriers to Trade

Quotas: (VER)
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Barriers to Trade
The closing of US auto manufacturing facilities was
creating in the US, a volatile anti-Japan sentiments
among the people and the US Congress.
Fearing punitive legislation in Congress if Japan did not
limit its exports to the US, the Japanese government
and its car makers self-imposed a VER on cars meant
for exports to the US.
Japanese car markets were making
significant inroads into the US car market.

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Subsidies:(Non-Tariffs)
• A subsidy is a government payment to a domestic
producer.
• Subsidies take several forms including cash grants,
low-interest loans, tax breaks and government
equity participation in local firm.
• By lowering costs, subsidies help domestic
producers in two ways:
1. They help them compete against low-cost
foreign imports.
2. Gain excess to export markets.
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Barriers to Trade

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Embargo: (Non-Tariffs)
• An embargo refers to a complete ban on trade
(imports and exports) in one or more products with
a particular country.
For example, import of beef in any form and import of
products containing beef in any form into India is
prohibited because Hindus, who form majority in
the total population, shun beef.
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Barriers to Trade

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Local Content Requirement: (Non-Tariffs)
• These refer to the legal stipulation that a
specified amount of a good or service be
supplied by producers in the domestic market.
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Barriers to Trade

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Administrative Delay: (Non-Tariffs)
• Regulatory controls or bureaucratic rules designed to
impair the flow of imports into a country.
• Includes a wide range of government actions such as
1. requiring international air carriers to land at
inconvenient airports
2. requiring product inspection (health & safety
inspection) that damage the product itself
3. purposely understaffing customs offices to cause
unusual delays and
4. requiring special license that take a long time to
obtain.
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Barriers to Trade

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Currency Control: (Non-Tariffs)
• This refer to restrictions on the convertibility of a
currency into other currencies. Any domestic
company (that wishes to import) must obtain foreign
currency from its nation’s domestic banking system.
• Government can declare that companies desiring
such a currency apply for a license to obtain it.
Thus, a country’s government can discourage
imports by restricting currency.
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Barriers to Trade

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Product & Testing Standards: (Non-Tariffs)
• This non-tariff barrier requires that foreign goods
meet a country’s domestic product or testing
standards before they can be offered for sale in that
country.
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Barriers to Trade
China, for example, requires extensive and
expensive testing of foreign motors vehicles
machinery, electric goods and pesticides
before they enter its market.

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Trade Theories
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Trade Theories
Year
1500 1600 1700 1800 1900 2000
Mercantilism
Absolute Advantage
Comparative Advantage
Factor Proportions Theory
International product Life Cycle
New Trade Theory
National Competitive Advantage (Porter’s Diamond)
TIME LINE OF TRADE
THEORIES
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1. Mercantilism
• First theory, emerged in England in the mid-16th
century.
• The hypothesis is that gold & silver are the mainstays of
national wealth and essentials to vigorous commerce.
• Gold & silver were currency of trade between countries;
a country could earn gold & silver by exporting goods.
• To surplus, govt. is expected to discourage imports by
imposing tariffs & quotas and subsidizing exports.
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Trade Theories

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1. Mercantilism
• Colonizing resource rich, less developed countries was
yet another source of mercantilism.
• Mercantilists Doctrine (policy) is being criticized on the
ground that it believes in a zero-sum game.
However, exporters welcome mercantilism because of
the subsidies and incentives they receive from the
government. Local manufacturer welcome the policy as
it would protect them from competition from imports.
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Trade Theories

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2. Theory of Absolute Advantage
The theory has been propounded by
Adam Smith, generally considered to be
the father of economics. In his book,
Smith argued that countries differ in their
ability to produce goods efficiently.
IILM-GSM
Trade Theories
 In his time, the English (UK), by virtue of their superior
manufacturing processes, were the world’s most
efficient textile manufacturer.
 Due to the combination of favorable climate, good
soils, and accumulated expertise, the French has the
world’s most efficient wine industry.

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ENGLAND
(Absolute Advantage in Textiles)
FRANCE
(Absolute Advantage in Wines)
Export
Wines
Import
Textile
Import
Wines
Export
Textile
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Trade Theories
The English had
an absolute
advantage in
the production
of textiles.
The French has
the absolute
advantage in
the production
of wine.

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2. Theory of Absolute Advantage: Numerical Examples
• The efficiency of each country in the production of the
two products is measured in terms of the labor hours
required to produce one unit of each product.
1. Obviously, Spain has an absolute advantage in
production of olive oil (it takes only 2 hours to produce
one unit),
2. whereas Italy has absolute advantage to produce shoes
(it takes just 2 hours per unit of shoes).
COUNTRY Olive Oil Shoes
Spain 2 4
Italy 4 2
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Trade Theories

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• Tata Steel, Hero Honda & Hero Cycles, each of these
companies has acquired absolute advantage over the
rest of the world.
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Trade Theories
A more complicated picture emerges when one of the
trading partners has an absolute advantage in the
production of both the goods, namely, oil and shoes.

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3.Theory of Comparative Advantage
In his book, Ricardo argued that it makes
sense for a country to specialize in the
production of those goods that it
produces most efficiently and to buy the
goods that it produces less efficiently
from other countries, even if this means
buying goods from other countries that it
could produce itself efficiently.
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Trade Theories
Theory holds that nations should produce those goods
for which they have the greatest relative advantage.

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• Obviously, for every unit of resource used, Spain can
produce more oil and shoes than Italy. Spain has
absolute advantage in the production of both the goods,
but it has comparative advantage in shoes.
• Italy is unable to produce oil/shoes more efficiently than
Spain but able to produce shoes more efficiently than oil.
In Spain, 1 Unit of Resources = 1 Unit of Oil or ½ Unit of Shoes.
In Italy, 1 Unit of Resources = 1/6 Unit of Oil or 1/3 Unit of Shoes.
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Trade Theories
COUNTRY Olive Oil Shoes
Spain 1 2
Italy 6 3

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• The difference between the theory of absolute
advantage and the theory of comparative advantage is
subtle.
• Absolute advantage looks at absolute productivity
differences; comparative advantage looks at relative
productivity differences.
What are the limitation of these two theories ?
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Trade Theories

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Trade Theories
Year
1500 1600 1700 1800 1900 2000
Mercantilism
Absolute Advantage
Comparative Advantage
Factor Proportions Theory
International product Life Cycle
New Trade Theory
National Competitive Advantage (Porter’s Diamond)
TIME LINE OF TRADE
THEORIES
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4. Factor Proportions/Endowments Theory
• Ricardo’s theory stresses that comparative advantage
arises from differences in productivity. He emphasized
that differences in labor productivity between nations
underlie the nature of comparative advantage.
• Swedish economist Eli Heckscher (1919) put forward
a different explanation of comparative advantage. He
argued that comparative advantage arises from
difference in national factor endowments.
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Trade Theories

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4. Factor Proportions/Endowments Theory
• The theory says that a country with capital abundance
will export capital-intensive goods while the labor-
abundant countries will export labor-intensive products.
TISCO in India is now ranked the first among the
top world-class steel makers because of
the factors favorable to it.
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Trade Theories

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5. International Product Life Cycle
• IPLC theory, propounded in 1960s by Raymond Vernon
of Harvard Business School, has two lessons: why
trade takes place and why investment occurs.
• Theory explain how a company will begin by exporting
its products and eventually undertake foreign direct
investment, as the product moves through its life cycle.
• Theory has identified 3 stages in the life of a product:
1. New Product Stage
2. Maturing Product Stage
3. Standardized Product Stage
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Trade Theories

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5. International product Life Cycle
1. New Product Stage
• In this stage a firm introduces an innovative product in
response to felt need in the domestic market.
• As the fortunes of the product are not known, it is
produced in a limited quantity and is sold mainly in the
domestic market.
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Trade Theories
Exports are either non-existent or take place in a
limited way, gradually growing late in the new
product stage.

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2. Maturing Product Stage
• As the product picks up in consumer acceptance and
popularity, demand for it rises both domestic as well as
in foreign markets.
• The innovating firm sets up manufacturing facilities
abroad to expand production capacity, and to meet
growing demand from domestic & foreign consumers.
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Trade Theories
Near the end of maturity stage, attempts are
made to produce the product in the
developing countries.

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• This is the last stage in PLC.
 Here, the market for the product stabilizes. The
product becomes a commodity.
 Market becomes price sensitive and the
manufacturers are motivated to search for low cost
producing countries in order to bring down the cost
of production.
 As a result, the production begins to be imported
into the innovating firm’s home country.
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Trade Theories

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• This is the last stage in PLC.
IPLC approach possesses versatility as it can be
applied to a variety of products, such as
synthetic fibers, electronics goods, radio and
television, computer.
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Trade Theories

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Trade Theories: International PLC
• PLC theory can be illustrated by taking photocopiers.
• The photocopiers was first developed in the early
1960s by Xerox in the US and sold initially to the
users in that country. Originally Xerox exported
photocopiers from the US to Japan and to the
advanced countries of western Europe.
• As demand began to grow in those countries, Xerox
entered into joint ventures to set up production in
Japan (Fuji-Xerox) and Great Britain (Rank Xerox). In
addition, once Xerox’s patents on the photocopier
process expired, other foreign competitors began to
enter the market (Canon in Japan, Olivetti in Italy).

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• As a consequence, exports from the US declined and
users in the US began to buy photocopiers.
• More recently, Japanese companies have found that
manufacturing costs are too high in their own country,
so they have begun to switch production to developing
countries such as Singapore and Thailand.
• As a result, the US and several other advanced
countries (e.g. Japan, Great Britain) have switched
from being exporters to being importers of
photocopiers.
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Trade Theories: International PLC

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6. New Trade Theory
A new trade theory to explain foreign trade emerged during
1970s and 1980s.The new trade theory states that:
1. There are gains to be made from specialization and
economics of scale.
2. The first movers into any market can create entry
barriers to others.
3. Governments may have a role to play in assisting its
home based firms.
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Trade Theories

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7. National Competitive Advantage
• Michael Porter, Professor at Harvard, explained how a
firm can become competitive.
• According to Porter, a firm’s competitive advantage
stems from:
Strategy &
Rivalry
Related & Supporting
Industries
Factor
Conditions
Demand
Conditions
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Trade Theories: Porter’s Diamond

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Factor Conditions:
• It includes land, labor and natural resources. These
factors will give initial competitive advantage to a nation.
• But a sustained competitive advantage comes from
advanced and specialized factors. Such as skilled labor,
capital and infrastructure.
• Specialized factors are difficult to duplicate and a firm
that possesses these enjoys competitive advantage
because others can not easily replicate them.
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Demand Conditions:
• It includes the size and sophistication of its market and
the appropriateness of product standards.
• Sophisticated local customers enhance the country’s
competitiveness by providing firms with insight into
emerging customer needs.
• Example is the French wine industry. The French are
discernible wine consumers. Those consumer force, help
& expect French wineries to produce high quality wines.
• Because of the exacting demands of Italian buyers,
producers are producing high quality leather products.
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Related and Supporting Industries:
• Extant related and supporting industries enhance
competitive advantage of a firm through close working
relationships, joint research and problem-solving, close
proximity and sharing of knowledge and experience.
• While it is possible to outsource some of these facilities
to distant suppliers, using nearby vendors is better.
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Strategy, Structure and Rivalry:
• The ability of a firm to compete successfully in global
markets depends on its strategy, its structure and
domestic rivalry.
• National policies tend to affect the firm’s international
strategies. Policies that encourage investment, protect
IPR, open local market for overseas trade and reduce
corruption make firms strong.
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Usefulness of Trade Theory
Assignments:
Write down a short notes on the
usefulness/practical aspect of Trade theories.
Which theory is having important insights &
practical application in Globalizations.
IILM-GSM

Gbm unit-02 (global trade & theory)

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