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  • Country Focus: Is China a Neo-Mercantilist Nation? This feature analyzes claims that China is a neo-mercantilist nation. Exports are largely responsible for China’s recent rapid economic growth. The country, capitalizing on its cheap labor force, has been focused on converting raw materials into products that are exported to developing countries like the United States. In 2005, China’s trade surplus was a record $121 billion, and its holdings of foreign exchange reserves were over $800 billion. Another Perspective : Students may also want to read the following article { } for more information on this issue. The article specifically addresses the role of China’s President, Hu Jintao in the country’s trade policy.
  • Mercantilism suggests that countries should design policies that lead to an increase in their holdings of gold and silver. This was usually done by increasing exports and limiting imports. This economic philosophy was used by Europeans from about the 1500s to the late 1700s. It fueled colonialism in Britain, France, the Netherlands and Spain. Nations increase their wealth by maintaining trade surpluses. The key problem with the mercantilist view is that it views trade as a zero sum game, where if one country benefits the other must lose. As an economic philosophy, mercantilism is flawed. Yet many political views today have the goal of boosting exports while limiting imports by seeking only selective liberalization of trade.
  • In 1776, Adam Smith attacked the mercantilist assumption that trade is a zero-sum game and argued that countries differ in their ability to produce goods efficiently, and that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods produced by other countries.
  • Country Focus: Moving U.S. White Collar Jobs Offshore This feature goes to the heart of a debate that has been played out many times over the past half century—the transference of jobs from the United States to lower-wage countries. The difference now however, is that rather than blue-collar jobs being transferred, the new trend is for white-collar jobs to move, jobs associated with the knowledge-based economy. Another Perspective : Oracle, the software maker, recently made a move to shift more of its jobs offshore to India. To learn more about why this company chose this strategy visit { }. Another Perspective : The outsourcing of health care is becoming more and more common. Ask students to discuss this trend, and consider what it means to consumers and to workers in the healthcare industry. Duke University recently conducted a study on the outsourcing of jobs, the results of the study can be found at { }
  • Basic factors: Natural resources Climate Geographic location Demographics While basic factors can provide an initial advantage they must be supported by advanced factors to maintain success. Advanced factors: The result of investment by people, companies, and government are more likely to lead to competitive advantage. If a country has no basic factors, it must invest in advanced factors.
  • Management Focus: The Rise of Finland’s Nokia This feature is about the growth of the cellular telephone equipment industry, and more specifically, about the rise in competitiveness of Nokia, a Finnish cellular telephone company. The feature explains the reasons that Nokia was particularly well positioned to take advantage of the growth of the global cellular telephone industry. Teaching Tip : For more information on the company, go to Nokia’s homepage at { /}
  • Porter’s theory should predict the pattern of international trade that we observe in the real world. Countries should be exporting products from those industries where all four components of the diamond are favorable, while importing in those areas where the components are not favorable.


  • 1. InternationalBusiness 7e by Charles W.L. HillMcGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2. Chapter 5 International Trade Theory
  • 3. An Overview Of Trade TheoryFree trade refers to a situation where a government doesnot attempt to influence through quotas or duties what itscitizens can buy from another country or what they canproduce and sell to another country 5-3
  • 4. The Benefits Of TradeSmith, Ricardo and Heckscher-Ohlin show why it isbeneficial for a country to engage in international tradeeven for products it is able to produce for itselfInternational trade allows a country:to specialize in the manufacture and export of productsthat it can produce efficientlyimport products that can be produced more efficiently inother countries 5-4
  • 5. The Patterns Of International TradeSome patterns of trade are fairly easy to explain - it isobvious why Saudi Arabia exports oil, Ghana exportscocoa, and Brazil exports coffeeBut, why does Switzerland export chemicals,pharmaceuticals, watches, and jewelry? Why does Japanexport automobiles, consumer electronics, and machinetools? 5-5
  • 6. Trade Theory And Government PolicyMercantilism makes a crude case for governmentinvolvement in promoting exports and limiting importsSmith, Ricardo, and Heckscher-Ohlin promoteunrestricted free tradeNew trade theory and Porter’s theory of nationalcompetitive advantage justify limited and selectivegovernment intervention to support the development ofcertain export-oriented industries 5-6
  • 7. MercantilismMercantilism suggests that it is in a country’s bestinterest to maintain a trade surplus -- to export more than itimportsMercantilism advocates government intervention toachieve a surplus in the balance of tradeIt views trade as a zero-sum game - one in which a gainby one country results in a loss by another 5-7
  • 8. Absolute AdvantageAdam Smith argued that a country has an absoluteadvantage in the production of a product when it is moreefficient than any other country in producing itAccording to Smith, countries should specialize in theproduction of goods for which they have an absoluteadvantage and then trade these goods for the goodsproduced by other countries 5-8
  • 9. Absolute AdvantageAssume that two countries, Ghana and South Korea,both have 200 units of resources that could either be usedto produce rice or cocoaIn Ghana, it takes 10 units of resources to produce oneton of cocoa and 20 units of resources to produce one tonof riceSo, Ghana could produce 20 tons of cocoa and no rice,10 tons of rice and no cocoa, or some combination of riceand cocoa between the two extremes 5-9
  • 10. Absolute AdvantageIn South Korea it takes 40 units of resources to produceone ton of cocoa and 10 resources to produce one ton ofriceSo, South Korea could produce 5 tons of cocoa and norice, 20 tons of rice and no cocoa, or some combination inbetweenGhana has an absolute advantage in the production ofcocoaSouth Korea has an absolute advantage in theproduction of rice 5-10
  • 11. Absolute AdvantageWithout trade:Ghana would produce 10 tons of cocoa and 5 tons of rice South Korea would produce 10 tons of rice and 2.5 tonsof cocoaIf each country specializes in the product in which it has anabsolute advantage and trades for the other product:Ghana would produce 20 tons of cocoaSouth Korea would produce 20 tons of riceGhana could trade 6 tons of cocoa to South Korea for 6tons of rice 5-11
  • 12. Absolute AdvantageAfter trade:Ghana would have 14 tons of cocoa left, and 6 tons ofriceSouth Korea would have 14 tons of rice left and 6 tons ofcocoaBoth countries gained from trade 5-12
  • 13. Absolute AdvantageTable 5.1 Absolute Advantage and the Gains from Trade 5-13
  • 14. Comparative AdvantageDavid Ricardo asked what might happen when onecountry has an absolute advantage in the production of allgoodsRicardo’s theory of comparative advantage suggests thatcountries should specialize in the production of thosegoods they produce most efficiently and buy goods thatthey produce less efficiently from other countries, even ifthis means buying goods from other countries that theycould produce more efficiently at home 5-14
  • 15. Comparative AdvantageAssume:Ghana is more efficient in the production of both cocoa and riceIn Ghana, it takes 10 resources to produce one tone of cocoa, and13 1/3 resources to produce one ton of riceSo, Ghana could produce 20 tons of cocoa and no rice, 15 tons ofrice and no cocoa, or some combination of the twoIn South Korea, it takes 40 resources to produce one ton of cocoaand 20 resources to produce one ton of riceSo, South Korea could produce 5 tons of cocoa and no rice, 10 tonsof rice and no cocoa, or some combination of the two 5-15
  • 16. Comparative AdvantageWith trade:Ghana could export 4 tons of cocoa to South Korea inexchange for 4 tons of riceGhana will still have 11 tons of cocoa, and 4 additionaltons of riceSouth Korea still has 6 tons of rice and 4 tons of cocoaIf each country specializes in the production of the goodin which it has a comparative advantage and trades for theother, both countries gainComparative advantage theory provides a strongrationale for encouraging free trade 5-16
  • 17. Comparative AdvantageTable 5.2: Comparative Advantage and the Gains from Trade 5-17
  • 18. Qualifications And AssumptionsThe simple example of comparative advantage assumes:only two countries and two goodszero transportation costssimilar prices and valuesresources are mobile between goods within countries,but not across countriesconstant returns to scalefixed stocks of resourcesno effects on income distribution within countries 5-18
  • 19. Extensions Of The Ricardian ModelResources do not always move freely from one economicactivity to another, and job losses may occurUnrestricted free trade is beneficial, but because ofdiminishing returns, the gains may not be as great as thesimple model would suggestOpening a country to trade:might increase a countrys stock of resources asincreased supplies become available from abroadmight increase the efficiency of resource utilization, andfree up resources for other usesmight increase economic growth 5-19
  • 20. The Samuelson CritiquePaul Samuelson argues that dynamic gains from trademay not always be beneficialThe ability to offshore services jobs that were traditionallynot internationally mobile may have the effect of a massinward migration into the United States, where wageswould then fall 5-20
  • 21. Heckscher-Ohlin TheoryRicardo’s theory suggests that comparative advantagearises from differences in productivityEli Heckscher and Bertil Ohlin argued that comparativeadvantage arises from differences in national factorendowments – the extent to which a country is endowedwith resources like land, labor, and capitalThe Heckscher-Ohlin theory predicts that countries willexport goods that make intensive use of those factors thatare locally abundant, while importing goods that makeintensive use of factors that are locally scarce 5-21
  • 22. Classroom Performance SystemAll of the following theories advocated free trade excepta) Mercantilismb) Comparative Advantagec) Absolute Advantaged) Hecksher-Ohlin 5-22
  • 23. The Leontief ParadoxWassily Leontief theorized that since the U.S. wasrelatively abundant in capital compared to other nations,the U.S. would be an exporter of capital intensive goodsand an importer of labor-intensive goods.However, he found that U.S. exports were less capitalintensive than U.S. importsSince this result was at variance with the predictions ofthe theory, it became known as the Leontief Paradox 5-23
  • 24. Classroom Performance SystemWhich theory suggested that comparative advantage arisesfrom differences in national factor endowments?a) mercantilismb) absolute advantagec) Heckscher-ohlind) comparative advantage 5-24
  • 25. The Product Life Cycle TheoryThe product life-cycle theory, proposed by Raymond Vernon,suggested that as products mature both the location of sales and theoptimal production location will change affecting the flow and directionof tradeVernon argued that the size and wealth of the U.S. market gave U.S.firms a strong incentive to develop new productsVernon argued that initially, the product would be produced and soldin the U.S., later, as demand grew in other developed countries, U.S.firms would begin to exportOver time, demand for the new product would grow in otheradvanced countries making it worthwhile for foreign producers to beginproducing for their home markets 5-25
  • 26. The Product Life Cycle TheoryU.S. firms might also set up production facilities in those advancedcountries where demand was growing limiting the exports from the U.S. As the market in the U.S. and other advanced nations matured, theproduct would become more standardized, and price the maincompetitive weaponProducers based in advanced countries where labor costs werelower than the United States might now be able to export to the U.S.If cost pressures became intense, developing countries would beginto acquire a production advantage over advanced countriesThe United States switched from being an exporter of the product toan importer of the product as production becomes more concentratedin lower-cost foreign locations 5-26
  • 27. The Product Life Cycle Theory Figure 5.5: The Product Life Cycle Theory 5-27
  • 28. The Product Life Cycle TheoryThe product life cycle theory accurately explains whathas happened for products like photocopiers and a numberof other high technology products developed in the US inthe 1960s and 1970sBut, the increasing globalization and integration of theworld economy has made this theory less valid in todaysworld 5-28
  • 29. Classroom Performance SystemWhich theory suggests that as products mature the optimalproduction location will change?a) Mercantilismb) Comparative Advantagec) Absolute Advantaged) Product life-cycle 5-29
  • 30. New Trade TheoryNew trade theory suggests that the ability of firms to gaineconomies of scale (unit cost reductions associated with alarge scale of output) can have important implications forinternational tradeNew trade theory suggests that:through its impact on economies of scale, trade canincrease the variety of goods available to consumers anddecrease the average cost of those goodsin those industries when output required to attaineconomies of scale represents a significant proportion oftotal world demand, the global market may only be able tosupport a small number of enterprises 5-30
  • 31. Variety And Reducing CostsWithout trade, nations might not be able to produce thoseproducts where economies of scale are importantWith trade, markets are large enough to support theproduction necessary to achieve economies of scaleSo, trade is mutually beneficial because it allows for thespecialization of production, the realization of scaleeconomies, and the production of a greater variety ofproducts at lower prices 5-31
  • 32. Economies Of Scale, First Mover Advantages, And The Pattern Of TradeThe pattern of trade we observe in the world economymay be the result of first mover advantages (the economican strategic advantages that accrue to early entrants intoan industry) and economies of scaleNew trade theory suggests that for those products whereeconomies of scale are significant and represent asubstantial proportion of world demand, first movers cangain a scale based cost advantage that later entrants finddifficult to match 5-32
  • 33. Implications Of New Trade TheoryNations may benefit from trade even when they do notdiffer in resource endowments or technologyA country may dominate in the export of a good simplybecause it was lucky enough to have one or more firmsamong the first to produce that goodWhile this is at variance with the Heckscher-Ohlin theory,it does not contradict comparative advantage theory, butinstead identifies a source of comparative advantage An extension of the theory is the implication thatgovernments should consider strategic trade policies thatnurture and protect firms and industries where first moveradvantages and economies of scale are important 5-33
  • 34. Classroom Performance SystemEconomies of scale and first mover advantages areimportant to which trade theory?a) Mercantilismb) Product life cyclec) New trade theoryd) Comparative advantage 5-34
  • 35. National Competitive Advantage: Porter’s DiamondMichael Porter tried to explain why a nation achievesinternational success in a particular industry and identifiedfour attributes that promote or impede the creation ofcompetitive advantage:Factor endowmentsDemand conditionsRelating and supporting industriesFirm strategy, structure, and rivalry 5-35
  • 36. National Competitive Advantage: Porter’s DiamondFigure 5.6: Determinants of National Competitive Advantage: Porter’s Diamond 5-36
  • 37. Factor EndowmentsFactor endowments refer to a nation’s position in factorsof production necessary to compete in a given industryA nations position in factors of production can lead tocompetitive advantageThese factors can be either basic (natural resources,climate, location) or advanced (skilled labor, infrastructure,technological know-how) 5-37
  • 38. Demand ConditionsDemand conditions refer to the nature of home demandfor the industry’s product or serviceThe nature of home demand for the industry’s product orservice influences the development of capabilitiesSophisticated and demanding customers pressure firmsto be competitive 5-38
  • 39. Relating And Supporting IndustriesRelating and supporting industries refer to the presenceor absence of supplier industries and related industries thatare internationally competitiveThe presence supplier industries and related industriesthat are internationally competitive can spill over andcontribute to other industriesSuccessful industries tend to be grouped in clusters incountries - having world class manufacturers of semi-conductor processing equipment can lead to (and be aresult of having) a competitive semi-conductor industry 5-39
  • 40. Firm Strategy, Structure, And RivalryFirm strategy, structure, and rivalry refers to theconditions governing how companies are created,organized, and managed, and the nature of domesticrivalryThe conditions in the nation governing how companiesare created, organized, and managed, and the nature ofdomestic rivalry impacts firm competitivenessDifferent management ideologies affect the developmentof national competitive advantageVigorous domestic rivalry creates pressures to innovate,to improve quality, to reduce costs, and to invest inupgrading advanced features 5-40
  • 41. Evaluating Porter’s TheoryGovernment policy can:affect demand through product standardsinfluence rivalry through regulation and antitrust lawsimpact the availability of highly educated workers andadvanced transportation infrastructure.The four attributes, government policy, and chance workas a reinforcing system, complementing each other and incombination creating the conditions appropriate forcompetitive advantage 5-41
  • 42. Classroom Performance SystemPorter’s diamond of competitive advantage includes all ofthe following excepta) Factor endowmentsb) Demand conditionsc) First-mover advantagesd) Firm strategy, structure, and rivalry 5-42
  • 43. Implications For ManagersThere are three main implications for internationalbusinesses:location implicationsfirst-mover implicationspolicy implications 5-43
  • 44. LocationDifferent countries have advantages in differentproductive activitiesIt makes sense for a firm to disperse its variousproductive activities to those countries where they can beperformed most efficientlyInternational trade theory suggests that firm sthat fail todo this, may be at a competitive disadvantage 5-44
  • 45. First-Mover AdvantagesBeing a first mover can have important competitiveimplications, especially if there are economies of scale andthe global industry will only support a few competitorsFirms that establish a first-mover advantage maydominate global trade in that product 5-45
  • 46. Government PolicyGovernment policies with respect to free trade orprotecting domestic industries can significantly impactglobal competitivenessBusinesses should work to encourage governmentalpolicies that support free tradeFirms should also lobby the government to adopt policiesthat have a favorable impact on each component of thediamond 5-46
  • 47. Classroom Performance System_________ refer to the nature of home demand for theindustry’s product or service.a) Demand conditionsb) Factor endowmentsc) Firm strategy, structure, and rivalryd) Related and supporting industries 5-47