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Chapter 3 Powerpoint Slides


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Chapter 3 Powerpoint Slides

  1. 2. 3 Theories of International Trade and Investment International Business by Ball, McCulloch, Frantz, Geringer, and Minor McGraw-Hill/Irwin Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved. <ul><li>This chapter covers: </li></ul><ul><li>Why goods are traded internationally </li></ul><ul><li>Arguments for imposing trade restrictions </li></ul><ul><li>Kings of import restrictions </li></ul><ul><li>Weakness of GNP/capita as economic indicator </li></ul><ul><li>Characteristics of developing nations </li></ul><ul><li>Theories of foreign direct investment </li></ul>
  2. 3. Chapter Objectives <ul><li>Understand the theories of international trade. </li></ul><ul><li>Comprehend the arguments of imposing trade restrictions. </li></ul><ul><li>Explain the two basic kinds of import restrictions. </li></ul><ul><li>Appreciate the relevance of the changing status of tariff and non tariff barriers. </li></ul><ul><li>Recognize the weaknesses of GNP/capita as an economic indicator. </li></ul><ul><li>Understand the new definition of economic development. </li></ul><ul><li>Understand why governments change from import substitution to export promotion. </li></ul><ul><li>Explain some of the theories of foreign direct investment. </li></ul><ul><li>3-2 </li></ul>
  3. 4. International Trade Theory <ul><li>Mercantilism </li></ul><ul><ul><li>Believed nation’s welfare was in accumulation of stock of precious metals. </li></ul></ul><ul><ul><li>Trade surplus created by import restrictions and government subsidies to exporters. </li></ul></ul><ul><ul><li>Mercantilist era ended in 1700s. </li></ul></ul><ul><li>3-3 </li></ul>
  4. 5. Modern Day Mercantilism <ul><li>Economic Nationalism </li></ul><ul><ul><li>Industrial policy based on state intervention </li></ul></ul><ul><ul><li>France nationalized key industries and banks to use the power of the state as </li></ul></ul><ul><ul><ul><li>Stockholder and financier </li></ul></ul></ul><ul><ul><ul><li>Customer and marketer to revitalize the nation’s base </li></ul></ul></ul><ul><ul><ul><li>In 1986, little growth and high unemployment led government to reverse “mercantilist” policy </li></ul></ul></ul><ul><ul><li>Japan called “fortress of mercantilism” by some </li></ul></ul><ul><ul><ul><li>Nearly impenetrable market </li></ul></ul></ul><ul><ul><ul><li>Effort to maintain a cheap yen </li></ul></ul></ul><ul><li>3-4 </li></ul>
  5. 6. Theory of Absolute Advantage <ul><li>“ The capacity of one nation to produce more of a good with the same amount of input than another country.” </li></ul><ul><ul><li>Adam Smith claimed that market forces, not government controls should determine the direction, volume, and composition of international trade. </li></ul></ul><ul><ul><li>Each nation should specialize in producing goods it could produce most efficiently </li></ul></ul><ul><ul><li>In absolute advantage, both nations would gain from trade. </li></ul></ul><ul><li>Assumptions </li></ul><ul><ul><li>Perfect competition and no transportation costs in a world of two countries and two products. </li></ul></ul><ul><li>3-5 </li></ul>
  6. 7. Theory of Comparative Advantage <ul><li>“ A nation having absolute disadvantages in the production of two goods compared to another nation, </li></ul><ul><ul><li>has a comparative advantage in producing the good in which its absolute disadvantage is less.” </li></ul></ul><ul><ul><li>Theory of comparative advantage demonstrated by Ricardo in 1817. </li></ul></ul>3-6
  7. 8. Production Possibility Frontiers <ul><li>The following two graphs illustrate Chinese and U.S. production possibility frontiers using constant cost for simplicity. </li></ul><ul><li>These curves, in the absence of trade, also illustrate the possible combinations of goods for consumption. </li></ul><ul><li>3-7 </li></ul>
  8. 9. Offshoring Service Jobs to India <ul><li>Approximately 1 Billion people </li></ul><ul><ul><li>Comparative advantage in production of goods or services that require large amounts of labor </li></ul></ul><ul><ul><li>Citizens speak English </li></ul></ul><ul><ul><li>Low labor costs due to large workforce </li></ul></ul><ul><ul><li>Internet and telephone communications much less expensive </li></ul></ul><ul><ul><li>Industries offshoring include software engineering, telemarketing, banking, medical services, claims processing, IT jobs, financial services, insurance </li></ul></ul><ul><li>Jobs created overseas generate jobs at home </li></ul><ul><li>3-8 </li></ul>
  9. 10. Heckscher-Ohlin Theory of Factor Endowment <ul><li>States that international and interregional differences in production costs occur because of differences in the supply of production factors. Therefore, </li></ul><ul><ul><ul><li>India should export labor intensive goods. </li></ul></ul></ul><ul><ul><ul><li>Germany, with relatively more capital than labor should specialize in capital intensive products. </li></ul></ul></ul><ul><li>3-9 </li></ul><ul><li>Assumptions </li></ul><ul><ul><li>The price of factors depend only on the factor endowment. </li></ul></ul><ul><ul><ul><li>Not a perfect market </li></ul></ul></ul><ul><ul><ul><li>Legislated wages and benefits </li></ul></ul></ul><ul><ul><ul><li>Tax credits </li></ul></ul></ul><ul><ul><li>Given technology is universally available. </li></ul></ul><ul><ul><ul><li>Always a lag between intro of new technology and world application </li></ul></ul></ul>
  10. 11. Leontief Paradox <ul><li>Study in 1953 by economist Wassily Leontief disputed the usefulness of the Heckscher-Ohlin Theory as a predictor of the direction of trade. </li></ul><ul><ul><ul><li>Found that the U.S., one of the most capital-intensive countries in the world, was exporting labor intensive products. </li></ul></ul></ul>3-10
  11. 12. Effect of Money on Trade <ul><li>Exchange Rate </li></ul><ul><ul><li>The price of one country’s currency stated in terms of the other. </li></ul></ul><ul><li>Influence of Exchange Rates </li></ul><ul><ul><li>European companies pressured to incraese prices of exports to maintain Euro profits </li></ul></ul><ul><ul><li>Currency devaluation </li></ul></ul><ul><ul><ul><li>Lowering of a country’s currency in terms of other currencies. </li></ul></ul></ul><ul><ul><ul><ul><li>Example is tourism and currency rates in Mexico during 1980s </li></ul></ul></ul></ul>
  12. 13. Newer Explanations of the Direction of Trade <ul><li>Economies of Scale and the Experience Curve </li></ul><ul><ul><li>As output increases cost per unit decreases </li></ul></ul><ul><ul><ul><li>Larger and more efficient equipment </li></ul></ul></ul><ul><ul><ul><li>Volume discounts </li></ul></ul></ul><ul><ul><ul><li>Fixed cost allocation </li></ul></ul></ul><ul><ul><ul><li>Drop in learning curve </li></ul></ul></ul><ul><li>3-12 </li></ul><ul><li>First Mover Theory </li></ul><ul><ul><li>Gain market share </li></ul></ul><ul><ul><li>Discourage foreign entrants </li></ul></ul><ul><li>The Linder Theory of Overlapping Demand </li></ul><ul><ul><li>Customers’ tastes determined by income levels </li></ul></ul><ul><ul><li>Trade greater between nations with similar per capital incomes </li></ul></ul>
  13. 14. International Product Life Cycle (IPLC) <ul><li>Four stages of the IPLC in the U.S. </li></ul><ul><li>1) U.S. exports </li></ul><ul><li>2) Foreign production begins </li></ul><ul><li>3) Foreign competition in export markets </li></ul><ul><li>4) Import competition in the U.S </li></ul>3-13
  14. 15. Stages of the International Product Life Cycle <ul><li>Exports </li></ul><ul><ul><li>May be only manufacturer of new product </li></ul></ul><ul><ul><li>Overseas customers learn of product, export market develops </li></ul></ul><ul><li>Foreign production </li></ul><ul><ul><li>Export volume grows </li></ul></ul><ul><ul><li>Production technology becomes stable </li></ul></ul><ul><ul><li>Reduced costs for transportation </li></ul></ul><ul><ul><li>Exports diminish </li></ul></ul><ul><li>3-14 </li></ul><ul><li>Foreign competition </li></ul><ul><ul><li>Foreign manufacturers gain experience </li></ul></ul><ul><ul><li>Compete in export markets </li></ul></ul><ul><li>Import competition </li></ul><ul><ul><li>Foreign producers obtain economies of scale </li></ul></ul><ul><ul><li>Compete in quality and undersell domestic company in domestic market </li></ul></ul>
  15. 16. International Technology Life Cycle <ul><li>Initial Stage </li></ul><ul><ul><li>Development of new technology in an industrialized country </li></ul></ul><ul><li>Subsequently exported to other developed countries </li></ul><ul><ul><li>Increasing cost of labor make it no longer profitable to use in developed nation </li></ul></ul><ul><li>Technology exported to developing nation </li></ul><ul><li>Technology produced abroad for domestic consumption </li></ul><ul><li>3-15 </li></ul>
  16. 17. Porter’s Competitive Advantage of Nations <ul><li>Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage. </li></ul><ul><ul><li>Demand conditions </li></ul></ul><ul><ul><li>Factor conditions </li></ul></ul><ul><ul><li>Related and supporting industries </li></ul></ul><ul><ul><li>Firm strategy, structure, rivalry </li></ul></ul>3-16
  17. 18. Porter’s Competitive Advantage of Nations <ul><li>Demand Conditions </li></ul><ul><ul><li>Nature of domestic demand. </li></ul></ul><ul><ul><ul><li>If customers are demanding, firms will produce high-quality and innovative products gaining competitive advantage </li></ul></ul></ul><ul><li>Factor Conditions </li></ul><ul><ul><li>Level and consumption of factors of production </li></ul></ul><ul><ul><li>Lack of natural endowments has caused nations to invest in the creation of advanced factors </li></ul></ul><ul><li>3-17 </li></ul><ul><li>Related and supporting industries </li></ul><ul><ul><li>Suppliers and industry support services tend to form a cluster in a given location </li></ul></ul><ul><li>Firm Strategy, Structure, Rivalry </li></ul><ul><ul><li>Extent of domestic competition, </li></ul></ul><ul><ul><li>The existence of barriers to entry </li></ul></ul><ul><ul><li>The firm’s management style and organization. </li></ul></ul>
  18. 19. Trade Restrictions <ul><li>Arguments for </li></ul><ul><ul><li>National Defense </li></ul></ul><ul><ul><ul><li>Certain industries need protection </li></ul></ul></ul><ul><ul><ul><li>Imports may not be available during wartime </li></ul></ul></ul><ul><ul><ul><li>Prevent valuable technologies from being used to strengthen competition, especially militarily </li></ul></ul></ul><ul><ul><li>Sanctions to Punish Offending Nations </li></ul></ul><ul><ul><ul><li>Inflict economic damage to encourage to modify behavior </li></ul></ul></ul><ul><ul><li>Protect Infant or Dying Industry </li></ul></ul><ul><ul><ul><li>In the long run will have a comparative advantage </li></ul></ul></ul><ul><ul><ul><li>Meant to be temporary for emerging industry or to protect jobs of dying industry </li></ul></ul></ul><ul><li>3-18 </li></ul>
  19. 20. Trade Restrictions <ul><li>Arguments for </li></ul><ul><ul><li>Protect Domestic Jobs from Cheap Foreign Labor </li></ul></ul><ul><ul><ul><li>Productivity per worker greater in developed countries </li></ul></ul></ul><ul><ul><ul><li>Fails to consider cost of other factors of production </li></ul></ul></ul><ul><ul><li>Scientific Tariff or Fair Competition </li></ul></ul><ul><ul><ul><li>Bring cost of imported goods up to domestically produced goods to prevent unfair advantage </li></ul></ul></ul><ul><ul><li>Retaliation </li></ul></ul><ul><ul><ul><li>Import restrictions placed by another country may result in similar restrictions by domestic government </li></ul></ul></ul><ul><ul><ul><ul><li>EU ban on hormone treated U.S. beef </li></ul></ul></ul></ul><ul><li>3-19 </li></ul>
  20. 21. Other Reasons for Retaliation <ul><li>Dumping is the selling of a product abroad for less than </li></ul><ul><ul><li>The average cost of production in the exporting nation </li></ul></ul><ul><ul><li>The market price in the exporting nation </li></ul></ul><ul><ul><li>The price to third countries </li></ul></ul><ul><li>Result of </li></ul><ul><ul><li>Excess production </li></ul></ul><ul><ul><li>Cyclical or seasonal factors </li></ul></ul><ul><ul><li>Attempt to force domestic producers out of business </li></ul></ul><ul><li>3-20 </li></ul>
  21. 22. Sanctions Justified <ul><li>Dumping for which sanctions are considered justified </li></ul><ul><ul><li>Social dumping </li></ul></ul><ul><ul><ul><li>Lower labor costs and poorer working conditions </li></ul></ul></ul><ul><ul><li>Environmental dumping </li></ul></ul><ul><ul><ul><li>Lax environmental standards </li></ul></ul></ul><ul><ul><li>Financial services dumping </li></ul></ul><ul><ul><ul><li>Low requirements for bank capital/asset ratios </li></ul></ul></ul><ul><ul><li>Cultural dumping </li></ul></ul><ul><ul><ul><li>Cultural barriers aid local firms </li></ul></ul></ul><ul><ul><li>Tax dumping </li></ul></ul><ul><ul><ul><li>Differences in corporate tax rates or special breaks </li></ul></ul></ul><ul><li>3-21 </li></ul>
  22. 23. Other Reasons for Retaliation <ul><li>Subsidies </li></ul><ul><ul><li>Government provides to domestic firm to encourage exports or protect from imports </li></ul></ul><ul><ul><li>Can be </li></ul></ul><ul><ul><ul><li>Cash payment </li></ul></ul></ul><ul><ul><ul><li>Government participation in ownership </li></ul></ul></ul><ul><ul><ul><li>Low-cost loans </li></ul></ul></ul><ul><ul><ul><li>Preferential tax treatment </li></ul></ul></ul><ul><li>Countervailing Duties </li></ul><ul><ul><li>Set by importing nation to offset effects of subsidy </li></ul></ul><ul><ul><li>Equal to the subsidy amount </li></ul></ul><ul><li>3-22 </li></ul>
  23. 24. Types of Restrictions - Tariffs <ul><li>Ad Valorem </li></ul><ul><ul><ul><li>Percentage of invoice value </li></ul></ul></ul><ul><li>Specific </li></ul><ul><ul><ul><li>Fixed sum of money per unit </li></ul></ul></ul><ul><li>Compound duty </li></ul><ul><ul><ul><li>Combination of the above </li></ul></ul></ul><ul><li>3-23 </li></ul><ul><li>Official Prices </li></ul><ul><ul><li>Minimum import duty regardless of invoice price </li></ul></ul><ul><li>Variable Levy </li></ul><ul><ul><ul><li>Calculated daily based on world market price </li></ul></ul></ul><ul><li>Lower Duties for Local Input </li></ul><ul><ul><ul><li>Encourages some local production </li></ul></ul></ul>
  24. 25. Types of Restrictions - Nontariff <ul><li>Quantitative </li></ul><ul><ul><li>Quotas </li></ul></ul><ul><ul><li>Voluntary Export Restraints </li></ul></ul><ul><ul><li>Orderly Marketing Arrangements </li></ul></ul><ul><li>Nonquantitative Nontariff </li></ul><ul><ul><li>Direct government participation in trade </li></ul></ul><ul><ul><li>Customs and other administrative procedures </li></ul></ul><ul><ul><li>Government and private standards </li></ul></ul>3-24
  25. 26. Levels of Economic Development <ul><li>Developed </li></ul><ul><ul><li>Classification for all industrialized nations, which are mostly technologically developed. </li></ul></ul><ul><li>Developing </li></ul><ul><ul><li>Classification for world’s lower income nations, which are less technically developed. </li></ul></ul><ul><li>Newly Industrialzing Countries (NICs) </li></ul><ul><ul><li>Fast-growing, middle-income or higher economies </li></ul></ul><ul><ul><li>Heavy concentration of foreign investment </li></ul></ul><ul><ul><li>Exported large quantities of manufactured goods, including high-tech products </li></ul></ul><ul><li>3-25 </li></ul>
  26. 27. Levels of Economic Development <ul><li>Newly Industrialized Economies (NIEs) </li></ul><ul><ul><li>Primarily used to refer to the four tigers </li></ul></ul><ul><ul><ul><li>Taiwan, Hong Kong, Singapore, South Korea </li></ul></ul></ul><ul><li>IMF combines NIEs with Industrialized Nations to form “advanced economies </li></ul><ul><li>Emerging Market Economies </li></ul><ul><ul><li>Chile, Malaysia, China, Thailand, Indonesia </li></ul></ul><ul><li>Transition Countries or Eastern Europe </li></ul><ul><ul><li>Former communist countries </li></ul></ul><ul><li>3-26 </li></ul>
  27. 28. The World Bank Classification System <ul><li>Based on GNP/capita </li></ul><ul><ul><li>Low income ($735 or less) </li></ul></ul><ul><ul><li>Lower middle income ($736 - $2935) </li></ul></ul><ul><ul><li>Upper middle income ($2,936 - $9,075) </li></ul></ul><ul><ul><li>High income ($9,076 or more) </li></ul></ul><ul><li>3-27 </li></ul>
  28. 29. GNP/Capita as an Indicator <ul><li>Concerns </li></ul><ul><ul><li>GNP/Capital data does not include Underground Economy </li></ul></ul><ul><ul><ul><li>Undeclared legal production </li></ul></ul></ul><ul><ul><ul><li>Production of illegal goods and services </li></ul></ul></ul><ul><ul><ul><li>Concealed income – barter </li></ul></ul></ul><ul><ul><ul><li>Underground Economy larger if </li></ul></ul></ul><ul><ul><ul><ul><ul><li>Higher level of taxation </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Oppressive government red tape </li></ul></ul></ul></ul></ul><ul><ul><li>Currency conversion </li></ul></ul><ul><ul><ul><li>Local currency converted to the dollar by using exchange rate </li></ul></ul></ul><ul><ul><ul><li>Conversions do not reflect domestic purchasing powers of currencies, must use purchasing power parity (PPP ) </li></ul></ul></ul><ul><ul><ul><li>World Bank uses Atlas methodology </li></ul></ul></ul><ul><li>3-28 </li></ul>
  29. 30. Characteristics of Developing Nations <ul><li>GNP/capital less than $9,075 </li></ul><ul><li>Unequal distribution of income </li></ul><ul><li>Technological dualism </li></ul><ul><li>Regional dualism </li></ul><ul><li>Majority of population working in agricultural sector </li></ul><ul><li>Disguised unemployment or underemployment </li></ul><ul><li>High population growth </li></ul><ul><li>3-29 </li></ul><ul><li>High rate of illiteracy and insufficient educational facilities </li></ul><ul><li>Widespread malnutrition and health problems </li></ul><ul><li>Political instability </li></ul><ul><li>High dependence on a few products </li></ul><ul><li>Inhospitable topography </li></ul><ul><li>Low savings rates and inadequate banking facilities </li></ul>
  30. 31. Human Needs Approach to Economic Development <ul><li>Defines economic development as the reduction of poverty, unemployment, and inequality in the distribution of income. </li></ul><ul><ul><li>Less illiteracy, less malnutrition, less disease and early death, shift from agricultural to industrial production </li></ul></ul><ul><li>Human Development Index (HDI) based on </li></ul><ul><ul><li>A long and healthy life </li></ul></ul><ul><ul><li>Ability to acquire knowledge </li></ul></ul><ul><ul><li>Access to resources for a decent standard of living </li></ul></ul><ul><ul><li>Measured by life expectancy, adult literacy, and GDP/capita adjusted for PPP </li></ul></ul><ul><li>3-30 </li></ul>
  31. 32. Development Theory <ul><li>No generally accepted theory </li></ul><ul><li>Economists concentrating on </li></ul><ul><ul><li>Population growth </li></ul></ul><ul><ul><li>Income distribution </li></ul></ul><ul><ul><li>Unemployment </li></ul></ul><ul><ul><li>Transfer of technology </li></ul></ul><ul><ul><li>Role of government </li></ul></ul><ul><ul><li>Investment in human capital </li></ul></ul><ul><ul><ul><li>The education of people </li></ul></ul></ul>3-31
  32. 33. Contemporary Theories of FDI <ul><li>Monopolistic Advantage Theory </li></ul><ul><ul><li>FDI occurs largely in oligopolistic industries </li></ul></ul><ul><li>Product and Factor Market Imperfections </li></ul><ul><ul><li>FDI typically from companies with heavy product research and marketing efforts </li></ul></ul><ul><li>International Product Life Cycle </li></ul><ul><ul><li>FDI normal state in life of a product </li></ul></ul><ul><li>Other Theories </li></ul><ul><ul><ul><li>Follow-the-leader theory </li></ul></ul></ul><ul><ul><ul><li>Cross investment </li></ul></ul></ul><ul><ul><ul><li>Internalization theory </li></ul></ul></ul><ul><ul><ul><li>Theory of International production </li></ul></ul></ul><ul><li>3-32 </li></ul>
  33. 34. Current U.S. Trade Sanctions <ul><li>Balkans </li></ul><ul><li>Burma (Myanmar) </li></ul><ul><li>Cuba </li></ul><ul><li>Diamond Trading </li></ul><ul><li>Iran </li></ul><ul><li>Iraq </li></ul><ul><li>Liberia </li></ul><ul><li>Source: </li></ul><ul><li>Libya </li></ul><ul><li>Narcotics Trafficking </li></ul><ul><li>Nonproliferation </li></ul><ul><li>North Korea </li></ul><ul><li>Sudan </li></ul><ul><li>Syria </li></ul><ul><li>Terrorists </li></ul><ul><li>Zimbabwe </li></ul>
  34. 35. Export Screening Guidelines <ul><li>Screening Elements </li></ul><ul><ul><li>Element 1: Denied Persons Screen Element 2 : Product Classification/License Determination Screen Element 3: Diversion Risk Screen Element 4: Sensitive Nuclear End-Uses/End-Users Screen Element 5 : Missile End-Use/End-Users Screen Element 6: Chemical and Biological Weapons End-Uses/End-Users Screen Element 7: Antiboycott Screen Element 8 : Informed Letter/Entity List Screen </li></ul></ul>Source:
  35. 36. Department of Commerce Transshipment Country Export Control Initiative (TECI) <ul><li>TECI is a multi-faceted, cooperative initiative that seeks to strengthen the trade compliance and export control systems of those countries and companies that constitute global transshipment hubs. By working to strengthen those systems, the DOC seeks to enhance security and confidence in international trade flows. </li></ul><ul><li>Source: </li></ul>
  36. 37. GDP Growth Source:
  37. 38. AIDS Crisis Source:
  38. 39. Antidumping Measures <ul><li>The United States maintains 54 of its outstanding 288 antidumping measures against products from China. </li></ul><ul><li>In 2003, new cases against China were initiated at the brisk pace of one per month. These actions hit consumable products like honey, apple juice concentrate, mushrooms, and pencils, as well as raw material inputs like creatine monohydrate, polyvinyl alcohol, barium carbonate and ferrovanadium. </li></ul>Source: