Trade and Factor

1. CHAPTER 5
TRADE AND FACTOR
MOBILITY THEORY

2. OBJECTIVES:
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 labor and capital,
move internationally
7. Describe the relationship between foreign trade and
international factor mobility
8. Grasp scenarios of possible changes in trade patterns

3. Laissez-faire versus interventionist
approaches to export and import
Once countries set economic and Political Objectives
officials enact policies including trade policies to achieve
desired results. This influence which countries can produce
given products more efficiently and whether countries will
permit imports to compete against their domestically
produced goods and service.

4. Figure 5.1 International Operations and Economic Connections

5. THEORIES OF TRADE PATTERN
We examine those that help explain trade patterns
including theories of country size, factor proportions, and
country similarity. We then consider theories dealing with
the dynamics of countries trade competitiveness for
particular products. Which include product life cycle theory
and the demand of national competitive advantage theory.

6. - Because the stability and dynamics of
countries competitive positions depend
largely on the quantity and quality of their
production factors(land, labor, capital,
technology).
- These different theories expand our
understanding of how government trade
policies might affect business competitiveness.
Trade Theories and Business
Factor Mobility Theory

7. INTERVENTIONIST THEORIES
- holds that a country's wealth is
measured by its holdings of "treasure",
which usually means its gold.
Mercantilism

8.  The concept of Balance
of Trade
-Some terminology of the
mercantilist era has endured for
example a favorable balance of
Trade (Trade surplus) still
indicates that a country is
exporting more than its imports.
-An unfavorable balance of Trade
(Trade deficit) indicates the
opposite.
 Governmental Policies
- To export more than they
imported, governments
restricted imports and
subsidised production that
otherwise could not compete
in domestic or export markets.

9. Neomercantilism
- Describes the approach of countries that try
to run favorable balances of Trade in an
attempt to achieve some social or political
objective. A country may aim for increased
employment by setting economic policies
that encourages its companies to produce in
excess of the demand at home and sell the
surplus abroad.

10. FREE – TRADE THEORIES
Why do countries need to grade at all?
Why can’t Costa Rica (or any other country) be content with the goods
and services it produces?
In fact, many countries following mercantilist policy tried to become as
self-sufficient as possible. In this section, we discuss two theories
supporting free trade: absolute advantage and comparative
advantage.

11. Both theories hold that nations should neither
artificially limit imports nor promote exports. The
market will determine which producers survive
as consumers buy those products that best
serve their needs. Both free trade theories imply
specialization. Just as individuals and families
produce some things that they exchange for
things that others produce, national
specialization means producing some things for
domestic consumption and export while using
the export earnings to buy imports of products
and services produced abroad.

12. THEORY OF ABSOLUTE ADVANTAGE
In 1776, Adam Smith questioned the mercantilists’ assumptions by stating that the real wealth
of a country consists of the goods and services available to its citizens rather than its holdings
of gold. This theory of absolute advantage holds that different countries produce some goods
more efficiently than others and questions why the citizens of any country should have to buy
domestically produced goods when hey can buy them more cheaply from abroad. Smith
reasoned that unrestricted trade would lead a country to specialize in those products that gave
it a competitive advantage. Its resources would shift to the efficient industries because it could
not compete in the inefficient ones. Through specialization, it could increase its efficiency for
three reasons:
1. Labor could become more skilled by repeating the same tasks.
2. Labor would not lose time in switching production from one kind of production to
another.
3. Long production runs would provide incentives for developing more effective
working methods.

13. The country could then use its excess specialized production to buy more imports
than it otherwise could have produced. But in what products should a country
specialize? Although Smith believed the marketplace would make the determination,
he thought that a country’s advantage would be either natural or acquired.
A country’s natural advantage in creating a product or service comes from climatic
conditions access to certain natural resources, or availability of certain labor forces. As we saw
in our opening case, Costa Rica’s climate and soil support the production of bananas,
pineapples, and coffee, while its biodiversity supports a thriving ecotourism industry. Costa Rica
imports wheat. If it were to increase its wheat production, for which its climate and terrain are
less suited, it would have to use land now devoted to the cultivation of bananas,
pineapples, and coffee, or convert some of its biodiverse national park areas
to agricultural production, thus reducing those earnings.
 Natural Advantage

14. Most of today’s world trade is of manufactured goods rather than agricultural
goods and natural resources. Countries that are competitive in manufactured goods
have an acquired advantage, usually in either product or process technology. An
advantage of product technology is that it enables a country to produce a unique
product or one that is easily distinguished from those of competitors.
For example, Denmark exports silver tableware, nor because there are rich Danish
silver mines but because Danish companies have developed distinctive products.
Considering the concepts of money and exchange rates, we define the cost
of production in terms of the resources needed to produce either commodity. This
example is realistic because real income depends on the output of goods
compared to the resources used to produce them.
 Acquired Advantage

15. Theory of Comparability
Advantage
The theory of comparative advantage introduces
opportunity cost as a factor for analysis in choosing
between different options for production.
 Comparative Advantage by Analogy
An analogy is a comparison between two objects, or
systems of objects, that highlights respects in which
they are thought to be similar. Comparative advantage
is what you do best while also giving up the least.

16.  Production Possibility
is a graph that shows all of the different combinations of output that can be
produced given current resources and technology. Sometimes called the
production possibilities frontier (PPF), the PPC illustrates scarcity and trade-offs.
 Don’t Confuse Comparative and Absolute Advantage
Where absolute advantage refers to the ability of an entity to produce a greater
quantity of a product or service, comparative advantage refers to the ability to
produce goods and services at a lower opportunity cost compared to the
competition.

17. Both absolute and comparative advantage theories are based
on increasing output and trade through specialization.
However, these theories make assumptions, some of which are
not always valid.
 Full Employment
is an economic situation in which all available labor resources
are being used in the most efficient way possible.
.
Theories of Specialization:
Some Assumptions and Limitations

18.  Economic Efficiency
is when all goods and factors of production in an economy are distributed or
allocated to their most valuable uses and waste is eliminated or minimized.
 Division of Gains
When the investments done by all the partners for the equal amount of time, the
profit or loss will be distributed between the partners in the ratio of their
investments.
 Transport Costs
are the costs internally assumed by the providers of transport services.

19.  Statics and Dynamics
In general, dynamic means energetic, capable of action
and/or change, or forceful, while static means stationary
or fixed.
 Services
is an (intangible) act or use for which a consumer, firm,
or government is willing to pay.

20.  Production Networks
A production network typically includes nodes of suppliers and
manufacturers involved in direct value-adding activities, distribution
centers and logistics service providers, as well as facilities and
channels for reverse logistics.
 Mobility
is defined as the potential for movement and the ability to get from one
place to another using one or more modes of transport to meet daily
needs.

21. TRADE PATTERN THEORIES
The free trade theories demonstrate how
economic growth occurs through
specialization and trade; however, they do
not deal with trade patterns such as how
much a country trades, what products it
trades, or who will be its trading partners
when following a free trade policy.

22. Free-trade theories of specialization neither
propose nor imply that only one country
should or will produce a given product or
service. Nontradable goods—products and
services that are seldom practical to export
because of high transportation costs—are
produced in every country.
How Much Does A Country Trade?

23.  Theory of Country Size
The theory of country size holds that large countries
usually depend less on trade than small ones. Countries with
large land areas are apt to have varied climates and an
assortment of natural resources, making them more self-
sufficient than smaller ones.
 Size of the Economy
While land area helps explain the relative dependence on trade,
countries’ economic size helps explain differences in the absolute
amount of trade.

24.  Factor-Proportions Theory
Eli Heckscher and Bertil Ohlin developed the factor proportions theory,
maintaining that differences in countries’ endowments of labor compared to
land or capital endowments explain differences in the cost of production
factors.
- According to the factor proportions theory, factors in relative
abundance are cheaper than factors in relative scarcity.
What Types of Products Does A
Country Trade?

25. - Production factors :
 People and Land
Factor-proportions theory appears logical.
 Manufacturing Locations
Casual observation of manufacturing
locations also seems to substantiate the theory
 Capital, Labor Rates, and Specialization
Production factors, especially labor, are not
homogeneous.
Factor-Proportions Theory

26.  Process Technology
Companies may substitute capital for labor,
depending on the cost of each. Bigger countries
depend more on products requiring larger
production runs.
 Product Technology
Most new products originate in developed
countries.

27. Figure 5.4 Worldwide Trade by Major Sectors

28. Below are the roles that country similarity and distance play in determining trading partners;
 Country-Similarity Theory
Theories explaining why trade takes place have focused so far on the
differences among countries in terms of natural conditions and factor
endowment proportions.
 Specialization and Acquired Advantage
It is in order to export, a company must provide consumers abroad
with an advantage over what they could buy from their domestic
producers.
With Whom Do Countries Trade?

29.  Product Differentiation
Trade also occurs because companies differentiate products, thus
creating two-way in seemingly similar products.
 The Effects of Cultural Similarity
Importers and exporters perceive greater ease in doing business in
countries that are culturally similar to home, such as those that speak a
common language.
 The Effects of Political Relationships and Economic
Agreements
Political relationships and economic agreements among countries
may discourage or encourage trade between them.

30.  The Effects of Distance
Although no single factor fully explains specific pairs of trading partners,
the geographic distance between two countries is important. In essence,
greater distances usually mean higher transportation costs; that’s why
Intel’s cost to ship semiconductors from Costa Rica to the United States
is lower than if it had to bring them from say, Argentina. However,
distance is more important for homogeneous products than for
differentiated products in as much as the former compete more on the
basis of price.
 Overcoming Distance
Transport cost is not the only factor in trade partner choice.
New Zealand competes with Chile, Argentina, and
South Africa for our-of-season sales of apples to the
Northern Hemisphere –but with a disadvantage in freight
costs to the United States and Europe.

31. Has two theories – the product life cycle theory and
diamond of national advantage
State that the production location of certain manufactured
products shifts as they go through their life cycle. The
cycle consist of four stages: Introduction, Growth,
Maturity, and Decline.
THE STATICS AND
DYNAMIC OF TRADE
Product Life Cycle (PLC) Theory

32.  Changes over the cycle
Companies develop new products primarily because they
observe nearby needs for them; thus a U.S. is company is most
to create a new product for U.S. market, a French company for
the French market, and so on.
 Introduction
Once a company has created a new product, theoretically
it an manufacture it anywhere in the world.
 Growth
Sales growth attracts competitors to the
market, particularly in other developed countries.

33.  Maturity
Worldwide demand begins to level off, although it may be growing in
some countries and declining in others. Typically, there is a shakeout
of producers, more standardized productions, and increased
importance of price as a competitive weapon.
 Decline
As a product moves into the decline stage those factors occurring
during the maturity stage continue to evolve. The markets in
developed countries decline more rapidly than those in developing
economies as affluent customers demand ever newer
products

34.  Verification and Limitations of PLC Theory
The PLC theory holds that the location of production facilities that serve
world markets shifts as products move through their life cycle.
Types of products abound for which production locations usually
do not shift. Such exceptions include the following:
• Products with high transport costs that may have to be
produced close to the market, thus never becoming significant exports.
• Products that, because of very rapid innovation, have extremely
short life cycles, making it impossible to reduce costs by
moving production from one country to another. Some fashion
items fit this category.

35. • Luxury products for which cost is of little concern to the consumer.
In fact, production in
a developing country may cause consumers to perceive the product as
less luxurious.
• Products for which a company can use a differentiation strategy,
perhaps through advertising, to maintain consumer demand without
competing on the basis of price.
• Products that require specialized technical personnel to be
located near production so as to move the products into their next
generation of models. This seems to explain the long-term U.S.
dominance of medical equipment production and German dominance in
rotary printing presses.

36. The diamond of national competitive advantage is a theory showing four
features as important for competitive superiority: demand conditions;
factor conditions; related and supporting industries; and firm
strategy, structure, and rivalry.
The Diamond of National Competitive

37. Figure 5.5

38.  Facets of the Diamond
Usually, all four conditions need to be favorable for an industry
within a country to attain and maintain global supremacy.
1. Demand Conditions
are the first feature in the theory. Both PLC theory and
country-similarity theory show that new products (or industries)
usually arise from companies’ observation of need or demand,
which has traditionally been in their home country,
when they start up production.

39. 3. Related and Supporting
Industries
The third feature—the existence of nearby
related and supporting industries (enamels
and glazes)—was also favorable. Recall,
for instance, the importance of transport
costs in the theory of country size, in
assumptions of specialization, and in the
limiting factors of the PLC theory.
2. Factor Condition
the second feature—factor influenced
both the choice of tile to meet
consumer demand and the choice of
Italy as the production location. Wood
was expensive, and most production
factors (skilled labor, capital,
technology, and equipment) were
available within Italy on favorable
terms.
4.Firm Strategy, Structure, and Rivalry
The combination of three features—demand, factor
conditions, and related and supporting industries—
influenced companies’ decisions to initiate production
of ceramic tiles in post war Italy.

40. The existence of the Four favorable conditions does not
guarantee that an industry will develop in a given locale.
Entrepreneurs may face favorable conditions for many different
lines of business.
A second limitation concerns the growth of globalization. The
industries on which this theory is premised grew when
companies’ access to competitive capabilities was much more
domestically focused.
Limitations of the Diamond of National
Advantage Theory

41. We can see how globalization affects each of the four conditions:
1. Observations of foreign or foreign-plus-domestic demand conditions have
spurred much of the recent Asian export growth.
2. Companies and countries do not depend entirely on domestic factor conditions.
3. If related and supporting industries are not available locally, materials and
components are now more easily brought in from abroad because of transportation
advancements and relaxed import restrictions.
4. Companies react not only to domestic rivals but also to foreign-based rivals they
compete with at home and abroad. Thus the prior domestic absence of any of the
four conditions from the diamond may not inhibit companies and
industries from gaining these conditions and becoming globally competitive.

42. By expanding the diamond of national advantage
theory to include changes brought about by
globalization, we can see its validity for countries’
economic policies. In our opening case, Costa
Rica diversified its economy from agricultural
products to modern high-tech products by
satisfying the market entry conditions of the
diamond.
Using the Diamond for Transformation

43. As both the quantity and quality of countries’ factor conditions
change, their relative capabilities change as well, possibly
because of internal circumstances. For instance, if savings rates
crease, countries have more capital relative to their factors of
land and labor. If they spend relatively more on education, they
improve the quality of the labor factor.
Factor-Mobility Theory

44. Why Production Factors
Move
 Capital
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).
 People
People are less mobile than capital. Some, of course,
travel to other countries as tourists, students, and
retirees; however, this does not affect factor
endowments because these travelers do
not work in the destination countries.

45.  Economic Motives
People work in another country largely for economic
reasons, such as Indonesian laborers working in
Malaysia to earn more than at home.
 Political Motives
People also move for political reasons—for
example, because of persecution or war dangers, in
which case they are known as refugees and usually
become part of the labor pool where they live.

46.  Factor movements alter factor endowments.
 Factor movements are substantial for many
countries and insignificant for others.
 Although labor and capital are different
production factors, they are intertwined.
 Pros and cons of outward and inward migration
Effects of Factor Movements

47.  A controversial issue is the effect
of outward migration on countries.
On the one hand, countries lose
potentially productive resources
when educated people leave—a
situation known as a brain drain.
 What Happens When People Move?

48.  Substitution
o When the factor proportions vary widely among countries, pressures exist
for the most abundant factors to move to countries with greater
scarcity—where they can command a better return.
The Relationship Between Trade And
Factor Mobility
Factor movement is an alternative to trade that may or may not be a more
efficient use of resources. Let’s see how free trade coupled with freedom of
factor mobility internationally can result in the most efficient resource
allocation.

49. o Similarly, capital tends to move away from countries in
which it is abundant to those in which it is scarce. For
example, Mexico gets capital from the United States,
and the United States gets labor from Mexico. However,
as is true of trade, there are restrictions on factor
movements that make them only partially mobile
internationally—such as both U.S. immigration
restrictions that limit the legal and illegal influx of
Mexican workers and Mexican ownership restrictions in
the petroleum industry that limit U.S. capital movements
to invest in that industry.
o The lowest costs occur when trade and
production factors are both mobile.
Substitution

50. o Many of the exports would not occur without foreign
investments, partly because a company may export
equipment as part of its foreign investment. Another
reason is that domestic operating units may export
materials and components to their foreign facilities for
use in a finished product, such as Coca-Cola’s exports
of concentrate to its bottling facilities abroad. Finally, a
company’s foreign facility may produce part of the
product line while serving as sales agent for exports of
its parent’s other products.
 Complementarity

51. o Finally, immigration enhances trade by creating ethnic enclaves that form one side of
ethnic networks linking immigrants with their native countries. The enclaves serve as
niche markets for imports from their native countries, such as early U.S. soy sauce
imports sold mainly to Asian-Americans. The ethnic networks embody product and
country-specific knowledge that aid both importers and exporters. This is more
important when a network is from a low-trust culture, especially one that also values
family ties strongly.
Complementarity

52. Group 5
PAÑA, BRENT LUIGI TIZON, PRINCESS MAE
MARABABOL, MARDIE ALINSUB, VIANCA
GANTALA, NIKKA MARIE CAHUCOM, YOCHABEL SHINN