M06 rugm 6563_05_ppw_ch06

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Alan M Rugman and Simon Collinson, International Business, 5th
Edition, © Pearson Education Limited 2009
International trade
Chapter 6

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International trade
• Objectives
• Introduction
• International trade theory
• Barriers to trade
• Non-tariff barriers to trade
• Other economic developments.

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Objectives
• Define the term international trade and discuss
the role of mercantilism in modern international
trade.
• Contrast the theories of absolute advantage and
comparative advantage.
• Relate the importance of international product life
cycle theory to the study of international
economics.
• Explain some of the most commonly used
barriers to trade and other economic
developments that affect international economics.
• Discuss some of the reasons for the tensions
between the theory of free trade and the
widespread practice of national trade barriers.

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Introduction
• International trade: the branch of economics
concerned with the exchange of goods and
services with foreign countries.
• We will focus on:
– International trade theory
– Barriers to trade.

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International trade theory

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Why do nations trade?
Trade theories:
• Mercantilism;
• theory of absolute advantage;
• theory of comparative advantage;
• factor endowment theory;
• international product cycle theory;
• other considerations.

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Mercantilism
• A trade theory which holds that a government
can improve the well-being of the country by
encouraging exports and stifling imports.
Cf.) Neo mercantilism: without the reliance on
precious metal (gold).

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Theory of absolute advantage
• A trade theory which holds that by specializing in
the production of goods, which they can produce
more efficiently than any others, nations can
increase their economic well-being.
An example
• Assume:
– labour is the only cost of production;
– lower labour-hours per unit of production means
lower production costs and higher productivity of
labour.

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• North has an absolute advantage in the production of cloth.
• South has an absolute advantage in the production of grain.
It follows that:
• If North produces cloth and South produces grain, and an
exchange ratio can be arranged, both the countries will benefit
from trade.
Theory of absolute advantage
(Continued)

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Theory of comparative advantage
• A trade theory which holds that nations should
produce those goods for which they have the
greatest relative advantage.
An example
• Assume:
– labour is the only cost of production;
– lower labour-hours per unit of production means
lower production costs and higher productivity of
labour.

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• North has an absolute advantage in the production of both cloth and grain but
the relative costs differ (i.e. gains from trade).
• In North, one unit of cloth costs 50/100 hours of grain.
• In South, one unit of cloth costs 100/100 hours of grain.
It follows that:
• If North can import more than a half unit of grain for one unit of cloth, it will
gain from trade.
• If South can import one unit of cloth for less than one unit of grain, it will also
gain from trade.
• Under the circumstance presented in the above example, both countries can
benefit from trade.
Theory of comparative advantage
(Continued)

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Factor endowment theory
• Also known as the Heckscher-Ohlin theory,
– It extends the concept of comparative advantage by
bringing into consideration the endowment and cost of
factors of production and helps to explain why nations
with relatively large labour forces will concentrate on
producing labour-intensive goods, whereas, countries
with relatively more capital than labour will specialize
in capital-intensive goods.
• Weaknesses of factor endowment theory:
– Some countries have minimum wage laws that result
in high prices for relatively abundant labour.
– The Leontief paradox: countries like the United
States actually export relatively more labour-intensive
goods and import capital-intensive goods.
No single theory can explain the role of economic factors in trade theory.

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International product life
cycle theory (IPLC)
• A theory of the stages of production for a product
with new “know-how”: it is first produced by the
parent firm, then by its foreign subsidiaries and
finally anywhere in the world where costs are the
lowest; it helps to explain why a product that
begins as a nation’s export often ends up as an
import.

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Figure 6.1 The international product life cycle
Source: Raymond Vernon and Louis T. Wells, Jr., The Manager in the International Economy (Englewood Cliffs, NJ: Prentice Hall, 1991), p. 85

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Other considerations
• Government regulation
• Monetary currency valuation
• Consumer tastes

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Barriers to trade

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Reasons for barriers to trade
• Protect local jobs by shielding home-country
business from foreign competition.
• Encourage local production to replace imports.
• Protect infant industries that are just getting started.
• Reduce reliance on foreign suppliers.
• Encourage local and foreign direct investment.
• Reduce balance of payments problems.
• Promote export activity.
• Prevent foreign firms from dumping, that is, selling
goods below cost in order to achieve market share.
• Promote political objectives such as refusing to trade
with countries that practice apartheid or deny civil
liberties to their citizens.

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Commonly used barriers to trade
• Price-based barriers
– Tariffs: a tax on goods shipped internationally
• Quantity limits
– Quotas: a quantity limit on imported goods
– Embargos: a quota set to zero
• International price fixing
– A cartel: a group of firms that collectively agree to fix
prices or quantities sold in an effort to control price
• Non-tariff barriers
• Financial limits
– Exchange controls: controls that restrict the flow of
currency
• Foreign investment controls
– Limits on FDI
– Limits on transfer or remittance of funds

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Types of tariffs
• Import and export tariffs: a tax levied on
imports or exports of a country.
• Transit tariff: a tax levied on goods passing
through the country.
• Specific duty: a tariff based on the number of
items being imported.
• Ad valorem duty: a tariff based on a percentage
of the value of imported goods.
• Compound duty: a tariff consisting of both a
specific and ad valorem duty.

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Figure 6.2 Impacts of a tariff

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Reasons for tariffs
• To retaliate against dumping: the selling of goods
at a price below cost or below that in the home
country.
• To protect local industry.
• To raise revenue.
• To reduce foreign expenditures by citizens in
order to improve the country’s balance of
payments.

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Non-tariff barriers to trade

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Non-tariff barriers to trade
• Quotas
• “Buy national” restrictions
• Customs valuation
• Technical barriers
• Antidumping legislation, subsidies and
countervailing duties
• Agricultural product regulations and subsidies
• Export restraints.

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Table 6.2 Common non-tariff barriers to trade

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Other economic developments

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Other economic developments
• Countertrade: barter trade in which the
exporting firm receives payments in products
from the importing country.
• Trade in services: as high-income countries
move toward a service economy, trade in
services has grown.
• Free trade zones: a designated area where
importers can defer payment of customs duty
while further processing of products takes place
(as a foreign trade zone).

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Table 6.3 Overview of the US balance of current account, 2006, preliminary
Source: Adapted from BEA, Survey of Current Business, June 2007, Table 2 International transactions

M06 rugm 6563_05_ppw_ch06

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