Theories of International Trade and Investment

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 FOUNDATION CONCEPTS
Comparative advantage
Superior features of a country that provide it with
unique benefits in global competition – derived from
either national endowments or deliberate national
policies
Competitive advantage
Distinctive assets or competencies of a firm – derived
from cost, size, or innovation strengths that are
difficult for competitors to replicate or imitate

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 EXAMPLES OF NATIONAL COMPARATIVE
ADVANTAGE

 Abundant, low-cost labor in China

 Mass of IT workers in India

 Huge reserves of bauxite in Australia

 Abundant agricultural land in the USA

 Oil in Saudi Arabia

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 EXAMPLES OF FIRM COMPETITIVE ADVANTAGE

 Dell’s prowess in global supply chain management

 Procter & Gamble’s skill in marketing

 Samsung’s leadership in flat-panel TV

 Apple’s design leadership in cell phones and personal music

players

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WHY NATIONS TRADE: CLASSICAL THEORIES

 Mercantilism: the belief that national prosperity is the

result of a positive balance of trade – maximize exports
and minimize imports
 Absolute advantage principle: a country should
produce only those products in which it has absolute
advantage or can produce using fewer resources than
another country

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 One ton of
Cloth Wheat
---------------------------------------------
France 30 40

Germany 100 20
----------------------------------------------
Example of Absolute Advantage (labor cost in days of
production for one ton)
WHY NATIONS TRADE: CLASSICAL THEORIES
 Comparative advantage principle: it is beneficial for
two countries to trade even if one has absolute advantage
in the production of all products; what matters is not the
absolute cost of production but the relative efficiency
with which it can produce the product.

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 One ton of
Cloth Wheat
---------------------------------------------
France 30 40

Germany 10 20
----------------------------------------------
Example of Comparative Advantage (labor cost in days of
production for one ton)
 LIMITATIONS OF EARLY TRADE
THEORIES
 Do not take into account the cost of international
transportation
 Tariffs and import restrictions can distort trade flows
 Scale economies can bring about additional
efficiencies
 When governments selectively target certain
industries for strategic investment, this may cause
trade patterns contrary to theoretical explanations
 Today, countries can access needed low-cost capital
in global markets
 Some services cannot be traded internationally

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 CLASSICAL THEORIES: FACTOR PROPORTIONS THEORY

 Factor proportions (endowments) theory: each

country should produce and export products that
intensively use relatively abundant factors of production,
and import goods that intensively use relatively scarce
factors of production
 Examples:
 Chinaand labor
 USA and pharmaceuticals
 Canada and electric power

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 CLASSICAL THEORIES:
INTERNATIONAL PRODUCT CYCLE THEORY
 International product cycle theory: each product and its
associated manufacturing technologies go through three stages
of evolution: introduction, growth, and maturity. Think of
cars, TVs.
 In the introduction stage, the inventor country enjoys a
monopoly both in manufacturing and exports
 As the product’s manufacturing becomes more standard, other
countries will enter the global marketplace
 When the product reaches maturity, the original innovator
country will become a net importer of the product
 Applicability to the contemporary global economy: Today, the
cycle from innovation to maturity is much shorter making it
harder for the innovator country to sustain its lead in a
particular product

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 HOW NATIONS ENHANCE COMPETITIVE
ADVANTAGE
 The contemporary view suggests that governments can
proactively implement policies to enhance a nation’s
competitive advantage, beyond the natural endowments
the country possesses
 Governments can create national economic advantage
by: stimulating innovation, targeting industries for
development, providing low-cost capital, minimizing
taxes, investing in IT, etc.

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 MICHAEL PORTER’S DIAMOND MODEL:
SOURCES OF NATIONAL COMPETITIVE ADVANTAGE

1. Firm strategy, structure, and rivalry – the presence of strong

competitors at home serves as a national competitive advantage
2. Factor conditions – labor, natural resources, capital, technology,
entrepreneurship, and know how
3. Demand conditions at home – the strengths and sophistication of
customer demand
4. Related and supporting industries – availability of clusters of
suppliers and complementary firms with distinctive competences

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INDUSTRIAL CLUSTERS
 A concentration of suppliers and supporting firms from
the same industry located within the same geographic
area
 Examples include: the Silicon Valley, fashion cluster in
northern Italy, pharma cluster in Switzerland, footwear
industry in Pusan, South Korea, and the IT industry in
Bangalore, India
 Can serve as a nation’s export platform

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 NATIONAL INDUSTRIAL POLICY

Proactive economic development plan enacted by the government to nurture

or support promising industries sectors.
Typical initiatives:
 Tax incentives
 Investment incentives
 Monetary and fiscal policies
 Rigorous educational systems
 Investment in national infrastructure
 Strong legal and regulatory systems
(Examples: Japan, Dubai, and Ireland)

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DOMINANCE OF FDI-BASED EXPLANATIONS OF THE INTERNATIONAL
FIRM

 Most IB theories about the firm emphasize the MNE,

since it was long the major player in international
business.

 Foreign direct investment (FDI) is the main strategy used

by MNEs in international expansion; thus, earlier
theories emphasized motives for, and patterns of, FDI

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FDI BASED EXPLANATIONS:
MONOPOLISTIC ADVANTAGE THEORY

 Suggests that FDI is preferred by MNEs because it

provides the firm with control over resources and
capabilities in the foreign market, and a degree of
monopoly power relative to foreign competitors
 Key sources of monopolistic advantage include
proprietary knowledge, patents, unique know-how, and
sole ownership of other assets

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 FDI BASED EXPLANATIONS:
INTERNALIZATION THEORY

 Explains the process by which firms acquire and retain

one or more value-chain activities inside the firm –
retaining control over foreign operations and avoiding
the disadvantages of dealing with external partners.

 In contrast to arm’s-length entry strategies (such as

exporting and licensing) which imply developing
contractual relationships with external business partners,
FDI provides the firm with control and ownership of
resources

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 FDI BASED EXPLANATIONS:
DUNNING’S ECLECTIC PARADIGM
Three conditions determine whether or not a company will internalize
via FDI:
1. Ownership-specific advantages – knowledge, skills, capabilities,
relationships, or physical assets that form the basis for the firm’s
competitive advantage
2. Location-specific advantages – advantages associated with the
country in which the MNE is invested, including natural
resources, skilled or low cost labor, and inexpensive capital
3. Internalization advantages – control derived from internalizing
foreign-based manufacturing, distribution, or other value chain
activities

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 NON-FDI BASED EXPLANATIONS:
INTERNATIONAL COLLABORATIVE VENTURES
 While FDI-based internationalization is still common, beginning
in the 1980s firms have emphasized non-equity, flexible
collaborative ventures to internationalize.
 Collaborative venture: a form of cooperation between two or
more firms. Through collaboration, a firm can gain access to
foreign partner’s know-how, capital, distribution channels, and
marketing assets, and overcome government imposed obstacles.
 Venture partners share the risk of their joint efforts, and pool
resources and capabilities to create synergy.

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 TWO TYPES OF
INTERNATIONAL COLLABORATIVE VENTURES

1. Equity-based joint ventures result in the formation of a new

legal entity. Here, the firm collaborates with local partner(s) to
reduce risk and commitment of capital.

2. Project-based alliances involve cooperation in R&D,

manufacturing, design, or any other value-adding activity, a
partnership aimed at a narrowly defined scope of activities and
timeline

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End of the Session