Location and trade are two sides of a coin

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Chapter 10

• Location and trade are two sides of a coin
• International trade is spatial interaction
  between countries
• The importer is a poor location to manufacture
  the good that is imported
• Relative costs of manufacturing that product
  lower in the exporter country

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Chapter 10

• What are the dynamics in international spatial
  interaction?
• Of course, distances may be greater than in local
  trade
• Hence, costs could be more
• More important role of government and politics

3
International Trade

• We need to first understand why international
  trade occurs
• Because of differences in
• Resources
• Economic environment
• competitiveness

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International Trade

• Resources
• Or production factors
• Labor, capital, technology, raw materials, etc.
• Not all factors in every country
• That means some goods not produced in a country
• Need to import those goods

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International Trade

• Economic environment
• Many economic factors play a critical role in how
  much a country may import or export
• Some of those factors include
• Exchange rates
• business climate--power of labor
• Laws--on labor, tax, patents, etc.

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Trade Theory

• Comparative advantage theory focuses on
  differences in production costs between locations
• Goes back to Adam Smiths idea of advantages of
  economic specialization
• Specialization leads to greater efficiency in
  production

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Trade Theory

• Question is which country should specialize in
  what product?
• National specialization based on comparative costs

8
Ricardos Explanation

• Some countries produce certain products at a
  comparatively lower cost than others
• They are efficient locations for those products
• Efficiency leads to surplus
• But, another question crops up
• Why do costs vary between countries?

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Heckscher-Ohlin Trade Theory

• Source of cost advantage in a country is its
  factor endowments
• Abundance of factors means relatively low costs
• Factor endowment theory is, therefore, a
  least-cost theory of international trade

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Heckscher-Ohlin Trade Theory

• The best, or cheapest, factor is consumed
  initially
• Then more costly lower quality resources will be
  used
• (recall this discussion from chapter 3)
• This means the cost of production will start to
  increase

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Heckscher-Ohlin Trade Theory

• Cost increase will eventually equal cost in other
  countries
• This is the idea behind factor price equalization
• Factor mobility can also lead to price
  equalization
• Labor migration, in the long run, will equalize

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Trade Theory Key Deficiencies

• Neglect of
• Scale economies and
• Transportation costs
• From previous chapters, we know that these are
  important criteria
• Neglect of the role of MNCs

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Fairness Issues

• Terms of trade
• Ratio of prices received for exports to prices
  paid for imports
• Could be an unequal exchange for poor countries
• Similar to the discussion on unequal exchange
  conditions for farmers (recall from chapter 5)

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Terms of Trade

• Table 10.1 shows how some countries are dependent
  on a single commodity for export earnings
• Table 10.2 shows decline in prices of minerals
  and ores

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Terms of Trade

• Poor countries export primary commodities, and
  import higher technology products
• Relative prices of commodities have dropped over
  the years (again, similar to the case of farm
  products, from chapter 5)
• This situation is referred to as a deterioration
  in the terms of trade

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INDICATOR PRICE INDICES 1985100
                                                  
                                                  
                                                  
                                
ALL FOOD

TROPICAL BEV. AND FOOD

- TROPICAL BEVERAGES

- FOOD

VEGETABLE OILSEEDS AND OILS

Ag. RAW MATERIALS

MINERALS, ORES AND METALS

Petroleum (/barrel)


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Data

• Latest data on trade available from the World
  Trade Organization (WTO)
• http//www.wto.org/english/res_e/statis_e/its2002_
  e/chp_1_e.pdf
• For long term trends
• http//www.wto.org/english/res_e/statis_e/its2002_
  e/chp_2_e.pdf
• And more at
• http//www.wto.org/english/res_e/statis_e/its2002_
  e/chp_4_e.pdf

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World Merchandise Trade
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Capital--A Mobile factor

• You may recall from the previous chapters that
• Liquid capital is extremely mobile
• Which makes new locations for manufacturing more
  feasible than before
• Private capital flow has had a tremendous impact
  on location of manufacturing and, hence, trade

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Capital--A Mobile factor

• You may recall that we discussed MNCs in chapter
  8, and their role in moving capital around
• A major type of investment involves equities
  (shares in a company)
• Without managerial control portfolio investment
• Else, direct investment

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Foreign Direct Investment (FDI)

• As we noted in earlier chapters, firms may
  manufacture in more than one country because of
  the bottom line profits
• FDI is equivalent to seeking higher location
  rents
• In this case, location is a country

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Foreign Direct Investment (FDI)

• Three strategies to maximize profits
• Resource
• Cheaper, and productive, raw materials or labor
• Market
• Sell in countries where the good was not sole
  before
• Efficiency
• Seek most economic sources of production

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Foreign Direct Investment (FDI)

• FDI is a drive to find better locations
  throughout the world
• However, this does not mean that capital will be
  efficiently invested based on where profits can
  be maximized
• Why?

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Bias in FDI

• Geographic bias
• Closer to home
• Cultural bias
• Investing in countries with similar cultures
• Historical bias
• Investing in countries with historical ties

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Investment Who and Where

• Figure 10.10 on page 448 shows that
• The US/Western Europe/Japan are major sources of
  FDI
• Investments made in fellow advanced countries and
  lesser developed countries
• Rapidly developing countries such as South Korea,
  Brazil, etc. also invest in other countries

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FDI MNCs

• Multinational corporation (MNC)
• Conducts and controls productive activities in
  many countries
• MNCs are HUGE corporations--employees as well as
  revenue

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Revenues in 1999 (billion )

• GM 161
• Ford 144
• Walmart 139
• Exxon 101
• GE 100
• Fortune 500s 500th Company 3 billion

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GNP in 1997 (billion PPP)

• Bangladesh 129.6
• Denmark 120
• Nigeria 103.5
• Guatemala 43.1
• Kenya 31.2
• Sierra Leone 2.4

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A quick note

• The previous slides on MNC revenues and GNPs are
  only for comparison of numbers
• GNP is a measure of value added
• A country can consume the entire GNP
• But, a company has to meet costs from the
  revenues generated
• Pay for labor, equipment, loans,

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FDI

• As shown in Figure 10.15, California is the
  favored location in the US for FDI

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FDI Good or Bad?

• Most of the criticism goes back to the late 1960s
  and 1970s
• In parallel with the idea that poor countries
  will remain poor unless they unshackle themselves
  from the prevailing economic system
• The dependency theory
• That the rich countries cause underdevelopment

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FDI Good or Bad?

• The economic crisis of the 1980s led to a
  counter-revolution in thinking
• Now, the same countries that threw out MNCs
  serenade them
• Countries have also invariably changed their
  economic approach from import-substituting to
  export-led industrialization
• Encourages FDI

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FDI Good or Bad?

• MNCs also criticized for two approaches in order
  to
• Maximize their profits
• pay less taxes in the host country
• These approaches are
• Transfer pricing
• Tax havens

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Transfer Pricing

• An accounting juggling of numbers in order to
  take advantage of difference in taxation rates
  between countries.
• Components produced in a high tax country
• Sold for loss to another division in a low tax
  country
• Final product sold in low tax country at market
  prices
• Very little paid as taxes on profits

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Tax Havens

• Tax havens are countries where taxes are zero, or
  very low.
• Many times a company may be based in tax havens
  such as the Isle of Man, or Cayman Islands
• Taking advantage of tax havens and transfer
  pricing are legal tax avoidance strategies
• Result poor countries dont get the taxes they
  may depend on

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Tax Havens

• The case of Rupert Murdochs empire
• (Murdoch owns, among others, FOX, Dodgers, )
• Main holding company Newscorp Investments
• Profits for 11 years (until 1999) was 2.1
  billion, it paid no net British corporation tax
• Roughly 800 subsidiaries, including some 60
  incorporated in tax havens

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So, what prevents more FDI?

• If there are better locations around the world,
  are there any barriers?
• Plenty
• Entrepreneurial
• Distance
• government

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Entrepreneurial

• Businesses may not explore other locations
  (countries) because
• They neglect the foreign market
• Lack of knowledge about the opportunities
• Lack of skills
• Inertia (once again!)

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Distance

• While the distance between Los Angeles and Mexico
  City is less than distance between LA and NY,
• Distance can be a major factor
• Such as between Peru and France
• Distance means additional costs
• Transportation and
• Transaction

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Government

• Over time, the entrepreneurial problems have been
  overcome
• Information about foreign markets is readily
  available
• Cultures are becoming global
• For your reading pleasure, go to
• http//www.bostonphoenix.com/archive/books/00/05/2
  5/PICO_IYER.html

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Government

• Governments impede FDI
• Most common is the import tariff
• Tax collected on goods or services that enter a
  country
• Why the tariff?
• Limit imports
• Thereby limit consumption
• Provide revenue for government
• Protect local industries from competition

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Government

• There are non tariff barriers as well
• Import quotas
• Quantitative restrictions on imports by weight,
  volume or value
• For all the same reasons as tariffs, with one
  difference
• No revenue to government

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Government

• Other non tariff barriers
• Geographical quotas
• In textiles, for instance, every country has a
  quota that they can export to the US
• Voluntary export restraints
• Licensing standards, health/safety regulations,
  etc.
• Net result fewer imports

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Effect of Government Barriers

• Consumers pay through higher prices
• Does not promote economic efficiency through
  comparative advantage
• Sometimes hurts the development of poorer
  countries

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A quick note on the WTO

• A forum to settle trade disputes such as tariffs
  and quotas
• Criticized by environmental and labor groups
• What if the exported goods were manufactured
• With high environmental impacts?
• With poor labor conditions
• Hence, the protests in Seattle (remember?)

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Trading Blocs

• Most of the European countries now a part of the
  European Union
• free mobility of capital AND LABOR
• No internal trade barriers
• Common currency (the Euro)
• Macroeconomic requirements (budget deficit as a
  percentage of the GDP, etc.)

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Trading Blocs

• NAFTA is another example
• The latest wave is international corporate
  mergers
• Daimler Chrysler
• Merger of Daimler Benz and Chrysler Motors

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