ECIS591: Lecture 1

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ECIS591 Lecture 1

• Fundamentals of International Business

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Theory of International Trade

• Evolution of international trade based on
• Collapse of feudal system (autarky)
• Emergence of a mercantile philosophy
• National expansion requires wealth (gold) to
  control colonies, support armies, maintain power
• A simple plan
• Promote exports, discourage exports, get paid in
  gold
• Age of mercantilism

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Decline of mercantilism

• Inevitable
• Industrial revolution introduced advantages of
  mass production
• Exploitation of colonies stopped
• Trade originated in the need for governments to
  control
• Todays international trade still significantly
  involves governmental bodies

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Evolution of International Trade Theory

• Adam Smith (1776)
• Wealth of Nations
• Two main contributions
• Absolute advantage
• Division of labor

Theory of Absolute Advantage
Each country should specialize in production and
export of that good it produces most efficiently
(least labor hours
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Theory of Absolute Advantage

• Absolute advantage
• Some countries produce same products with fewer
  labor hours
• Due to
• Worker skills
• Natural resources
• Other factors

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Valuable, but what about

• Smiths theory suggests each country specializes
  in a particular product (for which it has
  absolute advantage)
• More produced for less
• If a country had no absolute advantage could it
  play the game? Could it trade?

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Evolution of International Trade Theory

• David Ricardo (1819)
• On the Principles of Political Economy and
  Taxation
• Countries cannot be equally good at producing two
  products

Theory of Comparative Advantage
Even if a country is efficient at producing two
goods, it must be relatively more efficient in
producing one of them. Should make that one and
import the other
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Classical Trade Theory

• Smiths and Ricardos work considered Classical
  Trade Theories
• Left us with some key concepts
• Division of labor
• Comparative Advantage
• Gains from trading (nations can actually consume
  more than they produce through free trade)

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Evolution of International Trade Theory

• Heckscher-Ohlin
• Two factors of production labor, capital
• Different products need different proportions of
  the two factors
• Technology determine these proportions
• Cost of production determined by cost of factors
  (assume no labor or capital movement)

Theory of Factor Proportions
Countries that are relatively labor (capital)
abundant should specialize in the production and
export of products that are labor (capital)
intensive
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Evolution of International Trade Theory

• Wassily Leontief (1950)
• Developed input-output analysis methodology
• Found US was exporting labor-intensive products
• Factor Proportion Theory predicts the opposite
• Plenty of arguments

The Leontief Paradox
Test of factor proportion theory which resulted
in the unexpected finding that the US was
actually exporting labor-intensive products
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Evolution of International Trade Theory

• Staffan Linder
• Based on consumer preferences for products
• As per capita income increases, complexity,
  quality and diversity of product demands increase
• Countries of similar income levels have
  overlapping product ranges
• Entrepreneurs would find it difficult o service
  dissimilar countries

Linders Overlapping Product Ranges
Countries of similar income levels (per capita)
will trade most intensively with one another due
to overlapping product demands
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Evolution of International Trade Theory

• Raymond Vernon (1966)
• Two technology-based premises
• Technical innovation is capital-intensive found
  in industrialized countries
• The innovation goes through stages of maturation
  become low-skill and shift across countries
• Emphasizes technologys impact on production

Product Cycle Theory
Countries with comparative advantage change over
time as the product technology matures
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Evolution of International Trade Theory

• Michael Porter
• Nations competitive advantage based on
• Factor conditions
• Demand conditions
• Related and supporting industries
• Firm strategy, structure and rivalry

Competitive Advantage of Nations
A countrys competitiveness depends on its
ability to innovate this comes from having
strong domestic competition and demanding local
customers
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Porters Diamond of National Advantage
Firm strategy, structure and rivalry
Factor conditions
Demand conditions
Supporting Industries
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But, what about barriers to trade between
countries?

• Trade is between a company and a buyer (not
  between countries)
• Not always possible to simply manufacture and
  export from home country
• Consider
• Sales are restricted due to tariffs on imports
• Product requires natural resources available in
  only some countries
• Competition forces you to produce where it is
  cheaper

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Foreign Direct Investment

• Traditional theories assume immobility of capital
• Not true today movement of capital has allowed
  FDI across the globe
• If there is competitive advantage to be obtained,
  the capital can get there

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The FDI Decision Sequence
The Firm and its Competitive Advantage
Change CA
Exploit CA from abroad
Production at home
Production abroad
Licensing
Control Assets
IJV
Wholly-Owned Affiliate
Greenfield
Acquire foreign unit
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Why do firms go beyond licensing and exporting?

• Firms as Seekers
• Firms as Exploiters of Imperfections
• Firms as Internalizers

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Firms as Seekers

• In the 18th and 19th centuries, firms were
  seeking valuable natural resources of other
  countries
• Now
• Natural resources
• Low-cost labor
• Knowledge
• Political stability
• Markets

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Firms as Exploiters of Imperfections

• Not a perfect market (supply and demand)
• Government interference leads to imperfections
• Aim to support and protect domestic industries
• Multinationals invest locally to sidestep these
  restrictions

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Firms as Internalizers

• Cannot firms achieve competitive advantage
  through licensing?
• Sometimes, core of business is the proprietary
  knowledge of the production process (Coca Cola,
  for example)
• Internalization is better than an arms-length
  management in such situations

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Free trade is nice in theory, but

• Theory is one thing welcome to the real world
• All countries place trade restrictions
• The extent of the interference varies from
  country to country
• Interference manifests itself in two forms
• Tariffs
• Non-tariff barriers to trade

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Tariff barriers to trade

• Tax levied on a good when it crosses the boundary
  of a customs area
• Country boundary
• Group of nations boundary
• Also referred to as duties
• Broken down into two types
• Protective tariffs
• Revenue tariffs

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Tariffs contd.

• May be based on the physical quantity (per ton,
  per yard, etc.) called a specific tariff
• May be based on value of the import called ad
  valorem tariffs
• May be differentially applied depending on
  products country of origin

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Non-tariff barriers

• Voluntary Export Restraints (VERs)
• Japanese cars (Italy 1992)
• Non-human dolls (EU 1994) yes to Kirk, no to
  Spock
• Quotas
• Quantitative restriction on number of units
  imported usually applied through import license
  requirements

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Why place such restrictions?

• Revenue
• Infant-industry argument
• Environmental concerns (Mexican tuna)
• Competition from low-wage countries
• National security and defense

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Trade Agreements

• May be bilateral or multilateral
• Bilateral Agreements
• Reciprocity
• MFN Status
• Multilateral
• GATT
• OECD

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General Agreement on Tariffs and Trade (GATT)

• Multilateral agreement that acts charter for most
  countries of the world (except most communist
  countries)
• Signed in Geneva Oct. 1947 23 countries which
  accounted for 4/5ths of world trade
• Has gone through a number of rounds
  Kennedy(1964-67), Tokyo(1973-79), Uruguay (1986-?)

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Main GATT Principles

• No trade discrimination (MFN status for all
  members)
• Free trade groupings are acceptable as long as
  third countries do not face discrimination
• Many, many exception clauses

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Organization for Economic Cooperation and
Development (OECD)

• Originally formed by European nations in response
  to US offer of economic aid (post WWII)
• Did much to improve trade within Europe
• Expanded in 1960s and 70s to include USA, Canada,
  Japan, Australia, New Zealand

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Goals of OECD

• Promote economic growth of member nations
• Contribute to growth of lesser developed
  countries
• Foster conditions for world trade

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Economic Integration

• Takes many forms
• Free Trade Association
• No duty on imports from member states.. Each
  member may charge different duties to non-members
  (EFTA)
• Customs Union
• All member states agree to charge same duties on
  non-member imports

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Economic Integration contd.

• Common Market
• Extends the Customs Union concept to include free
  flow of labor/capital between member states
• Economic Union
• Common market members agree to harmonize economic
  policies
• Total Economic Integration

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European Union

• Most nations in Western Europe
• Works toward economic and political integration
• Also covers unified action in security, foreign
  affairs, and police matters
• Common currency

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Other Regional Groups

• Central American Common Market (El Salvador,
  Guatemala, Nicaragua, Costa Rica)
• The Latin American Integration Association (11
  countries)
• Andean Group is a sub group of LAIA
• The Caribbean Community and Common Market
  (CARICOM)

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Types of global enterprises

• International
• Global
• Multinational
• Transnational

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The International Strategy

• Subsidiaries leverage parent competencies
• Coordinated federation

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Global

• RD, manufacturing done at HQ
• Strategic decisions are centralized
• Central hub

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Multinational

• Multidomestic
• Aims at local responsiveness
• Knowledge developed/retained at subsidiary level
• Decentralized federation

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Transnational

• Shared decision-making
• Complex coordination
• Centers of excellence
• Dispersed resources
• Integrated network