L6 - International Trade Theories

What are the classical international trade theories?

• Mercantilism

• Absolute advantage (Adam Smith)

• Comparative advantage (David Ricardo)

(16th - 19th Century)

What are the neo-classical international trade theories?

• Hecksher-Ohlin Theory (Factor endowment)

(Early 20th Century)

What are the modern/contemporary international trade theories?

• Product lifecycle theory (Vernon)

• New trade theory (Krugman)

• National competitiveness/Porter’s diamond model

(Late 20th century - present)

What is a comparative advantage?

An economic principle stating that a country, business, or individual can produce a good or service at a lower opportunity cost than its competitors, typically due to an abundance in a country of:

• Natural resources

• Land

• Climate

• Skilled labour

What is a competitive advantage?

The unique set of assets, capabilities, or conditions that allows a company to outperform its rivals, typically arising from a firm’s abundance of:

• Specific knowledge

• Capabilities

• Superior strategies

What is mercantilism?

• An economic theory practiced from the 16th to 18th centuries, designed to maximise a nation’s wealth by exporting more than it was importing, and accumulaiting preciaous metals such as silver and gold

What is Adam Smith’s theory of an absolute advantage?

• A country should only produce products in which it has an absolute advantage or can produce using fewer resources than any other country, by leveraging each other’s aboslute advantage, output and consumption both increase

• This theory challenged mercantilism

What is the comparative advantage theory?

• Countries should specialise in producing goods for which they have the lowest opportunity cost, rather than those they can produce the most efficiently

• Comparative advantage focuses on who sacrifices the least of another good to produce

What is the Heckscher-Ohlin (Factor endowment) theory?

• A country's natural abundance of economic resources dictates its role in international trade

• A country will export goods that make intensive use of the factors it has in abundance, and it will import goods that make intensive use of factors that are scarce domestically

What are some evaluations of the Hecksher-Ohlin theory?

What are some evaluations of classical theories?

• Absolute Advantage and Comparative Advantage are the bedrock of international economics

• They successfully debunked the mercantilist view and proved instead that free trade could allow all participating nations to consume more than they could produce in isolation

• The theories are based on some unrealistic assumptions:

  • Zero transportation costs

  • Perfectly free trade

  • Full emplloyment of FoP

• Ignores the distribution of income and wealth

What are the contemporary international trade theories?

• The Product Life Cycle theory (Vernon, 1960s)

• New trade theory (Krugman, 1970s-80s)

• Michael Porter’s diamond model (1990)

What is the Product Life Cycle theory?

• Each production and manufacturing technologies go through three stages of revolution

• Introduction → Maturity → Standardisation

Explain each stage of the Product Life Cycle theory

Introduction: Monopoly in manufacturing and exporting

Maturity: Competition and the end of monopoly, focus from innovation to efficiency

Standardised stage: Production knowledge widely spread, production shifts to low-cost locations, exportes from developing to developed countries

What are some evaluation points for the PLC theory?

• Extreme ethnocentrism: The theory assumes all new, innovative products are developed and launchesd in the US because of its unique high-income consumer base and large pool of talent

• Vernon assumed a product must be born, tested, and matured in its domestic market before it ever crosses a border, however, global supply chains are highly fragmented

What is Krugman’s new trade theory? (1970s-1980s)

• Explains why similar industrialised countries trade similar goods with one another, the core concepts are:

• Economies of Scale: As production increases, average cost per unit decreases

• Intra-Industry Trade: Countries with similar economies, labour, and technology trade identical or similar product categories

• First-Mover Advantage: The first company or nation to establish mass production in an industry locks in lower cost and network effects, making it hard for new competitors to enter

What is Michael Porter’s diamond model? (1990)

• Nations trade because they develop competitive advantages: through innovation, clusters, and strong domestic environments

What do factor conditions represent in PDM?

Porter argued that created factors such as educationn and advanced institutes are far more important than basic inherited factors

What do demand condtitions represent in PDM?

The nature of home-market’s demand for the industry’s product or service, if local consumers are demaning, firms are forced to innovate, this company is typically well equipped to dominate globally

What do relating and supporting industries represent in PDM?

An industry rarely succeeds in isolation, successful industries typically require the presence of capable, competitive suppler industries and related industries within the same nation. The proximity allows for rapid innovation, cost-effective supply chains, and the sharing of technology

What do firm strategy, structure, and rivalry represent in PDM?

Dictates how companies are created, organised, and managed, as well as the nature of domestic rivalry

- Intense domestic competition is the most powerful driver of global success, when companies fight in a domestic market, they are forced to lower cost, improve quality, and innovate, making them good competitors when they expand internationally

What do Governments represent in PDM?

• Government: A catalyst and challenger, its role is to encourage industries to raise theur performance by stimulating early demand, enforcing strict standards, or investing in specialised education

What does Chance represent in PDM?

• Unpredictable events (Wars, Major technoloigcal breakthroughs, Sudden market shifts) can disrupt the status quo, allowing new nations and firms to alter their competitive positions

What are some strengths of Porter’s Diamond Model?

• Provides a comprhensive explanation for why a nation achieves international success in a specific industry
  
  

• Demonstrates that competitive advantage is driven by the interaction of four determinants, rather than relying merely on natural resources of labour costs

What are some weaknesses of Porter’s Diamond Model?

• Global Value Chains (GVC): A firm’s competitive advantage today, often stems from the combined resources and capabilities of multiple countries, rather than a single domestic diamond

• MNEs: Modern global firms can operate independently of their home country’s diamond

• Digitalisation: Digital industries and assets are not confined to the borders of one specific country

What are some geopolitical factors affecting global business?

Trade

Tarifts

Domestic industrial policies

Domestic environmental, labor, and immigration policies

Export, import, and capital controls

Foreign-investment restrictions

Sanctions

Technology, data, intellectual property, and cyber controls

What is the nature and general rationale for government intervention?

Nature

• Based on protectionism, it alters the competitive landscape by hindering or helping the ability of firms to compete internationally
  
  

Rationale

• Government revenue

• Ensuring safety, security, and welfare

• Economic, Political, Social objectives

• Interests of domestic firms and industries

What are some Instruments of government intervention

• Tariffs

• Quotas

• Local content requirements

• Regulations and standards

• Subsidies

What are the consequences of protectionist government intervention?

• Reduced supply of goods and varieties to buyers

• Price inflation:

  • Import tariffs are in effect a tax on consumers

• Reduced industrial competitveness by protecting inefficient firms