International Business Exam 2

Cross Boarder Trade

• Dramatic Growth

• Acceleration of value

• Countries Specialize

• Shift in policy

Free Trade

Government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country

Adam Smith’s theory of absolute advantage

A country should produce and sell products that can make it more efficiently in another country

David Ricardo’s theory of comparative adavantage

A country should specialize in producing something it can make at a lower opportunity cost, even if another country is better at producing everything.

• Focuses on differences in productivity

Hecksher - Ohlin theory

Countries should specialize in products that use the resources they have in abundance.

• Focuses on factors of production

The gains from trade

Trade theories explain why international trade is beneficial even for products a country can produce itself, allowing specialization

Limits on imports

are often in interests of domestic producers but not domestic consumers

Vernon’s product life-cycle theory

focuses on production location changes as products become more widely accepted internationally

Krugman’s new trade theory

focuses on first-mover advantages

Mercantilism

advocates government involvement in promoting exports and limiting imports

Smith, Ricardo, and Heckshcher-Ohlin

call for unrestricted free trade

New trade theory and Porter’s national competitive advantage theory

justify limited government intervention for certain expert oriented industries

Flaw

is that it views trade as a zero-sum game, a gain by one country results in a loss by another

Both countries

benefit by engaging and trading

The theory of comparative advantage

suggests that trade is a positive-sum game in which all countries that participate realize economic gains

Extensions of Ricardian Model - Immobile resrouces

• Resources do not always move easily from one economic activity to another

• Political opposition to a free trade regime typically comes from those whose jobs are most at risk

Extensions of the Ricardian Model - Diminishing returns

• Comparative advantage model assumes constant returns to specialization

• More realistic to assume diminishing returns to specialization

• Not all resources are the same quality

• Different goods use resources in different proportions

Extensions of Ricardian Model - Dynamic effects and economic growth

• Free trade can result in two types of dynamic gains

Type 1 of dynamic gain

Increase a country’s stock of resources as increased supplies of labor and capital from abroad become available within the country

Type 2 of dynamic gains

Increase the efficiency with which a country uses its resources

Dynamic gains

in both the stock of a country’s resources and the efficiency with which resources are utilized will cause a country’s PPF to shift outward

Extensions of Ricardian Model - Trade, Jobs, and Wages: The Samuelson critique

• Paul Samuelson

• Lower prices might not make up for lower wages

• Concerned with offshoring service jobs

• Free trade has benefited rich countries

• Introducing protectionist measures

Extensions of Ricardian Model - Evidence for the link between trade and growth

• More open stance toward international trade

• Sachs and Warner crated a measure of how “open” to International trade economy was

• Impact to tariff barriers

Paul Samuelson asks:

What happens when a rich country (U.S) enters into a free trade agreement with a “poor” country (China) that rapidly improves its productivity after the introduction of a free trade regime?

Comparative advantage arises from differences in national factor endowments

Extent to which a country is endowed with resources such as land, labor, and capital

Countries will export goods that make

intensive use of factors that are locally abundant

Countries will import goods that make

intensive use of factors that are locally scarce

The Leontief Paradox

• Raised questions about the validity of the Heckscher - Ohlin theory

• Found that U.S. exports were less capital intensive than U.S imports

Raymond Vernon’s Product Life- Cycle Theory

For the most of twentieth century, new products were development and first sold in the United States - due to wealth and size of the U.S. market and cost- saving process innovations

Limited initial demand

necessitates some exports early in product life cycle

Overtime, demand grows in other countries,

the product becomes standardized, and price becomes the main competitive weapon

Other countries can now produce product at lower costs,

limiting the potential for U.S. exports

Product Life Cycle Theory in the Twenty First Century

Historically accurate, but now seems ethnocentric and increasingly dated

Cost reductions associated with

large scale production

Trade increase the variety of goods available

to consumers and decrease the average cost of those goods

The global market may support only a small number of

enterprises for industries in which the output required to attain economics of scale represents a significant proportion of total world demand

What would happen in a world without trade?

The variety of goods a country can produce and the scale of production are limited by the size of the market, low volumes and higher costs

What happens in a world with trade?

Individual national markets are combined into a larger world market, each nation can increase the variety of goods and lower the costs of those goods

First-mover advantages:

• Economic and strategic advantages accruing to early to enter a market

• Can gain a scale-based cost advantage; later entrants find it almost impossible to match

Nations may benefit from trade

even when they do not differ in resource endowments or technology

A country may predominate in the export of a good simply because

It was lucky enough to have one or more firms among the first to produce that good - may create a barrier to entry

Porter

• Wanted to explain why a nation achieves International success in a particular industry

• Four broad attributes of a nation shape the environment in which local firms compete

The four attributes of a nation shape the environment in which local firms compete

1. Factor endowments

2. Demand conditions

3. Related and supporting industries

4. Firm strategy, structure, and rivalry

Firms are most likely to succeed in industries or industry segments where the diamond is most favorable

• The diamond is a mutually reinforcing system

• Two addition variables can influence the national diamond

Two addition variables can influence the national diamond

Chance and Government

Basic factors of endowments

• Natural resources, climate, location, and demographic

• Can provide an initial advantage

Advanced factors of endowments

• Communication infrastructure, sophisticated and skilled labor, research facilities, and technological know how

• Are a product of investment by individuals, companies, and governments

Firms gain competitive advantage if their domestic consumers are

sophisticated and demanding

Investments in advanced factors of production by

related and supporting industries can help the industry achieve a strong competitive position internationally

Successful industries within a country tend to be grouped into

clusters of related industries; Silicon Valley, Medicon Valley

Different nations are characterized by

different management ideologies, which may or may not help them build national competitive advantage

Strong association between vigorous domestic rivalry and the

creation and persistence of competitive advantage in an industry

Government can influence each component

either positively or negatively

Factor endowments can be affected by

subsidies, policies, toward capital markets, policies toward education, and more

Can shape domestic demand through

local product standards or with regulations

Can influence firm rivalry through

capital market regulation, tax policy, and antitrust laws

Location

from a profit perspective, firms should disperse production to countries where they can be performed most efficiently

First-mover advantages

it pays to invest substantial financial resources in building an early advantage

Government policy

businesses can exert a strong influence on government trade policy

According to Porter,

government should invest in education, infrastructure, and basic research - his theory has not been subjected to detailed empirical testing

Free trade

occurs when governments do not attempt to restrict what citizens can buy from another country or what they can sell to another country

Nations nominally committed to free trade but

intervene to protect interests of politically important groups

Modern international trading system is

base don General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO)

Import Tariffs

• Taxes levied on imports

• Specific tariffs are levied as a fixed charge for each unit of imported good

• Ad valorem tariffs are levied as a proportion of the value of an imported good

• Are paid by the importer

• Governments can increase revenue

• Domestic producers gain protection from foreign competitors

• Comsumers pay more for certain imports

Economic Impact of Tariffs

• Are pro-producer and anti-consumer

• Reduce overall efficiency of the world economy

Export Tariff

is a tax placed on the export of a good

• Goal is to discriminate against in order to ensure that there is sufficient supply of a good within a country

Export ban

is a policy that partially of entirely restricts the export of a good

• Example: 1975 ban on U.S. crude oil exports

Subsidies

Government payment to a domestic producer

1. Cash grants

2. Low-interest loans

3. Tax breaks

4. Government equity participation

Domestic producers gain while

consumers typically absorb

Import quotas

are direct restrictions on quantity of some good that may be imported

Tariff rate quotas

provide a lower tariff rate to imports within the quota than those over the quota

Voluntary export restraint (VER)

is a quota on trade imposed by the exporting country

Quota rent

refers to the extra profit producers make when supply is artificially limited by an import quota

Local Content Requirements (LCR)

• Some fraction of a good must be produced locally

• Expressed in either physical or value terms

• Protects domestic producers

• Consumers face higher prices

Administrative Policies

• Bureaucratic rules designed to make it difficult for imports to enter a country

• Hurt consumers by limiting choice

Dumping

occurs when companies sell goods in a foreign market at below their costs of production or below their “fair” market value - a way to unload excess production

Antidumping policies

punish foreign firms that engage in dumping, protecting domestic producers from unfair foreign competition - also know as countervailing duties

Protecting jobs and industries

• Most common political argument for government intervention

• Critics say claims of unfair competition are over stated for political reasons

Protecting national security

• Certain industries, like defense-related ones, must be protected. EU looking at US credit card alternatives etc.

• In 2017, the United States was importing about 30 percent of steel used in the country, with the largest sources of imports being Canada and Mexico

Retaliating

• Government should use threat of intervention as bargaining tool to open foreign markets

• May liberalize trade and result in economic gains

• Risky strategy

Protecting consumers:

• Protect from unsafe products

• Indirect effect is to limit or ban imports

Furthering foreign policy objectives

• Government may grant preferential trade terms to a country where it wants to build strong relations

• Trade policy can be used to punish “rogue states”

Protecting human rights

government trade policy used to improve human rights policies of trading partners

• Example: apartheid in South Africa

The infant industry argument

• Governments should temporarily support new industries EVs + until they have grown strong enough to meet international competition

• Support comes through tariffs, import quotas, and subsides

Two criticisms of infant industry argument

• Protection of manufacturing from foreign competition does no good unless it helps make the industry efficient

• Assumes firms are unable to make efficient long-term investments by borrowing money from the domestic or international capital market

Strategic Trade Policy

• Government can help raise national income when a domestic firm gains first-mover advantages

• Might pay for a government to intervene in an industry by helping domestic firms overcome the barriers to entry created by foreign firms that have already reaped first mover advantage

• Both arguments support government intervention in international trade

Krugman

argues the strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry boost national income at the expense of other countries

• will probably provoke retaliation

• help establish antidumping policies and rules that minimize trade-distorting subsidies

Domestic policies

• Governments don’t always act in the national interest

• Political interest groups may influence policy

• Krugman concludes that strategic trade policy is almost certain to be captured by special-interest groups, which will distort it to their own ends

Smoot-Hawley Act created a wall of

tariff barriers against imports into the United States → U.S. exports tumbled in response and world slid further into the Great Depression

Following the Great Depression

United States embraced free trade

GATT was a multilateral agreement

designed to liberlize trade by eliminating tariffs, subsidies, import quotas, and so on

• Tariff reduction was spread over eight rounds with great success

Three reasons for increased protectionism

• Japans perceived protectionist (neo-mercantilist) policies crated intense political pressures in other countries

• Trade deficits → unemployment

• non-tariff barriers → increased VERs

Uruguay Round sought to

• Extend GATT rules to cover trade in services

• Develop rules on intellectual property

• Reduce agricultural subsides

• Strengthen GATT’s monitoring and enforcement mechanism

The Uruguay Round and the WTO

• Encompasses GATT and two other groups:

• General Agreement on Trade in Services (GATS).

• Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).

WTO: Experience to Date

• By 2024, 164 members accounting for 98 % of world trade.

• Strong early start, but since late 1990s unable to get agreements to further reduce barriers.

• Limited protectionism returned following global financial crisis of 2008 - 2009.

• The Brexit vote and election of Donald Trump also suggest a move toward greater protectionism.

WTO as global police:

• Enforcement mechanisms appear to be having a positive effect.

• Countries involved have mostly adopted WTO’s recommendations.

Expanded Trade Agreements

• Global telecommunication and financial services industries.

• Foreign direct investment.

WTO: Unresolved Issues

1. The rise of anti-dumping policies.

2. The high level of protectionism in agriculture.

3. The lack of strong protection for intellectual property rights in many nations.

4. Continued high tariffs on nonagricultural goods and services in many nations.

WTO Antidumping actions

• Vague definition of what constitutes “dumping”; many countries exploiting loophole.

• Concentrated in certain sectors: metal industries, chemicals, plastics, and machinery and electrical equipment.

• WTO pushing members to strengthen regulations governing antidumping duties.

WTO Protection of intellectual Property

• TRIPS agreement obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years.

• Inadequate protections would reduce the incentive for innovation, resulting in less economic growth.