International Trade, FDI & Regional Integration – Bullet-Point Exam Notes

Exam 2 Master Review Topics

• Comprehensive list provided by Prof. Rowe (p. 1) – be sure you can define, apply, and inter-relate every term below:

  • Greenfield investment vs. Mergers & Acquisitions (M&A)

  • Adam Smith: ‘‘The Wealth of Nations’’

  • EU treaties: Treaty of Rome, Maastricht, Lisbon

  • FDI vs. Portfolio Investment; Ownership Restrictions; Performance Demands

  • Dumping, Quota Rent, Trade Barriers & Firm Strategy

  • Porter’s Diamond Model; New Trade Theory; Mercantilism; Absolute vs. Comparative Advantage (Smith & Ricardo)

  • Tariff types: Ad Valorem, Specific, Compound duties

  • TRIPS; WTO; Uruguay Round; Doha; Leontief Paradox

  • Regional trade agreements: NAFTA, MERCOSUR, EU (incl. the €), levels of integration

  • Infant-industry argument; ‘‘protecting jobs’’ rhetoric; import quotas

Module 5 – Classical & Modern Trade Theory

Free Trade Basics

• Free trade = no government interference (quotas/duties) with what citizens buy/sell abroad.

• Benefits (Smith, Ricardo, Heckscher-Ohlin): specialization according to efficiency, import the rest.

Smith – Absolute Advantage

• A nation has absolute advantage if it can produce a good with fewer resources than any other nation.

• Policy prescription: specialize where absolute advantage exists; trade the surplus.

Ricardo – Comparative Advantage

• Even if a country has absolute advantage in all goods, mutual gains arise when each specializes in the good with lowest opportunity cost.

• Simple 2×2 model assumptions: 2 countries, 2 goods, $\text{zero}\;TC$, constant returns, mobile factors domestically, etc.

• Gains from Trade: positive-sum, welfare-increasing.

Qualifications & Extensions

• Immobile resources ⇒ adjustment costs, structural unemployment.

• Diminishing returns ⇒ PPF bowed outward; marginal opportunity cost ↑.

• Dynamic effects: trade ↑ resource stock & efficiency; can shift PPF outward.

• Samuelson critique: offshoring may lower rich-country wages; dynamic gains can be negative.

• Empirics: open economies grow faster.

Heckscher-Ohlin (H-O)

• CA determined by factor endowments (land, labor, capital). Export goods using abundant factors.

• Leontief Paradox: U.S. (capital-abundant) exported labor-intensive goods ⇒ technology differences matter.

Product Life-Cycle (Vernon)

• Innovation in home market → export → foreign production in other adv. countries → shift to low-cost developing countries.

• Less predictive today due to simultaneity of launch & global production networks.

New Trade Theory

• Economies of scale & first-mover advantages (FMA) create trade even when endowments equal.

• Implications: limited number of global firms; potential role for strategic trade policy.

Porter’s Diamond – National Competitive Advantage

1. Factor endowments (basic & advanced)

2. Demand conditions (sophisticated home demand)

3. Related & supporting industries (clusters)

4. Firm strategy, structure & rivalry (domestic competition)

• Government & chance act on all four.

Managerial Implications (Location ‑ FMA ‑ Policy)

• Disperse activities to nations with CA; lobby for supportive trade policy.

Module 6 – Trade Policy Instruments & Rationale

Seven Main Instruments

1. Tariffs

   • Specific $T_s = a$ per unit

   • Ad Valorem $T_{av}=b\times \text{value}$

   • Compound $T_c = a + b\times V$

2. Subsidies (export, production, R&D)

3. Import Quotas / Tariff-Rate Quotas; Voluntary Export Restraints (VER)

   • Generate Quota Rent $\text{QR} = (P<em>q - P</em>w)\times Q_{import}$

4. Local Content Requirements (LCR)

5. Administrative Policies (red-tape discrimination)

6. Anti-Dumping duties (Countervailing Duties)

7. Technical standards / Safety rules (can be hidden barriers)

Political Arguments

• Protecting jobs & industries; National security; Retaliation leverage; Consumer protection (e.g., EU beef-hormone case); Foreign-policy goals; Human-rights concerns.

Economic Arguments

• Infant-industry protection $\text{LRAC}\downarrow \text{with time}$; Strategic trade policy (capture FMA & economies of scale).

Revised Case for Free Trade (Krugman)

• Retaliation risk → trade wars.

• Policy capture by special interests.

Evolution of Global Trading System

• 1947 GATT → tariff cuts (Rounds: Kennedy, Tokyo, Uruguay).

• 1995 WTO = GATT + GATS + TRIPS; binding dispute-settlement.

• Key unresolved issues: Anti-dumping proliferation; Agri-protection; IPR enforcement; Non-agricultural tariff peaks.

• Doha Round agenda: agriculture, services, investment, antidumping discipline – stalled.

Module 7 – Foreign Direct Investment (FDI)

Definitions & Forms

• FDI = ownership ≥10 % in foreign entity.

• Greenfield investment: new subsidiary.

• Cross-Border M&A: minority (10-49 %), majority (50-99 %), full (100 %).

• Flow vs. Stock; Inflows vs. Outflows.

Global Trends

• FDI growth > trade > GDP due to: protectionism fear; liberalization in developing world; strategic location presence.

• Direction: Historically to developed nations; surge into China & SE Asia; Latin-America rising.

• Source countries: $US, UK, NL, FR, DE, JP$ ≈ 56 % of outflows (1998-2006).

• Shift toward services (finance, telecom, retail) due to liberalization & technology.

Theories Explaining FDI Choice

1. Market imperfections / Internalization

   • Exporting limited by $TC_{transport}$ & barriers.

   • Licensing drawbacks: knowledge leakage, control loss, non-codifiable capabilities.

2. Knickerbocker (Oligopolistic rivalry) & Multipoint competition.

3. Product Life-Cycle extension: FDI at maturity stage to cut costs.

4. Eclectic Paradigm (Dunning OLI)

   • Ownership advantages (O)

   • Location advantages (L)

   • Internalization advantages (I)

Ideological Views of FDI

• Radical (Marxist) → retreat post-1980s.

• Free-Market → comparative advantage logic.

• Pragmatic Nationalism → weigh costs/benefits case-by-case.

Host-Country Effects

• Resource-transfer (capital, tech, management)

• Employment creation (direct + spillover)

• BoP current-account improvement (import-substitution & exports)

• Competition & growth stimulus
  − Competition may crush local firms
  − BoP outflows (profit repatriation; import of inputs)
  − Loss of sovereignty/autonomy

Home-Country Effects

• Inward earnings improve BoP

• Exports of capital goods, intermediate inputs

• Learning transfers home
  − BoP: initial capital outflow; possible negative current account if FDI is substitution for exports
  − Employment losses in home production (offset if HQ, design jobs stay)

Policy Instruments toward FDI

• Home: insurance, tax incentives, financing → encourage; capital controls, double taxation → restrict.

• Host: incentives (tax holidays, grants); restrictions (ownership caps, performance reqs, screening).

• WTO increasing coverage (TRIMs, TRIPS) but no full multilateral FDI code yet.

Module 8 – Regional Economic Integration

Levels (from low → high)

1. Free Trade Area (FTA) – remove internal tariffs (EFTA, NAFTA)

2. Customs Union – FTA + common external tariff (Andean Community)

3. Common Market – CU + free factor movement (MERCOSUR goal)

4. Economic Union – CM + harmonized policy & common currency (EU)

5. Political Union – one government (USA; EU partial)

Economic Case

• Larger market, scale economies, specialization ⇒ $\text{Welfare}\uparrow$

Political Case

• Reduced conflict; greater collective bargaining power.

Potential Costs

• Trade diversion vs. trade creation.

• Loss of national sovereignty.

European Union (EU)

• Origins: 1951 ECSC → 1957 Treaty of Rome (EEC) → Single European Act 1987 → Maastricht 1992 → enlargements (now 27 members).

• Institutions:

  • European Commission (exec, proposes law, monitors)

  • Council of the EU (co-legislator, member-state ministers)

  • European Parliament (co-legislator, citizens)

  • Court of Justice (supreme court)

• Treaty of Lisbon (2009) ↑ Parliament power, creates President of Council, foreign policy chief.

Single Market & SEA 1992 Measures

• Remove frontier controls; mutual recognition; open procurement; services & capital liberalization; trucking cabotage.

The Euro (€)

• Maastricht convergence criteria; launched 1999 (book); coins/notes 2002; 19 countries today use €.

• Benefits: price transparency, elimination of FX costs, competitive pressure, deep capital markets, $\sigma_{\text{rates}}\downarrow$

• Costs: loss of monetary policy; euro-zone not optimal currency area (asymmetric shocks).

EU Enlargement (2004, 2007, 2013…)

• Added CEE states + Cyprus/Malta; potential accession: Western Balkans, Turkey (controversial).

NAFTA

• Entered 1994; eliminates $99\%$ of tariffs by 2004; FDI liberalization; IPR protection; side commissions on labor & environment.

• Results: modest trade & job effects; intra-industry expansion; political stability in MX.

• Ongoing issues: trucking, rules of origin, renegotiation (USMCA 2020 not on exam but context).

Other American Blocs

• Andean Community (customs union); MERCOSUR (CU, aiming CM; members: BR, AR, UY, PY, VE – latter suspended).

• CAFTA-DR (US + Central America + Dom. Rep.)

• CARICOM → CSME.

• Proposed FTAA (34 nations) stalled – agriculture vs. IPR disputes.

Asia & Africa

• ASEAN + AFTA → goal common market by 2025.

• APEC (21 economies) – forum, not binding.

• Numerous African blocs (ECOWAS, EAC, SADC, COMESA) – limited progress; AU vision of continental FTA.

Managerial Implications of Blocs

Opportunities

• Larger, tariff-free regional markets ⇒ scale production, rationalize plants, standardize product.

• Location: site production in lowest-cost member; exploit rules of origin.
  Threats

• ↑ Competition inside bloc.

• Non-members risk trade diversion (‘‘fortress’’ effect).

• Regulatory intervention (e.g., EU merger control) can constrain strategy.

Additional Key Terms & Concepts (Cross-Module)

• Greenfield vs. Brownfield (acquisition) FDI implications for control, speed, culture fit.

• TRIPS – minimum 20-year patents, 50-year copyright.

• Quota Rent formula above; can accrue to import licensees or foreign exporters in VER.

• Tariff revenue identity: $R = T\times Q_{import}$

• Balance-of-Payments structure: $\text{BOP}=\text{Current Account}+\text{Capital Account}+\text{Financial Account}=0$

• Dumping test under WTO: export price < $\min(\text{home mkt price}, \text{AVC}+\text{FC share})$.

• Strategic Trade Policy prerequisite: industry must exhibit $\text{economies of scale}$ & $\text{FMA}$.

• Porter Cluster externalities: knowledge spillovers $\Rightarrow$ productivity <> $f(distance)$ (inverse).