International Trade and Factor-Mobility Theory Notes

International Business Environments & Operations

Chapter 5: International Trade and Factor-Mobility Theory

Learning Objectives:
  • Understand different approaches to international trade theories and how they help policymakers achieve economic objectives.
  • Comprehend the historical and current rationale for interventionist trade theories.
  • Explain how free trade improves global efficiency.
  • Distinguish factors affecting national trade patterns.
  • Recognize why a country’s export capabilities are dynamic.
  • Detect why production factors, especially labor and capital, move internationally.
  • Describe the relationship between foreign trade and international factor mobility.
  • Grasp scenarios of possible changes in trade patterns.

Laissez-Faire vs. Intervention

Trade Theory Helps Answer:
  • What products should we import and export?
  • How much should we trade?
  • With whom should we trade?
Laissez-faire Approach:
  • Free trade theories: absolute advantage and comparative advantage
Intervention Approach:
  • Mercantilism and neomercantilism

International Operations and Economic Connections

Country A and Country B Interact Through:
  • Importing and exporting goods and services (trade)
  • Transferring production factors, such as labor and capital, internationally

Trade Theories and Business

  • A checklist of what major trade theories do and don’t discuss.

Factor Mobility Theory

A Country’s Competitiveness Depends On:
  • Quality and quantity of production factors
    • Land
    • Labor
    • Capital

Interventionist Theories

Theories That Support Government Intervention in the Flow of Trade:
  • Mercantilism
  • Neomercantilism

Mercantilism - Neomercantilism

Mercantilism:
  • Countries should export more than they import.
  • Maintain a favorable balance of trade (trade surplus).
  • Avoid an unfavorable balance of trade (trade deficit).
Neomercantilism:
  • Run an export surplus to achieve social or political objectives.

Mercantilism - Neomercantilism

Adam Smith's Critique:
  • The Wealth of Nations attacked mercantilism, a system of nationalistic economics dominating economic thought in the 1700s.
  • Smith disproved the belief that trade was a zero-sum game where one nation's gain is another's loss.
  • Voluntary exchange (trade) is a positive-sum game where both nations gain.

Free Trade Theories

Two Theories That Support Free Trade:
  • Absolute advantage theory
  • Comparative advantage theory
Market Forces Should Determine Trade:
  • Specialization
  • Absolute productivity advantage: A country has a higher labor productivity. If each country has an absolute productivity advantage in one of the goods, both benefit by specializing in that good and trading it for the other good.

Theory of Absolute Advantage

Theory of Absolute Advantage:
  • Different countries produce some goods more efficiently than others.
Free Trade Brings:
  • Specialization
    • Natural advantage
    • Acquired advantage
      • Product technology
      • Process technology
  • Greater efficiency
  • Higher global output

Theory of Absolute Advantage: Production Possibilities

Assumptions for Costa Rica:
  1. 100 units of resources available
  2. 10 units to produce a ton of wheat
  3. 4 units to produce a ton of coffee
  4. Uses half of total resources per product when there is no foreign trade
Assumptions for United States:
  1. 100 units of resources available
  2. 5 units to produce a ton of wheat
  3. 20 units to produce a ton of coffee
  4. Uses half of total resources per product when there is no foreign trade
Production Example:
  • Without Trade:
    • Costa Rica (point A): 12.5 tons coffee, 5 tons wheat
    • United States (point B): 2.5 tons coffee, 10 tons wheat
    • Total: 15 tons coffee, 15 tons wheat
  • With Trade:
    • Costa Rica (point C): 25 tons coffee, 0 tons wheat
    • United States (point D): 0 tons coffee, 20 tons wheat
    • Total: 25 tons coffee, 20 tons wheat

Theory of Comparative Advantage

Theory of Comparative Advantage:
  • Free trade can increase global output even if one country has an absolute advantage in the production of all products.
  • Comparative productivity advantage: A country’s opportunity costs of producing a good are lower than those of its trading partners. The concept is based on the idea that nations maximize their material well-being when they use their resources where they have their highest value. Consider
    • comparative advantage
    • absolute disadvantage

Theories of Specialization: Assumptions and Limitations

Theories of Specialization Make Assumptions That May Not Be Valid:
  • Full employment
  • Economic efficiency
  • Division of gains
  • Transport costs
  • Statics and dynamics
  • Mobility

How Much Does a Country Trade?

Theory of Country Size:
  • Large countries depend less on trade than small countries.
Large Countries Usually:
  • Export a smaller portion of output and import a smaller part of consumption.
  • Have higher transportation costs for foreign trade.

Imports and Exports as a Percentage of GDP in Various Countries in 2001

  • Figure 1-1 shows a comparison of imports and exports as a percentage of GDP for various countries in 2001, including:
    • U.S.
    • Japan
    • Australia
    • U.K.
    • Mexico
    • Korea
    • Netherlands
    • Belgium

What Types of Products Does a Country Trade?

Factor Proportions (Factor Endowment) Theory:
  • Factors in relative abundance are cheaper than factors that are relatively scarce.
  • Countries should focus on producing with abundant factors.
  • If labor is abundant, produce labor-intensive products.
Process Technology:
  • Capital versus labor.

Worldwide Trade by Major Sectors

Percentage of Trade by Sector (1980, 1990, 2000, 2011):
  • Commercial services
  • Agricultural products
  • Fuels and mining products
  • Manufactured products

With Whom Do Countries Trade?

Gravity Theory:
  • Size, distance, similarity, openness.
Country Similarity Theory:
  • Most trade occurs among developed countries.
    • Share similar market characteristics.
    • Produce and consume much more than developing countries.
Trading Partners Are Affected By:
  • Cultural similarity
  • Political relations between countries
  • Distance

Product Life Cycle Theory

The Product Life Cycle Theory:
  • The production location of certain manufactured products shifts as they go through their life cycle.
Four Stages:
  1. Introduction
  2. Growth
  3. Maturity
  4. Decline

Life Cycle of the International Product

During Its Life Cycle, Focus On a Product's Production and Market Locations Often Shifts From Industrial to Developing Markets.
  • The process is accompanied by changes in the competitive factors affecting both production and sales, as well as in the technology used to produce the product.
Life Cycle Stage Details:
  • Introduction:
    • Production: Innovating (usually industrial) country.
    • Market: Mainly in innovating country, with some exports.
    • Competitive Factors: Near-monopoly position; Sales based on uniqueness rather than price.
    • Production Technology: Evolving product characteristics; Short production runs; Evolving methods to coincide with product evolution; High labor input and labor skills relative to capital input.
  • Growth:
    • Production: In innovating and other industrial countries.
    • Market: Mainly in industrial countries; Shift in export markets as foreign production replaces exports in some markets; Fast-growing demand.
    • Competitive Factors: Number of competitors increases; Some competitors begin price cutting.
    • Production Technology: Product becoming more standardized; Capital input increases; Methods more standardized.
  • Maturity:
    • Production: Multiple countries; Growth in developing countries; Some decrease in industrial countries; Overall stabilized demand.
    • Market: Overall stabilized demand.
    • Competitive Factors: Number of competitors decreases; Price is very important, especially in developing countries.
    • Production Technology: Long production runs using high capital inputs; Highly standardized; Less labor skill needed.
  • Decline:
    • Production: Mainly in developing countries.
    • Market: Mainly in developing countries; Some developing country exports; Overall declining demand.
    • Competitive Factors: Price is key weapon; Number of producers continues to decline.
    • Production Technology: Unskilled labor on mechanized long production runs.

Diamond of National Advantage

The Diamond of National Advantage:
  • Four conditions are important for gaining and maintaining competitive superiority:
    • Factor conditions
    • Demand conditions
    • Related and supporting industries
    • Firm strategy, structure, and rivalry

The Diamond of National Competitive Advantage

  • Factor conditions: Are sufficient quantities and combinations of the quality of labor, capital, and raw materials available at acceptable prices?
  • Demand conditions: Are consumers likely to buy what we can produce with the factor conditions above and at the price we can deliver to them?
  • Related and supporting industries: Can we outsource production of sufficient components and services to allow us to concentrate our efforts on what we can do best?
  • Firm strategy, structure, and rivalry: Will competitive conditions and our reactions to them enable us to evolve our operations to sustain and improve our market position?

Why Production Factors Move

Factor Mobility Theory:
  • Focuses on why production factors move, the effects of that movement on transforming factor endowments, and the impact of international factor mobility on world trade.
Capital and Labor Move Internationally To:
  • Gain more income (demand-pull factors).
  • Flee adverse political situations (supply-push factors).

Effects of Factor Movements

  • Factor movements alter factor endowments.
  • Factor movements can be substantial for some countries and insignificant for others.
  • The movement of labor and capital are intertwined.
  • Pros and cons of outward and inward migration.

Trade and Factor Mobility

  • There are pressures for the most abundant factors to move to areas of scarcity.
  • The lowest costs occur when trade and production factors are both mobile.

Trade and Factor Mobility

Factor Mobility Through Foreign Investment Often Stimulates Trade Because Of:
  • The need for components.
  • The parent’s ability to sell complementary products.
  • The need for equipment for subsidiaries.

In What Direction Will Trade Winds Blow?

Issues to Consider:
  • Displacement of jobs as developed countries shift production to more rapidly developing countries.
  • Relationships among land, labor, and capital will continue to evolve.
  • Continued trend toward a more finely tuned specialization of production among countries.

In What Direction Will Trade Winds Blow? - Monitor

  • As economies grow, efficiencies of multiple production locations also grow because they can all gain sufficient economies of scale.
  • Small-scale production methods may enable countries to produce many goods efficiently for their own consumption.
  • Output from 3D printers.
  • Services are growing more rapidly than products as a portion of production and consumption within developed countries.