Jan 232011

I’m currently taking International Business as part of my MBA program at Rutgers, and decided to share my outline for what I’m studying at the moment – international trade theory.  These notes are a combination of my own interpretation of the materials presented in “International Business” by Charles W. L. Hill, and direct quotes from that text (which I did not explicitly demarcate).  Assume all thoughts and ideas presented here are Hill’s.

1. Mercantilism

  • 1630, Thomas Mun: “…to increase our wealth…sell more to strangers yearly than we consume of theirs in value”

2. Absolute Advantage

  • 1776, Adam Smith.  A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it
  • If two countries specialize in production of different products (in which each has an absolute advantage) and trade with each other, both countries will have more of both products available to them for consumption

3. Comparative Advantage

  • 1817, David Ricardo - Even if one country has an absolute advantage in producing two products over another country, trading with that other country will still yield more output for both countries than if the more efficient producer did everything for themselves.
  • The country with the absolute advantage in producing both products would still produce both products, but less of the one they would trade for, allowing them to essentially allocate more resources to producing the product that they’re comparatively most efficient at producing
  • Assumes many things:
    • Only 2 countries and 2 goods
    • No transportation costs
    • No price differences for resources in both countries
    • Resources can move freely from producing one product to producing another product
    • Constant returns to scale
    • Fixed stock of resources
    • Free trade does not affect production efficiency
    • No effects of trade on income distribution within a country
  • There are some descriptions of potential outcomes of relaxing some of these assumptions, but I’ll leave this as a thought exercise for you, the reader

4. Heckscher-Ohlin Theory

  • 1919, Eli Heckscher and 1933, Bertil Ohlin – Comparative advantage arises from differences in national factor endowments, such as land, labor, or capital, as opposed to Ricardo’s theory which stresses productivity
  • 1953, Wassily Leontief – The Leontief Paradox – theorized that since the U.S. has abundant capital compared to other nations, they would expor capital-intensive goods and import labor-intensive goods.  Data showed that was not the case.
  • Therefore, Ricardo’s theory seemed to be more predictive.
  • However, controlling for technological differences (e.g. eliminating them) does yield a predictive model based on factor endowments

5. The Product Life-Cycle Theory

  • 1960′s, Raymond Vernon – attempts to explain global trade patterns.  First, new products are introduced in the United States.Then, as demand grows in the U.S., it also appears in other developed nations, to which the U.S. exports.  Then, other developed nations begin to produce the product as well, thus causing U.S. companies to set up production in those countries as well, and limiting exports from the U.S.  Then, it all happens again, but this time production comes online in developed nations.  Ultimately, the U.S. becomes an importer of the product that was initially introduced within its borders.
  • Weakness – Not all new products are created in the United States.  Many come from other countries first, such as video game consoles from Japan, new wireless phones from Europe, etc.  Several new products are introduced in several developed countries simultaneously

6. New Trade Theory

  • 1970′s – Via the achievement of economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods.  Further, the ability to capture economies of scale before anyone else is an important first-mover advantage.
  • Nations may benefit from trade even when they do not differ in resource endowments or technology
  • Example – If two nations both want sports cars and minivans, but neither can produce them at a low enough price within their own national markets, trade can allow each to focus on one product, allowing for the achievement of economies of scale that will increase the variety of products in both countries at low enough prices
  • Example – Airbus spent $14 billion to develop a new super-jumbo jet.  Demand is estimated at 400-600 units over the next 20 years, and Airbus will need to sell at least 250 of them to become profitable in this line of business.  Boeing estimates the demand to be much lower, and has chosen not to compete.  Airbus will have the first mover advantage in this market, and may never see competition in this market segment.
  • New trade theory is not at odds with Comparative Advantage, since it identifies first mover advantage as an important source of comparative advantage
  • Debate – should government provide subsidies that spawn industries such that companies can gain first mover advantages?  Later chapter (and blog post) covers this.

7. National Competitive Advantage – Porter’s Diamond

  • 1990, Michael Porter – seeks to answer the question of why a nation achieves international success in a particular industry.  Based on four attributes:
    • Factor endowments
      • Basic factors – natural resources, climate, location, demographics
      • Advanced factors – communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how
      • Advanced factors are a product of investment by individuals, companies, and governments
      • Porter argues that advanced factors are the most significant for competitive advantage
    • Demand conditions – if customers at home are sophisticated and demanding, companies will have to produce innovative, high quality products early, which leads to competitive advantage
    • Relating and supporting industries – If suppliers or related industries exist in the home country that are themselves internationally competitive, this can result in competitive advantage in the new industry.
    • Firm strategy, structure, and rivalry
      • Different nations are characterized by different management ideologies, which can either help or hurt them in building competitive advantage
      • If there is a strong domestic rivalry, it helps to create improved efficiency, making those firms better international competitors
  • Porter also notes that chance (such as new breakthrough innovations) and government policies (such as regulation, investments in education, etc.) can influence the “national diamond”

Implications for Managers

  • Location – productive activities should be done in the location in which it is most efficient
  • First-mover implications – “the idea is to preempt the available demand, gain cost advantages related to volume, build an enduring brand ahead of later competitors, and, consequently, establish a long-term sustainable competitive advantage”
  • Policy implications – lobbying for or against free trade or government restrictions.
  • It’s in a firm’s best interest to invest in upgrading advanced factors of production; for example, to invest in better training for its employees and to increase its commitment to R&D
  • Businesses should lobby for investment in education, infrastructure, and basic research and any policy promoting strong domestic competition

  24 Responses to “7 International Trade Theories”

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  15. how is Porter’s theory different from other theories?

  16. continoue in this way

  17. What is Equal Advantage Theory of International Trade?

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