2000 chp 6 intl trade
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Chapter 6
InternationalTrade Theory
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Why Is Free Trade Beneficial?
Free trade - a situation where agovernment does not attempt to influencethrough quotas or duties what its citizenscan buy from another country or what theycan produce and sell to another country
Trade theory shows why it is beneficial fora country to engage in international trade
even for products it is able to produce foritself
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Why Is Free Trade Beneficial?
International trade allows a countryto specialize in the manufacture and export of
products and services that it can produceefficiently
import products and services that can beproduced more efficiently in other countries
limits on imports may be beneficial toproducers, but not beneficial for consumers
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Why Do Certain
Patterns Of Trade Exist?Some patterns of trade are fairly easy to
explain
it is obvious why Saudi Arabia exports oil,
Ghana exports cocoa, and Brazil exportscoffee
But, why does Switzerland exportchemicals, pharmaceuticals, watches, and
jewelry?
Why does Japan export automobiles,consumer electronics, and machine tools?
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What Role Does
Government Have In Trade?The mercantilist philosophy makes a crude case
for government involvement in promoting
exports and limiting imports
Smith, Ricardo, and Heckscher-Ohlin promoteunrestricted free trade
New trade theory and Porters theory of national
competitive advantage justify limited and
selective government intervention to support the
development of certain export-oriented
industries
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What Is Mercantilism?
Mercantilism (mid-16th century) suggeststhat it is in a countrys best interest tomaintain a trade surplus -to export more
than it importsadvocates government intervention to achieve
a surplus in the balance of trade
Mercantilism views trade as a zero-sumgame - one in which a gain by one countryresults in a loss by another
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What Is Smiths Theory
Of Absolute Advantage?
Adam Smith (1776) argued that a country
has an absolute advantage in the
production of a product when it is more
efficient than any other country inproducing it
countries should specialize in the production
of goods for which they have an absoluteadvantage and then trade these goods for
goods produced by other countries
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How Does The Theory
Of Absolute Advantage Work?
If each country specializes in theproduction of the good in which it has anabsolute advantage and trades for theother, both countries gaintrade is a positive sum game
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What Is Ricardos Theory
Of Comparative Advantage?
David Ricardo asked what happens when onecountry has an absolute advantage in theproduction of all goods
The theory ofcomparative advantage (1817) -countries should specialize in the production ofthose goods they produce most efficiently andbuy goods that they produce less efficiently fromother countries
even if this means buying goods from othercountries that they could produce moreefficiently at home
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How Does The Theory Of
Comparative Advantage Work?
If each country specializes in theproduction of the good in which it has acomparative advantage and trades for the
other, both countries gain
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How Does The Theory Of
Comparative Advantage Work?
Comparative advantage theory provides astrong rationale for encouraging free trade
total output is higher
both countries benefit
Trade is a positive sum game
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Is Unrestricted Free Trade
Always Beneficial? Unrestricted free trade is beneficial, but the gains may
not be as great as the simple model of comparativeadvantage would suggest immobile resources
diminishing returns dynamic effects and economic growth
the Samuelson critique
But, opening a country to trade could increase a country's stock of resources as increased supplies become
available from abroad the efficiency of resource utilization and so free up resources for
other uses
economic growth
ld h
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Could A Rich Country Be
Worse Off With Free Trade?Paul Samuelson - the dynamic gains from trade
may not always be beneficial
free trade may ultimately result in lower
wages in the rich countryThe ability to offshore services jobs that were
traditionally not internationally mobile may havethe effect of a mass inward migration into the
United States, where wages would then fallbut, protectionist measures could create a
more harmful situation than free trade
h h
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What Is The
Heckscher-Ohlin Theory?Eli Heckscher (1919) and Bertil Ohlin
(1933) - comparative advantage arises
from differences in national factor
endowments
the extent to which a country is endowed with
resources like land, labor, and capital
The more abundant a factor, the lower itscost
Wh I Th
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What Is The
Heckscher-Ohlin Theory?The pattern of trade is determined by
factor endowments
Heckscher and Ohlin predict that countries
will
export goods that make intensive use of
locally abundant factors
import goods that make intensive use offactors that are locally scarce
D Th H k h Ohli
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Does The Heckscher-Ohlin
Theory Hold?
Wassily Leontief (1953) theorized that since theU.S. was relatively abundant in capital comparedto other nations, the U.S. would be an exporterof capital intensive goods and an importer oflabor-intensive goods.
However, he found that U.S. exports wereless capital intensive than U.S. imports
Since this result was at variance with thepredictions of trade theory, it became known asthe Leontief Paradox
Wh I Th
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What Is The
Product Life Cycle Theory?
The product life-cycle theory- as products
mature both the location of sales and the
optimal production location will change
affecting the flow and direction of trade
proposed by Ray Vernon in the mid-1960s
At this time most of the worlds new products were
developed by U.S. firms and sold first in the U.S.
Wh I Th
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What Is The
Product Life Cycle Theory?
According to the product life-cycle theory
the size and wealth of the U.S. market gave U.S.
firms a strong incentive to develop new products
initially, the product would be produced and sold inthe U.S.
as demand grew in other developed countries, U.S.
firms would begin to export
demand for the new product would grow in otheradvanced countries over time making it worthwhile for
foreign producers to begin producing for their home
markets
Wh I Th
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What Is The
Product Life Cycle Theory?
U.S. firms might set up production facilitiesin advanced countries with growingdemand, limiting exports from the U.S.
As the market in the U.S. and otheradvanced nations matured, the productwould become more standardized, andprice would be the main competitive
weapon
Wh I Th
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What Is The
Product Life Cycle Theory?Producers based in advanced countries where
labor costs were lower than the United Statesmight now be able to export to the United States
If cost pressures were intense, developing
countries would acquire a production advantageover advanced countries
Production became concentrated in lower-costforeign locations, and the U.S. became an
importer of the product
Wh I Th
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What Is The
Product Life Cycle Theory?The Product Life Cycle Theory
D Th P d t Lif
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Does The Product Life
Cycle Theory Hold?
The product life cycle theory accurately explainswhat has happened for products likephotocopiers and a number of other hightechnology products developed in the UnitedStates in the 1960s and 1970s
mature industries leave the U.S. for low costassembly locations
D Th P d t Lif
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Does The Product Life
Cycle Theory Hold?
But, the globalization and integration of theworld economy has made this theory lessvalid today
the theory is ethnocentricproduction today is dispersed globally
products today are introduced in multiplemarkets simultaneously
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What Is New Trade Theory?
New trade theory suggests that the ability offirms to gain economies of scale (unit costreductions associated with a large scale ofoutput) can have important implications for
international trade Countries may specialize in the production and
export of particular products because in certainindustries, the world market can only support alimited number of firms
new trade theory emerged in the 1980s
Paul Krugman won the Nobel prize for hiswork in 2008
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What Is New Trade Theory?
1. Through its impact on economies of scale, tradecan increase the variety of goods available toconsumers and decrease the average cost ofthose goods
without trade, nations might not be able to producethose products where economies of scale areimportant
with trade, markets are large enough to support theproduction necessary to achieve economies of scale
so, trade is mutually beneficial because it allows forthe specialization of production, the realization ofscale economies, and the production of a greatervariety of products at lower prices
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What Is New Trade Theory?
2. In those industries when output required toattain economies of scale represents asignificant proportion of total world demand,the global market may only be able to support
a small number of enterprises first mover advantages - the economic and
strategic advantages that accrue to earlyentrants into an industry
economies of scale first movers can gain a scale based costadvantage that later entrants find difficult tomatch
Wh t A Th I li ti Of
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What Are The Implications Of
New Trade Theory For Nations?Nations may benefit from trade even when they
do not differ in resource endowments or
technology
a country may dominate in the export of a goodsimply because it was lucky enough to have one or
more firms among the first to produce that good
Governments should consider strategic trade
policies that nurture and protect firms andindustries where first mover advantages and
economies of scale are important
Wh t I P t Di d Of
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What Is Porters Diamond Of
Competitive Advantage? Michael Porter (1990) tried to explain why a
nation achieves international success in aparticular industry
identified four attributes that promote or
impede the creation of competitiveadvantage
1. Factor endowments - a nations position infactors of production necessary to compete in
a given industry can lead to competitive advantage can be either basic (natural resources, climate,
location) or advanced (skilled labor, infrastructure,technological know-how)
What Is Porters Diamond Of
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What Is Porters Diamond Of
Competitive Advantage?2. Demand conditions - the nature of home
demand for the industrys product or service influences the development of capabilities
sophisticated and demanding customers pressure
firms to be competitive3. Relating and supporting industries - the
presence or absence of supplier industries andrelated industries that are internationallycompetitive can spill over and contribute to other industries
successful industries tend to be grouped in clustersin countries
What Is Porters Diamond Of
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What Is Porter s Diamond Of
Competitive Advantage?
4. Firm strategy, structure, and rivalry - theconditions governing how companies arecreated, organized, and managed, and thenature of domestic rivalry different management ideologies affect the
development of national competitive advantage
vigorous domestic rivalry creates pressures toinnovate, to improve quality, to reduce costs, and to
invest in upgrading advanced features
What Is Porters Diamond Of
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What Is Porter s Diamond Of
Competitive Advantage?Determinants of National Competitive Advantage: Porters Diamond
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Does Porters Theory Hold?
Government policy canaffect demand through product standards
influence rivalry through regulation and antitrust laws
impact the availability of highly educated workers and
advanced transportation infrastructure.The four attributes, government policy, and
chance work as a reinforcing system,complementing each other and in combinationcreating the conditions appropriate forcompetitive advantage
So far, Porters theory has not been sufficientlytested to know how well it holds up
What Are The Implications Of
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What Are The Implications Of
Trade Theory For Managers?
1. Location implications - a firm should disperse itsvarious productive activities to those countries wherethey can be performed most efficiently
firms that do not may be at a competitive
disadvantage2. First-mover implications - a first-mover advantage can
help a firm dominate global trade in that product
3. Policy implications - firms should work to encouragegovernmental policies that support free trade
want policies that have a favorable impact on eachcomponent of the diamond
What Is The
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What Is The
Balance Of Payments? A countrys balance of payments accounts
keep track of the payments to and receiptsfrom other countries for a particular time period
double entry bookkeeping
sum of the current account balance, thecapital account and the financial accountshould be zero
What Is The
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What Is The
Balance Of Payments? There are three main accounts1. The current account records transactions of goods,
services, and income, receipts and payments
current account deficit - a country imports morethan it exports
current account surplus a country exports morethan it imports
2. The capital account records one time changes in thestock of assets
3. The financial account records transactions that involvethe purchase or sale of assets
net change in U.S. assets owned abroad
foreign owned assets in the U.S.
What Is The
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What Is The
Balance Of Payments?United States Balance of Payments Accounts, 2010
Is A Current
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Is A Current
Account Deficit Bad?Question:Does current account deficit in the
United States matter?
A current account deficit implies a net debtor
so, a persistent deficit could limit future
economic growthBut, even though capital is flowing out of the
U.S. as payments to foreigners, much of it flowsback in as investments in assets
Yet, suppose foreigners stop buying U.S. assetsand sell their dollars for another currency
a dollar crisis could occur
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