Chapter 5

INTERNATIONAL TRADE THEORY

OUTLINE Overview Mercantilism Absolute advantage Comparative

advantage Heckscher-Ohlin

theory

Product life-cycle theory

New trade theory Porter’s diamond Implication for

managers Closing case

OVERVIEW 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.

OVERVIEW The benefit of trade:

A country may gain even if they buy products from other nations.

Allow a country to specialize in the manufacture, and export products that can be produced most efficiently in that country.

OVERVIEW The pattern of International Trade:

Some are easy to understand (Saudi Arabia/oil or Mexico/labor intensive

goods) Some are not so easy to understand

(Japan/cars)

MERCANTILISM

MERCANTILISM (mid-16th century)

Currency: gold, silver. Theory: the country should maintain a

trade surplus. Trade is viewed as a “zero-sum game”.

In 1752, David Hume showed an inconsistency:

In the long run, no one can keep a trade surplus.

ABSOLUTE ADVANTAGE

ABSOLUTE ADVANTAGE Adam Smith: Wealth of Nation ( 1776) Capability of one country to produce more

efficiently of a product with the same amount of input than other country.

Eg: English textiles

French wine

Both are beneficial in trade.

Example

Country: Ghana, Korea Resources: 200 units Ghana:

10 resources 1 ton of cocoa20 resources 1 ton of rice

Korea: 40 resources 1 ton of cocoa10 resources 1 ton of rice

Specialization and trade

COMPARATIVE ADVANTAGE

COMPARATIVE ADVANTAGE David Ricardo: Principles of Political

Economics (1817) It is make sense for a country to specialized

in the production of those goods that it produces most efficiently.

Example

Country: Ghana, Korea Resources: 200 units Ghana:

10 resources 1 ton of cocoa13 1/3 resources 1 ton of rice

Korea: 40 resources 1 ton of cocoa10 resources 1 ton of rice

COMPARATIVE ADVANTAGE Efficiency of resource utilization leads to

more productivity. Make better use of resources. Trade is a positive-sum game.

Extensions of the Ricardo model Immobile Resources

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

A short-term phenomenon gain from trade is significant and enduring.

Diminishing Returns Constant return to specialization: the units of

resources to produce a good (cocoa or rice) is the same.

Diminishing returns to specialization: more units of resources to produce each additional product.

Cocoa: 12 ton + 10 units of resources 13 ton 13 ton + 11 units of resources 14 ton

Why??? Not all resources are the same quality. Different goods use resources in

different proportion.E.g. Growing cocoa uses more land and less labor than growing rice.

Results

Under the effect of diminishing returns, the gains is lower than the gains in case of the constant returns.

Dynamic effects and Economic growth Free trade might increase a country’s

production resources. Increase the efficiency of resource

utilization.

Samuelson Critique Consider rich country like U.S and poor one like

China US customer buy lower price goods from China

lower the wage rates in the US.

“ Being able to purchase groceries 20 percent cheaper at Wal-Mart (due to international trade) does not necessarily make up for the wage losses (in America)”

Evidence for the link between Trade and Growth

Stance toward international trade higher growth rate

Jeffery Sachs and Andrew Warner research from 1970 1990 In developing nation group: open economy

4.49%/year, closed economy 0.69%/year. In developed nation group: open economy

2.29%/year, closed economy 0.74%/year.

Wacziarg and Welch data from 1950 to 1998: liberalized countries 1.5% compared to preliberalization times.

HECKSCHER – OHLIN THEORY

HECKSCHER (1919) – OHLIN (1933) THEORY Ricardo: comparative advantage arises from

differences in productivity. Heckscher – Ohlin: comparative advantages

arises from differences in national factor endowments.

Heckscher – Ohlin said: Export goods – locally abundant Import goods – locally scarce

The Leontief Paradox, 1953 Leontief found: US exports were less

capital intensive than US imports variance.

Explain for US: Export goods heavily use skill labor. Import heavy manufacturing products.

Heckscher vs Ricardo Economists prefer Heckscher on theoretical

grounds but is relatively poor predictor of trade patterns.

Ricardo’s comparative advantage theory, regarded as too limited for predicting trade patterns, actually predicts them with greater accuracy.

In the end, differences in productivity may be the key to determining trade patterns.

PRODUCT LIFE – CYCLE THEORY

PRODUCT LIFE – CYCLE THEORY (Raymond Vernon, 1966)

As products mature, both location of sales and optimal production changes.

Affects the direction and flow of imports and exports.

Globalization and integration of the economy takes this theory less valid.

Example XEROX: US Japan (Fuji-Xerox) & Great

Britain (Rank-Xerox) Singapore, Thailand. consistent with product life-cycle theory that mature industries tend to go out of the US and into low-cost assembly locations. This theory is not without weakness: Life-Cycle

theory said most new products are developed and introduced in US ethnocentric.

NEW TRADE THEORY

New Trade Theory (1970s)

Economies of scale are unit cost reduction associated with large volume of output 2 important points:

1. Increasing product variety and reducing costs2. First-mover advantage

First-mover advantage The first movers in an industry can gain a

scale-based cost advantage that later entrants find almost impossible to match. Airbus new super-jumbo jet 550-seat, A380 Boeing is dominant in commercial jet air

craft

First-mover advantage (cont) The first movers’ ability to benefit from

increasing returns creates a barrier to entry. Japanese firms decided not to enter air

industry. New trade theorists stress the role of

luck, entrepreneurship and innovation in giving a firm first-mover advantage.

PORTER’S DIAMOND

FACTOR ENDOWMENTS

Basic factors: natural resource, climate, location, demographic

Advanced factors: Communication, infrastructure, skilled labor, research facilities, technology know-how, production of investment by individual, company, government

Basic factors=>initial advantage, expansion Disadvantage of basic factor => invest in advanced

factor (Japan)

DEMAND CONDITIONS Home demand => increase competitive

advantage Innovative products (Wireless cell

phone : Nokia)

RELATED, SUPPORTING INDUSTRIES Successful industries tend to group into

clusters of related industries Knowledge flow when employees move

between different firms

FIRM STRATEGY, STRUCTURE, RIVALRY

Different method of management Strong domestic rivalry => improve

efficiency, innovation => better internationally competition

IMPLICATIONS FOR MANAGERS

IMPLICATIONS for MANAGERS

1) LOCATION: Firm disperse its productive activities to

counties perform most EFFICIENTLY

IMPLICATIONS for MANAGERS

2) FIRST-MOVER ADVANTAGES

IMPLICATIONS for MANAGERS

3) GOVERNMENT POLICY:

Lobby to promote the free trade or restriction, to adopt the policies that have favorable impact (on each component of Porter Diamond)

Example: tariff on Japanese LCD makes the price of IBM laptop increase.

CLOSING CASE

SUMMARY Logitech: The world largest producer of computer

mice, a technological innovator in business of personal computer peripheral.

Founded in 1981, Switzerland. Differentiate their products by continuing

innovation (91 new products in 2003), high brand recognition, strong retail presence.

SUMMARY R&D (software programming) in Switzerland Corporate headquarter in Fremont, California –

the headquarter for the company’s global marketing, finance, logistic – close to many of American’s high-technology enterprises.

Design product in Ireland. Manufacture in Asia

SUMMARYManufacture in Asia: 1980s - Taiwan: qualified people, high volume,

low cost (7% of total cost), better design product, well-developed supply based for parts, rapidly expanding local computer industry, science-based industrial park for fee of $200,000

Logitech win the contract with Apple Others invest

SUMMARYManufacture in Asia: 1990s – China: 4000 employees: young

women, each is paid $75/month for sitting all day.

Product price $40, $8 for R&D, $8 for shareholders, $15 for distribution, $14 for supplier, $3 for wages, power, transport, other cost.

SUMMARYCHINA: Potential place for manufacturing:

Motorola, Intel,..... Top exporter of high-tech export: chip,

disk driver,..

QUESTION 1, 2, 31. In a world without trade, what would American consumers

have to pay for Logitech’s products?

2. Explain how trade lowers the costs of making computer peripherals such as mice and keyboards.

3. Use the theory of comparative advantage to explain the way in which Logitech has configured its global operations. Why does the company manufacture in China and Taiwan, undertake basic R&D in California and Switzerland, design products in Ireland, and coordinate marketing and operations from California?

QUESTION 1 In a world without trade, every parts of

process to produce goods of Logitech must be made at USA. Fair: marketing, R&D and design quality. High cost: labor, supply.

No specialization.

American consumers suffer higher cost.

QUESTION 2 Activities of Logitech in trade to lowers

the costs of making computer is shown following

QUESTION 2

QUESTION 3 Logitech will put its production where it

can be completed most efficiently: China and Taiwan low labor and supplies

resources. California and Switzerland high technology. Fremont communication gate to the World.

QUESTION 4

Who creates more value for Logitech, the 650 people it employs in Fremont and Switzerland or the 4,000 employees as its Chinese factory? What are the implications of this observation for the argument that free trade is beneficial?

FREE TRADE IS BENEFICIAL

Logitech (company):

FREE TRADE IS BENEFICIAL

Chinese and Taiwan factories (being outsourced):

FREE TRADE IS BENEFICIAL

American (customers):

QUESTION 4

! 4000 Chinese labors !Why???

4000 > 650 (^.^) Super low labor cost (75$/month) super

value

QUESTION 4: My answer is: 650 people Logitech

employs in Fremont and Switzerland creates more value.

Why??? These 650 employees take important roles in

company. No these 650 white-collars no 4000 blue-

collars.

QUESTION 5

Why do you think the company decided to shift its corporate headquarters from Switzerland to Fremont?

About Fremont: It is close to the center of Silicon Valley. It

has attracted the headquarters of many high-tech companies of the US (Nielsen Norman Group, Corsair Memory and Lexar…), foreign companies (Elitegroup Computer Systems, Asus and Universal abit…)

It is also home to blue-collar industry.

Advantages of this location:

The presence of high-quality and specialized inputs such as scientific and technical talents.

An environment that encourages investment and intense rivalry.

Pressure and insight gained from a sophisticated local market.

Local presence of related and supporting industries.

QUESTION 6

To what extent can Porter’s diamond help explain the choice of Taiwan as a major manufacturing site for Logitech?

Choice of TAIWAN as a manufacturing site based on PORTER’S DIAMOND

QUESTION 7

Why do you think China is now a favored location for so much high-technology manufacturing activity? How will China’s increasing involvement in global trade help that country? How will it help the world’s developed economies? What potential problems are associated with moving work to China?

China is now a favored location for so much high-technology manufacturing activity.

Low costs (land, labor, utilities) Proximity to market, suppliers Reliability of local infrastructure, logistics Availability of a good agent or distributor Legal environment Government incentives

China’s increasing involvement in global trade will help that country.

Create jobs Raise income Increase living standards.

It will help the world’s developed economies.

Low costs Increased specialization of production

lower average costs and increased efficiency.

Potential problems are associated with moving work to China. Culture, language

Tastes don't easily translate overseas. English is not the first language.

Expertise Employee educated but lack of experience. Lack of trained managers for new business.

Shipping After the September 11th attacks, import regulations

were strengthened.

GROUP MEMBERS Hồ Ngọc Bích – BA060022 Nguyễn Thanh Dũng – BA060024 Hoàng Lê Minh – BA060031 Nguyễn Xuân Thành – BA060039