MKTG 10 - International MarketingChapter 2 – Economic Rational of Multinational Trade and Business

Professor : Mr. A. T. Quiwa, MBA

Modern trade take place because a foreign country is able to provide a material or product cheaper than native industry can.

The theory of comparative advantage states that even if a country is able to produce all its goods a lower costs than another country can, trade still benefits both countries, based on comparative, not absolute, cost.

COUNTRYCOUNTRY Hand Hand CalculatorCalculator

Bottles of Bottles of WineWine

United StateUnited State 66 88

ItalyItaly 3030 1515

Labor Costs Per Unit ( In Hours )

Every nation seeks to increase the material standard of living of its people; living standard increase as a function of productivity.

With greater productivity, the same amount of labor yield more goods and services.

As productivity increases, greater material wealth results.

Ex. Sweden has made a choice of longer vacations; the U.S. prefer increased material possession. Whatever the eventual choice, increased productivity affords a wider range of choice.

OperatingOperating 11 33

Capital cost Capital cost

AmortizationAmortization1 1 22

Total Total 22 55

World Price -World Price -InIn

Labor hr Labor hr Equv.Equv.

5.05.0 5.55.5

IncomeIncome

( per labor ( per labor hr) hr)

2.52.5 1.11.1

Labor Hours per BarrelCountry A Country B

The economic law of comparative advantage states that every nation benefits when specialization and trade take place. Even when one nation cannot produce goods more efficiently than another can, it is still in the economic interest of both nation for each to specialize.

Regardless of its productivity relative to other suppliers, every nation has comparative advantages in producing certain goods rather than others.

The specialization and the advantage are achieved on the basis on one or more factors.

1. Natural resources 4. Managerial know-how 2. Technology 5. Labor 3. Capital

The product life cycle model states that products go through the following four stages.

Phase I U.S. export strength builds Phase II Foreign production starts Phase III Foreign production becomes competitive in export markets. Phase IV Import competition begins in domestic U.S. markets

The international theory assumes that the firm has a global horizon, and it recognize that the enterprise needs a competitive advantage or a unique asset to expand.

Underlying thesis of internalization is the firm’s desire to extend its own direct operation rather than use external markets.

The internalization approach rests on two general axioms:

(a) firms choose the least-cost location for each activity they perform.

(b) firms grow by internalizing markets up to the point where the benefits of further internalization are outweighed by the costs.

The internalization theory provides an economic rationale for the existence of MNC’s. The sourcing decision rests on the cost and benefits to the firm, taking into consideration industry-specific factors(e.g. nature of the product), region-specific factors(e.g. geographic location), nation-specific factors (e.g. political climate), and firm-specific factors(e.g. managerial ability to internalize).

The internationalization theory primarily focuses on the motives and decision processes within the multinational firm but pay little attention to the host country policies and other external factors that may affect internalization cost/benefits.

Government impose all sorts of barriers to restrict trade and business across national boundaries. But there are reasons for trade barriers and for the effort that have been made internationally to liberate trade.

These are the two types of trade barriers: 1. Tariff 2. Non-tariff

To all nations except those that have tariff treaties with particular country. A tariff may be worked out on the basis of a tax permit, called specific duty, or as a percentage of Tariff refer to taxes levied on goods moved between nations. The most important of these is the tax usually called the custom duty that is levied by the importing nation. But tax may also be imposed by the exporting nation, and that is called an export tax.

Different nations handle tariff barriers differently.1. A country may have a single tariff system for all

goods from all sources. This is called a unlinear or single-column tariff.

2. The general-conventional tariff implies f the value of the item, which is referred to as advalorem tax.

Nontariff barriers include quotas, import equalization taxes, road taxes, laws giving preferential treatment to domestic suppliers, administration of antidumping measures, exchange controls, and a variety of ‘invisibe” tariffs that impede trade.

Specific limitation on trade Customs and administrative entry

procedures. Standards Government participation in trade Charges on imports others categories like voluntary export

restraints and ordinary marketing agreements.

Internationally, systematic tariff reduction program started after world war II. In 1947, the U.S. and 22 other major trading countries got together in Geneva to find ways to reduce tariffs and remove trade barriers.

The General Agreement on Tariffs and Trade (GATT) resulted. Since then, eight major efforts to reduce trade barriers have been undertaken under GATT’s auspices.

Major Agreement Number ofContractingParties

Value of worldTrade involved

Percent ofaverage tariffreduction

1947 Geneva 23 $ 10.0 n.a.

1949 Annecy, France

33 n.a. n.a.

1951 Torquay, England

37 n.a. n.a.

1956 Geneva 35 2.5 4

1962 Geneva(Dillon Round)

40 4.9 7

1967 Geneva( Kennedy Round)

70 40.0 35

The agreement creates a World Trading Organization (WTO) to replace the GATT secretariat, but details of the new organization’s powers remain unclear.

The WTO would, however,, have more authority to oversee trade in services and agriculture than GATT now does.

Liberalization of U.S. foreign trade began with enactment of the Reciprocal Trade Agreement Act of 1934. With the act, Congress authorized the president to reduce then-existing tariff duties by 50 percent.

A noteworthy aspect of the act was the inclusion of the most-favored-nation clause, which limited discrimination in trade by extending to third parties the same terms provided to contracting parties.

Multinational corporations (MNC’s) are among the most, if not the most, influential factors in global economic life today. Within the last 30 years they have become the most formidable single factor in world trade and investment.

MNC’s play a decisive role in the allocation and use of the world resources. They conceive new products and services, create and stimulate demand for them, and develop new modes of manufacture and distribution.

We have examined the rationale for world trade and business activity. The classic explanation of world trade is provided by the theory of comparative advantage.

When one country has an advantage over another, not only in the production of one product but all products, and its advantage in the production of the one product is greater than its advantage in the production of their other products, country, according to the theory, has a comparative advantage, each country should figure out which product have a comparative advantage and concentrate its productive efforts on those other products should be imported in exchange.