Trade Theories: #8…….

Human Skills Theory

Rybczynski TheoremProduct Cycle Model

OLI TheoryNational Competitive Advantage

Human Skills Theory (We looked that this with Leontief)

• Donald Keesing (1966)

• Emphasizes differences in endowments and intensities of skilled and unskilled workers.

• Explains the Leontief paradox: Since the U.S. has highly trained, educated workers relative to other countries, U.S. exports tend to be skilled-labor intensive.

Rybczynski TheoremExtension to the H-O model

• At constant world prices, if a country experiences an increase in the supply of one factor, it will produce more of the product intensive in that factor and less of the other.

• Not really a “trade” model, but rather looks at the “endowments” that we have been discussing.

Rybczynski TheoremExtension of H-O model

Look at ONE Country’s PPF

Production of Goods … S and T

T – capital intensive … S – Labor intensive

Production mix is originally at Point Xo

commodity prices are given

If there is an increase in Labor (which is used intensively in the production of S … ecoomic Growth will occur and the PPF will shift outward (with a bias toward S)

Production will now occur at X1 where there is an increase in the production of S and a decrease in the production of T

The Effect of an Increase in a Factor

Extension of the HO Model: The Product Cycle

• Developed by Raymond Vernon

• Production of a good is cyclical

– When a manufactured good is developed, producers experiment and seek consumers’ reactions

– When production leaves the early stage, the good begins to be standardized in terms of size, features, and manufacturing process

– Finally, consumption of the good in a high-income country exceeds its production: production moves where labor costs are lower

The Product Cycle in High-Income Countries

Consumption

Production

The Product Cycle in Low-Income Countries

Consumption

Production

The Product Cycle and Trade Implications

• Increased emphasis on technology’s impact on product cost

• Explained international investment

• Limitations– Most appropriate for technology-based products– Some products not easily characterized by stages of

maturity– Most relevant to products produced through mass

production

Intra-firm Trade: Extension of the HO Model:Foreign Trade versus Foreign Investment

• Much of international trade is driven by foreign investment by multi-national firms

– Firms prefer to invest abroad and produce there directly, rather than export (they substitute foreign investment for foreign trade)

– Output produced in the foreign operation can be sold directly to the foreign market or shipped back to the home nation (they engage in intra-firm trade to take advantage of advantageous foreign conditions)

Intra-firm Trade

• Reasons for intra-firm trade– Firms take advantage of cross-country differences in the

price of inputs– A firm may reduce distribution costs in a foreign market by

operating through an affiliate

• Intra-firm trade is growing in importance– Around 2005, more than 1/3 of US merchandise exports

and 2/5 of merchandise imports were intra-firm

OLI Theory

OLI theory (Ownership-Location-Internalization)

– Firms investing abroad own an asset that gives them an competitive advantage (Ownership)

– Firms seek a production location that offers them advantages (Location)

– Firms try to internally capture the advantages of foreign asset ownership (Internalization)

Off-shoring and Outsourcing

• Outsourcing is the reassignment of activities to another firm, either inside or outside the home country

– Trade in services is consistent with traditional trade models based on comparative advantage

– Fundamental debate is the impact of outsourcing on jobs

• Off-shoring is defined as the movement of some or all of a firm’s activities to a location outside the home country

– Some firms off-shore, but do not outsource, choosing to use a foreign affiliate; a foreign-based operation owned by the firm in the home country

Theory of national competitive advantage

• The theory attempts to analyze the reasons for a nations success in a particular industry

• Michael Porter studied 100 industries in 10 nations– postulated determinants of competitive advantage of a

nation based on four major attributes• Factor endowments• Demand conditions• Related and supporting industries• Firm strategy, structure and rivalry

Porter’s diamond• Success occurs

where these attributes exist.

• More/greater the attribute, the higher chance of success

• The diamond is mutually reinforcing

Factor endowments

• Basic factors: Factors present in a country– Natural resources– Climate– Geographic location– Demographics

• While basic factors can provide an initial advantage they must be supported by advanced factors to maintain success

Advanced factor endowments

• Advanced factors: The result of investment by people, companies, governments and are more likely to lead to competitive advantage

– communications– skilled labor– research– technology– education

• If a country has no basic factors, it must invest even more in advanced factors

Demand conditions

• Demand:– creates capabilities – creates sophisticated and demanding

consumers

• Demand impacts quality and innovation

Related and supporting industries

• Creates clusters of supporting industries that are internationally competitive

• Must also meet requirements of other parts of the Diamond

Firm Strategy, Structure and Rivalry

• Long term corporate vision is a determinant of success

• Management ‘ideology’ and structure of the firm can either help or hurt you

• Presence of domestic rivalry improves a company’s competitiveness

Determinants of Competitive Advantage in nations

GovernmentGovernment

ChanceChance

Two external factors influence the four determinants.

Porter’s Theory-predictions

• Porter’s theory should predict the pattern of international trade that we observe in the real world

• Countries should be exporting products from

those industries where all four components of the diamond are favorable, while importing in those areas where the components are not favorable

Implications for business

• Location implications:– Disperse production activities to countries where

they can be performed most efficiently• First-mover implications:

– Invest substantial financial resources in building a first-mover, or early-mover advantage

• Policy implications: – Promoting free trade is in the best interests of the

home-country, not always in the best interests of the firm, even though, many firms promote open markets