Transcript Slide 1

International Business
by
Prof. Yong-Sik Hwang
Theories of International Trade and Investment
Theories of International Trade and Investment
Theories of International Trade and Investment
Mercantilism and Neomercantilism
• Mercantilism: A belief, popular in the 16th century,
that national prosperity results from maximizing
exports and minimizing imports.
• Today, some argue for neomercantilism—the idea
that a nation should run a trade surplus.
• Supporters of neomercantilism include:
 Labor unions (want to protect domestic jobs)
 Farmers (want to keep crop prices high)
 Some manufacturers (rely on exports)
But is neomercantilism best for all?
Free Trade
The absence of restrictions to the
flow of goods and services among nations
• Free trade is usually best because it leads to:
 More and better choices for consumers and firms
 Lower prices of goods for consumers and firms
 Higher profits and better worker wages (because
imported input goods are usually cheaper)
 Higher living standards for consumers (because their
costs are lower)
 Greater prosperity in poor countries
Adam Smith (1723-1790)
Absolute Advantage Principle
A country should produce only those products in which it has
absolute advantage or those it can produce using fewer
resources than another country.
(Labor Cost in Days of Production for One Ton)
Comparative Advantage Principle
“Two men can make both shoes and hats, and one is superior to
the other in both employments, but in making hats he can only
exceed his competitor by one fifth or 20 percent, and in making
shoes he can excel him by one third or 33 percent; will it not be for
the interest of both that the superior man should employ himself
exclusively in making shoes and the inferior man in making hats?”
David Ricardo, 1817
Comparative Advantage Principle
It is beneficial for two countries to trade even if one has
absolute advantage in the production of all products; what
matters is not the absolute cost of production but the relative
efficiency with which it can produce the product.
(Labor Cost in Days of Production for One Ton)
Comparative Advantage Principle (cont.)
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While Germany can make both items more cheaply than
France, it is still beneficial for Germany to trade with France.
The key is the ratio of production costs. In the exhibit,
Germany is comparatively more efficient at producing cloth
than wheat: It can produce three times as much cloth as
France (30/10), but only two times as much wheat (40/20).
Germany should specialize in producing cloth and import all
the wheat it needs from France. France should specialize in
producing wheat and import all its cloth from Germany.
Each country benefits by specializing in the product in which
it has a comparative advantage and importing the other
product.
Comparative Advantage Principle (cont.)
• The principle applies to all goods. It reveals how
countries use scarce resources more efficiently.
Example
•Arguably, no country is better than Japan at making
cars and cell phones. But because Japan is especially
good at making cars, it concentrates its resources on
making them.
•Other countries, such as China and Finland, focus on
making cell phones.
•In this way, Japan makes maximal use of its
resources, and the world gets great cars.
Limitations of Early Trade Theories
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Fail to account for international transportation costs.
Governments distort normal trade by selectively imposing
protectionism (e.g., tariffs) or investing in certain
industries (e.g., via subsidies).
Services: Some cannot be traded; others can be traded
freely via the Internet or global telephony.
Factor Proportions Theory
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Also known as the Factor Endowments Theory, it
argues that each country should produce and export
products that intensively use relatively abundant factors
of production, and import goods that intensively use
relatively scarce factors of production.
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Factor Proportions Theory (cont.)
• However, the Leontief Paradox revealed that
countries can successfully export products that use
less abundant resources (e.g., the U.S. often
exports labor-intensive goods).
• This implies that international trade is complex and
cannot be fully explained by a single theory.
International Product Life Cycle Theory
• Each product and its associated manufacturing
technologies go through three stages of evolution:
introduction, maturity, and standardization.
• In the introduction stage, the inventor country
enjoys a monopoly both in manufacturing and
exports. Example: the television set.
International Product life Cycle Theory (cont.)
• In the maturity stage, the product’s manufacturing
becomes relatively standardized, and other
countries start producing and exporting the product.
International Product life Cycle Theory (cont.)
• In the standardization stage, manufacturing
ceases in the original innovator country, and this
country becomes a net importer of the product.
Today, due to globalization, the cycle occurs quickly
for many products.
National Competitive Advantage
Critical Role of Innovation
in National Economic Success
• Innovation is a key source of competitive
advantage.
• The firm innovates in four major ways. It can
develop:
(1) A new product or improve an existing product
(2) New ways of manufacturing
(3) New ways of marketing
(4) New ways of organizing company operations
• Many innovative firms in a nation leads to national
competitive advantage
Critical Role of Productivity
in National Economic Success
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Productivity is the value of the output produced by a
unit of labor or capital.
It is a key source of competitive advantage for firms.
The greater the productivity of the firm, the more
efficiently it uses its resources.
The greater the aggregate productivity of the firms in
a nation, the more efficiently the nation uses its
resources.
Aggregate productivity is a key determinant of the
nation’s standard of living.
Productivity Levels in Selected Countries
(Output per hour in manufacturing, 1985–2005; Indices, where 1992=100)
Michael Porter’s Diamond Model:
Sources of National Competitive Advantage
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The Diamond Model:
Sources of National Competitive Advantage (cont.)
• Factor conditions: Quality and quantity of labor,
natural resources, capital, technology, know-how,
entrepreneurship, and other factors of production
Example
An abundance of cost-effective and well-educated
workers gives China a competitive advantage in the
production of laptop computers.
The Diamond Model:
Sources of National Competitive Advantage (cont.)
• Related and supporting industries: The presence
of suppliers, competitors, and complementary firms
that excel within a given industry
Example
Silicon Valley in California is a great place to
launch a computer software firm because it is home
to thousands of knowledgeable firms and workers in
the software industry.
The Diamond Model:
Sources of National Competitive Advantage (cont.)
• Demand conditions at home: The strengths and
sophistication of customer demand
Example
Japan is a densely populated, hot, and humid country
with very demanding consumers. These conditions
led Japan to become one of the leading producers of
superior, compact air conditioners.
The Diamond Model:
Sources of National Competitive Advantage (cont.)
• Firm strategy, structure, and rivalry: The nature
of domestic rivalry and the conditions that
determine how a nation’s firms are created,
organized, and managed
Example
Italy has many top firms in design
industries such as textiles,
furniture, lighting, and fashion.
Vigorous competitive rivalry puts
these firms under constant
pressure to innovate, which has
propelled Italy to a leading position
in design worldwide.
Industrial Cluster
• A concentration of suppliers and supporting firms
from the same industry located within the same
geographic area; similar to Porter’s Related and
Supporting Industries.
• A strong cluster can serve as an export platform for
the nation.
Examples
Silicon Valley; pharmaceutical cluster in Switzerland;
footwear industry in Pusan, South Korea; IT industry in
Bangalore, India; fashion cluster in northern Italy; and
Silicon Valley North near Ottawa, Canada
National Industrial Policy
• A proactive economic development plan
employed by the government to nurture or
support promising industry sectors with potential
for regional or global dominance. Initiatives can
include:
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Tax incentives
Monetary and fiscal policies
Rigorous educational system
Investment in national infrastructure
Strong legal and regulatory systems
Examples of National Industrial Policy
• In the 1990s, Vietnam’s government privatized
state enterprises and modernized the economy,
emphasizing competitive, export-driven industries.
Vietnam became one of the fastest-growing
economies, averaging around 8 percent annual
GDP growth.
• Singapore adopted pro-business, pro-investment,
export-oriented policies, combined with statedirected investments in strategic corporations. The
approach stimulated economic growth that
averaged 8 percent annually from 1960 to 1999.
Examples of National Industrial Policy (cont.)
• New Zealand’s government, starting in 1984,
transformed the country from an agrarian,
protectionist, regulated economy to an
industrialized, free-market economy that today
competes globally.
• The Czech government in the 1990s created a
business-friendly legal and regulatory environment.
The country privatized state-owned companies.
Government FDI incentives attracted numerous
MNEs, such as Daewoo, ING, Siemens, and Toyota.
Examples of National Industrial Policy (cont.)
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In the 1990s, Ireland
implemented various
pro-business policies—
fiscal, monetary, tax;
investment in education;
and emphasis on highvalue industries such as
pharma and IT—that
dramatically grew GDP
and reduced
unemployment.
National Industrial Policy and Dubai
Stages in Company Internationalization
Domestic Focus
Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Experimental Involvement
Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Experimental Involvement
Active Involvement
Stages in Company Internationalization
Domestic Focus
Pre-export Stage
Experimental Involvement
Active Involvement
Committed Involvement
How Firms Gain and Sustain
International Competitive Advantage
• Because the MNE was traditionally the major player
in international business, scholars have offered
numerous explanations of what makes these firms
pursue, and succeed in, internationalization.
• Because FDI has been MNEs’ main strategy in
international expansion, theoretical explanations
have tended to emphasize it.
FDI-Based Explanations:
Monopolistic Advantage Theory
• Argues that MNEs prefer FDI because it provides
the firm with control over resources and capabilities
in the foreign market and a degree of monopoly
power relative to foreign competitors.
• Key sources of monopolistic advantage include
proprietary knowledge, patents, unique know-how,
and sole ownership of other assets.
Example
Novartis earns substantial profits by marketing various
patent medications through its subsidiaries worldwide.
FDI-Based Explanations:
Internalization Theory
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Explains how the MNE chooses to acquire and retain
one or more value-chain activities inside itself.
Such “internalization” provides the MNE with greater
control over its foreign operations.
Internalization avoids the drawbacks of dealing with
external partners, such as reduced quality control and
the risk of losing proprietary assets to outsiders.
Example
In China, Intel owns much of its value chain, which ensures
that Intel knowledge, patents, and other assets are not
misused or illicitly obtained by potential rivals.
FDI-Based Explanations:
Dunning’s Eclectic Paradigm
• Three conditions determine whether or not a
company will enter a given foreign country via FDI:
1. Ownership-specific advantages: Knowledge, skills,
capabilities, relationships, or physical assets that the firm
owns and that are the basis of its competitive advantages
2. Location-specific advantages: Similar to comparative
advantages; specific advantages that exist in the country
that the MNE has entered, or is seeking to enter, such as
natural resources, low-cost labor, or skilled labor
3. Internalization advantages: Control derived from
internalizing foreign-based manufacturing, distribution, or
other value-chain activities
Example of the Eclectic Paradigm: Sony in China
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Ownership-Specific Advantages. Sony possesses
a huge stock of knowledge and patents in the
consumer electronics industry, as represented by
products like the Playstation and Vaio laptop.
Location-Specific Advantages. Sony desires to
manufacture in China in order to take advantage of
China’s low-cost, highly knowledgeable labor force.
Internalization Advantages. Sony wants to maintain
control over its knowledge, patents, manufacturing
processes, and quality of its products.
Thus, Sony entered China via FDI
Non-FDI-Based Explanations:
International Collaborative Ventures
• A form of cooperation between two or more firms.
Partners pool resources and capabilities to create
synergies and share the risk of joint efforts.
• Starting in the 1980s, firms increasingly began
using collaborative ventures to expand abroad.
• Collaboration provides access to foreign partners’
know-how, capital, distribution channels, and
marketing assets. It also helps overcome
government-imposed obstacles.
Two Types of
International Collaborative Ventures
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Equity-based joint ventures result in the formation
of a new legal entity. In contrast to the wholly owned
FDI, the firm collaborates with local partner(s) to
reduce risk and commitment of capital.
Project-based alliances do not require equity
commitment from the partners, but simply a
willingness to cooperate in R&D, manufacturing,
design, or any other value-adding activity. Because
project-based alliances have a narrowly defined
scope of activities and timeline, they provide greater
flexibility to the firm than equity-based ventures.
Born Global Firms and
International Entrepreneurship
• The slow, gradual internationalization predicted by
the process model is no longer practical or realistic in
today’s fast-paced, interconnected economy
• Today many firms, even those that are young or
without much experience, take bold steps to
internationalize
• Indicative of this trend is the emergence of Born
Global companies – young, entrepreneurial firms
that take on internationalization early in their
evolution and leapfrog into global markets