The Topic Discussion Notes provide you with a brief summary of the essential concepts to master in each Topic and the major Learning Outcomes. Show
Specifically, each of the key concepts in the relevant chapters for each Topic are summarised briefly. In addition, there are brief summaries of each slide related to the Course Slides for each chapter. You will find that the summaries for each slide provide you with an essential background of knowledge, ideally after you have read each chapter. In this way it enables you to test your knowledge, as well as laying a foundation to build on and deepen your knowledge of international business by reading many of the of the Course Journal Articles. While they are optional reading, reading the Course Journal Articles will assist you to have a much broader, more contemporary and practical knowledge base from which to apply your knowledge now and in the future. Note that the Course Slides are located on the Learnonline site and the Journal Articles are available through the e-Library Resources for this Course. Chapter 6: International Trade Theory Learning objectives
LECTURE OUTLINE The PPT slides include additional notes that can be viewed by clicking on “view,” then on “notes.” The following provides a brief overview of each Power Point slide. Slides 6-2 and 6-3 The Benefits of Trade Free trade refers to a situation where a 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. Smith, Ricardo, and Heckscher-Ohlin show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. Slide 6-4 The Patterns of Trade International trade allows a country to specialize in the manufacture and export of products that it can produce efficiently, and import products that can be produced more efficiently in other countries. Some patterns of trade are fairly easy to explain—it is obvious why Saudi Arabia exports oil, the United States exports agricultural products, and Mexico exports labor intensive goods. Yet others are not so obvious or easily explained, such as cars exported from Japan. Slide 6-5 Trade Theory and Government Policy The various theories have differing prescriptions for government policy on trade. Mercantilism makes a crude case for government involvement in promoting exports and limiting imports. Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade. New trade theory and Porter’s theory of national competitive advantage justify limited and selective government intervention to support the development of certain export-oriented industries. Slide 6-7 Mercantilism Mercantilism suggests that it is in a country’s best interest to maintain a trade surplus— to export more than it imports, and advocates government intervention to achieve a surplus in the balance of trade. It views trade as a zero-sum game—one in which a gain by one country results in a loss by another. Another Perspective: An interesting perspective of how the mercantilist philosophy may be a hindrance to trade negotiations between the United States and the European Union can be found at {http://www.cato.org/blog/no-time-mercantilist-posturing-transatlantic-trade-talks}. Slides 6-8 through 6-13 Absolute Advantage Adam Smith argued that countries differed in their ability to produce goods efficiently, and should specialize in the production of the goods they can produce the most efficiently. If Ghana were to specialize in cocoa production and South Korea in rice production, Smith argued that both Ghana and South Korea could consume more cocoa and rice than if each only produced for their own consumption. Thus, trade is a positive sum game. Slides 6-14 through 6-19Comparative Advantage David Ricardo asked what might happen when one country has an absolute advantage in the production of both goods. Ricardo’s theory of comparative advantagesuggests that countries should specialize in the production of those goods they produce most efficiently and buy goods that they produce less efficiently from other countries, even if this means buying goods from other countries that they could produce more efficiently at home. The simple example of comparative advantage presented in the text makes a number of assumptions: only two countries and two goods; zero transportation costs; similar prices and values; resources are mobile between goods within countries, but not across countries; constant returns to scale; fixed stocks of resources; and no effects on income distribution within countries. While these are all unrealistic, the general proposition that countries will produce and export those goods that they are the most efficient at producing has been shown to be quite valid. Slide 6-20 Is Unrestricted Free Trade Always Beneficial? Extensions of the Ricardian Model Diminishing returns to specialization suggest that after some point, the more of a good that a country produces, the greater will be the units of resources required to produce each additional item. If crops are grown on increasingly less fertile land, mining is done on less productive ore, or less skilled personnel need to be hired to perform high skilled jobs, production per unit of input will decrease. (Diminishing returns implies a PPF which is convex.) In reality, countries do not specialize entirely, but produce a range of goods. It is worthwhile to specialize up until that point where the resulting gains from trade are offset by diminishing returns. Opening an economy to trade is likely to generate dynamic gains of two types. First, trade might increase a country's stock of resources as increased supplies become available from abroad. Secondly, free trade might increase the efficiency of resource utilization, and free up resources for other uses. Another Perspective: An overview of the ideas and philosophies of David Ricardo, from which his theory of comparative advantage emerged, is available at {http://www.econlib.org/library/Enc/bios/Ricardo.html}. Students might also consult {http://www.newschool.edu/nssr/het/profiles/ricardo.htm}. Slide 6-21 The Samuelson Critique Samuelson argues that in some cases, the dynamic gains from trade may not be so beneficial. He argues that the ability to off-shore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages fall. Slides 6-22 and 6-23 Heckscher-Olin Theory The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors of production which are locally abundant, while importing goods that make intensive use of factors that are locally scarce. It focuses on differences in relative factor endowments rather than differences in relative productivity. Another Perspective: A more complete description of the Heckscher-Ohlin theory is available at {http://www.newschool.edu/nssr/het/profiles/heckscher.htm}. Slide 6-24 The Leontief Paradox Using the Heckscher-Ohlin theory, Leontief, in 1953 postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital intensive goods and an importer of labor-intensive goods. To his surprise, however, he found that U.S. exports were less capital intensive than U.S. imports. Since this result was at variance with the predictions of the theory, it has become known as the Leontief Paradox. Another Perspective: A more extensive description of the Leontief Paradox is available at {http://www.newschool.edu/nssr/het/profiles/leontief.htm}. Slides 6-25 through 6-30 The Product Life Cycle Raymond Vernon suggested that as products mature, both the location of sales and the optimal production location will change, affecting the direction and flow of imports and exports. Globalization weakens this theory. Slides 6-31 through 6-33 New Trade Theory New trade theory suggests that because of economies of scale and increasing returns to specialization, in some industries there are likely to be only a few profitable firms. Firms with first mover advantages will develop economies of scale and create barriers to entry for other firms. New trade theory does not contradict the theory of comparative advantage, but instead identifies a source of comparative advantage. A nation may be able to specialize in producing a narrower range of products than it would in the absence of trade, yet by buying goods that it does not make from other countries, each nation can simultaneously increase the variety of goods available to its consumers and lower the costs of those goods. The pattern of trade we observe in the world economy may be the result of first-mover advantages (economic and strategic advantages that accrue to early entrants into an industry) and economies of scale. Slide 6-34 Think Like a Manager:First-Mover Advantages Slide 6-35 Implications of New Trade Theory New trade theory suggests that nations may benefit from trade even when they do not differ in resource endowments or technology. The theory also suggests that a country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good. Slides 6-36 through 6-39 Theory of National Competitive Advantage Michael Porter hypothesizes that a nation’s competitiveness depends on the capacity of its industry to innovate and upgrade. Porter's study tried to explain why a nation achieves international success in a particular industry. This study found four broad attributes that promote or impede the creation of competitive advantage: factor endowments, demand conditions, relating and supporting industries, and firm strategy, structure, and rivalry. These attributes form Porter’s diamond. Factor endowments are the nation’s relative position in factors of production. They are divided into basic and advanced. Demand conditions refer to the nature of home demand for the product or service, and influences the development of production capabilities. Sophisticated and demanding customers pressure firms to be competitive. Related and supporting industries refer to the presence in a nation of supplier industries and related industries that are internationally competitive, and can spill over and contribute to other industries. Firm strategy, structure and rivalry refer to the conditions in the nation governing how companies are created, organized, and managed, and how the nature of domestic rivalry impacts firms' competitiveness. Firms that face strong domestic competition will be better able to face competitors from other firms. Slide 6-40 Evaluating Porter’s Theory In addition to these four main attributes, government policies and chance can impact any of the four. Government policy can affect demand through product standards, influence rivalry through regulation and antitrust laws, and impact the availability of highly educated workers and advanced transportation infrastructure. Slide 6-41 Implications for Managers There are at least three main implications of the material discussed in this chapter for international businesses: location implications, first-mover implications, and policy implications. From a profit perspective, it makes sense for a firm to disperse its various productive activities to those countries where, according to the theory of international trade, they can be performed most efficiently. Being a first mover can have important competitive implications, especially if there are economies of scale and the global industry will only support a few competitors. Firms need to be prepared to undertake huge investments and suffer losses for several years in order to reap the eventual rewards. Being a first mover can have important competitive implications, especially if there are economies of scale and the global industry will only support a few competitors. Firms need to be prepared to undertake huge investments and suffer losses for several years in order to reap the eventual rewards. One of the most important implications for businesses is that they should work to encourage governmental policies that support free trade. If a business is able to get its goods from the best sources worldwide, and compete in the sale of products into the most competitive markets, it has a good chance to survive and prosper. If such openness is restricted, a business’s long-term survival will be in greater question. Another Perspective: For information about foreign governments and their approaches to international trade, visit the Electronic Embassy at {http://www.embassy.org/}. This site provides links to all of the foreign embassies located in Washington D.C. Slides 6-42 through 6-45 Balance of Payments The balance-of-payments accounts keep track of the payments to foreigners for imports of goods and services, and receipts from foreigners for goods and services exported to them. There are three main accounts: the current account, the capital account, and the financial account. In the United States, the current account deficit has been growing because of its imports of physical products, but the country runs a current account surplus in trade in services. Chapter 7: Government Policy and International Trade Learning objectives
This chapter focuses on the political systems and tools of trade policy. The major objective of this chapter is to describe how political realities shape the international trading system. With an introduction to tariffs, subsidies, and the development of the world trading system, the chapter describes the evolution of the World Trade Organization and its impact on the global business environment. While in theory many countries adhere to the free trade ideal outlined in Chapter 5, in practice most have been reluctant to engage in unrestricted free trade. The United States, as do many other developed markets, continues to restrict trade in technological and militarily sensitive products as well as in textiles, sugar, and other basic products in response to domestic political pressures. The opening case explores the decision by the United States and members of the European Union to levy tariffs on solar panels imported from China. China has been accused of subsidizing its solar panel industry in order to gain an unfair advantage and “dump” (export at below-market prices) panels in the United States and elsewhere. The tariffs, however, did not produce the expected results of protecting domestic manufacturing jobs in the United States or the EU. Instead, they resulted in driving global production to Malaysia. The closing case explores the economic effects of the longstanding U.S. policy to support the sugar industry. LECTURE OUTLINE The PPT slides include additional notes that can be viewed by clicking on “view,” then on “notes.” The following provides a brief overview of each Power Point slide. Slide 7-2 What Is the Political Reality of Free Trade? Free trade refers to a situation in which a government does not attempt to restrict what its citizens can buy from another country or what they can sell to another country. Slides 7-3 through 7-9 Instruments of Trade Policy The main instruments of trade policy are:
Tariffs are the oldest form of trade policy. The principal objective of most tariffs is to protect domestic producers and employees against foreign competition. Tariffs also raise revenue for the government. Domestic producers gain, because tariffs afford them some protection against foreign competitors by increasing the cost of imported foreign goods. Consumers lose because they must pay more for certain imports. Tariffs reduce the overall efficiency of the world economy. Subsidies take many forms (cash grants, low-interest loans, tax breaks, and government equity participation in domestic firms). By lowering production costs, subsidies help domestic producers in two ways: they help them compete against foreign imports and they help them gain export markets. Subsidy revenues are generated from taxes. Governments typically pay for subsidies by taxing individuals. Therefore, whether subsidies generate national benefits that exceed their national costs is debatable. Subsidies encourage overproduction, inefficiency and reduced trade. In practice, many subsidies are not very successful at increasing the international competitiveness of domestic producers. Rather, they tend to protect the inefficient and promote excess production. Quotas and Voluntary Export Restraints (VER) are direct restrictions on the quantity of some good that may be imported into a country. The quota restriction is usually enforced by issuing import licenses to a group of individuals or firms. A VER is a quota on trade imposed by the exporting country, typically at the request of the importing country’s government. Local content regulations have been widely used by developing countries to shift their manufacturing base from the simple assembly of products whose parts are manufactured elsewhere into the local manufacture of component parts. They have also been used in developed countries to try to protect local jobs and industry from foreign competition. From the point of view of a domestic producer of parts going into a final product, local content regulations provide protection in the same way an import quota does: by limiting foreign competition. The aggregate economic effects are also the same; domestic producers benefit, but the restrictions on imports raise the prices of imported components. Governments sometimes use informal or administrative policies to restrict imports and boost exports. Administrative trade policiesare bureaucratic rules that are designed to make it difficult for imports to enter a country. Another Perspective: Information about U.S. trade is readily available on government sites. Visit {www.business.gov} to access an array of links. You can also review the current U.S. tariffs at the U.S. Office of Tariff Affairs and Trade Agreements at {www.usitc.gov/tata/index.htm}. Dumping is defined as selling goods in a foreign market at below cost of production or at below “fair” market value. Slide 7-10 The Case for Government Intervention There are two types of arguments for government intervention, political and economic. Slides 7-11 through 7-15 Political Arguments for Intervention Political arguments for government intervention include:
The most common political reason for trade restrictions is “protecting jobs and industries.” Countries sometimes argue that it is necessary to protect certain industries because they are important for national security. Defense-related industries often get this kind of attention (e.g., aerospace, advanced electronics, semiconductors). Government intervention in trade can be used as part of a "get tough" policy to open foreign markets. Consumer protection can also be an argument for restricting imports. Since different countries do have different health and safety standards, what may be acceptable in one country may be unacceptable in others. Sometimes, governments use trade policy to support their foreign policy objectives. Governments sometimes use trade policy to create pressure for improving the human rights policies of trading partners. For years the most obvious example of this was the annual debate in the United States over whether to grant most favored nation (MFN) status to China. MFN status allows countries to export goods to the United Status under favorable terms. Under MFN rules, the average tariff on Chinese goods imported into the United States is 8 percent. If China’s MFN status were rescinded, tariffs would probably rise to about 40 percent. Another Perspective: In the United States, the Bureau of Export Administration enhances the nation's security and its economic prosperity by controlling exports for national security, foreign security, foreign policy, and short supply reasons. To learn more, go to {http://www.bis.doc.gov/} and click on Export Administration regulations. Slide 7-16 Think Like a Manager: Government Intervention and Job Creation Slides 7-17 through 7-20 Economic Arguments for Intervention Protecting infant industries and strategic trade policy are the main economic reasons for trade restrictions. The infant industry argument has been considered a legitimate reason for protectionism, especially in developing countries. Many economists criticize this argument: protection of manufacturing from foreign competition does no good unless the protection helps make the industry efficient. Brazil built up the world’s 10th largest auto industry behind tariff barriers and quotas. Once those barriers were removed in the late 1980s, however, foreign imports soared and the industry was forced to face up to the fact that after 30 years of protection, the Brazilian industry was one of the most inefficient in the world. Strategic trade policy suggests that government intervention may be justified in an industry when the world market will profitably support only a few firms because of the existence of substantial scale economies. Such intervention reduces the competitive effect of existing first-mover advantages held by foreign companies. Revised Case for Free Trade: While strategic trade policy identifies conditions where restrictions on trade may provide economic benefits, there are two problems that may make restrictions inappropriate: retaliation and politics. Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countries. Special interest groups may influence governments. Slides 7-21 through 7-25 Development of the World Trading System How has today’s world trade system evolved? Up until the Great Depression of the 1930s, most countries had some degree of protectionism. Great Britain, as a major trading nation, was one of the strongest supporters of free trade. Although the world was already in a depression, in 1930 the United States enacted the Smoot-Hawley tariff, which created significant import tariffs on foreign goods. As other nations took similar steps and the depression deepened, world trade fell further. After WWII, the United States and other nations realized the value of freer trade, and established the General Agreement on Tariffs and Trade (GATT). The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate barriers to trade. Over 100 countries became members of GATT, and worked together to further liberalize trade. Another Perspective: A full review of GATT, containing an actual copy of the agreement, is available at {http://www.ciesin.org/TG/PI/TRADE/gatt.html}. Calls for protectionism were motivated by 3 factors: 1. Japan’s success in such industries as automobiles and semiconductors coupled with the sense that Japanese markets were closed to imports and foreign investment by administrative trade barriers. 2. The world’s largest economy, the United States, was plagued by a persistent deficit. The loss of market share to foreign competitors in industries such as automobiles, machine tools, semiconductors, steel, and textiles, and the resulting unemployment gave rise to renewed demands in the U.S. Congress for protection against imports. 3. Many countries found ways to get around GATT regulations. The Uruguay Round wrote the rules governing:
Slides 7-26 and 7-27 The Future of the WTO: Unresolved Issues and the Doha Round In addition to the impasse at the meetings over agricultural subsidies, the Seattle round was a lightning rod for a diverse collection of organizations from environmentalists and human rights groups to labor unions that opposed free trade. All these organizations argued that the WTO is an undemocratic institution that was usurping the national sovereignty of member states and making decisions of great importance behind closed doors. They took advantage of the Seattle meetings to voice their opposition. The Doha Round had several initiatives: Cutting tariffs on industrial goods and services. In 2000, for example, the average tariff rates on non-agricultural products were 4.4% for Canada, 4.5% for the European Union, 4.0% for Japan, and 4.7% for the United States. On agricultural products, however, the average tariffs rates were 22.9% for Canada, 17.3% for the European Union, 18.2% for Japan, and 11% for the United States. Phasing out subsidies. Subsidies introduce significant distortions into the production of agricultural products. The net effect is to raise prices to consumers, reduce the volume of agricultural trade, and encourage the overproduction of products that are heavily subsidized (with the government typically buying up the surplus). Reducing anti-dumping laws. WTO rules allow countries to impose anti-dumping duties on foreign goods that are being sold cheaper than at home, or below their cost of production, when domestic producers can show that they are being harmed. WTO on intellectual property should allow for health protection in poorer nations. Rich countries have to comply with the rules within a year. Poor countries, in which such protection generally was much weaker, have five years’ grace, and the very poorest have ten years. Another Perspective: To see current issues at the WTO, go to {http://www.wto.org} and click on “News.” Slides 7-28 and 7-29 Implications for Managers Managers need to consider how trade barriers affect the strategy of the firm and the implications of government policy on the firm. Trade barriers are a constraint upon a firm’s ability to disperse its productive activities. International firms have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategy. Copyright © 2017 McGraw-Hill Education. Adapted for MBA BUSS 5251 International Business for the purpose of individual study and course preparation. Which of the following two theories justify some limited and selective government intervention to support the development of certain export oriented industries?New trade theory and Porter's theory of national competitive advantage justify limited and selective government intervention to support the development of certain export-oriented industries.
Which of the following is a theory that can be used to justify limited government intervention?Laissez-faire is an economic philosophy of free-market capitalism that opposes government intervention.
Which of the following theories endorse government intervention in trade?Mercantilism advocates that governments should actively intervene in international trade to maintain a trade surplus.
What is Ricardo's theory of comparative advantage?Ricardo's widely acclaimed comparative advantage theory suggests that nations can gain an international trade advantage when they focus on producing goods that produce the lowest opportunity costs as compared to other nations.
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Which of the following two theories justify some limited and selective government intervention?
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