Sprott School of

Business

Bus. 2701
Fundamentals of
International
Business
Lecture # 5
1
 Administration

Assignment # 1
Due on Monday, 9 th
of February
2017 @ 5:00 PM
Upload to cuLearn (dropbox);
hard copy is not required
Any Questions on Assignment
#1 ?

2
Lecture # 5 Program

1)TED Talks video on globalization

2)Assignment # 1 on Country
Assessment
3)Review of Country Differences:
political, economic, legal systems,
cultural differences
4)Activity examining countries
5)Lecture Trade Theories
6)Conclusion
TED Talks global economic
growth
https://www.ted.com/talks/alex
_tabarrok_foresees_economic_gr
owth#t-
328381
Cross-Border
Trade and
Investment

5
International
Trade
Theories

Chapter 5

6
International Trade lecture # 5

Learning Outcome:

See how trade developed and

why countries tend to specialize.
Learn theories explaining trade
flows, and arguments for and
against government policies on
trade.
Understand implications of Trade
Theories for International
Business . 7
Theory to Practice...

The economic arguments surrounding

the benefits and costs of free trade in
goods and services are not abstract
academic ones.

8
Trade has Economic Benefits

Examples: the Asian Tigers

1960s 1980s Japan
1980s 2000s Singapore, Korea
1990s 2010s China, Vietnam
2000s India

All are modernising and

benefiting from trade, and are
at different phases of
development
9
Theory - Practice

International trade theory has shaped

the economic policy of many nations for
the past 50 years.
It was the driver behind the World
Trade Organization and regional
trading blocs, such as:
the European Union and
the North American Free Trade
Agreement. (NAFTA).

10
 Case: Indias
Pharmaceutical Industry
1. What is the basis of Indias
comparative advantage in the
production of pharmaceutical drugs?
2.Is there an ethical issue to this?
3.Should pharmaceutical companies
have 20 years or more of patent
protection?
4.Are genetic pharmaceuticals
trustworthy? Would you have
confidence in drugs made in India?
Consider this.

A mechanical engineer in India

earns Ru 360,000 per year

This is about USD $5,400 !!!

Source:
http://www.payscale.com/research/IN/Job=M
echanical_Engineer/
Salary
Trade and Trade Theories

In the beginning..
Mercantilism

Mercantilism is an economic
philosophy advocating that
countries should
simultaneously encourage
exports and discourage
imports.
The flaw with mercantilism was that it
viewed trade as a zero-sum game.

14
Mercantalism a deeply flawed
philosophy!
https://ca.video.search.yahoo.com/video/play;_ylt=A2KLqIgxBLRWM1oA_0887olQ;_ylu=X3oDMTBzbmRuN
mJiBHNlYwNzcgRzbGsDdmlkBHZ0aWQDBGdwb3MDMjE-?
p=on+modern+theory+for+international+trade&vid=9bf6a0229427f44fc0a300034a564169&turl=http
%3A%2F%2Ftse3.mm.bing.net%2Fth%3Fid%3DOVP.Vb9e66eca129cdfba8347b5bfe6f32619%26pid
%3D15.1%26h%3D168%26w%3D300%26c%3D7%26rs%3D1&rurl=https%3A%2F%2Fwww.youtube.com
%2Fwatch%3Fv
%3DcVJrt33cE4w&tit=Trade+Theory+Mercantilism&c=20&h=168&w=300&l=356&sigr=11b3rhrld&sigt=1
0p28g0s3&sigi=1315klrp0&age=1401807876&fr2=p%3As%2Cv%3Av&hsimp=yhs-
fullyhosted_011&hspart=iry&tt=b
Benefits of Trade

The gains of trade arise

because international trade
allows a country to specialize in
the manufacture and export of
products that can be produced
most efficiently in that country,
while importing products that
can be produced more
efficiently in other countries.

16
An Overview of Trade Theory

Adam Smiths theory of

absolute advantage.
Proposed in 1776, Smiths
theory was the first to
explain why unrestricted free
trade is beneficial to a
country.
Free trade refers to a
situation where a
government does not
attempt to influence what its
citizens can buy and sell 17
Absolute Advantage

A country has an Absolute

Advantage in the production
of a product when it is more
efficient than any other
country in producing it.
The Wealth of Nations, Adam Smith (1776)

18
Absolute Advantage and the Gains
from Trade

Key to table: each start with 200 resource units (say: person hours) 19
Comparative Advantage

Theory that countries should

specialize in the production of
goods and services they can
produce most efficiently. A
country is said to have a
comparative advantage in the
production of such goods and
services.
Principles of Political Economy, David
Ricardo (1817)
20
Comparative Advantage and the
Gains from Trade

Again: remember each country has 200 resources

21
Video explaining Absolute and
Comparative Advantage
https://ca.video.search.yahoo.com/video/play;_ylt=A2KLqIgxBLRWM1oA_U887olQ;_ylu=X3oDMTBzYTJubD
R1BHNlYwNzcgRzbGsDdmlkBHZ0aWQDBGdwb3MDMTk-?
p=on+modern+theory+for+international+trade&vid=2c3488fb9df432599de1217cc4e287a5&turl=http
%3A%2F%2Ftse3.mm.bing.net%2Fth%3Fid%3DOVP.V70df496fc6c20ac7af58c05d02056bc6%26pid
%3D15.1%26h%3D225%26w%3D300%26c%3D7%26rs%3D1&rurl=https%3A%2F%2Fwww.youtube.com
%2Fwatch%3Fv%3DVvfzaq72wd0&tit=International+trade
%3A+Absolute+and+comparative+advantage&c=18&h=225&w=300&l=341&sigr=11bsle6br&sigt=11nd1
cbpg&sigi=1317g3e7e&age=1294144963&fr2=p%3As%2Cv%3Av&hsimp=yhs-
fullyhosted_011&hspart=iry&tt=b
An Overview of Trade Theory

Building on Smiths work are

additional theories
One was the theory of
comparative advantage, by
David Ricardo
Ricardos work was refined
by Eli Heckscher and Bertil
Ohlin, whose theory is
known as the Heckscher
Ohlin theory
The great strength of the theories of
Smith, Ricardo, and HeckscherOhlin
is that they identify with precision 23
The Benefits of Trade

The theories of Smith, Ricardo,

and HeckscherOhlin show why it
is beneficial for a country to
engage in international trade
even for products it is able to
produce for itself.
Many Canadians believe that to
help save Canadian jobs from
foreign competition, Canadian
consumers should buy products
produced in Canada, by Canadian
companies, whenever possible.

24
The Benefits of Trade

The theories of Smith, Ricardo, and

HeckscherOhlin tell us that a
country may gain if its citizens
buy certain products from other
nations that could be produced at
home.
The gains arise because
international trade allows a
country to specialize in the
manufacture and export of
products that can be produced
most efficiently in that country,
While importing products that
can be produced more efficiently
25
Heckscher-Ohlin Theory

The HeckscherOhlin theory

predicts that countries will export
those goods that make intensive
use of factors that are locally
abundant, while importing goods
that make intensive use of factors
that are locally scarce.
Like Ricardos theory, the
Heckscher Ohlin theory argues
that free trade is beneficial.
Eli Heckscher (1919) 26
The Pattern of International Trade

The theories of Smith, Ricardo, and

HeckscherOhlin also help to explain
the pattern of international trade that
we observe in the world economy.
Some aspects of the pattern are easy to
understand.
Climate and natural-resource endowments
explain why
Ghana exports cocoa,
Brazil exports coffee,
Saudi Arabia exports oil,
and China exports ginseng.
27
Canada in this Pattern of
International Trade
Due to Climate and Natural-Resource
Endowments, Canada must import a wide
range of goods:

Foodstuffs:
Raw Materials:
Manufactured Goods:
Industrial Equipment:

28
Canada in this Pattern of
International Trade
With the Natural-Resources, Services Sector,
and Manufacturing, Canada exports different
goods:

Foodstuffs:
Raw Materials:
Manufactured Goods:
Industrial Equipment:
However, these may be different foods,
materials, manufactured and industrial
good!
29
 Statistics Canada - Exports of goods on a balance-of-
payments basis, by product (www.statcan.gc.ca)
Exports of goods on a balance-of-payments basis, by product
2009 2010 2011 2012 2013
$millions
Farm&fishing 20,331 20,145 24,137 27,287 27,843
Energyproducts 74,369 83,569 103,692 105,585 113,400
Metalores&minerals 12,573 16,827 20,657 18,557 17,944
Metal&non-metallic
minerals 37,832 48,686 58,971 54,304 53,689
Basicandindustrial
chemical&plastic 26,283 30,582 35,773 33,064 35,132
Forestryproducts&
building&packaging 27,488 29,394 30,435 30,625 33,760
Electronic&electrical
equipment 24,146 22,484 23,212 22,917 22,507
Motorvehiclesandparts 44,227 57,357 59,584 68,474 68,187
Aircraft&transportation 17,746 15,816 16,131 17,308 17,390
Consumergoods 47,696 47,593 49,171 48,561 52,086
Specialtransactions 34,520 31,514 34,851 36,454 37,329
________ ________ ________ ________ ________
Exports 367,210 403,967 456,613 463,135 479,266
The Pattern of International Trade

The theories of Smith, Ricardo, and

HeckscherOhlin
Some aspects of the pattern are difficult to
understand
Leading to the New Trade Theory
New Trade Theory stresses that, in some
cases, countries specialize in the production
and export of particular products not
because of underlying differences in factor
endowments, but because in certain
industries the world market can support
only a limited number of firms.

31
The Product Life-Cycle Theory

Observation that new products

are often developed for large
& affluent markets, i.e. United
States and Europe
Initial production is for the
home market; then export
sales start, first to advanced
countries and to high-income
buyers.
As international demand
grows, production 32
The Product Life-Cycle Theory
(cont)
Markets in advanced
economies mature.
Product becomes more
standardized and price
becomes the main competitive
factor.
Production costs may become
key to holding profit margins.
Production migrates to lower-
cost locations (possibly to
33
developing countries).
The Product Life-Cycle Theory

Raymond Vernons
theory went on to
argue that early in the
life cycle of a typical
new product, while
demand is starting to
grow rapidly in the
United States, demand
in other advanced
countries is limited to
high-income groups.
34
New Trade Theory

The New Trade Theory began to emerge

in the 1970s when a number of
economists were arguing that
increasing returns to specialization
might exist in some industries.

Economies of scale:
Represent one particularly important
source of increasing returns.
Economies of scale are unit cost
reductions associated with a large scale
of output.
35
Thinking about New Trade
Theory
https://ca.video.search.yahoo.com/video/play;_ylt=A2KLqIpeDLRWt3IAXlI87olQ;_ylu=X3oDMTBzaWY2azlu
BHNlYwNzcgRzbGsDdmlkBHZ0aWQDBGdwb3MDNTA-?
p=on+new+trade+theory&vid=d53b77afa9176e6886e12c583ae14cc3&turl=http%3A%2F
%2Ftse1.mm.bing.net%2Fth%3Fid%3DOVP.Ve2b5062fadd466f3fa2e96c04eca8819%26pid%3D15.1%26h
%3D202%26w%3D300%26c%3D7%26rs%3D1&rurl=https%3A%2F%2Fwww.youtube.com%2Fwatch%3Fv
%3DZjQlo2X0ZBA&tit=Paul+Krugman+-
+Why+He+Won+the+Nobel+Prize&c=49&h=202&w=300&l=399&sigr=11b7p4p3i&sigt=119rjcp7q&sigi=
1310hpftb&age=1306028777&fr2=p%3As%2Cv%3Av&hsimp=yhs-fullyhosted_011&hspart=iry&tt=b
National Competitive Advantage

Michael Porters Theory (The

Competitive Advantage of Nations,
1990) determines that four broad
attributes of a nation shape the
environment in which local firms
compete, and these attributes
promote or impede the creation of
competitive advantage.
1. Demand conditions
2. Relating and supporting
industries
3. Factor endowments
4. Firm strategy, structure, and 37
Determinants of National Competitive Advantage:
Porters Diamond

Source: Reprinted by permission of Harvard Business Review. From The

Competitive Advantage of Nations, by Michael E. Porter, March/April 1990.

38
Porters The Competitive Advantage of
Nations, 1990 four broad attributes (1)

1. Demand conditions - the

nature of home demand for the
industrys product or service
influences the development of
capabilities
sophisticated and demanding
customers pressure firms to be
competitive
39
Porters The Competitive Advantage of
Nations, 1990 four broad attributes (2)

2. Relating and supporting

industries - the presence or
absence of supplier industries
and related industries that are
internationally competitive

can spill over and contribute to

other industries

successful industries tend to be

grouped in clusters in countries 40
Porters The Competitive Advantage of
Nations, 1990 four broad attributes (3)

3. Factor endowments - a
nations position in factors of
production necessary to
compete in a given industry
can lead to competitive
advantage
can be either basic (e.g. natural
resources, climate, location) or
advanced (e.g. skilled labor,
infrastructure, technological 41
Porters The Competitive Advantage of
Nations, 1990 four broad attributes (4)

4. Firm strategy, structure, and

rivalry - the conditions
governing how companies are
created, organized, and
managed, and the nature of
domestic rivalry

different management ideologies

affect the development of
national competitive advantage
42
Porter - continued

vigorous domestic rivalry creates

pressures:
to innovate,
to improve quality,
to reduce costs, and
to invest in upgrading
advanced features

43
Does Porters Theory Hold?

Government policy can:

affect demand through product
standards
influence rivalry through regulation
and antitrust laws
impact the availability of highly
educated workers and advanced
transportation infrastructure.

44
Porters Theory

The four attributes, and

government policy, and chance
work as a reinforcing system,
complementing each other and
in combination creating the
conditions appropriate for
competitive advantage

45
Video on agriculture in Ukraine

Natural factor endowments

Favourable government
policies

Specialization to optimize
aggregate income
https://www.youtube.com/watch?v=
Wfnpwaj7oyE
Why Is Free Trade Beneficial?

Free trade - 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.

Free trade - Governments take

a hands-off attitude to trade

47
Why Is Free Trade Beneficial?
Trade theory shows why it is
beneficial for a country to engage
in international trade even for
products it is able to produce for
itself
International trade allows a
country
To specialize in the manufacture and
export of products/services that it can
produce efficiently

To import products/services that can be48

Could A Rich Country Be Worse
Off With Free Trade?
Paul Samuelson - the dynamic gains from
trade may not always be beneficial
free trade may ultimately result in lower wages
in the rich country

The ability to off-shore services jobs that

were traditionally not internationally mobile
may be similar to off-shoring in
manufacturing: consumer prices may fall,
but wages and employment in sectors may
then also fall

49
Implications for International
Businesses
Location Implications
First-mover Implications
Policy Implications

50
Implications for International
Businesses
Location Implications
different countries have
particular advantages in
different productive activities
it makes sense for a firm to
disperse its productive
activities to those countries
where, according to the
theory of international trade,
they can be performed most
efficiently
51
Implications for International
Businesses
First-mover Implications
firms that establish a first-
mover advantage with
regard to the production of
a particular new product
may subsequently dominate
global trade in that product
it pays to invest substantial
financial resources in trying
to build a first-mover, or
early-mover, advantage,
even if that means several
52
years of substantial losses
Examples for 1st Mover Advantage

1) Researched products
i.e. pharmaceuticals

2) Consumer goods
i.e. Nokia in cellphones

3) Industrial goods
i.e. Bombardier in regional aircraft
Tesla - the all-electric four-door
Model S
http://blogs.canada.com/2012/06/
25/watch-tesla-model-s-cars-get-
built/

http://www.fastcoexist.com/1680063/watch-
the-tesla-model-s-get-made 54
CNN Money report:
Tesla's business plan - Riding on
fumes
Prices will start at $57,400
Autos industry needs economies of
scale to cover the fixed costs of
R&D, engineering, manufacturing,
marketing, and distribution
At http://www.teslamotors.com
Tesla claims development cost of
$400 million
How many Tesla model S must be
sold to recover the $400 million?
55
Implications for International
Businesses
Policy Implications
The theories of international trade also
matter to international businesses
because firms are major players on the
international trade scene.
Because of their pivotal role in
international trade, businesses
can influence government
trade policy, lobbying to
promote free trade or trade
restrictions
56
Case: Bangladesh
1. Bangladeshs exports of textiles
continued to grow even during the
2008 global recession. Why? How
has Bangladesh been able to attract
buyers even during slow economic
times?

2. Using Porters Diamond of

Competitive Advantage, discuss
Bangladeshs competitive advantage
in textiles. What factors contribute to
the countrys competitive advantage
in the production of textiles?
57
Lecture 5 Summary
Understand why nations engage
in international trade

Become familiar with the

different theories of international
trade

Understand why many

economists believe that free
trade can raise the economic 58