Chapter 6:

International
Trade and
Investment
Theory

International Business, 4th Edition

Griffin & Pustay
6-1 ©2004 Prentice Hall
 Chapter Objectives_1

 Understand the motivation for international

trade
 Summarize and discuss the differences
among the classical country-based theories
of international trade
 Use the modern firm-based theories of
international trade to describe global
strategies adopted by businesses
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 Chapter Objectives_2

 Describe and categorize the different

forms of international investment
 Explain the reasons for foreign direct
investment
 Summarize how supply, demand, and
political factors influence foreign
direct investment
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 International Trade

 Trade: voluntary exchange of goods,

services, assets, or money between one
person or organization and another
 International trade: trade between
residents of two countries

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 Figure 6.2 Sources of the World’s
Merchandise Exports, 2001

37%
40%
European Union
United States
Japan
Canada
Other countries

4% 12%
7%

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 The largest
component of the
annual $1.5 trillion
trade in
international services
is
travel and tourism

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Classical Country-Based Trade Theories

 Mercantilism
 Absolute Advantage
 Comparative Advantage
 Comparative Advantage with Money
 Relative Factor Endowments

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 Mercantilism

 A country’s wealth is measured by its

holdings of gold and silver
 A country’s goal should be to enlarge
holdings of gold and silver by
– Promoting exports
– Discouraging imports

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 Modern Mercantilism

 Neomercantilists or protectionists
– American Federation of Labor-Congress
of Industrial Organizations
– Textile manufacturers
– Steel companies
– Sugar growers
– Peanut farmers
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 Disadvantages of Mercantilism
 Confuses the acquisition of treasure with
the acquisition of wealth
 Weakens the country because it robs
individuals of the ability
– To trade freely
– To benefit from voluntary exchanges
 Forces countries to produce products it
would otherwise not in order to minimize
imports
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 Absolute Advantage

 Export those goods and services for

which a country is more productive
than other countries
 Import those goods and services for
which other countries are more
productive than it is

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 Table 6.1 The Theory of Absolute
Advantage: An Example

OUTPUT PER HOUR OF LABOR

France Japan
Wine 2 1

Clock 3 5
radios

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 Absolute Advantage’s Flaw

 What happens to trade if one country

has an absolute advantage in both
products?
 No trade would occur

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 Comparative Advantage

 Produce and export those goods and

services for which it is relatively more
productive than other countries
 Import those goods and services for
which other countries are relatively
more productive than it is

6-14 ©2004 Prentice Hall

 Differences between Comparative and
Absolute Advantage
 Absolute versus relative productivity
differences
 Comparative advantage incorporates
the concept of opportunity cost
– Value of what is given up to get the good

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 Table 6.2 The Theory of Comparative
Advantage: An Example

OUTPUT PER HOUR OF LABOR

France Japan
Wine 4 1

Clock 6 5
radios

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Comparative Advantage with Money

 One is better off specializing in what one

does relatively best
 Produce and export those goods and
services one is relatively best able to
produce
 Buy other goods and services from people
who are better at producing them

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 Table 6.3 The Theory of Comparative
Advantage with Money: An Example

Cost of Goods in France Cost of Goods in Japan

French Japanese French Japanese
Made Made Made Made
Wine €3 €8 ¥375 ¥1,000

Clock €3 €1.6 ¥250 ¥200

Radios

6-18 ©2004 Prentice Hall

 Relative Factor Endowments

 Heckscher-Ohlin Theory
 What determines the products for
which a country will have a
comparative advantage?
– Factor endowments vary among countries
– Goods differ according to the types of
factors that are used to produce them
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 Relative Factor Endowments_2

 A country will have a comparative

advantage in producing products that
intensively use resources (factors of
production) it has in abundance
– China: labor
– Saudi Arabia: oil
– Argentina: wheat
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 Figure 6.3 U.S. Imports and Exports,
1947: The Leontief Paradox

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Modern Firm-Based Trade Theories

 Country Similarity Theory

 Product Life Cycle Theory
 Global Strategic Rivalry Theory
 Porter’s National Competitive
Advantage

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 Growth of Firm-Based Theories

 Growing importance of MNCs

 Inability of the country-based theories
to explain and predict the existence and
growth of intraindustry trade
 Failure of Leontief and others to
empirically validate country-based
Heckscher-Ohlin Theory
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 Firm-Based Trade Theories

 Incorporate additional factors into

explanations of trade flows
– Quality
– Technology
– Brand names
– Customer quality

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 Country Similarity Theory

 Explains the phenomenon of

intraindustry trade
– Trade between two countries of goods
produced by the same industry
• Japan exports Toyotas to Germany
• Germany exports BMWs to Japan

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 Country Similarity Theory_2

 Trade results from similarities of

preferences among consumers in
countries that are at the same stage of
economic development
 Most trade in manufactured goods
should be between countries with
similar per capita incomes
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 Product Life Cycle Theory

 Describes the evolution of marketing

strategies
 Stages
– New product
– Maturing product
– Standardized product

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 Figure 6.4 The International Product Life
Cycle: Innovating Firm’s Country

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 Figure 6.4 The International Product Life
Cycle: Other Industrialized Countries

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 Figure 6.4 The International Product Life
Cycle: Less Developed Countries

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 Global Strategic Rivalry Theory

 Firms struggle to develop sustainable

competitive advantage
 Advantage provides ability to dominate
global marketplace
 Focus: strategic decisions firms use to
compete internationally

6-31 ©2004 Prentice Hall

 Sustaining Competitive Advantage

 Owning intellectual property rights

 Investing in research and development
 Achieving economies of scale or scope
 Exploiting the experience curve

6-32 ©2004 Prentice Hall

 Porter’s National
Competitive Advantage
 Success in trade comes from the
interaction of four country and firm
specific elements
– Factor conditions
– Demand conditions
– Related and supporting industries
– Firm strategy, structure, and rivalry
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 Figure 6.5 Porter’s Diamond of
National Competitive Advantage

Firm Strategy,
Structure,
and Rivalry
Factor Demand
Conditions Conditions
Related and
Supporting
Industries

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 The intense
competitiveness
of Japanese
market forces
manufacturers to
continually
develop and fine-
tune new
products

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 Figure 6.6 Theories of
International Trade
Country-Based Theories Firm-Based Theories
 Country is unit of analysis  Firm is unit of analysis
 Emerged prior to WWII  Emerged after WWII
 Developed by economists  Developed by business school
 Explain interindustry trade professors
 Include  Explain intraindustry trade
– Mercantilism  Include
– Absolute advantage – Country similarity theory
– Comparative advantage – Product life cycle
– Relative factor endowments – Global strategic rivalry
– National competitive
advantage

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 Types of International Investments

 Does the investor seek an active

management role in the firm r merely a
return from a passive investment?
– Foreign Direct Investment
– Portfolio Investment

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 Figure 6.7 Stock of Foreign Direct
Investment, by recipient

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 Table 6.4 Sources of FDI for the U.S.,
end of 2002
United Kingdom 283.3
France 170.6
Netherlands 154.8
Japan 152.
Germany 137.0
Switzerland 113.2
Canada 92.0
Luxembourg 34.3
Bermuda, Bahamas, Caribbean islands 32.5
Other European countries 113.3
All other countries 65.0
Total 1,348.0
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 Table 6.4 Destinations of FDI for the
U.S., end of 2002
United Kingdom 255.4
Canada 152.5
Netherlands 145.5
Bermuda, Bahamas, Caribbean islands 98.1
Switzerland 70.1
Japan 65.7
Germany 64.7
Mexico 58.1
France 44.0
Other European countries 217.2
All other countries 349.7
Total 1,521.0
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 International Investment Theories

 Ownership Advantages
 Internalization
 Dunning’s Eclectic Theory

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 Ownership Advantages

 A firm owning a valuable asset that

creates a competitive advantage
domestically can use that advantage to
penetrate foreign markets through FDI
 Why FDI and not other methods?

6-42 ©2004 Prentice Hall

 Internalization Theory

 FDI is more likely to occur when

transaction costs with a second firm are
high
 Transaction costs: costs associated
with negotiating, monitoring, and
enforcing a contract

6-43 ©2004 Prentice Hall

 Dunning’s Eclectic Theory

 FDI reflects both international business

activity and business activity internal
to the firm
 3 conditions for FDI
– Ownership advantage
– Location advantage
– Internalization advantage
6-44 ©2004 Prentice Hall
 Table 6.5 Factors Affecting
the FDI Decision
Supply Factors Demand Factors Political Factors

Production costs Customer access Avoidance of trade

barriers

Logistics Marketing advantages Economic

development
incentives
Resource availability Exploitation of
competitive advantages

Access to technology Customer mobility

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 Ikea
aggressively
exports its
furniture to
other
countries

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