International Business

Chapter 5
International Trade
by
Wild, Wild, & Han
 Learning Objectives
Describe how international trade volume and world
output are related, and identify overall international
trade patterns.
Describe mercantilism and explain its historical impact
on the world powers and their colonies.

Identify the differences between absolute advantage

and comparative advantage.

Explain the factor proportions and international

product life cycle theories.

Explain the new trade and national competitive

advantage theories.
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 International Trade
The purchase, sale, or
exchange of goods and
services across national
borders.
International Trade:
Provides a country’s people with a greater choice
of goods and services
Important engine for job creation
Example: The U.S. Commerce Department
estimates that for every $1 billion increase in
exports, 22,800 jobs are created in the United
States, 12 million US jobs depend on export.
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Benefits Of International Trade

Volume Of International Trade

International Trade Patterns

Trade Dependence And Independence

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 Volume Of International Trade
Most of world merchandise trade is comprised of trade in
manufactured goods (80%), the rest 20% is trade in
services.
World merchandise exports are > $14 trillion and service
exports > $3 trillion.
Trade and World Output
Higher world economic output encourages international
trade, lower output slows trade.
World trade expands at a rate is faster than growth in
world output.

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World’s Top Exporters

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Trade Patterns: Who trades with whom?

Merchandise trade among:

Low- and
middle-income
nations High-income
6% nations
60%

34%

High-income and low- and

middle-income nations

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Who Trades with Whom?

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 Trade Dependence and
Independence
Total Total
dependence independence

Potential effects of dependence:

+ Infuses needed capital
+ Creates jobs and raises wages
+ Imports technology and skills
– Economic recessions transferred
– Political turmoil can spill over

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 Discussion Question

What are the

patterns of global
and regional trade
flows that we see
among nations?

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Answer to Discussion Question
60 percent of world merchandise trade
occurs among high-income countries. 34
percent of world merchandise trade occurs
among high-income countries and low- and
middle-income nations. About 6 percent of
trade occurs only among low- and middle-
income nations.
Intra-regional trade accounts for 71 percent
of Europe’s exports, 52 percent of Asia’s
exports, and around 48 percent of North
America’s exports.
This century is called the ―Pacific century‖
due to expected growth in Asia and a shift in
trade from the Atlantic to the Pacific Ocean.
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 Change up 1

Who are Vietnam’s main trading

partners?
What are their main imports?
What are VNs main exports?

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Trade Theory Timeline

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 Mercantilism
Nations should accumulate financial
wealth by encouraging exports and
discouraging imports.

Trade Surplus: Trade Deficit:

The value of The value of
exports are imports are
greater than the greater than the
value of imports value of exports
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 How Mercantilism Worked -
main policies

1. Maintain trade surpluses: Countries

increased wealth by maintaining a trade
suplus => amount of gold coming in (in terms
of exports) was greater than amount of gold
going out (in terms of imports).

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 How Mercantilism Worked -
main policies

2.Government intervention
Mercantilists were not in favor of free
trade. Large volumes of trade were not the
goal. They were in favor of government
policies that limited imports by tariffs and
quotas, and policies that subsidized their
exports.

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 How Mercantilism Worked -
main policies
3. Colonization
For example, Spain explored and colonized
many parts of South America. Understand
colonization? It means subduing native populations
and imposing on them an alien way of life. Trade with
these colonies greatly benefited the mother countries,
and colonial nations were generally treated as
resources to be exploited.

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 Flaws of Mercantilism

Mercantilism viewed international trade as a zero-

sum game (positive for one, negative for another)
— that is, that one nation can benefit only at the
expense of others.

However, if all nations were to barricade their

markets from imports and push their exports onto
others, international trade would be severely
restricted.

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 Absolute Advantage(Scottish
economist - Adam Smith in 1776)

The ability of a nation to produce a good more

efficiently than any other nation. A nation with an
absolute advantage can produce greater output of
a good or service than other nations using same
amount of, or fewer, resources.

E.g: Vietnam (with favorable climate and good soil

and coffee) has AA when, for one unit of resource,
VN can produce more coffee beans than any other
nation (except maybe Brazil).

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 Absolute Advantage

Ability of a nation to produce a good more efficiently than any

other nation (greater output using same or fewer resources)

Riceland Tealand

1 resource unit = 1 ton rice or 1 resource unit = 1/6 ton rice or

1/5 ton tea 1/3 ton tea

Specialization and trade allows each to

produce and consume more
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 Trade Gains:
Absolute Advantage

Specialization and trade:

+ Riceland gets five times

more tea than it would
have produced itself

+ Tealand gets two times

more rice than it would
have produced itself

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Absolute Advantage: Main features
1. A nation’s wealth is measured by living standards
of its people (the variety and quality of goods
available for them to buy).
2. There are gains from specialization: Countries
increased their standards of living by trading with
others to obtain goods they would otherwise not
have, or higher quality goods.
3. Emphasizes on labor productivity.
4. Int’l Trade is a positive-sum game (win-win
game): Both parties to a trade arrangement can
benefit.
5. Emphasizes “free-trade” – low gov’t intervention.

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 One Big Problem

What if one country does not hold an AA

in the production of ANY product? That
would be true of many developing
countries, correct? Are there still benefits
to trade? Will trade even happen? =>An
extension of AA is CA

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 Comparative Advantage(English
economist, David Ricardo in 1817)

If one country held absolute advantages in the

production of both products, specialization and
trade could still benefit both countries.
A country has a comparative advantage
when it is unable to produce a good more
efficiently than other nations, but produces the
good more efficiently than it does any other
good.

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 Trade Gains:
Comparative Advantage

Specialization and trade:

+ Riceland gets two times

more tea than it would
have produced itself

+ Tealand gets two times

more rice than it would
have produced itself

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Assumptions and Limitations

• Nations strive only to maximize production

and consumption
• Only two countries produce and consume
just two goods
• No transportation costs of traded goods
• Labor is the only resource used to produce
goods and it cannot cross borders
• Specialization does not create efficiency
and improvement gains

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 Change-up 2

How does the theory of CA help explain why

Vietnam imports steel from Japan? Why would
Japan import sea products from Vietnam?
With its developed economy (high labor
productivity and large amounts of available
capital) wouldn’t Japan be more efficient in
producing sea products and garments AS WELL
AS steel than VN?

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Factor Proportions Theory (H-O Theory:
Two Swedish economists Heckscher and
Ohlin, 1930s)

Countries produce and export goods that

require resources (factors) that are
abundant and import goods that require
resources in short supply.

Capital
Categories Labor
Equipment

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Factor Proportions Theory: An example

The US has an abundance of land (large supply). It will

produce and export goods that require lots of land
(agricultural products).
The US has a short supply of labor. It will import goods
that require lots of labor (garments and footwear)
Vietnam has an abundance of labor. It will produce and
export goods that require lots of labor (garments and
footwear)
Vietnam has a short supply of capital. It will import
goods that require lots of capital equipment (steel).

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 H-O Theory:
H-O theory emphasizes the relative
amounts (the proportions) of available
resources (or factors), NOT only labor
productivity. H-O theory states that it is the
relative amounts of land, labor and capital
in different countries that determine amount
of trade between countries.

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 Leontief Paradox
Proposes that U.S. exports require more
labor-intensive production than its imports

Factor Proportions Theory

considers a country’s
production factors to be
homogeneous

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 International Product Life Cycle

A company begins by exporting its product and later undertakes

foreign direct investment as a product moves through its life cycle

Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.

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 New Trade Theory

Fundamentals First-mover advantage

 Gains from specialization  Economic and strategic

and economies of scale advantage of being first to
 Companies first to market enter an industry
create barriers to entry  May create a formidable
 Government may help by barrier to market entry for
assisting home companies potential rivals

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 National Competitive Advantage:
Michael Porter(1990)
National Competitive Advantage theory states that a nation’s
competitiveness in an industry depends on the capacity of the industry
to innovate and upgrade.

Firm Strategy,
Structure, & Rivalry

Factor Demand
Conditions Conditions

Related &
Supporting
Industries
Prentice Hall 2003 34
 National Competitive Advantage:
Firm Strategy, Structure, & Rivalry
Firm Strategy, Structure, and Rivalry
states that the strategic decisions of firms
have lasting effects on their future
competitiveness.
Managers committed to producing quality
products valued by buyers while
maximizing the firm’s market share
and/or financial returns are essential.
National Competitive Advantage Factor Conditions
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 National Competitive Advantage:
Factor Conditions
Factor Proportions Theory
considers a nation’s
resources, such as a large
labor force, natural
resources, climate, or
surface features, as
paramount factors in what
products a country will
produce and export.

National Competitive Advantage Demand Conditions

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 National Competitive Advantage:
Demand Conditions

Demand Conditions states that a

sophisticated domestic market drives
companies to modify existing products to
include new design features and develop
entirely new products and technologies.

National Competitive Advantage Related & Supporting Industries

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National Competitive Advantage:
Related and Supporting Industries

Related and Supporting Industries

states that companies that belong to a
nation’s internationally competitive
industries do not exist in isolation. Rather,
supporting industries spring up to provide
the inputs required by the industry.

National Competitive Advantage

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 Change up 3
Of all the theories we’ve discussed so far,
which one do you believe is the most
useful in accurately describing
international trading patterns? Which one
seems to give us the clearest pattern to
the IT chaos we see around us? Why?

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