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PART TWO: BUSINESS ACROSS BORDERS: THE FOUNDATIONS

CHAPTER 04: INTERNATIONAL TRADE AND INVESTMENTS


Free trade, is “trade uninhibited by trade barriers” (Peng&Meyer,2019)

CLASSIC TRADE THEORIES


1. MERCANTILISM
 The main idea of a 16th-century mercantilist philosophy is to encourage exports and discourage imports.
 By limiting imports through,
- Tariffs
- Quotas
- Subsidies, used to maximise profits.
 The modern version of this is protectionism, where a country actively protects its domestic businesses from imports while promoting exports.

Examples: Disadvantaged:

 Under the British empire, India was restricted in buying domestic industries and was forced to import salt from the UK. Protests against this salt tax led to the ‘salt tax
revolt’ led by Gandhi.
 Modern mercantilism,
 Undervaluation of currency. China has been accused of undervaluing its currency to gain an unfair advantage in global trade, this makes imports coming into
China more expensive thereby protecting domestic Chinese firms from import competition and retaining jobs and investments in the country. ()
 Unfair government subsidy. The US government has been providing subsidies for the cotton industry since 1995, averaging $2.1 billion annually, these amount to
50% of the actual value of the crop (Gro Intelligence,2018). This allows US cotton producers to escape free market pressures, keeping production and farmer
revenue artificially high.
 Surge of protectionist sentiment.

Strengths Weakness
 Economic growth as EXPORTS > IMPORTS as the GDP increases due to  Trade is a zero-sum game, where people benefit at the expense of others.
a surplus of BOP.  Stressing out government regulation and monopoly leads to inefficiencies and corruption.
 Protects domestic producers.  Can lead to high tariffs on imports and lead to retaliation.
 Inefficient allocation of resources such as over-subsidizing.
 Lack of innovation and competition.

2. ADAM SMITH AND ABSOLUTE ADVANTAGE


 “The economic advantage one nation enjoys due to higher productivity in an economic activity” (Peng & Meyer,2019)
 Opened floodgates for free trade.
 Argued that the wealth of nations in 1776, that trade without government intervention could be beneficial to countries.
 If each country produced and exported these products, it was the most efficient or absolute advantage.
 By being self-sufficient and inefficiently producing a wide range of goodsmercantilism reduces a nation’s wealth in the long run.
 It states that it is better for countries to produce what they are best at and exchange with each other.
 He argued that it is not a zero-sum game it’s a win-win game.

3. RICARDO AND COMPARATIVE ADVANTAGE


 “Relative advantage in one economic activity that one nation enjoys in comparison with other nations.” (Peng &
Meyer,2019).
 Issue of opportunity cost because of absolute advantage.
 Adam Smith looked at absolute poverty.
 Ricardo looked at relative productivity differences.
 Eli Heckscher and Bertil Ohlin extended Ricardo’s work by suggesting that a county’s comparative advantage is a result of
differences in national factor endowments.
 HECKSCHER theory argues that countries will export that make intensive use of factors of production that are locally abundant, and countries can import that
make intensive use of factors that are locally scarce.
 Two implications:
1. Nations gain from trade but not individual gains.
2. Factor endowments evolve.

EXAMPLES:

Luxembourg exporting capital-intensive products to India while importing labor-intensive products in return (Britannica: https://www.britannica.com/topic/Heckscher-
Ohlin-theory
MODERN TRADE THEORIES

1. PRODUCT LIFE CYCLE (RAYMOND VERNON,1966)


 How does a product mature and decline because of
internationalisation?
 Why products produced in home countries are now
imported from other less developed countries?
 The first dynamic theory considers Changes in the
pattern of trade.
 The world is divided into 3 categories:
1. Innovation nation.
2. Other developed nations.
3. Less Developing nations.

Stage 1: New Stage 2: Maturing Stage 3: Standardized

-The production of new products -Demand and ability to produce grow in other developed - Previously new product is standardized
demanding premium prices is nations so it is now worthwhile to produce there. - Production will now move to low-cost developing nations, which
concentrated in the USA, which  When the product has firmly established in the export to developed nations
exports to other developed nations. innovating country. - comparative advantage may change over the lifetime of a product.
 Corporations will keep the  Open production plants in other advanced countries to  Driving down the production cost by moving production to
manufacturing local (innovating reduce production costs and meet the increasing nations where the average income is much lower.
country). demand.  Demand in the innovation country where the product came
 Then sell /export. from begins to decline and eventually dwindles.
 Another new cycle starts.
 Exporters become importers.
 the product life cycle has three stages.

 Production in an innovating country  another advanced country as the product is established in the innovating country and to reduce production costs and meet
increasing demand as products become low cost and matured, they reach less developed countries this is because competition increases and the innovation
country losses its competitive advantage and therefore moves production to less developed countries to drive down costs as their average income is lower
innovating country becomes the importer of its own innovation where less developed countries export.

Example:()
CRITICISMS:

 Vernon’s argument that most new products are developed and introduced in the United States seems ethnocentric and increasingly dated. For example, video game
consoles are first introduced in jap and wireless phones in Europe.
 A growing number of new products are now introduced simultaneously in both developed and developing countries.

STRENGTHS WEAKNESS
o Market Insight: The IPLC theory helps companies analyze markets and set o Ethnocentric View: Vernon’s theory can be criticized for its ethnocentric
strategies ahead of competitors. By understanding the life cycle stages, perspective. It assumes that innovations primarily originate in industrialized
businesses can tailor their approaches and adapt to changing consumer countries like the US. However, many new products now emerge from advanced
preferences1. economies worldwide, challenging this assumption3.
o Competitive Advantage: Companies can gain a competitive edge by o Changing Market Conditions: The theory may not fully account for varying
leveraging the knowledge gained from earlier product cycles. Learning from market conditions. Consumption patterns differ across regions, affecting the
past successes and pitfalls allows for better decision-making and process success of products. What works well in one place may not necessarily thrive
improvement2. elsewhere4.
o Strategic Planning: The theory aids in strategic planning. Firms can
anticipate shifts from export to import, identify growth opportunities, and
allocate resources effectively.
2. STRATEGIC TRADE THEORY.
 Can the government add value?
 This theory suggests that governments also should support certain industry strategies so that they can gain a first-mover advantage making it harder to replicate.
 Suggests that strategic intervention by governments in certain industries can enhance their odds for international success.
 What are the industries:
- High up-front costs of entry.
- Notable investments in R & D.
- Tend to be high in capital intensive.
 Using strategic trade policy, government subsidies inspired by strategic trade theory.
 First mover advantage is an important concept here, companies that can achieve first mover advantage will develop economies of scale and create barriers to entry for
competitor forms which means that it will be a competitive advantage.

CRITICISMS:

FIRST, governments have very detailed information about the cost structures and can make rational decisions. What if? Governments are not sophisticated and objective
enough to do this job.

SECONDLY, a lot of industries claim that they are strategically important.

3. NATIONAL COMPETITIVE ADVANTAGE OF INDUSTRIES.

Micheal Porters 1990, DIAMOND MODEL

 Why certain industries within a particular nation are competitive internationally?

1.FACTOR ENDOWMENTS: nations position in FOP / refers to different types of resources that may or may not be present in the home country. They include:
Basic factors Advanced factors
 Natural resources  Human resources.
 Like climate minerals and oil where the mobility of the factors is low.  Research capabilities.
 For example, Saudi Arabia has the second-largest oil reserves in the  They are normally specific to the industry contrary to the conventional wisdom of simply
world and is one of the largest exporters of oil. having a general workforce that is high school or even college-educated represents no
 However, Porter indicates although basic factors create the ground for competition in modern international competition.
international competitiveness, they can never turn into real value  To support competitive advantage a factor must be highly specialized to an industry's
creation without advanced factors. particular needs.
 Like a scientific institute specialized in optics or a pool of venture capital to fund software
companies, these factors are scarcer and more difficult for foreign competitors to imitate
and they require sustained investment to create.
2. DEMAND CONDITIONS: The nature of the home country's demand for the industry’s product or service/
 The nation has gained competitive advantages in industries where their home demand gives their companies a clearer or earlier picture of emerging buyer's needs.
 Local buyers can give a nation's companies a competitive advantage by shaping their needs to anticipate global trends. “Early-warning indicators”.
 Global market trends sometimes anticipatory needs emerge because a nation’s political values foreshadow needs that grow elsewhere.
 For example, Sweden's concern for handicapped people has spawned an increasingly competitive industry focused on special needs more generally national companies
can anticipate global trends if the nation’s values are spreading,
 For example, the international success of the US companies in the fast-food industry reflects not only the American desire for convenience but also the spread of those
tastes to the rest of the world.
 Nations export their values and tastes through media, training foreigners, political influence, and foreign activities of their citizens and companies.

3.RELA TED
SUPPORTED INDUSTRIES: the presence or absence of supplier industries and related industries that re internationally competitive / i ndustrial production does not
take place in isolation but rather relies on a network of supplier’s components manufacturing, and distributors.

 Therefore, the presence of related and supporting industries provides the foundation on which the focal industry can excel.
 Companies are often dependent on alliances and partnerships with other companies to create additional value for customers and become more
competitive.
 Suppliers are more important in enhancing innovation through more efficient and higher quality inputs, timely feedback and short-line
communication.
 A nation's companies most benefit when their supplier themselves are global leaders it can often take years or decades and hard work for strong
related and supporting industries to assist domestic companies to become globally competitive.
 However, once those factors are in place the entire region or nation can often benefit from its presence

For example, after three decades of continuous development Shenzhen a city bordering Hong Kong and south China has evolved into an innovation and
manufacturing hub for the electronics industry it has cultivated an ecosystem to support the manufacturing supply chain including thousands of
component manufacturers assembly suppliers distributors and strong tech workforce that why is the Shenzhen is the birthplace of many famous tech
companies which includes the internet and gaming giant ” Tencent”,
The global information communication provider “Huawei” and the world's largest drone maker “DJI” and robot kit maker “make a block”.

4. FIRM STARTEGY, STRUCTURE AND


RIVALRY: national circumstances can create strong tendencies in how companies are created, organized and managed.
 In Italy successful international competitors are often small or mid-sized companies that are privately owned and operated by
extended families.
 In industries where Italian companies are world leaders, such as sliding furniture, footwear, willet fabrics and packaging
machines, a company strategy that emphasizes focus, customized products, niche marketing, rapid change and breathtaking
flexibility fits both the dynamics of the industry and the character of the Italian management system.
 Competitiveness in a specific industry result from the convergence of the management practices and organizational modes
favoured in the country and the sources of competitive advantage in the industry

 German companies tend to be strictly hierarchical in organization and management practices, and top managers usually have
technical backgrounds. No one managerial system is universally appropriate.
 German management system works well in technical or engineering-oriented industries such as optics, chemicals and
complicated machinery, where complex products demand precision manufacturing, a careful development process after cell
service and thus a highly disciplined management structure.
 Moreover, domestic rivalry is instrumental to international competitiveness since it forces companies to develop
unique and sustainable strengths and capabilities. The more intense domestic rivalry is, the more companies are
being pushed to innovate and improve in order to maintain their competitive advantage. In the end, this will only
help companies when entering the international.
 A good example of this is the Japanese automobile industry, with intense rivalry between players such as Nissan,
Honda, Toyota, Suzuki, Mitsubishi and Subaru. Because of their own fierce domestic competition, they have become
able to more easily compete in foreign markets as well.

Beside these four factors, the role of the government and chants are often included in porters diamond model. Governments can encourage and push companies to
raise their aspirations and move to even higher levels of competitiveness. This can be done by stimulating early demand for advanced products, focusing on specialized
factor creations such as infrastructure, education system and the health sector, promoting domestic rivalry by enforcing antitrust laws. And encouraging change, the
government can assist the development of the four aforementioned factors in a way that should benefit the industries in a certain country. Lastly, although Porter
hasn't officially mentioned, chance or luck is often associated with the diamond model, There are external events such as natural disasters or war that can make a
positive or negative impact on the industry or country. While such factors are beyond the control of companies, they should at least monitor them so they can make
well informed decisions.

. Now let's do a quick review of today's topic. Porters diamond model is a strategic economic model that attempts to explain why one country is more successful than
another for a particular industry. According to the model, for an industry to have a national competitive advantage, 4 determinant factors must be present. This work
factors are factor conditions, demand, conditions related and supporting industries and firms, strategy, structure and rivalry. Additionally, the actions of the
government and chance can play a role in determining if an industry achieves a competitive advantage.
NATIONAL INSTITUTIONS AND INTERNATIONAL TRADE

PROTECTIONISM: GOVERNMENT POLICIES DESIGNED TO PROTECT A DOMESTIC TRADE INDUSTRY FROM FOREIGN COMPETITION. (PEND AND MEYER,2019)
 levied on imports that effectively raise the cost of imported products relative to domestic products.
 Increases tax revenues for the government.
 Provides protection for domestic producers by increasing the cost of imported goods which means high consumer prices discourage demand.
TARIFFS  Favour producers> consumers.
 Can cause losses, why? Impose them politics.
Non-tariff barriers:  Payments to domestic producers.
 In the form of grants, low-interest loans, and tax breaks.
SUBSIDIES  Help domestic producers compete against low-cost imports.
 Are they effective? domestic producers can become more dependent and less efficient and tend to protect them.
 Is a direct restriction on the quantity of some goods that may be imported to a country.
 Worse than a tariff because this could lead to a constraint of supply which creates the same effect as a monopoly, prices go up, and consumers pay more.
IMPORT QUOTA  Straightforward denial of absolute and comparative advantage.
 They are protectionist pure and simple; they are political costs that a country should shoulder in today’s largely pro-free trade environment.
 Quotas on trade imposed by the exporting country, typically at request from the importing country.
VOLUNTARY EXPORT  Similar effects to import quota.
RESTRAINTS  Foreign producers agree to VERs fear more damaging punitive tariffs or import quotas might follow if they do not agree.
(VERs)  Agreeing to a VER is seen to make the best of a bad situation by appeasing protectionist pressures in a country.
 The extra profit that producers make when supply is artificially limited by an import quota is referred to as a quota rent.

 Export tariffs are tariffs placed on the export of a good.


EXPORT TARIFFS &  Goal: discriminate against exporting in order to ensure there is a sufficient supply of goods within a country.
PROHIBITIONS  E.g.: Argentina has export tariffs on several of its agricultural products (wheat, corn, and soybeans) reducing exports and making more products available for
domestic consumers at a lower price  hasn’t been good for Argentina’s farmers and economy.
 Export ban: a policy that partially or fully restricts the export of a good
 Is a requirement that some specific fraction of a good should be produced locally.
LOCAL CONTENT  The requirement can be expressed either in physical terms or in value.
REQUIREMENTS  Favour domestic producers but not consumers due to high prices.
(LCR)
 Bureaucratic rules designed to make it difficult for imports to enter a country.
ADMINISTRATIVE  Maybe used to restrict imports and boost exports.
TRADE POLICIES  Extensive documentation is required to show commercial goods being exported to a country have complied with the rules and regulations of the importing country
(e.g.: health & safety standards certificates, insurance documents)
 Since 2008 Indonesia and Malaysia have limited imports to certain ports, and India has banned Chinese toys, citing safety concerns.
 Imposed when goods are sold in a foreign market below their cost of production, or when they are sold in a foreign market at below their fair market value.
ANTI-DUMPING  Unload excess production in foreign markets.
POLICIES  Policies designed to punish foreign companies that are dumping and protect domestic producers from this type of unfair competition.

GOVERNMENT INTERVENTION AND FREE TRADE: THE DEBATE

Is free trade the best? Many argue that, economically and over the long term, it is ,
 Free trade can increase the country’s stock of resources.
 Increase the efficiency of resource utilization.
 Can gain economies of scale associated with larger production.
 It shows that there is a link between trade and economic growth.
 Countries adopt more open standards toward international trade tend to have a higher growth than that lose their economies to trade.
 Times where restrictions are counterproductive.
Eg: can involve in retaliation and trade wars or domestic policies.
 special interests are not necessarily national interests.
 Argues that country needs to protect its own domestic industries and also its new emerging industries.
 Determining when an industry has grown up enough to stop government support.

The main arguments,

POLITICAL ARGURMENTS ECONOMIC ARGUEMENTS


 Protecting jobs and industries.  The infant industries.
 Protecting national security.  Strategic trade policy
 Retaliating. 
 Protecting consumers.
 Furthering foreign policy objectives.
 Protecting human rights.
 Environment and social responsibility.

FOREIGN DIRECT INVESTMENTS: “Foreign direct investment (FDI) is when a firm invests directly in
facilities to produce or market a good or service in a foreign country.” (Hill, 2022)

GREEN FIELD ACQUISITION OR MERGER

establishing a wholly owned new operation in a with an existing company in the foreign country
foreign country
Ownership Advantages (O-advantages): resources of a
firm that are transferrable across borders and enable the
firm to gain competitive advantages overseas.

Locational Advantages (L-advantages): advantages that


firms enjoy by operating in particular locations. These
include markets, resource endowments, agglomeration,
and institutions

Internalization Advantages (I-advantages): advantages of


organising activities within an MNE rather than using
market transactions; replaces cross-border markets like
exporting and importing, with one firm located in two or
more countries
GOVERNMENTS AND FDI

1. OUTRIGHT BANNING
2. CASE BY CASE APPROVAL
3. OWNERSHIP REQUIREMENTS
4. LOCAL BUSINESS REGULATIONS
5. LOCAL CONTENT REQUIREMENTS

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