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Modern Firm Based Theories

Modern firm-based theories of international trade emerged post-World War II, focusing on multinational companies and intraindustry trade, unlike classical country-based theories. Key theories include Linder's country similarity, Vernon's product life cycle, and Porter's national competitive advantage, each addressing factors like consumer preferences, product stages, and innovation capabilities. These theories provide a more nuanced understanding of trade flows by incorporating elements such as brand loyalty, technology, and market conditions.

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19 views34 pages

Modern Firm Based Theories

Modern firm-based theories of international trade emerged post-World War II, focusing on multinational companies and intraindustry trade, unlike classical country-based theories. Key theories include Linder's country similarity, Vernon's product life cycle, and Porter's national competitive advantage, each addressing factors like consumer preferences, product stages, and innovation capabilities. These theories provide a more nuanced understanding of trade flows by incorporating elements such as brand loyalty, technology, and market conditions.

Uploaded by

vbollam27
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Modern Firm Based Theories

Firm Based Theories defined…


• In contrast to classical, country-based trade theories, the category of
modern, firm-based theories emerged after World War II and was
developed in large part by business school professors, not economists.
• The firm-based theories evolved with the growth of the multinational
company (MNC). The country-based theories couldn’t adequately
address the expansion of either MNCs or intraindustry trade, which
refers to trade between two countries of goods produced in the same
industry. For example, Japan exports Toyota vehicles to Germany and
imports Mercedes-Benz automobiles from Germany.
• Unlike the country-based theories, firm-based theories incorporate
other product and service factors, including brand and customer loyalty,
technology, and quality, into the understanding of trade flows.
Modern Firm Based Theories…

1. Country Similarity
2. Product Life Cycle
3. Global Strategic Rivalry
4. Porter’s National Competitive Advantage
5. The Eclectic Paradigm
6. Linder Theory of International Trade
7. Gottfried Haberler’s Theory of International Trade
Country Similarity

• Swedish economist Steffan Linder developed the country similarity theory in


1961, as he tried to explain the concept of intraindustry trade.
• Linder’s theory proposed that consumers in countries that are in the same or
similar stage of development would have similar preferences.
• In this firm-based theory, Linder suggested that companies first produce for
domestic consumption. When they explore exporting, the companies often
find that markets that look similar to their domestic one, in terms of customer
preferences, offer the most potential for success.
• Linder’s country similarity theory then states that most trade in manufactured
goods will be between countries with similar per capita incomes, and
intraindustry trade will be common.
• This theory is often most useful in understanding trade in goods where brand
names and product reputations are important factors in the buyers’ decision-
making and purchasing processes.
Product Life Cycle

• Raymond Vernon, a Harvard Business School professor, developed the product


life cycle theory in the 1960s.
• The theory, originating in the field of marketing, stated that a product life cycle
has three distinct stages: (1) new product, (2) maturing product, and (3)
standardized product.
• The theory assumed that production of the new product will occur completely in
the home country of its innovation. In the 1960s this was a useful theory to
explain the manufacturing success of the United States. US manufacturing was
the globally dominant producer in many industries after World War II.
• It has also been used to describe how the personal computer (PC) went through
its product cycle. The PC was a new product in the 1970s and developed into a
mature product during the 1980s and 1990s.
• Today, the PC is in the standardized product stage, and the majority of
manufacturing and production process is done in low-cost countries in Asia and
Mexico.
Contd…
• The product life cycle theory has been less able to explain current trade patterns
where innovation and manufacturing occur around the world.

• For example, global companies even conduct research and development in


developing markets where highly skilled labor and facilities are usually cheaper.

• Even though research and development is typically associated with the first or new
product stage and therefore completed in the home country, these developing or
emerging-market countries, such as India and China, offer both highly skilled labor
and new research facilities at a substantial cost advantage for global firms.
Global Strategic Rivalry

• Global strategic rivalry theory emerged in the 1980s and was based on the work of
economists Paul Krugman and Kelvin Lancaster.
• Their theory focused on MNCs and their efforts to gain a competitive advantage against
other global firms in their industry.
• Firms will encounter global competition in their industries and in order to prosper, they
must develop competitive advantages. The critical ways that firms can obtain a sustainable
competitive advantage are called the barriers to entry for that industry.
• The barriers to entry refer to the obstacles a new firm may face when trying to enter into
an industry or new market. The barriers to entry that corporations may seek to optimize
include:
1. research and development,
2. the ownership of intellectual property rights,
3. economies of scale,
4. unique business processes or methods as well as extensive experience in the industry,
and
5. the control of resources or favorable access to raw materials.
Porter’s National Competitive
Advantage
• In the continuing evolution of international trade theories, Michael
Porter of Harvard Business School developed a new model to explain
national competitive advantage in 1990.
• Porter’s theory stated that a nation’s competitiveness in an industry
depends on the capacity of the industry to innovate and upgrade.
• His theory focused on explaining why some nations are more
competitive in certain industries.
• To explain his theory, Porter identified four determinants that he
linked together. The four determinants are (1) local market resources
and capabilities, (2) local market demand conditions, (3) local
suppliers and complementary industries, and (4) local firm
characteristics.
The Eclectic Paradigm

• The eclectic paradigm, also known as the OLI Model or OLI Framework (OLI stands for

Ownership, Location, and Internalization), is a theory in economics.

• It is a further development of the internalization theory and published by John H.

Dunning in 1979.

• Modern Trade Theory incorporates this paradigm using the Grossman-Hart-Moore

Theory of the firm.


Linder Theory of International Trade
Gottfried Haberler’s Theory of International Trade

Comparative
advantage
Contd…
• The theory focuses on factor price differentials, especially wage differences, as a
determinant of trade patterns. This is a more nuanced explanation compared to classical
theories, which emphasize differences in absolute and comparative costs of production.
• The theory develops the concept of 'offer curves', which classical theories do not
consider. This contains parts of imperfect competition and pricing power that nations
may have.
• The theory relaxes some assumptions of classical theories, like perfectly flexible factor
prices. It accounts for real-world rigidities in factor markets.
• The theory complements existing theories like comparative advantage by highlighting an
additional factor - differences in factor prices - affecting production costs and trade. It
provides supplemental insights.
• While the theory does not refuse classical theories, it includes more variables and
beliefs to offer a more complete view of what drives trade among nations.

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