International Trade and Factor Mobility Theory

International Trade and Factor Mobility Theory

International Business

Sixteenth Edition

Chapter 6

International Trade and Factor Mobility Theory

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved.

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Learning Objectives (1 of 2)

6-1 Understand why policymakers rely on international trade and factor mobility theories to help achieve economic objectives

6-2 Illustrate the historical and current rationale for interventionist and free trade theories

6-3 Describe theories that explain national trade patterns

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved.

Learning Objectives for the chapter.

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Learning Objectives (2 of 2)

6-4 Explain why a country’s export capabilities are dynamic

6-5 Summarize the reasons for and major effects of international factor movements

6-6 Assess the relationship between foreign trade and international factor mobility

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved.

Learning Objectives for the chapter.

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Factor Mobility and Trade Theory Questions

Objective 6-1

What is Factor Mobility?

Trade theory and focus on IB

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Learning Objective 1: Understand why policymakers rely on international trade and factor mobility theories.

Factor mobility is the movement of capital, technology, and people.

Understanding trade theory helps managers to focus on these questions:

What products should we import and export?

How much should we trade?

With whom should we trade?

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Interventionist Theories

Objective 6-2

What is Mercantilism?

Governmental policies

Balance of Trade

What is neomercantilism?

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Learning Objective 2: Illustrate the historical and current rationale for interventionist and free trade theories.

Mercantilism holds that a country’s wealth is measured by its holdings of “treasure,” which usually means its gold. This theory, which formed the foundation of economic thought from about 1500 to 1800,2 holds that countries should export more than they import (run a trade surplus) and, if successful, receive gold from countries that run deficits.

Government policies to enact mercantilism: To run a trade surplus, governments restricted imports and subsidized noncompetitive production.

Balance of Trade: Some mercantilist terminology has endured. For example, a favorable balance of trade (also called a trade surplus) still indicates that a country is exporting more than it imports. An unfavorable balance of trade (also known as a trade deficit) indicates the opposite. These terms are misnomers because the word favorable implies “benefit,” and the word unfavorable suggests “impairment.” In fact, running a trade surplus is not necessarily beneficial, nor is running a trade deficit necessarily detrimental.

Neomercantilism is the running of a favorable balance of trade to achieve some social or objective. For example, a country may reduce unemployment by encouraging its companies to produce in excess of the home demand and send the surplus abroad. Or it may attempt to maintain political influence in an area by sending more merchandise there than it receives, such as a government granting merchandise aid or loans to a foreign government.

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Free Trade Theories

Objective 6-2

Why Trade at all?

Absolute Advantage

Natural Advantage

Acquired Advantage

Comparative Advantage

Assumptions made with Comparative Advantage and Absolute Advantage

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Learning Objective 2: Illustrate the historical and current rationale for interventionist and free trade theories.

Why do countries need to trade at all? To begin with, no nation has all the natural resources, geographic conditions, and technology necessary to produce everything we consume today.

In 1776, Adam Smith declared that a country’s well-being is its citizens’ access to goods and services rather than the mercantilists’ concept of its ownership of gold. His theory of absolute advantage holds that different countries produce different things more efficiently than others and that consumers should not have to buy domestically produced goods when they can buy them more cheaply from abroad.

A country’s natural advantage in production comes from climatic conditions, access to certain natural resources, or availability of certain labor forces. Most of today’s world trade is in manufactured goods that compete through an acquired advantage, usually in either product or process technology.

Comparative advantage says that global efficiency gains may still result from trade if a country specializes in what it can produce most efficiently—regardless of other countries’ absolute advantage.

Assumptions made about absolute and comparative advantage

Fully employed resources—assumes use of full resources

Economic efficiency–assumes the goal is maximum income

Division of Gains—may forgo trading if to prevent others from gaining an advantage

Transport costs—If it costs more to transport than the savings, the theories don’t work

Insufficient Demand—Even with insufficient demand, there is still an advantage

Statics and Dynamics—Looking at one point in time

Services—The theories deal with products rather than services

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Illustration of Absolute Advantage

Objective 6-2

Figure 6.2 Production Possibilities under Conditions of Absolute Advantage

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Learning Objective 2: Illustrate the historical and current rationale for interventionist and free trade theories.

Comparison of wheat and tea production to illustrate absolute advantage.

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Illustration of Comparative Advantage

Objective 6-2

Figure 6.3 Production Possibilities under Conditions of Comparative Advantage

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Learning Objective 2: Illustrate the historical and current rationale for interventionist and free trade theories.

Comparison of wheat and tea production to illustrate comparative advantage.

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Map of State and Relative Country Economies

Objective 6-2

Map 6.2 U.S. States’ Economies Compared to National Economies

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Learning Objective 2: Illustrate the historical and current rationale for interventionist and free trade theories.

This map shows the comparison between US state economies and similar sized country economies.

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Theories to Explain Trade Patterns

Objective 6-3

How much does a country trade?

Theory of country size

Size of the economy

What types of products should a country trade?

Factor Proportions Theory

With whom do countries trade?

Country-Similarity theory

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Learning Objective 3: Describe theories that explain national trade patterns.

How much does a country trade?

The theory of country size holds that countries with larger land masses usually depend less on trade than smaller ones. They are apt to have more varied climates and an assortment of natural resources that make them more self-sufficient.

Size of the economy: While land area helps explain the relative dependence on trade, countries’ economic size helps explain absolute differences in the amount of trade. The world’s largest five economies in 2014 were also the top five exporting countries.

What types of products should a country trade?

Factor proportions theory: According to the factor proportions theory, countries have their best trade advantage when depending on their relatively abundant production factors.

With whom do countries trade?

The country-similarity theory says that companies create new products in response to market conditions in their home market. They then turn to markets they see as most similar to what they are accustomed, especially those markets where consumers have comparable levels of per capita income.

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PLC Theory

Objective 6-4

What is the Product Lifecycle Theory (PLC)?

Introduction

Growth

Maturity

Decline

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Learning Objective 4: Explain why a country’s export capabilities are dynamic.

The international product life cycle (PLC) theory of trade states that the production location of certain manufactured products shifts as they go through their life cycle. The cycle consists of four stages: introduction, growth, maturity, and decline

The introduction stage is marked by

• innovation in response to observed need,

• exporting by the innovative country, and

• evolving product characteristics.

Growth is characterized by

• increases in exports by the innovating country,

• more competition,

• increased capital intensity, and

• some foreign production.

Maturity is characterized by

• a decline in exports from the innovating country,

• more product standardization,

• more capital intensity,

• increased competitiveness of price, and

• production start-ups in emerging economies.

Decline is characterized by

• a concentration of production in developing countries,

• an innovating country becoming a net importer.

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Limitations of PLC Theory

Objective 6-4

Exceptions to PLC Theory

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Learning Objective 4: Explain why a country’s export capabilities are dynamic.

Some types of products abound for which production locations usually do not shift. Such exceptions include the following:

Products with high transport costs (non-tradable goods) that may have to be produced close to the market, thus never becoming significant exports.

Products that, because of very rapid innovation, have extremely short life cycles, making it impossible to reduce costs by moving production from one country to another. Some fashion items fit this category.

Luxury products for which cost is of little concern to the consumer. In fact, production in a developing country may cause consumers to perceive the product as less luxurious.

Products for which a company can use a differentiation strategy, perhaps through advertising, to maintain consumer demand without competing on the basis of price.

Products that require specialized technical personnel to locate near production so as to continually move the products into their next generation of models. This seems to explain the long-term U.S. dominance of medical equipment production and German dominance in rotary printing presses.

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Diamond of National Competitive Advantage Theory

Objective 6-4

Figure 6.4 The Diamond of National Competitive Advantage

Source: Based on Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review, 68:2 (March–April 1990).

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Learning Objective 4: Explain why a country’s export capabilities are dynamic.

According to the diamond of national competitive advantage theory, companies’ development and maintenance of internationally competitive products depends on favorable

demand conditions,

factor conditions,

related and supporting industries, and

firm strategy, structure, and rivalry.

Limitations of this theory:

Observations of foreign or foreign-plus-domestic demand conditions have spurred much of the recent Asian export growth. In fact, such Japanese companies as Uniden and Fujitech target their sales almost entirely to foreign markets.

Companies and countries do not depend entirely on domestic factor conditions. For example, capital and managers are now internationally mobile, and companies may depend on foreign locations for portions of their production.

If related and supporting industries are not available locally, materials and components are now more easily brought in from abroad because of transportation advancements and relaxed import restrictions. In fact, many MNEs now assemble products with parts supplied from a variety of countries.

Companies react not only to domestic rivals but also to foreign-based rivals at home and abroad. Thus the prior domestic absence of any of the four conditions from the diamond may not inhibit companies.

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The Theory and Effects of Factor Mobility

Objective 6-5

What is the Factor Mobility Theory?

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Learning Objective 5: Summarize the reasons for and major effects of international factor movements.

The factor mobility theory, which focuses on why production factors move, the effects of that movement on transforming factor endowments, and the impact of international factor mobility (especially people) on world trade.

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Why Production Factors Move

Objective 6-5

Capital

People

Effects of factor movements

Brain drain

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Learning Objective 5: Summarize the reasons for and major effects of international factor movements.

Capital, especially short-term capital, is the most internationally mobile production factor. Companies and private individuals primarily transfer capital because of differences in expected return (accounting for risk) that is caused by their outlooks of economic and political conditions.

People are less mobile than capital. Some, of course, travel to other countries as tourists, students, and retirees; however, this does not affect factor endowments because these travelers do not work in the destination countries. Unlike funds that can be cheaply transferred by wire, people usually must incur high transportation costs to work abroad.

A controversial issue is the effect of outward migration on countries. On the one hand, countries lose potentially productive resources when educated people leave—a situation known as a brain drain. On the other hand, many of these people are now sending remittances back. For example, remittances account for 29 percent of Nepal’s GDP. There is also evidence that the outward movement and remittances of people leads to an increase in start-up companies and capital in their home countries. countries receiving productive human resources also incur costs by providing social services and acculturating people to a new language and society.

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The Relationship Between Trade and Factor Mobility

Objective 6-6

Substitution

Complementarity

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Learning Objective 6: Assess the relationship between foreign trade and international factor mobility.

Substitution: When the factor proportions vary widely among countries, pressures exist for the most abundant factors to move to countries with greater scarcity, where they can command a better return. If permitted, many in the labor pool where workers are unemployed or poorly paid, go to countries that have full employment and higher wages. They receive higher wages not only because of the greater scarcity, but also because more capital-rich countries have invested in machinery and infrastructure that make the imported laborers more productive than in their home countries.

Complementarity:

Factor mobility through foreign investment often stimulates trade because of

the need for components,

the parent company’s ability to sell complementary products, and

the need for equipment for subsidiaries.

Immigration enhances trade by creating ethnic enclaves of networks that link immigrants with their native countries. The enclaves serve as niche markets for imports from their native countries (e.g., early U.S. soy sauce imports sold mainly to Asian-Americans).

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Copyright

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved.


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