Transcript The International Business Context

The International Business
Context
Mikkeli 2005
Compiled by Rulzion Rattray
International Business
• Business activity that involves the transfer
of resources across national boundaries.
• International Trade occurs when a firm
exports goods or services to buyers in
another country.
• International Business results from
domestic business for market, economic
or strategic motives
International Trade Theories
• Mercantilism:
– Mid 16th Century. Governments have 2 goals.
• Increase national wealth by acquiring gold
• Extract trade gains from foreign countries through
regulation and control
• Gold useful to hire mercenary armies
– Limitations:
• More gold higher local prices raising price of
exports
• Overlooks other sources of wealth, quantity of
capital, skill or workforce, natural resources
Absolute Advantage
Adam Smith 1776
• Adam Smith suggested that countries
could benefit from specialising in goods
that they had an absolute advantage in
(and trading any surpluses of them).
– Absolute advantage - ability to produce those
products at the lowest resource cost (less
capital and labour) than other countries.
– Countries should specialise where they have
absolute advantage.
– What if they don’t have any?
Comparative Advantage
 Ricardo in 1817:
~ even if country has an absolute advantage in all goods it is still
beneficial to specialise in the good in which it has the largest
absolute advantage - Ie in which it has a comparative
advantage.
• Example:
________________________________________
Country
Output CDS
Output Videos
________________________________________
A
2,000
800
B
1,000
200
________________________________________
Country A has an absolute advantage in both products
(greater output for same resource) but a comparative
advantage in videos: A is twice as efficient as B in CDs
but four times as efficient as B in videos.
Comparative Advantage
• Likewise, B has an absolute disadvantage in both
products but a comparative advantage in CDs: B is only
one quarter as efficient as A in videos it is only one half
as efficient as A in CDs. B should therefore specialise in
CDs and trade these for videos that A produces.
• Can look at same comparative advantage idea in terms
of OPPORTUNITY COST.
• In Country A the production of an extra video has an
opportunity cost of 2.5 CDs whereas for Country B the
production of an extra video has an opportunity cost of 5
CDs. So, A has lower opportunity cost in videos than
country B (and therefore has a comparative advantage in
video production).
• What is the opportunity cost for A and B of producing an
extra CD?
Comparative Advantage
• Answer:Country
Opportunity Cost
of 1 extra CD
Opportunity cost
of 1 extra video
A
2.5 CDs
0.4 videos
B
5.0 CDs
0.2 videos
• B has a lower opportunity cost
(comparative advantage) in CD
production.
Factor Endowment Theory
(aka Heckscher-Ohlin [HO] theory).
• Sources of Comparative and Competitive
Advantage
» HO suggest that those countries with an abundance
of certain types of factor will be able to produce
products which embody those abundant factors
relatively more cheaply than other, less well endowed,
countries. Simple, labour abundant countries export
labour intensive products. Capital abundant countries
export capital intensive products.
» Nice idea! but little supporting empirical evidence for
this being the major cause of patterns of trade!! E.g
similar Factor endowed economies exporting to each
other similar goods (Eg. Cars around Europe).
International Product Life Cycle
Quantity
(IPLC) - Vernon
Exports
Domestic Production
Imports
Product Cycle
O
A
New Product
B
Growth Product
C
Mature Product
Adapted from:
Vernon, R. (1966), “International investment & international trade in
the product life cycle,” Quarterly Journal of Economics, May, pp. 190-207.
Types of Trade Flow
Inter-Industry Trade: where a country exports
products which are fundamentally different in
type from those that it imports.
• Intra-Industry Trade: where a country exports
certain items from a given product range while
at the same time importing other items from the
same product range. Example, UK exports cars
to Germany and imports cars from Germany.
Note - factor endowment theory often used to
explain inter-industry trade whereas intraindustry trade needs to be explained with other
theories such as International Product Life
Cycle.
Critics of Free Trade
• Drawbacks may not result in full benefit.
• Assumes full employment domestic output
may fall leading to unemployment. Welfare
loss may be more than gain.
• Also fails to asses how the gains will be
distributed. Arguing in practice gains more
likely to go the more powerful economy.
References
• Griffiths, A., and Wall, S., (Eds), (1999), “Applied
Economics”, Prentice Hall.
• Heckscher, E. (1949), "The Effects of foreign trade on
the distribution of income", reprinted in Ellis, H. & L.,
Metzler (eds), (1949) "Readings in the The Theory of
International Trade", Homewood, IL: Irwin, Cited in
Shenkar, O. and Luo, Y.(2004), International Business,
John Wiley and Sons, Inc. pp 20.
• Ohlin, B., (1933) International & Inter regional Trade,
Cambridge, MA: Harvard Economic Studies, revised
edition, 1967. Cited in Shenkar, O. and Luo, Y.(2004),
International Business, John Wiley and Sons, Inc. pp
20.
• Shenkar, O. and Luo, Y.(2004), “International
Business”, John Wiley and Sons, Inc.
• Tayeb, M., (2000), “International Management;
Theories and Practice”, Prentice Hall.