Transcript Chapter 3: International Trade Theory New Trade Theory US FACTOR ENDOWMENTS EU China Australia PORTER’S DIAMOND Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides.

Chapter 3: International Trade Theory
New Trade
Theory
US
FACTOR
ENDOWMENTS
EU
China
Australia
PORTER’S DIAMOND
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
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TOPIC PLAN:
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

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

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Mercantilism
Absolute advantage
Comparative advantage
Comparative advantage versus competitive
advantage
Factor endowments
The New Trade Theory
Porter’s Diamond
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Mercantilism: mid-16th century


A nation’s wealth depends on accumulation of
precious metals (e.g. holdings of gold and
silver).
Theory says you should have a trade surplus.
» Maximize exports through subsidies.
» Minimize imports through tariffs and quotas.


David Hume (1752): persistent trade surplus
will affect the money supply and in the long
run close the trade surplus
Key problem: “Zero-sum game”.
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Theories of International Trade:
Absolute Advantage

The exporting country holds a superiority in the
availability of certain goods. Reasons:
»
»
Climate,quality of land, and natural resources.
Differences in labour, capital, technology and
entrepreneurship
Beef
Computer Printers
(tonnes)
(units)
Australia
800
200
Japan
400
500
• Australia has an absolute advantage in beef, while
Japan has an absolute advantage in printers.
.
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Theory of Comparative Advantage
David Ricardo (1817)
 One country has a comparative advantage
over another in the production of a
certain commodity if its opportunity cost
of producing that commodity is lower

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Alternative production possibilities
from 100 units of resources
Commodity Cheese
Country
(tonnes)
Cloth
(bolts)
Australia
200
160
80
120
U.K.
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Opportunity Cost and Comparative
Advantage
Production
Australia
U.K
1 tonne of
cheese
0.8 bolts
of cloth
1.5 bolts
of cloth
1 bolt of
cloth
1.25 tonne 0.67
of cheese tonnes of
cheese
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Diversified production before trade
Production/Consumption
Resources
(units)
Cloth
(bolts)
Australia
100
37.5 x 1.6=60
U.K.
100
120
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The Theory of Comparative Advantage and
the Gains from Trade
Production and Consumption without Trade
Cheese (tonnes) Cloth (bolts)
Australia
U.K.
125
40
60
60
Total production 165
120
Production with Trade Specialization
Australia
U.K
Total production
200
200
120
120
Consumption after U.K. Trades 60Bolts of Cloth for 60 tons of
Australian Cheese
Australia
U.K.
140
60
60
60
Increase in Consumption as a Result of Specialization and Trade
Australia
15
0
U.K
20
0
Total consumption
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Comparative versus Competitive
Advantage
Comparative advantage is a concept
based on relative costs of production
(and opportunity cost) between nations.
 Competitive advantage is a concept
used to compare two company’s ability
to compete in the same business.

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Factor Endowments
(Heckscher and Ohlin)
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Explains differences in opportunity costs
Factor endowment: A country’s share of factors of
production (e.g. land,capital, labour,enterprise).
Countries will specialise in those goods which
make more intensive use of the abundant/cheap
factors.
»
»

Cheese:land-intensive
Cloth: labour-intensive
The theory can explain the Australia-Japan trade
patterns
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Limitations of the Trade Theory

The theory disregards a number of
considerations :
» The difficulty in moving resources in the desired
industries
» Fluctuations in demand
» Trade barriers
» Other political restraints
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The New Trade Theory
Began to be recognised in the 1970s.
 Deals with the returns on specialisation
where substantial economies of scale are
present.

» Specialisation increases output, ability to
enhance economies of scale increase.
» In some industries there are likely to be
only a few profitable firms.
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The New Trade Theory
Thus firms with first mover advantages will
develop economies of scale and create barriers
to entry for other firms.
 The commercial aircraft industry is an excellent
example (eg. Boeing, Airbus)
 New trade theory does NOT contradict the
theory of comparative advantage, but instead
identifies a source of comparative advantage

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Implications from the application of the
New Trade Theory
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Typically, requires industries with high, fixed
costs.
World demand will support few competitors.
Competitors may emerge because “they got there
first”
» first-mover advantage.

Some argue that it generates government
intervention and strategic trade policy (e.g. the
need to nurture and protect “first movers”)
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National Competitive Advantage:
Porter’s Diamond
(Harvard Business School, 1990)

Looked at 100 industries in 10 nations.
» Thought existing theories didn’t go far enough.
Results contained in The Competitive
Advantage of Nations.
 Question: “Why does a nation achieve
international success in a particular industry?”
(e.g. Switzerland in Watches and
Pharmaceuticals; Finland in Mobile Phones)

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Determinants of National
Competitive Advantage
Chance
Firm Strategy
Structure, and
Rivalry
Demand
Conditions
Factor
Endowments
Related and
Supporting
Industries
Government
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The Diamond

Success occurs where these attributes exist.
» More/greater the attribute, the higher
chance of success.
The four attributes, government policy and
chance work as a reinforcing system.
 Nokia is a good example of a firm which
has built its competitive advantage as a
result of factors in Porter’s diamond.

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Evaluating Porter’s Theory

If Porter is right, his model is expected to
predict the pattern of international trade in the
real world:
» a country’s exports should reflect the
presence of the four ‘diamond’ components.
» Countries will import in those areas where
the components are not favorable.

This theory is too new. Requires independent
empirical testing.
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International Trade and Investment by John Gionea
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