Chapter Two

International Trade and

Foreign Direct Investment

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objectives

 Appreciate the magnitude of international trade

 Identify the direction of trade, or who trades with
whom
 Explain the patterns of worldwide foreign direct
investment
 Identify who invests and how much is invested in the
U.S.
 Understand the reasons for entering foreign markets
 Comprehend that an international firm
i. Globalizes along at least seven dimensions
ii. Can be global in some dimensions, partially global
in others LO1
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 Large Firms Lead Overseas
Investment, They Also Export
 FDI from Large American international firms is at
its highest level ever because of
 global competition
 liberalization by host governments in regard to
foreign investment
 advances in technology
 U.S. FDI doubled from 2003 to 2006 reaching
$217 billion, even so…
 During the ten years to 2007, U.S. exports
increased 76% to $1,646 billion
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 World trade in 2010

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4
 Distribution of World Manufacturing Value
Added by Industrial Sector (% share)
Industrialized
Developing countries
Industrial Sector countries
1995 2000 2006 1995 2000 2006
15 - Food and beverages 67.8 66.6 60.3 30.5 31.6 37.3
16 - Tobacco products 44.2 37.0 24.5 55.3 62.1 74.7
17 - Textiles 53.0 48.6 36.1 45.8 50.3 62.6
18 - Wearing apparel, fur 71.0 61.6 41.2 28.2 37.3 57.5
21 - Paper and paper products 82.5 79.5 72.2 16.5 19.4 26.3
22 - Printing and publishing 89.4 89.2 85.0 10.4 10.5 14.5
23 - Coke, refined petroleum products, nuclear fuel 56.1 53.1 46.4 42.4 45.4 51.9
24 - Chemicals and chemical products 75.5 72.3 67.5 23.5 26.6 31.5
25 - Rubber and plastics products 73.3 70.8 61.8 26.0 28.5 37.3
26 - Non-metallic mineral products 67.3 66.6 60.1 30.5 31.6 37.3
27 - Basic metals 68.5 64.7 52.6 28.0 31.6 43.6
29 - Machinery and equipment n. e. c. 82.2 81.3 74.8 16.3 17.5 23.7
31 - Electrical machinery and apparatus 76.3 72.3 55.7 22.9 27.0 43.4
35 - Other transport equipment 71.0 65.8 48.4 27.0 32.4 50.2
36 - Furniture; manufacturing n. e. c. 79.9 80.5 73.5 19.3 18.7 25.3

Source: UNIDO, IDSB 2008 statistical database, “World – MVA Share of

Country Groups,” http://www.unido.org/index.php?id=o3474 (July 7, 2008). LO1
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 Direction of Trade
(percentage of total merchandise exports)
Exports from Year DE U.S. Can. Jap. Eur. DA D. Am CIS
Developed 1980 71 19 4 10 43 5 6 3
economies (DE) 2006 73 12 4 2 54 1 5 2
United States (U.S.) 1980 60 — 16 10 27 2 18 2
2006 52 — 22 6 22 1 21 1
Canada (Can.) 1980 85 63 — 6 13 1 5 3
2006 91 82 — <1 7 <1 2 <1
Japan (Jap.) 1980 48 25 2 — 14 5 7 3
2005 42 23 1 — 15 1 4 1
Europe (Eur) 1980 77 6 1 1 56 7 3 4
2006 81 8 1 1 71 1 2 2
Developing 1980 83 26 <1 2 46 3 6 3
Africa (DA) 2006 61 27 2 4 28 13 4 <1
Developing 1980 64 32 3 4 22 2 21 7
America (D. Am.) 2006 67 48 2 2 14 1 20 2
Former USSR 1980 28 1 <1 1 19 3 3 51
and E. Europe (CIS) 2006 60 3 <1 1 55 <1 2 7

Source: Monthly Bulletin of Statistics (New York: United Nations, 2001, 2000, 1997, 1993); Statistical Yearbook (New York: United Nations,
1969); 的International Trade—World Exports by Provenance and Destination, http://unstats.un.org/unsd/mbs/t41-July05-online.pdf (July 14,
2006); and International Trade—World Exports by Provenance and Destination, Monthly Bulletin of Statistics, July 2007, Table 40.
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 Why do Managers Focus on
Major Trading Partner Countries?
1. Export and import regulations are not
insurmountable
2. Favorable business climate in the importing nation
3. Minimal cultural objections to buying that nation’s
goods
4. Satisfactory transportation facilities already
established

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 Why do Managers Focus on
Major Trading Partner Countries?
5. Import channel members (merchants, banks,
customs brokers) are experienced in handling the
exporting country’s shipments
6. Foreign exchange is available to pay for exports
7. The trading partner’s government may be applying
pressure on importers to buy from the country’s
good customer nations

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Major Trading Partners of the
United States

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 Major Trade Flows

 Major trading flows are among developed nations

 Since 1990, trade flows among developed nations
and emerging nations (BRICs - Brazil, Russia, India,
China) have become important

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Two Aspects of Foreign Investment

 Portfolio investment
 The purchase of stocks and bonds of firms in other
countries to obtain a return on the funds invested
 Foreign Direct investment (FDI)
 The purchase of sufficient equity in a firm located
in another country to obtain significant
management control

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 Technology-profit pyramy
Area
Countries

Ideal and USA, Russia,

innovations
German(G1)
>300%
CNC machinery G1 + Japan,
Italy.. (G2)
201%-300%
Consuming G2+ Korea,
machine nery and
equipments
Taiwan,.. (G3)
101%-200%
Make consumer G3 + Thailand,
products
Vietnam,
0-100%
Malaysia...

World market Africa countries and Opec mambers

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 Two Dimensions of
Foreign Direct Investment

 Volume of Outstanding Stock of FDI

 The book value of all foreign direct investment
 Annual Inflows and Outflows of FDI
 The amount invested each year across national
borders

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Foreign Direct Investment
Outflows

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 Foreign Investment

 Level and Direction of FDI

 Can only get an idea of the rate and amounts of
such investments and of the places in which they
are being made
 Trade Leads to FDI
 Foreign trade is typically less costly and less risky
than making a direct investment into foreign
markets

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Top 15 countries of USA’s FDI

1. Bristish England 9. Puertro Rico

2. Germany 10. Nertheland
3. Australia 11. Singapore
4. Japan 12. Thailand
5. France 13. Switzerland
6. Mexico 14. China
7. Brazil 15. Peru
8. United Arabia
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U.S. FDI Position Abroad

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 Foreign Direct Investment
in the U.S.

Note: Figures are based on current cost. 2002 figures are preliminary.
Source: Elena L. Nguyen, “The International Investment Position of the United States at Year-End 2002,” Survey of Current Business,
July 2003, pp. 20–21; LO4 2-18

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 Why Do Firms Enter
Foreign Markets?
 Firms enter foreign markets to increase sales
and profits
 New sales from
 new customer base
 better managerial control through improved
communications technologies
 Obtain greater profits
 increased revenues
 lower cost of goods sold (maybe)

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 Why Do Firms Enter
Foreign Markets?
 Firms enter foreign markets to
 protect their domestic market
 attack in competitor’s home market and force
competitor to dedicate resources there
 guarantee supply of raw materials
 acquire technology and management know-how
 diversify geographically
 follow customers overseas
 satisfy management’s desire for expansion to a
particular country or region
 bypass protectionist regulations
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 Dimensions Along Which
Management Globalizes a Firm
 Management globalizes a firm through
 products
 markets
 promotion
 where value is added to the product
 competitive strategy
 use of non-home-country personnel
 extent of global ownership in the firm

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 International Trade Theory:
Mercantilism

 A nation’s wealth depends on accumulated treasure,

usually gold
 A country that has no gold must import it
 To increase wealth, government policies should
promote exports and discourage imports
 Importation of gold depends on exports of goods
 Importation of other goods tightly controlled
 Economic competition is a “zero sum game”: if
country advances economically, another loses

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 Theory of Absolute Advantage:
Adam Smith 1776

 Market forces, not government controls, determine

the direction, volume and composition of
international trade
 A country will export goods in which it has an
absolute advantage over other countries
 the proceeds from exports will allow the country
to import other goods

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 Theory of Absolute Advantage:
Adam Smith

 To have an absolute advantage a country must be

able to produce
 a larger amount of a good or service for the same
amount of inputs as can another country
 the same amount of a good or service using
fewer inputs than can another country
 In classic economics a “unit of input” is measured in:
land, labor, capital

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 Absolute Advantage Example

Assumptions:
 We consider two countries: China (A ) and USA (B) that
produce only rice and black tea (tea)
 Each has two “units of input” and uses one to produce
tons of rice and the other tea
 The U.S. has an absolute advantage producing black tea
 China has an absolute advantage producing rice

China USA
1 labor make 1 ton Rice 1/6 ton rice
1 labor make 1/5 ton tea 1/3 ton tea

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 Production limitation line

150 tons
of Rice

25 tons
of rice

30 tons of tea 50 tons of tea

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Absolutely advantages in international
trade
Each country make the goods as his absolutely advantages and trade off
together. Both of them get maximum ultility

A: China exchange 1ton

rice with 1ton tea

Get extra benefit 4/5

B: USA exchange
1ton tea with 1ton
rice

Get extra benefit 1/6

1/5 ton of tea 1/6 ton of rice

if make itself If make itself
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Discussion 1: Vietnam export

Pls show the name of Vietnamese

export goods in 2017?
Why does Vietnam export the rice so
much?

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Theory of Comparative Advantage:
David Ricardo 1817
 A nation may have absolute disadvantages in the
production of two goods with respect to another
nation
 Yet this nation has a comparative advantage or
relative advantage in the production of the good in
which its absolute disadvantage is lower
 By specializing in the production of the good in
which the country has lower comparative
disadvantage, and importing other goods, the total
goods available will increase

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Theory of Comparative Advantage:
Example

 Each has two “units of input” and uses one to

produce tons of rice and tea
 The quantities have changed from the prior
example
 China has the absolute advantage producing
both rice and tea
China USA
1 labor make 1 ton Rice 1/6 ton rice
1 labor make 1/2 ton tea 1/3 ton tea

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Comparative Advantage: Example
Event USA has no absolute advantage but it compares himself he can get
extra benefit of saving ½ labor if exchange goods in international market.
China: 1 labor make
1ton of rice and
trade off 1 ton of tea

Get extra benefit of 1/2

USA : 1 labor make

1/3 ton of tea and
trade off 1/3 ton of
rice
1/2 ton of tea
If make himself Get extra benefit of 1/6

1/6 ton of rice

If make himself

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Theory of Comparative Advantage:
Example

 The U.S. specializes in black tea and China in rice

 There are ½ rice and tea more
 If the U.S. exports to China and the U.S. consumer
has imported goods from china, both of them get
more benefit…
 China and USA still keep international business and
trade off commodities together

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How money and location
advantage affect to trade
Exchange rate Offshoring:
USD/ VND Locating activities
Vietnamese in another nation
currency:
+ decrease in
value
+ Increase in
value

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Discussion 3: The US and
China trade balance
- Why does American government ask
Chinese to release foreign currency
policy? What is about the foreign
currency policy of China?
- Why does american president take
care of human right in China?
Pls talk about political reasons and
economics reason

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 Some Newer Explanations
For The Direction Of Trade
1. Resources endowments- Heckscher-Ohlin Theory
of Factor Endowments
 Countries export products requiring large amounts of their
abundant production factors
 Lower cost to produce; more attractive abroad
 Imported products have low relative cost as producing
locally would require large amounts of the importing
country’s scarce production factors
 Does not consider
 Government influence on factor prices - no perfect market
 Transportation costs
 Differences in tastes
 Differences in climates
 Population diversity and income levels LO1
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 Some Newer Explanations
For The Direction Of Trade

 With demand increase in advanced countries

 Production follows there from the U.S.
 With demand expansion elsewhere
 Product becomes standardized
 Production moves to low production cost areas
 Product now imported to U.S. and to advanced
countries

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 Newer Explanations
For The Direction Of Trade
2. Linder Theory of
Overlapping
Demand
 Customers’ tastes
are strongly
affected by income
levels
 Income per capita
determines the
kinds of goods in
demand

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 Some Newer Explanations
For The Direction Of Trade

3. International Product Life Cycle (IPLC)

 Most new products initially conceived and produced
in the U.S. in 20th century
 U.S. firms kept production close to the market
 Aids decisions and minimizes risk of new
product introductions
 Demand not based on price yet so low
production cost not an issue
 Limited initial demand in other advanced countries
 Initially, exports to these markets more
attractive than production
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International Product Life Cycle

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 Discussion 4: Give a IPLC
example of Levi’s Jean
Levi’s jean was
discovered by
American. Why is it
popular today in the
word and the
american customer
have to import to
use?

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 Newer Explanations
For The Direction Of Trade
4. Economies of Scale and Learning Curve
 Economies of scale: as a plant gets larger, output
increases, per unit production cost decreases
 Learning curve: as firms produce more products, they
learn ways to improve production efficiency further
reducing costs
 A nation’s industries are now low cost producers and
exporters

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 Newer Explanations
For The Direction Of Trade
5. National Competitive Advantage
 Porter’s Diamond Model
 National Competitiveness: a nation’s relative
ability to design, produce, distribute, or service
products while earning increasing returns on
resources
 Four variables: factor endowments, demand
conditions, related and supporting industries,
and firm strategy, structure, and rivalry
Moreover, there are theories of Imperfect Competition-
-Paul Krugman and First-Mover Theory.
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Discussion 5: Honda and
suzuki in Vietnam
Why does Honda motorcycle get
royalty of Vietnamese?
Pls compare the Dream type (Honda)
and Nova type (Suzuki)? Give some
features explain that ITLC and first
mover theory?

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 Synopsis: Trade Theory

 Trade among countries results from relative price

differences that stem from different production costs
 Different production costs come from differences in
 Endowments of factors of production
 Levels of technology that determine the factor
intensities used
 Efficiencies with which factor intensities are used
 Foreign exchange rates
 Differences in tastes can reverse the direction of trade
predicted by theory
 Nations attain a higher quality of life by specializing in
those products for which they have a comparative
advantage and by importing the rest
 Trade restrictions harm a nation’s welfare in the LR
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 Trade Theory and Foreign Direct
Investment Theory are Linked
 Trade theory: focused at the national economy level
 Investment theory: focused at the company decision level
1. Portfolio investment: Purchase of stocks & bonds to obtain a return
on the funds investment.
2. Theory of foreign direct investment (FDI)
 Pertains to ownership and control of investments across national
borders
 Involves real or physical assets (plants, facilities)
 FDI occurs through
 greenfield investment: new facilities from ground up
 cross-border acquisition of an existing business

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 Newer Explanations
For The Direction Of Trade
 Factor endowments
 land, labor, capital, workforce, infrastructure
 Demand conditions
 large, sophisticated domestic consumer base: offers an
innovation friendly environment and a testing ground
 Related and supporting industries
 local suppliers cluster around producers and add to
innovation
 Firm strategy, structure, rivalry
 competition good
 national governments can create conditions which
facilitate and nurture such condition
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 Variables Impacting Competitive
Advantage: Porter’s Diamond

Source: Reprinted by permission of the Harvard Business Review. “The Competitive Advantage of Nations” by Michael E. Porter,
March–April 1990, p. 77. Copyright © 1990 by The President and Fellows of Harvard College; all rights reserved. LO1 2-47

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 Trade Theory and Foreign Direct
Investment Theory are Linked
 Strategic reasons that induce foreign direct
investment
 Find new markets
 Access raw materials
 Achieve production efficiencies
 Access new knowledge (technology, knowhow)
 Mitigate political risk
 Competition

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 Trade Theory and Foreign Direct
Investment Theory are Linked
 A company’s decisions on where to locate FDI
activities is influenced by the same economic
differences among countries articulated in trade
theory
 Endowments of factors of production
 Levels of technology that determine the factor
intensities used
 Efficiencies with which factor intensities are used
 Trade theory explains the flow of products and
services given the cross-national economic context
 FDI explains how companies act within the cross-
national context
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International Investment Theories
 Monopolistic Advantage Theory
 Oligopolistic industries
 FDI is made by firms that possess technical and
other advantages over indigenous firms
 Internalization Theory
 To obtain a higher return on its investment, a firm
will transfer its superior knowledge to a foreign
subsidiary rather than sell it in the open market
 Dynamic Capabilities Theory
 For a firm to successfully invest overseas, it must
have ownership of unique knowledge or resources
and the ability to dynamically create and exploit
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 Eclectic Paradigm of FDI (Dunning)

 Ownership advantage: creates a monopolistic

advantage which can be used to prevail in foreign
markets
 Brand, technology, economies of scale,
management know-how
 Location advantage: the FDI destination local market
must offer factors (land, capital, know-how, cost/quality
of labor, economies of scale) such that it is
advantageous for the firm to locate its investment there
(link to trade theory)
 Internalization advantage: transaction costs of an arms-
length relationship --licensing, exports-- higher than
managing the activity within the MNE’s boundaries
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theory can read more:
Product and Factor Market Imperfections (Hymer and
Caves)
 Superior knowledge leads to differentiated
products
 These lead to firm control on price
 These afford advantage over indigenous firms
 Financial Factors (Aliber)
 Imperfections in the foreign exchange markets
 capital
 International Product Life Cycle (Vernon)
 Follow The Leader (Knickerbocker)
 Cross Investment

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Discussion 6: Why does
Honda invest in Vietnam
1. Why does Honda invest directly in
Vietnam?
2. Why does Honda only make the car
with Euro’ 2 standard?
3. Pls list some strong points of Honda
compare with others rivals in
Vietnam market

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