Week 2 Part 1 International Trade Theories

BMS0076
The Context of International Business
Week 2:
Part 1- International trade theories
Nan Zheng
[email protected]
1
Learning objectives
 Understand the importance of international trade and its
impact on economic development
 Understand classic and modern trade theories
2
What is international trade?
Exporting:
• selling abroad
• goods and services
produced in one country
and then sent to anther
country
International trade: exchange of goods
and services across national borders
Importing:
• buying from abroad
• goods and services
produced in one country
and bought in by another
country
3
International trade and economic development
 International trade can make positive contribution to economic
development via a number of channels
 Expand markets
 Facilitate competition
 Disseminate knowledge and increase exposure to new
technologies
 Raise productivity
 As a result, trade creates opportunities for growth, poverty reduction

and human development.
Theories of international trade
Country-based theories Firm-based theories
Country is unit of analysis Firm is unit of analysis

Emerged prior to World War II Emerged after World War II
Developed by economists Developed by business school
Explain interindustry trade professors
Include: Explain intraindustry trade
 Mercantilism Include:
 Absolute advantage  Product life cycle
 Comparative advantage  National competitive
 Relative factor endowments advantage
(Heckscher-Ohlin)
5
Interventionist theory
 Theory of mercantilism maintains that a country’s wealth is

measured by its holdings of gold and silver. If one exports more
than one imports, the nation accumulates more gold and silver,
hence more national wealth.
 International trade is a zero-sum game. So government should

intervene and achieve a favorable trade balance.
6
Trump’s protectionist policies mean that government should
actively protect domestic industries from imports and vigorously
promotes exports.
Trade Deficit: a surplus of imports over exports
Trade Surplus: a surplus of exports over imports
7
Watch the following video and think about why do nations trade?
https://www.youtube.com/watch?v=-IW8ZzY3xt8&t=1s 8
So why do nations trade?
 Laissez-faire (free trade) theories: “the absence of restrictions to the
flow of goods and services between nations” (Cavusgil et al 2017, p.
146)
 Two theories that support free trade:

 Absolute advantage theory
 Comparative advantage theory
 Both absolute and comparative advantage (free trade) theories hold

that nations should neither artificially limit imports nor promote
exports.
9
The theory of absolute advantage
Adam Smith:
 A country should specialise in the production of goods in
which each has an absolute advantage, both countries
benefit by engaging in trade.
 Absolute advantage: capability of one country to produce
more of a product with the same amount of input than another
countries.
OUTPUT PER HOUR OF LABOR
France UK
The theory of comparative advantage
David Ricardo:
 A country has a comparative advantage when it produces the
good more efficiently than it does any other good.
 A country should specialise in most efficiently produced goods →
export!
 Produce and export those goods and services for which it has a
comparative advantage and import those goods and services for
which it has a comparative disadvantage.
OUTPUT PER HOUR OF LABOR

France UK
 Defeated Mercantilism, at least intellectually
 Free trade brings

 Specialisation
 Greater efficiency
 Higher global output
12
Assumptions and limitations
 Two countries and two goods (simple world and hard to compare all
nations)
 Transportation costs
 The theories are static, but trade conditions are dynamic
 Production networks (products are now made across countries within

MNEs)
What types of products
does a country trade?
Factor-Endowment Theory or H-O Theory (Eli Heckscher and
Bertil Ohlin)
 It emphasizes resource differences as the source of trade and
comparative advantage is influenced by relative factor abundance
in stead of productivity:
But this theory
 Each country should produce and export products that use still assumes
relatively abundant factors of production, and import goods that “static” trade.
use relatively scarce factors of production.
e.g., China: labour intensive manufacturing industries; Middle

east: exporting oil; U.S. and U.K.: capital (financial services) 14
Modern trade theory
 Product Life Cycle (PLC) Theory by Raymond Vernon (1966)
 Vernon observed that each product and its associated manufacturing

technologies go through three stages of evolution: Introduction, maturity,
and standardization.
15
Source: Adapted from Raymond Vernon, “International Investment and International Trade in the Product Cycle,” Quarterly
Journal of Economics 80 May 1966), pp. 190–207 and
http://www.provenmodels.com/583/international-product-life-cycle/raymond-vernon.
Product life cycle (PLC)
 In the introduction stage, the inventor country enjoys a monopoly both in

manufacturing and exports.
 In the maturity stage, the product’s manufacturing becomes relatively

standardized, other countries start producing and exporting the product.
 In the standardisation stage, manufacturing ceases in the original

innovator country, and it becomes a net importer of the product.
Today under globalisation, for many products, the cycle occurs quicker
and products are launched simultaneously around the world. 16
Porter’s diamond of
national competitive advantage
 Porter theorises that four broad
attributes (mutually-dependent, the Firm Strategy,
effect of one attribute is contingent on
the state of others) of a nation shape
Structure,
the environment in which firms and Rivalry
compete, and these attributes
promote or impede a nation’s
competitive advantage (or
competitive superiority) in an industry. Factor Demand
Conditions Conditions
This theory attempts to analyse the Related and

reasons for a nation’s success in a Supporting
particular industry.
Industries
Government and chance

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BMS0076

The Context of International Business

 Understand classic and modern trade theories

 As a result, trade creates opportunities for growth, poverty reduction

Country-based theories Firm-based theories

Country is unit of analysis Firm is unit of analysis

 Theory of mercantilism maintains that a country’s wealth is

 International trade is a zero-sum game. So government should

Trade Deficit: a surplus of imports over exports

Trade Surplus: a surplus of exports over imports

 Two theories that support free trade:

 Both absolute and comparative advantage (free trade) theories hold

OUTPUT PER HOUR OF LABOR

 Free trade brings

 The theories are static, but trade conditions are dynamic

 Production networks (products are now made across countries within

e.g., China: labour intensive manufacturing industries; Middle

 Vernon observed that each product and its associated manufacturing

 In the introduction stage, the inventor country enjoys a monopoly both in

 In the maturity stage, the product’s manufacturing becomes relatively

 In the standardisation stage, manufacturing ceases in the original

This theory attempts to analyse the Related and

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