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Chapter Objectives
To understand the traditional arguments of how and why international trade improves the welfare of all
To review the history and compare the implications of trade theory from the original work of Adam Smith to
the contemporary theories of Michael Porter
To examine the criticisms of classical trade theory and examine alternative viewpoints of which business and
economic forces determine trade patterns between countries
To explore the similarities and distinctions between international trade and international investment
Openin Vinette
!"#ba" O$ts#$rcin% C#&parative A'vantae T#'a(
This vignette gives an update on the theory of comparative advantage. That theory explains why countries
are most suitable for exports of goods and services. The update indicates here is that the source of a
nations comparative advantage comes from the mixture of its own labor skills! access to capital! and
technology. The advantages today are based more on services and their cross"border facilitation by
telecommunications and the #nternet. So global outsourcing creates a comparative advantage in intellectual
Chapter O$t"ine
#. T$% A&% '( M%)*A+T#,#SM
A. *ollapse of feudal society which met all of its needs internally
-. Mercantilism developed to help nations become wealthy and spread their influence
*. The #ndustrial )evolution ended the exploitation of colonies and trading partners
##. *lassical Trade Theory .(igure /.0! page 0/1 provides an excellent overview2
A. The Theory of Absolute Advantage
0. 3eveloped by Adam Smith
1. %ach country should speciali4e in the production and export of that good which it
produces most efficiently .with the fewest man"hours2
5. This theory extended work speciali4ation to speciali4ation of a nation
-. The Theory of *omparative Advantage
0. 3eveloped by 3avid )icardo
1. %ven if a country were most efficient in the production of two products! it should
speciali4e in the production and export of the product that it is relatively more efficient
in and import the other product
5. +ations could improve the welfare of their populations through international trade
###. (actor Proportions Trade Theory
A. 3eveloped by $eckscher and 'hlin
-. A country that is relatively labor abundant .capital abundant2 should speciali4e in the production
and export of that product which is relatively labor intensive .capital intensive2
*. The ,eontief Paradox6the finding that the 7nited States was actually exporting products that
were relatively labor intensive contradicting the (actor Proportions Theory
3. ,inders 'verlapping Product )anges Theory
0. The type! complexity! and diversity of product demands of a country increase as the
countrys income increases
1. #nternational trade patterns would follow this principle! so that countries of similar
income per capital levels will trade most intensively having overlapping product
#8. #nternational #nvestment and Product *ycle Theory
A. Product *ycle Theory
0. 3eveloped by )aymond 8ernon
1. The country that possess comparative advantage in the production and export of an
individual product changes over time as the technology of the products manufacture
5. Stages of the Product *ycle
a. Stage #: The +ew Product
b. Stage ##: The Maturing Product
c. Stage ###: The Standardi4ed Product
F#c$s #n P#"itics
)hen the N$&bers D#n*t A'' +p
This vignette points out that international trade statistics between countries often do not match. The 7.S.
3epartment of *ommerce studied this issue and determined that one reason for the discrepancy is
geographic coverage definitions. (or example! The 7.s. considers Puerto )ico and the 7.S. 8irgin #slands
as part of the 7nited States and Mexico regards them as separate countries. Another problem is partner
country attribution where the import entry form allows for the reporting of only a single country of origin
and the product may have been made in more than one country.
8. The +ew Trade Theory: Strategic Trade
A. #mperfect Markets and Strategic Trade by Paul 9rugman
0. Theories that explain changing trade patterns based on the imperfection of both factor
markets and product markets
a. %conomies of Scale and #mperfect *ompetition
02 #nternal %conomies of Scale
i. :hen the cost per unit of output depends on the si4e of an
individual firm! the larger the firm the greater the scale
benefits! and the lower the cost per unit
ii. A firm could then monopoli4e an industry and create an
imperfect market
12 %xternal %conomies of Scale
i. A country can dominate world markets if its industry can gain
economies of scale
ii. The industry can then maintain its dominance in the world
b. Strategic Trade
02 Price6a government can impose tariffs to offset the monopolistic
power of a foreign firm
12 *ost6governments protect the market from foreign competition to
allow domestic firms to grow and gain economies of scale
52 )epetition6government protection until the firm learns .through
repetition2 how to produce the product more efficiently
;2 %xternalities6government protects and nourishes an industry where it
believes future growth can be achieved
-. The *ompetitive Advantage of +ations by Michael Porter
0. A nations competitiveness depends on the capacity of its industry to innovate and
1. *ompanies gain competitive advantage because of pressure and challenge
5. *ompanies benefit from having strong domestic rivals! aggressive home"based
suppliers! and demanding local customers
;. *ompetitive advantage is also established through geographic <clusters= or
concentrations of companies in different parts of the same industry
8#. The Theory of #nternational #nvestment
A. The (oreign 3irect #nvestment 3ecision
0. :hether to exploit competitive advantage in new foreign markets or in the domestic
1. Should the firm produce at home and export or produce abroad>
5. Should the firm license production or try to control its assets abroad>
;. Should the firm use a ?oint venture or a wholly owned affiliate>
/. Should the firm ac@uire an existing foreign enterprise or build <from the ground up=
.greenfield investment2>
-. The Theory of (oreign 3irect #nvestment .the eclectic paradigm2
0. (irms as Seekers
a. Seeking resources
b. Seeking factor advantages .such as low cost labor2
c. Seeking knowledge
d. Seeking security
e. Seeking markets
1. (irms as %xploiters of #mperfections
a. #mperfections in access .to avoid tariffs2
b. #mperfections in factor mobility .using the mobility of capital to take advantage
of the immobility of labor2
c. #mperfections in management
5. (irms as #nternali4ers6by establishing their own multinational operations firms can
internali4e the production! thus keeping confidential the information that is at the core
of the firms competitiveness