Einheit 4: International Economic Exchange Flashcards
Theories of international trade and investment
cluster into nation- and firm level explanations
on Level of Global business:
national level-explanations
-> why do nations trade?
-> how can nations enhance their competititve advantage?
on level of international business:
Firm-level explanations
-> why do firms internationalize
-> how do firms internationalize?
-> how can internationalizing firms gain and sustain international competitive advantage?
explanations for why do nations trade?
International trade theories are a
set of economic models that aim to
explain trade patterns
These theories try to explain which
goods are exported and imported
and who imports and exports those
goods
Mercantilism
absolute advantage theory
factor endowment theory
international product life cycle theory
law of distance
new trade theory
explanations for how nations can ehnache their competitive advantage
diamond model
national industrial policy
Mercantilism
National prosperity results from
maximizing exports and minimizing imports
Mercantilism is a nationalist economic policy that is designed to maximize the exports and minimize the
imports for an economy
Belief in the Static Nature of Wealth: “Global wealth is static, and a nation’s economic health relies heavily on its supply of capital and gold.”
Mercantilism was popular in the 16th to 18th century
Today, some argue for neomercantilism – the idea that the nation should run a trade surplus
Supporters of neomercantilism include:
-Labor unions (want to protect domestic jobs),
-Farmers (want to keep crop prices high), and
-Some manufacturers (that rely on exports)
Restrictions to trade & Protectionism:
Mercantilists try to restrict trade with other nations (maintain trade surplus) and impose tariffs
Examples, mercantilism vs neo mercantilism
Mercantilism (examples from the past):
-Great Britain passed the Navigation Act of 1651, which forbade its colonies from
trading with the colonies of other European countries.
-Spain’s mercantilist policies were heavily focused on its colonies in the Americas,
particularly in extracting wealth through the exploitation of resources such as gold
and silver. The Spanish crown imposed strict regulations on colonial trade, including the establishment of the Casa de Contratación to control commerce with the colonies.
Neo-Mercantilism (examples from today):
-China is considered a neo-mercantilist nation in the contemporary era with economic policies defined under the neo-mercantilist paradigm. Most importantly, China has controlled population growth for social control and national development.
-The US entails a resurgence of protectionist policies (since Trump) aimed at bolstering domestic industries and reducing reliance on foreign goods. This approach emphasizes trade barriers, subsidies, and strategic economic interventions to
safeguard national interests in the global market.
Absolute vs comparative advantage
Absolute advantage refers to a country’s
ability to produce a good more efficiently
(using fewer resources) than another country
e.g. Saudi Arabia and oil production
-> Due to its vast oil reserves and low extraction costs, Saudi Arabia can produce oil at a much lower cost compared to other countries
-> Saudi Arabia has an absolute advantage in the production of oil
Comparative advantage refers to a country’s ability to produce a good at a lower opportunity cost than another country
e.g. Portugal and wine production
-> Portugal is less efficient in producing both wine and cloth compared to England
-> Portugal has a comparative advantage in
producing wine, if opportunity cost of
producing wine in Portugal (in terms of the
alternative) is lower than the opportunity cost of producing wine in England
Absolute advantage policy directive,
Policy Directive
- Produce and export those goods where production in the domestic market has an
absolute advantage over other countries
- Import goods that can be produced more efficiently abroad
Unrestricted free trade leads to specialization in goods with production advantages
Comparative advantage theory: production costs and capacities
Calculate opportunity costs to find more efficient country
opportunity costs: costs of foregoing the other alternative (between two goods x and y)
Production capacities:
-What would be the output if all
resources of a country were devoted to
producing one out of two goods?
-production capacities are known
-opportunity costs of good X expressed in terms of good Y
Opportunity costs of one unit of X= Production capacity of Y / Production capacity of X
Production costs
-What are a country’s production costs of good X expressed in terms of good Y
-Production costs are known
-Opportunity costs of
opportunity costs of one unit of X= Production costs of X / Production costs of Y
-> country with lower opportunity costs will specialize on that product
comparative advantage: global output perspective
Consider the maximum capacity of different products -> total output without trade vs with trade
Comparative advantage results
in increased global output due
to specialization
limits of absolute comparative advantage theory
Lack of guidance if one nation is inferior in terms of resources or
productivity compared to another (comparative advantage theory
provides remedy here)
-Simplistic assumptions
-Two countries/goods
-Resources are assumed to be immobile internationally but mobile
nationally
-Specialization based on advantages would restrict job opportunities to
certain industries
limits of comparative advantage theory
Static nature: assumes advantages to remain constant over time
Similarly simplistic assumptions as in absolute advantage theory
factor endowment theory
countries consider their resources
Factor endowment/proportions theory (Heckscher-Ohlin model) argues that each
country should produce and export products that intensively use relatively abundant factors of production while importing goods that intensively use relatively scarce factors of
production (climatic conditions are central examples for this)
Examples
▪ US & Caribbean: Caribbean countries have the climate, US
firms have the capital - FDI (Chiquita in the Caribbean)
▪ US & Mexico: US (relatively abundant in capital compared to
Mexico) tends to export capital-intensive goods such as machinery and technology; Mexico (relatively abundant in
labor), specializes in and exports labor-intensive products such
as textiles or low-skilled manufacturing
▪ Extractive industries: Endowments (natural resources, desirable destinations) located in countries that do not have the
capital to exploit them
limits of factor endowment theory, related reasons for diluting effect of FDI
Factor endowment theory also has its limits and policyrelated reasons for FDI have a diluting effec
Limitations of the factor endowment theory:
▪ For some countries it is more beneficial to import goods that use abundant resources
▪ Minimum wage laws in countries can lead to increasing labor prices despite abundance
▪ Countries can successfully export products that use less abundant resources
▪ Example: US shows a pattern of exporting a relatively higher proportion of laborintensive goods while importing capital-intensive goods
Policy-related reasons for FDI have a diluting effect
▪ Tariff barriers make exports expensive: FDI (Toyota in the US)
▪ Quotas create incentives for firms to relocate production to locations that are not affected (less affected) by trade restrictions
▪ Subsidies might incentives counter-intuitive FDI choices
Leontief paradox
The Leontief paradox unveils an important limitation of the factor endowment theory
Wassily Leontief made a surprising observation based on exports in the US
▪ The US was a highly industrialized nation with a comparative advantage in
capital-intensive industries, such as machinery and equipment
▪ Nevertheless, the US found itself exporting
▪ More labor-intensive goods (e.g., textiles; labor was not an abundant factor)
▪ Technology-intensive goods that require a highly educated workforce
(also not available in abundance at that time)
Leontief Paradox refers to the unexpected outcome in international trade where a country with a comparative advantage in producing capital-intensive goods ends up exporting more labor-intensive
products
Explanation:
▪ The paradox addresses considerations beyond labor hours, such as quality of labor
▪ Intraregional trade remains high due to similar income levels, demand patterns, and operational
efficiencies which reduce uncertainty and transaction costs
Critique of theory: Struggles to explain increased trade between developed countries and industrialized markets (similar income levels but different demand patterns)
international product life cycle theory
Internationally traded products go through phases
Four stages
1. In the first stage, the inventor country
(e.g., USA) enjoys a monopoly in exporting
a product (A) – Intellectual property
advantage should be strong
2. In the second stage, the imitating country
(e.g., Austria) starts producing the same
product (B)
3. In the third stage, foreign production in the imitating country becomes competitive in the export markets (C) – the imitating
country needs to have competitive products and a beneficial cost structure
4. In the fourth and final stage, the inventor
country becomes a net importer as
production in the inventor country starts to
decline (D)
Emphasizes the influence of market size and expansion in determining trade patterns and the role of technological innovations (overlooked
by comparative advantage theory)
lifecycle of the VW Käfer
1930s-1945:
Innovation: affordable
4-person car; invented
in Germany; WW II
haltered production
Post 1945:
Production resumed post
WW II
Start of exports
1950s:
Manufacturing locations
in South Africa (1951)
and Belgium (1954)
1950s – 1970s:
Increasing
standardization leading
to production in Mexico,
Brazil, Yugoslavia,
Nigeria
1978:
Reduced demand in
industrialized countries
(Golf) – manufacturing
of VW Käfer ceases in
Germany / imported
from Brazil and Mexico
2003:
Manufacturing of VW
Käfer in Brazil and
Mexico ends
new trade theory
Increasing returns to scale
incentivize trade between similar countries
In the 1970s, Paul Krugman observed that trade between countries with similar
factors of production was growing fastest
-> Example: Trade between the US and EU
New Trade Theory argues that increasing returns to scale and network effects play a
key role in explaining superior performance for booming industries by accessing the
global marketplace
Implications:
▪ Trade occurs between countries that are similar in terms of endowments,
production costs, and development
▪ Industries start becoming more specialized and gain economies of scale in niches –
intra-industry trade
▪ Intra-firm trade involving trade within a unified firm in intermediate products gives
firms some discretion over transfer prices (addressing financial barriers)
law of distance
trade tends to fall with distance
Trade and economic exchange are more likely and stronger between actors that are located close to each other
Gravity model of trade: Dyadic trade flows are determined by the economic size and the distance between two countries
Empirically well established (see example on UK)
Theoretically, the relationship can emerge if trade costs increase with distance
Original form considers geography and spatiality; other factors (colonial ties, institutional differences) apply equally
limitations to early trade theories
Do not properly account for international transportation costs
Do not properly account for taxes and non-tariff barriers
(quotas, subsidies, standards and product regulations, environmental & labor
regulations, etc.)
-> Examples of restrictions: US on steel, solar panels, and washing machines, EU on
steel and metal products, and US consumer products
Do not properly consider further factors:
For many firms, scale economies and superior business strategies provide efficiencies and other advantages
-> Example: Japan lacks comparative advantages, but Japanese firms succeeded
anyway, via superior strategies
Do not properly consider services:
Some services cannot be traded internationally while other services can be traded freely via the Internet, global telephony, or travel
diamond model
The diamond model explains national
competitive advantages in specific industries
interconnectedness of following factors:
Factor conditions – Quality and quantity of
labor, natural resources, capital, technology, know-how, entrepreneurship, and other factorsof production (emphasis on advanced and special factors)
Related and supporting industries – the
presence of suppliers, competitors, and
complementary firms leading to agglomeration effects and profitable inter-firm relationships
Demand conditions – the strengths and
sophistication of customer demand (driving firm innovation)
Firm strategy, structure, and rivalry – the
strategies employed, the organizational and managerial structures adopted, and the nature of domestic rivalry (heightened domestic rivalry
increasing a firm’s competitiveness globally)
two supplementary elements influece a country’s attractiveness
- governments
Government policies determine the
attractiveness of the primary four
factors (see Module 2 on formal
institutional environment). The
ancillary role of governments is
not uncontested. - chance
External events (innovations,
disruptions, wars, climate change)
can affect the primary
determinants (e.g., demand
conditions might change by
chance)
national industrial policy
A set of set of government
strategies designed to foster national economic growth
National industrial policy: A set of government strategies designed to promote and regulate the development of specific industries within a country and to address various challenges and opportunities within specific sectors of the economy
The primary objective of national industry policy is to foster economic growth,
enhance competitiveness, create jobs, and achieve sustainable development
Key components of national industry policy may include government actions like:
1. Strategic Planning: Identify key industries that are crucial for economic
development
2. Incentives and Subsidies: Provide financial incentives, tax breaks, or subsidies
3. Infrastructure Development: Invest in infrastructure development to support
targeted industries (e.g., transportation networks, communication systems, energy
infrastructure)
4. Research and Innovation: Fund research institutions, collaborate with industry
players, and create favorable conditions for innovation and technology adoption.
5. Trade policies: implement policies to protect and promote domestic industries
example of national industrial policy: Germany’s Industry 4.0 initiative
Goal:
-This Industry 4.0 policy (launched in the 2010s) aims to promote the integration of digital technologies, automation, and smart manufacturing processes
into the country’s industrial sector
-The goal is to maintain and enhance Germany’s position
as a global manufacturing powerhouse
Targeting: Under the Industry 4.0 initiative, the German government, in collaboration
with industry stakeholders, encourages the adoption of:
-Internet of Things (IoT)
-Artificial intelligence
-Data Analytics
Type of support: The policy includes financial incentives, research and development support, and the establishment of innovation hubs to facilitate the transition of
traditional industries toward more advanced, technology-driven manufacturing.
