Chapter 3 - International trade theory. This chapter examines the development of international trade theory from the seventeenth century through the second half of the twentieth century. The main goals of this chapter are to: Outline and critically evaluate the major theories that attempt to explain why nations should engage in international trade and the patterns of international trade; show, via simple examples, the case for free trade and how all countries can benefit from free trade;...
Chapter International trade theory Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–1 Lecture plan • Mercantilism • Absolute advantage • Comparative advantage • Comparative advantage versus competitive advantage • Factor endowments • The new trade theory • Porter’s diamond Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–2 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 – maximise exports through subsidies – minimise imports through tariffs and quotas • David Hume (1752): persistent trade surplus will affect money supply and in the long run close the trade surplus • Key problem: ‘zero-sum game’ Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–3 Theories of international trade: absolute advantage • Exporting country holds superiority in 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 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–4 Theory of competitive 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 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–5 Alternative production possibilities from 100 units of resources Commodity Cheese Country (tonnes) Cloth (bolts) Australia 200 160 UK 80 120 Source: Table 3.2 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–6 Opportunity cost and comparative advantage Production Australia tonne of cheese 0.8 bolts of cloth bolt of cloth 1.25 tonne of cheese UK 1.5 bolts of cloth 0.67 tonnes of cheese Source: Table 3.3 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–7 Diversified production before trade production/consumption Resources (units) Cloth (bolts) Australia 100 37.5 x 1.6 = 60 UK 100 120 Source: adapted from Table 3.4 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–8 Theory of comparative advantage and the gains from trade Australia UK Total production Production and Consumption without Trade Cheese (tonnes) Cloth (bolts) 125 60 40 60 165 120 Australia UK Total production Production with Trade Specialisation 200 120 200 120 Consumption after UK trades 60 bolts of cloth for 60 tons of Australian cheese Australia 140 60 UK 60 60 Total consumption 200 120 Increase in consumption as a result of specialisation and trade Australia 15 UK 20 Total consumption 35 Source: adapted from Table 3.5 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–9 Comparative vs 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 the ability of two companies to compete in the same business Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–10 Factor Endowments (Heckscher and Ohlin) • Explains differences difference ininopportunity opportunitycosts 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 abundant/cheap factors – cheese: land-intensive – cloth: labour-intensive • The theory can explain Australia-Japan trade patterns Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–11 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 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–12 The new trade theory • Began to be recognised in 1970s • Deals with 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 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–13 The new trade theory cont • 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 (e.g Boeing, Airbus) • New trade theory does NOT contradict the theory of comparative advantage, but instead identifies a source of comparative advantage Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–14 Implications from the application of new trade theory • 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’) Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–15 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) Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–16 Determinants of national competitive advantage Chance Firm Strategy Structure, and Rivalry Demand Conditions Factor Endowments Related and Supporting Industries Source: Fig 3.1 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea Government 3–17 Porter’s 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 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–18 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 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3–19 ... Table 3. 2 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3 6 Opportunity cost and. .. Source: Table 3. 3 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3 7 Diversified... Australia-Japan trade patterns Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 3 11