Because learning changes everything.
International
Trade and
Investment
Module 2
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Learning Objectives
2-1 Describe the magnitude of international trade and how it has grown.
2-2 Identify who participates in trade.
2-3 Distinguish among the theories that explain why certain goods are traded
internationally.
2-4 Describe the size, growth, and direction of foreign direct investment.
2-5 Explain several of the theories of foreign direct investment.
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Firms Invest Overseas, but They Also Export
Foreign direct investment (FDI) from
the United States to the rest of the
world was nearly $1.5 trillion from
2013 to 2017.
• Global competition, liberalized
trade policies of foreign
governments, and advances in
technology were major reasons.
• The annual average investment
was more than double the U.S.
average from 1995 to 2005.
Because FDI is used to set up or
acquire assets for producing goods
and services abroad, as FDI
increases, U.S. exports should
decline. Have they?
3
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Figure 2.1 U.S. Exports of Goods and Services in Billions of
Dollars, 1990–2017
Sources: “U.S. Trade in Goods and Services—Balance of Payments (BOP) Basis,” U.S. Census Bureau, Foreign Trade Division, June 6, 2018; “Goods Exports (BOP, current
US$),” The World Bank Group, 2018; “Service Exports (BOP, current US$),” The World Bank Group, 2018; and “Exports of Goods and Services (BOP, current US$),” The
World Bank Group, 2018.
Access the text alternative for slide images.
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International Trade 1
Volume of International Trade
• International trade in 1990 was $4 trillion.
• The volume grew to $23 trillion by 2017.
• Physical goods accounted for $17.5 trillion.
• Services accounted for $5.4 trillion.
• Trade in services has been growing faster than trade in merchandise for the
last 20 years.
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International Trade 2
How Evenly Has Trade Grown?
• The proportion of world trade from the Americas, Europe, Africa, and the Middle
East has decreased since 1983.
• An increase in the proportion of exports from Asia since 1980 has transformed
many nations that were once impoverished in the 1950s into developed
countries.
• Merchandise and service exports have increased in absolute dollar value in
almost all primary-world regions.
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Table 2.1 10 Leading Exporters and Importers in World Merchandise and
Commercial Services, 2016 ($ billions) 1
Merchandise Exporters Merchandise Importers
Rank Nation Value Rank Nation Value
1 China $2098 1 United States $2251
2 United States 1455 2 China 1587
3 Germany 1340 3 Germany 1055
4 Japan 645 4 United Kingdom 636
5 Netherlands 570 5 Japan 607
6 France 501 6 France 573
7 South Korea 495 7 Netherlands 503
8 Italy 462 8 Canada 417
9 United Kingdom 409 9 South Korea 406
10 Belgium 396 10 Italy 404
Sources: Central Intelligence Agency, The World Factbook, https://www.cia.gov, accessed July 4, 2018; World Trade Organization, World Statistical Review 2017, https://www.wto.org, accessed July 4, 2018; and United Nations
Conference on Trade and Development, “UNCTADSTAT,” http://unctadstat.unctad.org, accessed July 4, 2018.
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Table 2.1 10 Leading Exporters and Importers in World Merchandise and
Commercial Services, 2016 ($ billions) 2
Service Exporters Service Importers
Rank Nation Value Rank Nation Value
1 United States $733 1 United States $482
2 United Kingdom 324 2 China 450
3 Germany 268 3 Germany 311
4 France 236 4 France 236
5 China 207 5 United Kingdom 195
6 Netherlands 177 6 Ireland 192
7 Japan 169 7 Japan 183
8 India 161 8 Netherlands 169
9 Singapore 149 9 Singapore 155
10 Ireland 146 10 India 133
Sources: Central Intelligence Agency, The World Factbook, https://www.cia.gov, accessed July 4, 2018; World Trade Organization, World Statistical Review 2017, https://www.wto.org, accessed July 4, 2018; and United Nations
Conference on Trade and Development, “UNCTADSTAT,” http://unctadstat.unctad.org, accessed July 4, 2018.
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Direction of Trade 1
The Increasing Regionalization of Trade
• World trade continues to be dominated by exchanges within geographic
regions.
• Reinforced by the development of expanded regional trade associations and
agreements such as ASEAN, Mercosur, the EU, and NAFTA.
• Members of different trade groups are increasingly selling to one another.
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Direction of Trade 2
Major Trading Partners: Their Relevance for Managers
1. The business climate in these importing nations are already relatively
favorable.
2. Export and import regulations are not insurmountable.
3. There should be no strong cultural objections at home to buying that nation’s
goods.
4. Satisfactory transportation facilities have already been established.
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Direction of Trade 3
Major Trading Partners: Their Relevance for Managers continued
5. Import channel members (merchants, banks, and customs brokers) are
experienced in handling import shipments from the exporter’s area.
6. Currency from the foreign country is available to pay for the exports.
7. The government of a trading partner may be applying pressure on its importers
to buy from countries that, like the United States, are good customers for that
nation’s exports.
These sorts of advantages promote the expansion of trade among countries that are
major trading partners, and their presence may present a company with improved
prospects for expanding its international trade activities.
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Critical Thinking Question
Discuss and explain how international trade in merchandise and
services has changed over the past two decades and what the major
trends are. What future trends can you speculate about? How might
this information be of value to a manager?
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Direction of Trade 4
Major Trading Partners of the United States
• The top 10 trading partners accounted for 66 percent of total U.S. exports and
70 percent of total U.S. imports in 2017.
• Data supports the overall trend that developed nations and members of
regional trade agreements tend to trade with one another.
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Direction of Trade 5
Major Trading Partners of the United States continued
• Trade deficit: the amount by which the value of imports into a nation exceeds
the value of exports.
• Trade surplus: the amount by which the value of a nation’s exports exceeds the
value of its imports.
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Figure 2.2 Major Trading Partners of the United
States, Goods Only, 2017 ($ billions; % of total trade)
Many Asian countries are
both import and export
partners of the United States
because (1) their rising
standards of living; (2)
they are purchasing large
amounts of capital goods
to further their industrial
expansion; (3) they are
importing raw materials
and components and (4)
their governments,
pressured by the U.S.
Source: U.S. Census Bureau, “Top Trading Partners—December 2017,” https://www.census.gov, accessed July 4, 2018.
Access the text alternative for slide images.
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Explaining Trade: International Trade Theories 1
Mercantilism
• Views precious metals like gold and silver as the only source of wealth.
• To increase wealth, government policies should promote exports and
discourage imports.
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Explaining Trade: International Trade Theories 2
Theory of Absolute Advantage
• Exists when a nation can produce more of a good or service than another
country for the same or lower price.
• Nations specialize in producing the product at which it is most efficient.
• Nations trade its surplus for goods it cannot produce as efficiently.
• Perfect competition results in a marketplace that is efficient in production and
allocation of products.
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The table 1
Assume a world of two countries
and two products, with no
transportation costs and perfect
competition,. Suppose that in the
United States and China (a) one
unit of input (a combination of
The table 2 land, labor, and capital) can
Each Country Specializes produce the quantities of
soybeans and cloth listed in the
following table; (b) each nation
has two input units it can use to
produce either soybeans or
cloth; and (c) each country
currently uses one unit of input
The table 3 to produce each product. If
Terms of Trade (Ratio of International Prices) neither country imports nor
exports, the quantities shown in
the table 1 are also those that
are available for local
consumption. The total output of
the two nations is 4 tons of
soybeans and 6 bolts of cloth.
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Explaining Trade: International Trade Theories 3
Theory of Comparative Advantage
• When one nation is less efficient than another nation in the production of each
of two goods, the less efficient nation has a comparative advantage in the
production of that good for which its absolute disadvantage is less.
• An example:
Commodity United States China Total Output
Tons of soybeans 4 5 9
Bolts of cloth 2 5 7
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Theory of Comparative Advantage: An Example
Commodity United States China Total Output
• An example:
Tons of soybeans 4 5 9
Bolts of cloth 2 5 7
Commodity United States China Total Output
Each Country Specializes Tons of soybeans 8 0 8
Bolts of cloth 0 10 10
Exchange Rate: 3/4 bolt of cloth for 1 ton of soybeans
Commodity United States China
Tons of soybeans 4 4 Commodity United States China
Bolts of cloth 3 7
Tons of soybeans 4 5+
Result
Bolts of cloth 3 6
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Global Debate
Debate on whether service jobs should be offshored to India. This is a way
for multinational corporations to improve profitability through comparative
advantage offered by markets where the cost of labor is significantly less
than in the home country of a multinational. This simple lesson in
economics is quite controversial and serves as a starting point for a
stimulating class discussion on such topics as:
• What are the profit motives for outsourcing? What advantages other than profit can be
gained by outsourcing?
• How should a company manage outsourcing?
• How can outsourcing impact (help or hurt) a company’s corporate image?
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Explaining Trade: International Trade Theories 4
How Exchange Rates Can
Change the Direction of Trade
• Exchange rate: the price of one
currency stated in terms of the other.
• Traders must know a price in
domestic currency to determine if it
is better to produce locally or import.
• Countries can attempt to gain
competitive advantage through
currency devaluation.
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Explaining Trade: International Trade Theories 5
Some Newer Explanations for the Direction of Trade
• Differences in resource endowments: the land, labor, capital, and related
production factors a nation possesses.
• Overlapping demand: the existence of similar preferences and demand for
products and services among nations with similar levels of per capita income.
• Intra-industry trade sparked by overlapping demand due to product differentiation.
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Explaining Trade: International Trade Theories 6
Some Newer Explanations for the Direction of Trade continued
• International product life cycle (IPLC): theory explaining why a product that
begins as a nation’s export eventually becomes its import.
• Four stages: Export, foreign production, foreign competition, import competition.
• Useful in explaining trade and investment behavior when international firms introduce new
products in home markets first.
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Figure 2.3 International Product Life Cycle
Access the text alternative for slide images.
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Explaining Trade: International Trade Theories 7
Some Newer Explanations for the Direction of Trade continued
• Economies of scale: predictable decline in the average cost of producing each
unit of output as a production facility gets larger and output increases.
• Experience curve: rising scale on which efficiency improves as a result of
cumulative experience and learning.
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Explaining Trade: International Trade Theories 8
Some Newer Explanations for the Direction of Trade continued
• National competitiveness: nation’s relative ability to design, produce, distribute,
or service products within an international trading context while earning
increasing returns on its resources.
• Regional clusters give firms the upper hand because they can pool a labor force, use
specialized local suppliers, and share technological information.
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Figure 2.4 Variables Affecting National Competitive Advantage:
Porter’s Diamond
Access the text alternative for slide images.
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Explaining Trade: International Trade Theories 9
Summary of International Trade Theory
• Nations can attain a higher level of living by specializing in goods for which they
have a comparative advantage and importing those for which they have a
disadvantage.
• Trade restrictions that stop the free flow of goods harm a nation’s welfare.
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Foreign Investment 1
Two Key Components of Foreign Investment
• Portfolio investment: the purchase of stocks and bonds to obtain a return on
the funds invested.
• Direct investment: the purchase of sufficient stock in a firm to obtain significant
management control.
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Foreign Investment 2
Portfolio Investment
• Investors aren’t directly concerned with control of the firm but to gain ROI.
• Foreign portfolio investment is sizable and will grow as firms list bonds and
equities on foreign exchanges.
• Nonresidents owned U.S. stock and bonds with a value of $19.5 trillion in 2018.
• U.S.-owned foreign portfolio investments valued at $12.5 trillion at the beginning of 2018.
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Foreign Investment 3
Foreign Direct Investment (FDI)
• Outstanding stock: the book value of all FDI worldwide was nearly $30.8 trillion
at the beginning of 2018.
• Annual outflow often fluctuates greatly due to factors such as the level of
economic growth within and across nations.
• About two-thirds of all outflow comes from developed nations, but outflow from developing
nations has increased substantially.
• Much of the world’s outflow of FDI is associated with mergers and acquisitions.
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Foreign Investment 4
Foreign Direct Investment (FDI) continued
• Annual inflows: FDI investments into developed nations has declined; now a
large proportion of FDI is flowing into developing countries, particularly Asia.
• Worldwide, the absolute volume of FDI flowing into the developing countries as
a whole was seven times larger in 2000 than in 1990 and nearly tripled again
by 2017.
• Nations that receive appreciable amounts of foreign investments have
favorable investment climate and greater opportunities.
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Foreign Investment 5
Does Trade Lead to FDI?
• Historically, FDI followed foreign trade.
• Significant changes in today’s global business environment make FDI a
possible first step into international trade.
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Explaining FDI: Theories of International Investment 1
Main Forms of FDI
• Greenfield investment: the establishment of new facilities from the ground up.
• Cross-border acquisition: the purchase of an existing business in another
faction.
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Explaining FDI: Theories of International Investment 2
Monopolistic Advantage Theory
• FDI is made by firms in industries with relatively few competitors, due to their
possession of technical and other advantages over indigenous firms.
• Smartphones (Apple, Samsung), magnetic resonance imaging machines (General Electric,
Philips, and Toshiba), and commercial aircraft manufacturing (Boeing, Airbus).
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Explaining FDI: Theories of International Investment 3
Strategic Behavior Theory
• Oligopolistic industries have a limited number of competing firms.
• Strategic rivalry between firms in an oligopolistic industry result in firms closely
following and imitating each other’s international investments in order to keep a
competitor from gaining an advantage.
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Explaining FDI: Theories of International Investment 4
Internalization Theory
• To obtain a higher return on its investment, a firm will transfer its superior
knowledge to a foreign subsidiary that it controls, rather than sell it in the open
market.
Workers in a clean lab at a
production facility.
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Explaining FDI: Theories of International Investment 5
Dynamic Capabilities Theory
• For a firm to successfully invest overseas, it must have not only ownership of
unique knowledge or resources, but also the ability to dynamically create,
sustain, and exploit these capabilities over time.
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Explaining FDI: Theories of International Investment 6
Eclectic Theory of International Production
• Currently the most widely accepted theory of FDI.
• Three kinds of advantages needed for a firm to invest in facilities overseas:
1. Ownership-specific advantage.
2. Location-specific advantage.
3. Internalization advantage.
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Get That Job! From Backpack to Briefcase
Mark Haupt Mark Haupt discusses how he developed a career in international
business while still living in California. He discusses his preparation for
international travel and gives advice for those that are interested in
going abroad or working with others abroad.
• What do you think of Haupt’s goal to be involved in international
business while living in California instead of abroad? What kinds of
international jobs would require living in the U.S. and what kinds
would require living abroad? What qualifications would be the same
and what would be different for domestic-based and foreign-based
jobs?
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MiniCase
The minicase “Brazil: A Global Competitor in Information Technology
Outsourcing?” explores the issue of outsourcing and how countries may compete
to be the destination for outsourced activities.
1. Use the theories of international trade and investment in this module to help explain Brazil’s
intentions and actions regarding the international information technology sector.
2. What recommendations would you give to the Brazilian government and its outsourcing
industry in order to improve their prospects for success in building a strong international
competitive position in the information technology outsourcing business?
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