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International Business and Trade

Module 2

International business

• These are all commercial transactions, both private and public between nations of the world.
• Started from a story in fertile Mesopotamia (present-day Iraq)
• Sumerian farmers used their grain surplus as barter in exchange of coppers from Sinai Desert
traders to be used in making weapons and repel nomadic raiders.
• International trading yielded the farmers not only bounty of material goods but also an
understanding of the culture of their neighbors and a mutual desire to sell things to other
groups rather than to annihilate them.

Trade

• Earliest and simplest form of international business

• The two-way flow of exports and imports of goods (merchandise trade) and services (service
trade)
• It has influenced culture, shaped history, raised living standards, and expanded knowledge to
include new ways of thinking.
• It brings with it cultural and technological riches.
• It can also make the world peaceful because of national interdependence.
• It generates jobs in both export and import sectors of an economy.
• It increases competition, and like rivalry from new domestic companies, it does have negative
impact on some because of this disruptive change.
o Yet even today, policymakers in some countries continues to question the benefits of
trade by asking whether to open national borders to freer trade and foreign direct
investment (FDI), foreign inflow of capital, technology, and skills to domestic
investment and economic growth.

World’s Ten Largest Economies: Purchasing Power Parity Basis

• United Kingdom • France

• China • Brazil
• India • United Kingdom
• Germany • Italy
• Russia
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Top Ten Exporting Nations in 2012

• China • France
• United States • South Korea
• Germany • Russia
• Japan • Italy
• Netherlands • Hong Kong

PPP Conversion Factor

• the number of units of a country’s currency that is required to buy the same amount of goods
and services in the domestic market that a U.S. dollar would buy in the United States

Gross National Income (GNI)

• the total value of goods and services produced by a country plus net receipts of employee
compensation and property income from abroad.

Benefits provided by international trade to consumers

• A greater amount of choice in the availability of goods and services

• Lower prices for goods and services consumed
• Higher living standards

Foreign direct investment

• Inflows of capital from abroad for investing in domestic plant and equipment for the production
of goods and/or services as well as for buying domestic companies
• It brings funds and business culture from abroad, creates new well-paying jobs, introduces
innovative technologies, and enhances the skills of domestic workers.

Outsourcing

• The corporate practice of acquiring or producing quality goods or services abroad at a lower cost
thereby eliminating domestic production.
o This generally happens when assembly-line jobs in uncompetitive manufacturing sectors
migrate to countries like China and Vietnam, or when service jobs are outsourced
abroad to countries like India or the Philippines.
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Major Theories of International Trade

• No single nation in the world is capable of producing and consuming all the goods and services
that its citizens want or need.
• Therefore, nations of the world need to trade.
o Wealth Accumulation as a Basis for Trade Theory: Mercantilism
▪ It is a theory of international trade that supports the premise that a nation could
only gain from trade if it had a trade surplus.
➢ Happens when the value of exports exceeds the value of imports
➢ The opposite of a trade deficit
▪ It is one of the oldest forms of trade theory.
➢ It was practiced during the 1500-1750 period as Europe emerged from
the feudal systems of the Middle Ages and moved toward nationalism.
➢ Wealth was largely determined by the amount of precious metal to
which one had access.
➢ Land and labor were considered less important because they were
primarily factors of production that were needed to generate wealth.
✓ Endowments used to produce goods and services: land
(quantity, quality, and mineral resources beneath it), labor
(quantity and skills), capital (cost), and technology (quality)
▪ Mercantilists believed that for a nation to become wealthy, that nation must
export as much as possible and, in turn, import as little as possible.
➢ Rationale: Exports generate income, while imports were determined to
be a cost.
▪ Disadvantage: Mercantilists did not want, or care, to see the big picture.
➢ The surplus of exports in the world market would depress prices and,
therefore, earnings for exporting countries would drop.
✓ This decrease in wealth would result in lower wages in the
export sector.
➢ Second, as the demand for export drops, competitors in the export
market would want to undersell each other by further lowering their
prices in order to get rid of their exports.
▪ Mercantilists encouraged their people to produce large families by providing
bounties for children and penalties for the unmarried.
➢ Their concern was the inflow of national wealth and not the prosperity
of its citizens.
o Specialization as a Basis for Trade Theory: Absolute and Comparative Advantage
▪ During the mid-18th century, British economist Adam Smith, who came to be
known as the father of free market and open trade systems, recognized the
absurdity of mercantilism.
➢ He argued and proved that free trade without restrictions would
increase the wealth- in terms of rising real income.
➢ Theory of Absolute Advantage
✓ It exists when one country can produce a good more efficiently
than the other.
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➢ Theory of Comparative Advantage

✓ This approach is a refinement of Adam Smith’s theory of
absolute advantage and can be attributed to another great
British economist, David Ricardo
✓ It is the ability of one country that has an absolute advantage in
the production of two or more goods to produce one of them
relatively more efficiently than the other.
▪ When all countries follow this approach, resources can be used most efficiently,
and the total output and standard of living can be increased.
o Factor Endowments as a Basis for Trade Theory: Heckscher-Ohlin and Factor Price
Equalization
▪ In the 1930s, two Swedish economists, Eli Heckscher and Bertil Ohlin, refined
David Ricardo’s theory of comparative advantage and showed that nations
primarily export goods and services that intensely use their abundant factors of
production.
▪ Heckscher-Ohlin (H-O) theory
▪ Attributes the comparative advantage of a nation to its factor endowments.
➢ The quantity and quality of factors of production that a country owns
▪ They key assumptions for the H-O theory to work are:
➢ Perfect competition in the marketplace
➢ Perfect immobility of factors of production among countries.
▪ Factor Price Equalization Theory
➢ It states that when factors are allowed to move freely among trading
nations, efficiency further increases, which leads to superior allocation
of the production of goods and services among countries.
o Porters’ Diamond Model of National Competitive Advantage
▪ In 1990, American economist and Harvard Business School Professor, Michael
Porter published his seminal work, “The Competitive Advantage of Nations”
which reported the results of his four-year study of ten nations on why some
countries excel in certain industries and markets.
➢ Trade theories broadly explained the basis upon which countries
exported certain goods, services, or commodities.
➢ However, Porter believed that trade theories did not explain enough as
to why countries import and export.
▪ Porter looked more closely at the theory of firm and industry specifics to
identify characteristics that made firm and industries in countries, “winners” or
“losers” in international trade.
▪ It is the integration of the theory and structure of a firm’s behavior to trade
theory.
▪ It also explained that the interaction of these four groups of characters will
determine a country’s competitive advantage in the global arena.
▪ Factor Conditions
➢ Porter’s model looks more closely at the quality of the factor
endowments.
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▪ Demand Conditions
➢ Porter stresses the importance of domestic demand for goods and
services when determining a nation’s competitive advantage.
➢ When domestic demand remains high, the number of suppliers will also
be high.
➢ With sizable demand, domestic competition among suppliers will
intensify and result in lower prices as well as sophisticated, innovative
new products.
✓ This could lead to product specialization
▪ Related and Supporting Industries
➢ The quality and competitive nature of supplier industries will determine
how successful a country will be.
▪ Firm Strategy, Structure and Rivalry
➢ Firm strategy deals with the way companies in an industry manage their
operations as well as the structure of the organization.
➢ Management style – top down, bottom up, or consultative – has a large
impact on a firm’s performance.
➢ Firm structure and rivalry address the competitive structure of
industries in a nation.
➢ Monopolistic industrial structures are unlikely to create innovative or
dynamic firms willing to compete abroad or have the capability of
competing.
➢ Competitive industry will foster innovative, cost-efficient, aggressive
firms that can adjust to changing economic conditions at home and will
be well prepared to compete abroad.
▪ Porter also identified two other crucial variables outside the diamond that play
an important role in the competitiveness of nations:
➢ Chance
✓ It refers to an external shock or development that could
drastically change or hasten the course of economic
development.
➢ Government
✓ Government institutions and polices could help or hurt
competitiveness of nations due to the fact that government
institutions and policies have the potential to affect all four sets
of characteristics associated with Porter’s diamond.
▪ A country that exhibits relatively positive characteristics in all four diamonds will
be an exporter of certain types of goods and services.
▪ And a country that exhibits relatively negative characteristics will be a net
importer of goods and services.
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The Practice of Trade Policy

Trade policy

• All government actions that seek to alter the size of merchandise and/or service flows from and
to a country

Instruments of trade policy

• Tariffs (custom duties)

• Preferential duties
• Most favored nation status
• Nontariff barriers

Tariffs

• Taxes on imports; also known as custom duties

• Collected by a designated government agency responsible for regulating imports
• Import tariffs are major sources of government revenue
• Tariffs come in two forms:
o Specific
▪ An import tax that assigns a fixed dollar amount per physical unit
o Ad valorem
▪ A tax on imports levied as a constant percentage of the monetary value of one
unit of the imported good

Preferential duties

• An import tariff established by a nation for goods of certain countries and not applied to the
same goods of other countries
• It refers to low tariff rates applied to specific imports coming from certain countries, especially
from the developing world.
• This are therefore geographically discriminatory as certain countries receive different or
preferential treatment.

Generalized System of Preferences (GSP)

• An agreement where a large number of developed countries permit duty-free imports of a

selected list of products that originate from specific countries
• This could be based on a colonial relationship or based upon helping developing countries
succeed in trade – trade could be better than aid.
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Export Subsidy

• A negative tariff or tax break aimed at boosting exports

Export Taxes

• Taxes meant to raise export cost and divert production for home consumption

The Bretton Woods Conference of 1944

• At the end of World War II, three major international organizations were established to
accelerate trade and economic growth among countries of the world
o International Monetary Fund
o World Bank
o General Agreement on Tariffs and Trade
o Renamed the World Trade Organization and was formally established on January 1,
1955 to set rules of trade among nations on a near-global basis.

Most Favored Nation (MFN) Principle

• Any tariff concession granted by one member to any other country will automatically be
extended to all other countries of WTO – nondiscrimination in tariff policy

Nontariff Barriers

• Import Quotas

o Also known as Quantitative Restrictions (QRs), limit the amount or number of units of
products that can be imported to a country

o Generally worse than import tariffs because when a quota is reached, that particular
good can no longer be imported or purchased

• Voluntary Export Restraint (VER)

o An arrangement under which an efficient exporting nation agrees to limit exports of a

product to another country for a temporary period

• Domestic Content Provisions

o Regulations requiring that a certain percentage of the value of import be sourced

domestically

o It aims to protect jobs in the home country.

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Current Practice of “Managed” Trade

• Managed Trade refers to agreements, sometimes temporary, between countries that aim to
achieve certain trade outcomes for the countries involved.
• It aims to replace global market or economic forces with government actions to determine trade
outcomes,
• Under this regime, policymakers may use various socioeconomic or geopolitical rationales to
protect specific companies or industries and achieve strategic objectives.
o Socioeconomic Rationale
▪ Socioeconomics addresses the study of the relationship between business or
economic activity and the social life of residents in a nation.

▪ Countertrade

➢ It is an agreement in which an exporter of goods or services to another

country commits to import goods or services of corresponding value
from that country.

➢ Countries participate in countertrade, especially when they do not have

adequate amounts of foreign currencies to pay for their imports.

➢ Countries may also pursue countertrade because they may not be

capable of producing goods of international quality or because a
banking embargo has been imposed on them.

▪ Export cartels

➢ A group of countries that could effectively control export volume to

keep their export prices, revenues, and economic growth stable or high.

▪ Infant Industry Argument

➢ Temporary provision of protection to nascent industries that have good

prospects of becoming globally competitive in the medium term.

➢ It expects that economies of scale and comparative advantage of an

industry can only be exploited by providing temporary protection.

▪ Questionable Labor Practices and Environmental Considerations

➢ International Labor Organization (ILO) standards does not accept the

use of child labor, unusually long work hours, below subsistence-level
wages in the production of exports or working under dangerous
conditions with toxic chemicals.

▪ Health and Safety

➢ Food safety measures introduced to prevent the entry of harmful pests

and diseases via imported foods, animals, and plants are a justifiable
means to protect human life and health.
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o Geopolitical Rationale
▪ The geopolitical objective is to sacrifice some economic efficiency for the
greater good of the country in terms of national security, protection of critical
industries, and international commerce.

▪ National security

▪ Strategic industries

➢ Some countries provide protection to strategic industries that have a

significant employment impact on certain sectors of an economy – the
so-called national champions – when these champions are unable to
compete globally.

▪ Embargoes

➢ Trade sanctions that are imposed upon a nation to restrict trade with
that country

➢ These are meant to punish a country for perceived unacceptable

international behavior.