International Production Theory

Lecture 3 : Theories of International Trade and
International Production
Part A:Theories of International Trade
International Business Management

Part A: Theories of International Trade
Learning Objectives: To analyse the benefits for a country to engage in international trade. To review relevant theories that explain trade flows between nations: 1. 2. 3. 4. 5. 6. 7. Mercantilism Absolute Advantage Comparative Advantage Heckscher-Ohlin Theory The Product Life Cycle Theory New Trade Theory National Competitive Advantage: Porters Diamond
International Business Management 2

y
International Trade can be defined as the exchange of goods and services across borders. Free Trade refers to a situation where a Government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country.(Hill,1998 pp123). Adam Smith (1776) argued that the invisible hand of the market mechanism should determine what a country need to import or export and not the Government .

Benefits of International Trade Countries can import resources they lack at home. Countries experience unequal endowment of resources such as: Natural resources Human Resources Capital Technology Countries can import goods for which they are relatively inefficient producer. Specialisation often results in economies of scale and an increased in world output.

Mercantilism Emerged in England in the mid 16th century. Main tenant: Best interest in a country to maintain a trade surplus i.e. to export more than it imports. How to achieve trade surplus? Maximise export and minimise import Through Government Intervention ,i.e. by: Subsidising export and Limiting imports by imposing tariffs and quotas. Viewed trade as zerosum game in which a gain by one country results in a loss by another.

Mercantilism- Criticisms Later Adam Smith and David Ricardo demonstrated that trade is a positive-sum game i.e. a situation in which all countries can benefit , even if some benefits more than others. Trade Barriers are being gradually reduced in line with the policies the World Trade Organisation.

Theory of Absolute Advantage Adam Smith, 1776 The Wealth of Nations A country should specialize in production of and export products for which it has absolute advantage. A country has absolute advantage in the production of a product when it is more efficient than any other country producing it.

Theory of Comparative Advantage, David Ricardo(1817), Principles of Political Economy Rationale: Even if a country has absolute advantage in the production of all goods, it doesnt need to produce all of them. It should specialise in the production of those goods that it produces most efficiently and buy from other countries those goods which it produces less efficiently. Both countries gain from trade even if one of them is more efficient than the other in producing everything.

Theory of Comparative Advantage, David Ricardo(1817), Principles of Political Economy
Assumptions: Only two countries and two goods in real world there are
many countries and many goods. Zero transportation costs. Resources move freely from production of one good to another within a country, but not across countries. Price of resources in different countries are constant. Fixed stocks of resources.

Heckscher (1919)-Ohlin (1933) Comparative advantage arises from differences in national factor endowment. Factor endowments are the extent to which a country is endowed with resources such as land, labour and capital. As such, patterns of trade is determined by differences in factor endowments rather than differences in productivity.
Principle- A country should: Specialize in the production of goods that make intensive use of factors that are locally abundant, and then export those goods.
Import goods that make intensive use of factors that are locally scarce.

The Leontif Paradox (1953) Using Hecksher-Ohlin theory, Leontif postulated that since the US was relatively abundant in capital compared to other nations, the US would be an exporter of capital intensive goods and an importer of labour intensive goods. However, he found that US exports were less capital intensive than US imports
11

The Product Life Cycle, Raymond Vernon, 1966 Vernon argues that as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade. Vernon classifies the whole process of a new product in a market into four phases. In the initial stage: A new product is developed by an advanced country (USA) and sold in the domestic market. The producer monopolizes production of the new product.

The Product Life Cycle, Raymond Vernon, 1966 While demand starts to grow in the USA, demand in other advanced countries is limited to high income groups. The limited demand in other advances countries does not make it feasible for firms in those countries to start production. They would rather satisfy the needs by exports from the USA. Over time demand for the new product starts to grow in the other advanced countries to such an extent that it becomes viable for foreign producers to start producing the products for their home markets.

The Product Life Cycle, Raymond Vernon, 1966 While demand expand in the secondary markets: Product becomes standardised. Production moves to low production cost areas Product now imported to USA and to other advanced countries. Example Xerox was first developed in the USA then set up production in Japan (Fuji-Xerox) and Great Britain (Rank Xerox). Therefore, the place of production initially switches from the United States to other advanced nations and then to developing countries.

The new trade Theory - Paul Krugman (1970s) argues that:
Substantial economies of scale result in increasing returns i.e. as output increases ability to realise economies of scale increases and cost per unit eventually falls. Due to the presence of substantial economies of scale, world demand will support a few firms in many countries. The economic and strategic advantage of the firm act as barriers to entry.
15

The new trade Theory - Paul Krugman (1970s) argues that:
Countries may export certain products simply because they have one firm that was an early entrant in the industry (First-mover advantage). For example, Boeing Aircrafts. First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. Therefore, Government may subsidize the firm at period of entry and growth. However, this theory is in contravention to the idea of free trade.
16

The National Competitive Advantage Michael Porter (1990) Porter, in his thesis, seek to determine the factors that enable a nation to achieve and sustain international success in a particular industry. For example, Japan in the automobile industry. His findings revealed that four attributes of a nation shape the environment in which local firms compete and these attributes promote creation of competitive advantage at international level.
17

The National Competitive Advantage Michael Porter (1990)
Firm Strategy, Structure and Rivalry Factor Endowments Related and Supporting Industries
M.E Porter (1990), The Competitive Advantage of Nations, Harvard Business Review
Demand Conditions
18

The National Competitive Advantage Michael Porter (1990) Factor endowment: Nations position in factors of production necessary to compete in a given industry. Basic Factors: I.e. natural resources such as location, climatic conditions and demographic conditions. Advance Factors: Communication, skilled labour force, infrastructure and technological advancement. Unlike Basic factors, advanced factors are the products of investment by individuals, companies and Governments.
19

The National Competitive Advantage Michael Porter (1990) Demand conditions: The nature and characteristics of home demand for the industrys product or service. The characteristics of the local demand would normally pressurise local firms to produce high standard products quality and innovative products. High quality and innovative products improve firms competitive edge.
20

The National Competitive Advantage Michael Porter (1990) Related & Supporting Industries: The presence or absence in a nation of supplier industries or related industries that are nationally competitive. For instance, the quality of the input reflects to a large extent on the firms competitive edge at the international level.
21

The National Competitive Advantage Michael Porter (1990) Firm strategy, structure and rivalry: Conditions in the nation influencing how companies are created, organized, and managed. The nature and extent of domestic rivalry induces firm to: Be more innovative Improve quality of products Be more efficient vis- a- vis competitors Invest in research and development The above help to create world-class competitors.
22

Part B: Theories of International Production Learning Objectives: To understand the definition of Multinational.
Discuss the various theories of International Production: Classical/Neo Classical Models of Trade Hymers Theory of International Production Vernons Product Life Cycle The Electric Paradigm Technological Accumulation Theory The Investment Development Path Alliance Capitalism
23

Part B: Theories of International Production
Definition of Multinational Enterprise A Multinational Enterprise is an enterprise that engages in Foreign Direct Investment and owns and controls value-adding activities in more than one country (Dunning 1992).
Neoclassical/ Classical Theories of Trade Most of the theories of international investment in the neoclassical paradigm are principally based on assumptions of international trade theories (Ietto- Gillies, 2005). From a neoclassical point of view, investment is considered as general international investment and no distinction is made between portfolio and direct investment.

Definition of Port folio Investment The IMF Balance of Payment Manual (2003:98) includes in the category of portfolio investment equity securities and debt securities in the form of bonds and notes, money market instruments and financial derivatives. To Ietto-Gillies (2005), international portfolio investment is that investment which is undertaken for purely financial reason and includes loans and equity investment (i.e. the acquisition of shares in a foreign company).
25

Definition of Direct Investment IMF Balance of Payment Manual (2003:86) defines direct investment as investment made by the resident entity of one economy to acquire lasting interest in an enterprise resident in another economy According to the OECD (2004:6), foreign direct investment enterprise is an enterprise (institutional unit) in the financial or nonfinancial corporate sectors of the economy in which a non-resident investor owns 10 per cent or more of the voting power of an incorporated ....
26

Port Folio Investment Vs Direct Investment The demarcation between portfolio investment and FDI was first drawn by Hymer (1960) who had had contradictory views to that of neoclassical scholars (Iversen, 1935). Hymer (1960) distinguishes direct investment from portfolio investment by arguing that the former gives the firm control over the business activities abroad where as the latter does not.
27

Neoclassical/ Classical Theories of Trade The major assumptions of the neoclassical theory are: The market for cross border exchange was assumed to be a costless mechanism. Resources were assumed to be immobile across national boundaries but mobile within national boundaries. There was perfect flow of information. Firms were assumed to engage in single activity. Entrepreneurs were assumed to be profit maximisers.
28

Criticism on Neoclassical/ Classical Theories of Trade
The main criticisms of neoclassical approach to foreign investment are: The underlying concept of perfect competition is unrealistic. It fails to consider other transaction costs. It assumed perfect flow of information where as it is a fact that information in the financial market is pervasively asymmetric. It assumed no mobility of resources where as today the world is considered as a global village where resources move freely.
29

Hymers (1960) Theory of International Production
The work of Hymer (1960) is considered as the first theory in the literature of FDI. The underlying principle of Hymers doctoral thesis is the demarcation between FDI and portfolio investment. Hymer notes that international production occurs as a result of: The firms intention to grow further thus enhancing its market position. The existence of market imperfection
30

Hymers (1960) Theory of International Production
Hymer also advocates that firms will engage in international production only if they have advantage such as production technology, finance, product differentiation or superior distribution network that are actually not possessed by domestic firms.
Domestic Market Imperfection
Firms Specific Advantages
Foreign Market
31

Criticism of Hymers Theory
Hymers Theory was severely criticised by Dunning (1981) who argues that Hymers thesis was only concentrated on the motives of foreign investment (why) and completely omit the location factor (where) which play an important role in determining FDI decisions.
32

The Product Life Cycle, Raymond Vernon (1966)
Evaluating the growth of US FDI after the Second World War, Vernons theory examined the following issues: The factors that lead to the location of production abroad; The location where the production of new product is likely begin; The consequences resulting from the flow of FDI; and The location where new ideas and technology for new products are likely to originate.
33

His findings were as follows: He notes that the US market is very large and characterised by high unit labour cost, large supply of labour and high average income per capita. New product will be located in the USA because producers would be able to charge high prices given the high purchasing power of Americans
34

As the product reaches the maturity stage, competition steps in and demand for the product in other foreign market increases. The product is exported to nations most similar to the US in demand patterns and standard of living. In the final stage of the product life cycle, Vernon argues that as products become more and more standardised, it will eventually require high capital intensity and unskilled labour. The firm may relocate its production facilities to lower cost producing countries.

The Product Life Cycle, Raymond Vernon (1966)- Criticisms

Later in 1979, Vernon came up with a critical review of his previous analysis with more focus on the changing macro environment in Europe. He noted that changes in the macro economic environment have challenged the application of his initial theory which was relevant in the 1960s. For instance, changes in Europe between 1970 and 1979 have gradually closed up the gap between Europe and USA. (differences in standard of living, cost of labour, size of markets and consumer tastes between the two countries have significantly reduced).
36

The Product Life Cycle, Raymond Vernon (1966)- Criticism

Moreover, the technological leadership enjoyed by the US in the 50s and early 60s gave way to a more balanced technological competition between the US, Europe and Japan.
37

Dunnings Eclectic Framework (1977)

Dunnings (1977) eclectic framework is considered as the complete theory of international production as it corrected certain omissions in the earlier theories. Dunnings approach of internationalisation attempted to analyse the why, where and when decisions in terms of ownership, locational and internalisation (OLI) advantages.
38

Dunnings Eclectic Framework (1977)
Ownership Advantages Advantages that are specific to a particular enterprise. Locational Advantages Advantages that are specific to a country which are likely to make attractive for foreign investors, i.e. location-specific endowments Internalisation Advantages Benefits that are derived from producing internally to the firm.
39

Technological Accumulation Theory
Acknowledge that the superior Ownership advantages determine the establishment of foreign operations. However, there are other benefits accrued to firms which
are more important to ensure foreign establishment.
For instance, technological capabilities of a firm which are the result of internal learning processes involving trial and error, are primary sources of a firms competitive (or ownership, in the OLI paradigm) advantage (Dunning, 1993).
40

Technological Accumulation Theory
(Rosenberg, 1982) notes that technological change is
incremental in that it represents the cumulative impact of small improvements while Cantwell (1898,1990) argues that the innovation of a firm specific technology is a cumulative process.
Technology Accumulation Theory argue that the ability of the firms to continually improve and refine their technology which allow the multinationals to retain its competitive edge.
41

Investment Development Path (Dunning, 1981)

The objective of the research was to determine the relationship between a country's net foreign direct investment and its level of economic development The Investment Development Path (IDP) theory: establishes a dynamic and positive relationship between the countrys level of inward and outward foreign investment and the level of industrialisation and

identifies the stages through which countries progress.
42

Investment Development Path (Dunning, 1981)
The premise of the theory is two fold:
First, it identifies economic development as a process of structural change (such as improvement in the country's technological and productive system); The structural change influences the pattern of both inward and outward foreign direct investment. The IDP theory argues that countries progress through the following five stages. Countries progress in terms of the countrys location-specific advantage which gradually upgrade the domestic firms ownership specific advantage.

International Production Investment Development Path (Dunning, 1981)
Stages in the Investment Development Plan Characteristics
Stage
1st Stage Pre Industrial Society
Country
1. Weak Local Demand 2. Inadequate Infrastructure Limit Countrys attractiveness to foreign investors 1. Government initiates basic infrastructure. 2. Local Demand grows. 3. FDI takes place Net Investment position is negative
Local Firms
Local Firms lack ownership specific advantage to invest abroad. Ownership specific advantage of domestic firms are weak and limits outward investment. Firms may invest in other countries if subsidise by Government
2nd Stage

International Production Investment Development Path (Dunning, 1981)
Stages in the Investment Development Plan Characteristics
Stage
3rd Stage
Country
Decrease in the rate of growth of inward investment flows due to growing competitiveness of local firms. Countrys net outward investment position is still negative but is on an upward trend
Local Firms
Domestic firms increase outward investment due to improvement of ownership specific advantage.
4th Stage 5th Stage
Outward FDI stock exceeds inward FDI stocks Net Investment position will improve further.
More firms investing abroad.
45

International Production Alliance Capitalism
Constant pressure from both competitors and consumers to continually improve and upgrade quality of goods and services. Need to invest in research and development and at the same time to search for new market which entails huge investment. Thus, in order to exploit effectively their core competencies, firms are increasingly finding that they need to combine their core competencies with those of other firms. The above has led to the proliferation of what is known as alliance Capitalism
46

A Strategic Alliance can be defined as a mutually beneficial long-term relationship between two or more parties to pursue a set of agreed goals or to meet a critical business need while remaining independent organisations.
Main objective is to maximise the benefits of the joint internalisation of interrelated activities. Examples:
Alliance between BMW and Rolls Royce- Production of engine for the aero engine market. Sony- Ericsson
47

Benefits: 1. More flexible approach to production by capturing benefits of their own competencies.
2. More resources (Capital) for Research and Development. 3. More innovative ideas and fault free products as a result of continuous improvement and transfer of technology. 4. Better position to extend the Product Life Cycle.
48

Benefits:
5.
Ability to bring together complementary skills and assets that neither company could easily develop on its own. To gain access to new markets of distribution channels. Benefit from economies of scale.
6. 7.
8. To overcome Government mandated trade barriers.
49

International Production Theory

Diunggah oleh

Informasi Dokumen

Deskripsi Asli:

Judul Asli

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

International Production Theory

Diunggah oleh

Hak Cipta:

Format Tersedia

Lecture 3 : Theories of International Trade and

Part A:Theories of International Trade

International Business Management

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

Domestic Market Imperfection

Firms Specific Advantages

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and

International Business Management

Lecture 3 : Theories of International Trade and