INTERNATIONAL TRADE

THEORY
Chapter 5
OUTLINE
 Overview  Product life-cycle
Mercantilism
theory


 Absolute advantage
 Comparative advantage  New trade theory
 Heckscher-Ohlin theory  Porter’s diamond
 Implication for
managers
 Closing case
OVERVIEW
 Free trade:
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.
OVERVIEW
 The benefit of trade:
 A country may gain even if they buy products
from other nations.
 Allow a country to specialize in the
manufacture, and export products that can
be produced most efficiently in that country.
OVERVIEW
 The pattern of International Trade:
 Some are easy to understand
(Saudi Arabia/oil or Mexico/labor intensive
goods)
 Some are not so easy to understand

(Japan/cars)
MERCANTILISM
MERCANTILISM (mid-16th century)

 Currency: gold, silver.

 Theory: the country should maintain a
trade surplus.
 Trade is viewed as a “zero-sum game”.
In 1752, David Hume showed an
inconsistency:

 In the long run, no one can keep a

ABSOLUTE ADVANTAGE
ABSOLUTE ADVANTAGE
 Adam Smith: Wealth of Nation ( 1776)
 Capability of one country to produce more efficiently of a
product with the same amount of input than other country.
Eg: English  textiles
French  wine
 Both are beneficial in trade.
Example

 Country: Ghana, Korea

 Resources: 200 units
 Ghana:
10 resources  1 ton of
cocoa
20 resources  1 ton of rice
 Korea:
40 resources  1 ton of
cocoa
10 resources  1 ton of rice
Specialization and trade
COMPARATIVE ADVANTAGE
COMPARATIVE ADVANTAGE
 David Ricardo: Principles of Political
Economics (1817)
 It is make sense for a country to specialized
in the production of those goods that it
produces most efficiently.
Example

 Country: Ghana, Korea

 Resources: 200 units
 Ghana:
10 resources  1 ton of
cocoa
13 1/3 resources  1 ton of
rice
 Korea:
40 resources  1 ton of
cocoa
10 resources  1 ton of rice
COMPARATIVE ADVANTAGE
 Efficiency of resource utilization leads to
more productivity.
 Make better use of resources.
 Trade is a positive-sum game.
Extensions of the Ricardo
model
 Immobile Resources
 Resources do not always move easily from
one economic activity to another.
 A short-term phenomenon gain from trade
is significant and enduring.
Diminishing Returns
 Constant return to specialization: the units of resources to
produce a good (cocoa or rice) is the same.
 Diminishing returns to specialization: more units of
resources to produce each additional product.
 Cocoa: 12 ton + 10 units of resources 13 ton
13 ton + 11 units of resources 14 ton
Why???
 Not all resources are the same quality.
 Different goods use resources in
different proportion.
E.g. Growing cocoa uses more land and
less labor than growing rice.
Results
Under the effect of diminishing returns,
the gains is lower than the gains in case of
the constant returns.
Dynamic effects and Economic
growth
 Free trade might increase a country’s
production resources.
 Increase the efficiency of resource
utilization.
Samuelson Critique
 Consider rich country like U.S and poor one like China
 US customer buy lower price goods from China  lower
the wage rates in the US.
“ Being able to purchase groceries 20 percent cheaper
at Wal-Mart (due to international trade) does not
necessarily make up for the wage losses (in America)”
Evidence for the link between Trade
and Growth
 Stance toward international trade  higher
growth rate
 Jeffery Sachs and Andrew Warner research
from 1970  1990
 In developing nation group: open economy
4.49%/year, closed economy 0.69%/year.
 In developed nation group: open economy
2.29%/year, closed economy 0.74%/year.
 Wacziarg and Welch data from 1950 to
1998: liberalized countries 1.5%
compared to preliberalization times.
HECKSCHER – OHLIN
THEORY
HECKSCHER (1919) – OHLIN (1933)
THEORY
 Ricardo: comparative advantage arises from
differences in productivity.
 Heckscher – Ohlin: comparative advantages
arises from differences in national factor
endowments.
 Heckscher – Ohlin said:
 Export goods – locally abundant
 Import goods – locally scarce
The Leontief Paradox, 1953
 Leontief found: US exports were less
capital intensive than US imports 
variance.
 Explain for US:
 Export goods heavily use skill labor.
 Import heavy manufacturing products.
Heckscher vs Ricardo
 Economists prefer Heckscher on theoretical grounds but is
relatively poor predictor of trade patterns.
 Ricardo’s comparative advantage theory, regarded as too

limited for predicting trade patterns, actually predicts them

with greater accuracy.
 In the end, differences in productivity may be the key to
determining trade patterns.
PRODUCT LIFE – CYCLE
THEORY
PRODUCT LIFE – CYCLE THEORY (Raymond
Vernon, 1966)

 As products mature, both location of sales

and optimal production changes.
 Affects the direction and flow of imports
and exports.
 Globalization and integration of the
economy takes this theory less valid.
Example
 XEROX: US  Japan (Fuji-Xerox) & Great Britain
(Rank-Xerox)  Singapore, Thailand.
 consistent with product life-cycle theory that
mature industries tend to go out of the US and into
low-cost assembly locations.
 This theory is not without weakness: Life-Cycle theory
said most new products are developed and introduced in
US
 ethnocentric.
NEW TRADE THEORY
New Trade Theory (1970s)

 Economies of scale are unit cost

reduction associated with large volume
of output
 2 important points:
1. Increasing product variety and reducing costs
2. First-mover advantage
First-mover advantage
 The first movers in an industry can gain a
scale-based cost advantage that later
entrants find almost impossible to match.
 Airbus new super-jumbo jet 550-seat, A380
 Boeing is dominant in commercial jet air craft
First-mover advantage (cont)
 The first movers’ ability to benefit from increasing
returns creates a barrier to entry.
 Japanese firms decided not to enter air industry.
 New trade theorists stress the role of luck,
entrepreneurship and innovation in giving a
firm first-mover advantage.
PORTER’S DIAMOND
FACTOR ENDOWMENTS
 Basic factors: natural resource, climate, location, demographic
 Advanced factors: Communication, infrastructure, skilled labor,
research facilities, technology know-how, production of investment
by individual, company, government
 Basic factors=>initial advantage, expansion
 Disadvantage of basic factor => invest in advanced factor (Japan)
DEMAND CONDITIONS
 Home demand => increase competitive
advantage
 Innovative products (Wireless cell
phone : Nokia)
RELATED, SUPPORTING
INDUSTRIES
 Successful industries tend to group into
clusters of related industries
 Knowledge flow when employees move
between different firms
FIRM STRATEGY, STRUCTURE,
RIVALRY
 Different method of management
 Strong domestic rivalry => improve
efficiency, innovation => better
internationally competition
IMPLICATIONS FOR
MANAGERS
IMPLICATIONS for MANAGERS

1) LOCATION:
 Firm disperse its productive activities to

counties perform most EFFICIENTLY

IMPLICATIONS for MANAGERS
2) FIRST-MOVER ADVANTAGES
IMPLICATIONS for MANAGERS

3) GOVERNMENT POLICY:
Lobby to promote the free trade or restriction, to
adopt the policies that have favorable impact (on
each component of Porter Diamond)
Example: tariff on Japanese LCD makes the price of
IBM laptop increase.
CLOSING CASE
 SUMMARY
 Logitech: The world largest producer of computer
mice, a technological innovator in business of
personal computer peripheral.
 Founded in 1981, Switzerland.
 Differentiate their products by continuing
innovation (91 new products in 2003), high brand
recognition, strong retail presence.
 SUMMARY
 R&D (software programming) in Switzerland
 Corporate headquarter in Fremont, California –
the headquarter for the company’s global
marketing, finance, logistic – close to many of
American’s high-technology enterprises.
 Design product in Ireland.
 Manufacture in Asia
 SUMMARY
Manufacture in Asia:
 1980s - Taiwan: qualified people, high volume, low cost

(7% of total cost), better design product, well-developed

supply based for parts, rapidly expanding local computer
industry, science-based industrial park for fee of
$200,000
⇒ Logitech win the contract with Apple

⇒ Others invest
 SUMMARY
Manufacture in Asia:
 1990s – China: 4000 employees: young women, each

is paid $75/month for sitting all day.

 Product price $40, $8 for R&D, $8 for shareholders,

$15 for distribution, $14 for supplier, $3 for wages,

power, transport, other cost.
 SUMMARY
CHINA:
 Potential place for manufacturing:

Motorola, Intel,.....
 Top exporter of high-tech export: chip,

disk driver,..
QUESTION 1, 2, 3
1. In a world without trade, what would American consumers
have to pay for Logitech’s products?
2. Explain how trade lowers the costs of making computer
peripherals such as mice and keyboards.
3. Use the theory of comparative advantage to explain the
way in which Logitech has configured its global operations.
Why does the company manufacture in China and Taiwan,
undertake basic R&D in California and Switzerland, design
products in Ireland, and coordinate marketing and
operations from California?
QUESTION 1
 In a world without trade, every parts of
process to produce goods of Logitech must
be made at USA.
 Fair: marketing, R&D and design quality.
 High cost: labor, supply.

 No specialization.
 American consumers suffer higher cost.
QUESTION 2
 Activities of Logitech in trade to lowers
the costs of making computer is shown
following
QUESTION 2
QUESTION 3
 Logitech will put its production where it
can be completed most efficiently:
 China and Taiwan  low labor and supplies
resources.
 California and Switzerland  high technology.
 Fremont  communication gate to the World.
QUESTION 4
Who creates more value for Logitech, the
650 people it employs in Fremont and
Switzerland or the 4,000 employees as its
Chinese factory? What are the
implications of this observation for the
argument that free trade is beneficial?
FREE TRADE IS BENEFICIAL
Logitech (company):
 FREE TRADE IS BENEFICIAL
Chinese and Taiwan factories (being outsourced):
FREE TRADE IS BENEFICIAL
American (customers):
QUESTION 4
! 4000 Chinese labors !
Why???

 4000 > 650 (^.^)

 Super low labor cost (75$/month)  super
value
QUESTION 4:
 My answer is: 650 people Logitech employs in Fremont
and Switzerland creates more value.
 Why???
 These 650 employees take important roles in company.
 No these 650 white-collars  no 4000 blue-collars.
QUESTION 5
Why do you think the company decided to
shift its corporate headquarters from
Switzerland to Fremont?
About Fremont:
 It is close to the center of Silicon Valley. It has
attracted the headquarters of many high-tech
companies of the US (Nielsen Norman Group, Corsair
Memory and Lexar…), foreign companies (Elitegroup
Computer Systems, Asus and Universal abit…)
 It is also home to blue-collar industry.
Advantages of this location:
 The presence of high-quality and
specialized inputs such as scientific
and technical talents.
 An environment that encourages
investment and intense rivalry.
 Pressure and insight gained from a
sophisticated local market.
 Local presence of related and
supporting industries.
QUESTION 6
To what extent can Porter’s diamond
help explain the choice of Taiwan as a
major manufacturing site for Logitech?
Choice of TAIWAN as a manufacturing
site based on PORTER’S DIAMOND
QUESTION 7
Why do you think China is now a favored
location for so much high-technology
manufacturing activity? How will China’s
increasing involvement in global trade help
that country? How will it help the world’s
developed economies? What potential
problems are associated with moving work to
China?
China is now a favored location for
so much high-technology
manufacturing activity.
 Low costs (land, labor, utilities)
 Proximity to market, suppliers
 Reliability of local infrastructure, logistics
 Availability of a good agent or distributor
 Legal environment
 Government incentives
China’s increasing involvement in
global trade will help that country.
 Create jobs
 Raise income
 Increase living standards.
It will help the world’s developed
economies.
 Low costs
 Increased specialization of production
 lower average costs and increased
efficiency.
Potential problems are associated
with moving work to China.
 Culture, language
 Tastes don't easily translate overseas.
 English is not the first language.
 Expertise
 Employee educated but lack of experience.
 Lack of trained managers for new business.
 Shipping
 After the September 11th attacks, import regulations were
strengthened.
GROUP MEMBERS
 Hồ Ngọc Bích – BA060022
 Nguyễn Thanh Dũng – BA060024
 Hoàng Lê Minh – BA060031
 Nguyễn Xuân Thành – BA060039