Chapter 5

Trading Internationally
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LEARNING OBJECTIVES
After studying this chapter, you should be able to:

 5-1 use the resource-based and institution-based views to answer

why nations trade.

 5-2 understand classical and modern theories of international trade.

 5-3 realize the importance of political realities governing

international trade.

 5-4 participate in two leading debates concerning international

trade.

 5-5 draw implications for action.

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IMPORTING AND EXPORTING
export – selling abroad
import – buying from abroad
merchandise (goods) – tangible products being
traded
service – intangible services being traded

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WHY DO NATIONS TRADE?
 There are economic gains from trade
 “Nations trade” is a misleading statement; a
more accurate expression is “firms from
different nations trade”

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INTERNATIONAL TRADE
trade deficit – an economic condition in which a
nation imports more than it exports
trade surplus – an economic condition in which
a nation exports more than it imports
balance of trade – the aggregation of importing
and exporting that leads to the country-level
trade surplus or deficit

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TYPES OF INTERNATIONAL TRADE
THEORIES
classical trade theories – the major theories of
international trade that were advanced before the
20th century, which consist of (1) mercantilism, (2)
absolute advantage, and (3) comparative advantage
modern trade theories – the major theories of
international trade that were advanced in the 20th
century, which consist of (1) product life cycle, (2)
strategic trade, and (3) national competitive
advantage of industries

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MERCANTILISM
theory of mercantilism – a theory that
suggests that the wealth of the world is fixed and
that a nation that exports more and imports less
will be richer
protectionism – the idea that governments
should actively protect domestic industries from
imports and vigorously promote exports

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ABSOLUTE ADVANTAGE
free trade – the idea that free market forces should
determine how much to trade with little or no
government intervention
theory of absolute advantage – a theory that suggests
that under free trade, a nation gains by specializing in
economic activities in which it has an absolute advantage
absolute advantage – the economic advantage one
nation enjoys that is absolutely superior to other nations

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COMPARATIVE ADVANTAGE
theory of comparative advantage – a theory that
focuses on the relative (not absolute) advantage in one
economic activity that one nation enjoys in comparison
with other nations
comparative advantage – relative (not absolute)
advantage in one economic activity that one nation enjoys
in comparison with other nations
opportunity cost – cost of pursuing one activity at the
expense of another activity, given the alternatives (other
opportunities)

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SOURCE OF ABSOLUTE AND
COMPARTIVE ADVANTAGES
factor endowment – the extent to which
different countries possess various factors of
production such as labor, land, and technology
factor endowment theory (Heckscher-Ohlin
theory) – a theory that suggests that nations will
develop comparative advantages based on their
locally abundant factors

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PRODUCT LIFE CYCLE
product life cycle theory – a theory that
accounts for changes in the patterns of trade over
time by focusing on product life cycles

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STRATEGIC TRADE
strategic trade theory – a theory that suggests that
strategic intervention by governments in certain industries
can enhance their odds for international success
first-mover advantage – benefit that accrues to firms
that enter the market first and that late entrants do not
enjoy
strategic trade policy – government policy that
provides companies a strategic advantage in international
trade through subsidies and other supports

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NATIONAL COMPETITIVE
ADVANTAGE OF INDUSTRIES
theory of national competitive advantage of
industries (“diamond” theory) – a theory that
suggests that the competitive advantage of certain
industries in different nations depends on four aspects that
form a “diamond”
1. Country factor endowments
2. Domestic demand conditions
3. Firm strategy, structure, and rivalry
4. Related and supporting industries

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EVALUATING THEORIES OF
INTERNATIONAL TRADE
 The classical pro-free trade theories seem common sense today;
however, they were revolutionary 200 years ago, when the world
was dominated by mercantilistic thinking

 Classical theories rely on highly simplistic assumptions of a model

consisting of only two nations and two goods

 The theories assume perfect resource mobility—the assumption

that a resource used in producing a product for one industry can be
shifted and put to use in another industry

 Classical theories assume no foreign exchange complications and

zero transportation costs

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TARIFF BARRIERS
tariff barrier – trade barrier that relies on tariffs
to discourage imports
import tariff – a tax imposed on imports
deadweight cost – net losses that occur in an
economy as a result of tariffs

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NONTARIFF BARRIERS (NTBs)
nontariff barrier (NTB) – trade barriers that
rely on nontariff means to discourage imports

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TYPES OF NONTARIFF BARRIERS (NTBs)

subsidy – government payments to domestic

firms
import quota – restrictions on the quantity of
imports
voluntary export restraint (VER) –
international agreement that shows that exporting
countries voluntarily agree to restrict their
exports

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TYPES OF NONTARIFF BARRIERS (NTBs)
(cont’d)
local content requirement – requirement
stipulating that a certain proportion of the value
of the goods made in one country must originate
from that country
administrative policy – bureaucratic rules that
make it harder to import foreign goods
antidumping duty – tariff levied on imports that
have been “dumped” (selling below costs to
“unfairly” drive domestic firms out of business)

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ECONOMIC ARGUMENTS AGAINST
FREE TRADE
Prominent economic arguments against free trade are:
 The need to protect domestic industries, firms, and jobs
from “unfair” foreign competition—in short,
protectionism
 The necessity to shield infant industries
◦ infant industry argument – argument that if domestic firms
are as young as “infants,” in the absence of government
intervention, they stand no chance of surviving and will be
crushed by mature foreign rivals

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POLITICAL ARGUMENTS AGAINST
FREE TRADE
Political arguments against free trade advance a nation’s
political, social, and environmental agenda, regardless of
possible economic gains from trade, and include:
 National security
 Consumer protection
 Foreign policy
◦ trade embargo – politically motivated trade sanction against
foreign countries to signal displeasure

 Environmental and social responsibility

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TRADE DEFICIT VERSUS TRADE SURPLUS

 Free traders argue that international

trade is not about competition but rather
about mutually beneficial exchange
 Critics argue that international trade is
about competition—about markets, jobs,
and incomes

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CLASSIC THEORIES VERSUS NEW
REALITIES
 This debate centers on service trade and
high-skill jobs in high technology
◦ Classical theorists and modern-day theorists
disagree about the benefits and effects of
outsourcing

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.