Chapter 1

INTRODUCTION

LEARNING OBJECTIVES

At the end of this chapter, the student should:

1 Recognize the exponential growth of international trade in recent decades and the reasons for
it.

2 Acquire a basic idea of ancient and recent historical developments in the practice of logistics.
3 Know the basic theories of international trade.
4 Know the basic explanations for international trade.
5 Have a cursory exposure to the international business environment.

PREVIEW

This chapter lays the foundation of international trade, by reviewing its remarkable growth since
the mid-twentieth century, as well as identifying the “main players” in world trade. An important
foundation of this course is to understand the nature of international trade and why it is beneficial
to countries. It therefore reviews the traditional trade drivers (cost, competition, market, and
technology), as well as the main theories of international trade: the classic absolute advantage,
comparative advantage and factor endowment theories, but also the International Product Life
Cycle, and the cluster theory, including the variation introduced by Sheffi in 2012. Finally, the
chapter closes on a description of the elements of the international business environment.
1-2 Chapter 1: Introduction

CHAPTER OUTLINE

1.1 International Trade Growth

I. International trade has grown 3,180 percent from 1948 to 2012 [it is 32.8 times larger]
(in constant dollars)
a. From $ 518 billion per year (exports) in 1948 to $ 22,670 billion in 2012
b. Merchandise trade has almost quintupled [4.9 times] from $ 3,766 billion in 1992
to $ 18,323 billion in 2012
c. Services trade has almost quintupled [4.7 times] from $ 932 billion in 1992 to $
4,347 billion in 2012
II. The creation of multiple international institutions facilitated international trade
III. Reduction in transportation costs and transit times
IV. Greater acceptance of “things foreign”

1.2 International Trade Milestones

I. Development of important treaties and organizations
a. Bretton Woods Conference, July 1944, created International Monetary Fund
(IMF), December 1945
i. International payment system
ii. Stable currency exchange rates
b. General Agreement on Tariffs and Trade (GATT), 1949–94 resulted in gradual
reduction of average tariff from over 40 percent in 1947 to about 4 percent in
2008
c. World Trade Organization (WTO), January 1995
i. Replaces GATT
ii. Enforces free trade
II. Treaty of Rome, 1957, forerunner of European Union
III. The creation of other trade blocs (NAFTA in particular)
IV. Introduction of the euro as currency, 2002

1.3 Largest Exporting and Importing Countries

I. Mostly a review of Figures 1-4 and 1-5, with an emphasis on the relative ranks of the
United States as an exporter (second after China, and slightly ahead of Germany) and as
an importer (first, in front of Germany and China)
II. Emphasis on the imbalance between the value of exports and imports for several
countries (trade surpluses and trade deficits)

1.4 International Trade Drivers

Chapter 1: Introduction
1-3

1-4-1 Cost Drivers

I. Export
a. Some companies require large capital investments in plants and machinery
b. Strong incentive to spread the costs of these fixed costs over a large number of
units
II. Import / Outsourcing
a. Some companies, in response to consumer demands, attempt to offer goods at the
lowest possible price
b. Strong incentive to lower production costs
c. Several business processes are outsourced abroad

1-4-2 Competition Drivers

I. Companies follow their domestic competitors abroad to maintain their world-wide
market share
II. Companies retaliate against foreign competitors entering their home market by going to
these competitors’ home markets
III. Companies counter a competitor’s new product entry by offering a similar product,
often produced abroad

1-4-3 Market Drivers

I. Consumers’ tastes and preferences have become increasingly uniform worldwide
II. Consumers have become increasingly knowledgeable about products and willing to try
new foreign alternatives

1-4-4 Technology Drivers

I. Diffusion of information is universal
II. Competition for products is worldwide: the Internet allows people to trade with one
another
III. Competition for talent and employees is worldwide: “The World Is Flat” written by
Thomas Friedman

1.5 International Trade Theories

1.5.1 Absolute Advantage

Adam Smith’s Theory of Absolute Advantage (The Wealth of Nations, 1776)
When a nation can produce a certain type of goods more efficiently than other
countries, it is in its best interest to manufacture more of those goods than it needs, and
trade with countries that produce other goods more efficiently than that nation can.
Table 1-7 gives a numerical example.
1-5-2 Comparative Advantage
1-4 Chapter 1: Introduction

Ricardo’s Theory of Comparative Advantage (On the Principles of Political Economy

and Taxation, 1817)
a. Nations trade with one another when they can produce certain goods relatively
more efficiently than one another
b. Most international trade today is explained by the Theory of Comparative
Advantage
c. Table 1-8 gives a numerical example
1-5-3 Factor Endowment
Factor Endowment Theory developed by Hecksher and Ohlin (1933)
d. A country will enjoy a comparative advantage over other countries if it is
naturally endowed with a greater abundance of one of the factors of economic
production, such as land, labor, capital or entrepreneurship
e. Explains why certain countries specialize in the production of certain products
f. Table 1-9 gives numerical examples based on actual data
1-5-4 International Product Life Cycle
International Product Life Cycle Theory developed by Raymond Vernon (1966)
Over its life cycle, a product will be manufactured first in the country in which it
was first developed, then in other developed countries, and eventually in
developing countries. Figure 1-6 explains it graphically
1.5.5 Cluster Theory
Porter’s Cluster Theory (1980)
A firm can develop a substantial competitive advantage in manufacturing certain goods
when a large number of its competitors and suppliers are located in close proximity
The area attracts the most talented employees and the extraordinary competition between
the firms generates a greater need to innovate and become efficient
Such a grouping of companies is called a cluster
1.5.6 Logistics Cluster Theory
Sheffi’s Logistics Cluster Theory (2012)
An area can develop a substantial competitive advantage by providing several logistics
service providers in one area. The area then attracts export- and import-minded
manufacturers.
Such a grouping of trade-minded companies is called a logistics cluster

1.6 The International Business Environment

I. Culture
II. Demographics
III. Economics
IV. Regulations and Laws
V. Infrastructure
VI. Communications
VII. .....much of the international business environment is different from the domestic
environment
Chapter 1: Introduction
1-5

SUGGESTED HOMEWORK

1. Assign a report on U.S.–Chinese relations based on their rivalry for world influence and on
trade issues as postulated by Adam Smith and David Ricardo. If trade increases, will that
reduce tensions that could result in armed conflict?

2. Assign a report on the basic writings of Adam Smith and David Ricardo regarding
international trade.

3. Assign a report on the impact on international trade of emerging economies like those of
Eastern Europe, India, and China. What can we expect from them in the next 20 to 50 years?

4. Assign a report on the major organizations of international trade (WTO, World Bank, IMF,
ECB, BIS) and ask to show what their influence has been on the growth of trade.

5. Assign a report on the evolution of the euro and the benefits, for European countries
belonging to “euroland,” of having a joined currency.

6. Assign a report on the last twelve months of performance and impact of the euro on world
financial markets and on international trade. Where is the euro this week in relation to the
dollar and what are predictions regarding its future exchange rate?

KEY TERMS

international trade
The sale of goods and services across international borders.

constant dollars
Dollars adjusted for inflation so that it is possible to compare dollar values from one period to
another.

current dollars
Dollars not adjusted for inflation. Their value is determined by the year they were actually
received or paid.
1-6 Chapter 1: Introduction

World Trade Organization

The international organization responsible for enforcing international trade agreements and for
ensuring that countries deal fairly with one another.

Bretton-Woods
A 1944 conference at which many of the international institutions were created.

International Monetary Fund

The international organization created in 1945 to oversee exchange rates and develop an
international system of payments.

General Agreement on Tariffs and Trade

An agreement between countries to lower tariffs and trade barriers.

tariff
A tax collected by an importing country on the value of imported goods.

Treaty of Rome
The treaty between six European countries that created the European Union.

Maastricht Treaty
A 1992 Treaty between the European Union countries in which a number of standards were
adopted, including a standard currency.

euro
The common currency of 17 of the 27 countries of the European Union. Updates on the number of
countries that have adopted the euro can be found at the European Bank’s Web site,
http://www.ecb.europa.eu/euro/html/index.en.html.

trade deficit
A situation where the total exports of a country are worth less than its total imports.

trade surplus
A situation where the total exports of a country are worth more than its total imports.

cost driver
One reason a firm may go international is to spread its costs over a large number of units.

outsourcing
A practice which consists of a business contracting with other businesses to have them perform
some of the operations that it used to handle in-house. It decided that these operations were
deemed unessential to its core competency.

reshoring
The practice of returning to the home country the manufacturing processes that had been
outsourced abroad.
Chapter 1: Introduction
1-7

competition driver
One reason a firm may go international is to compete more aggressively against its foreign
competitors.

market driver
One reason a firm may go international is to follow its customers when they travel abroad.

technology driver
One reason a firm may go international is to respond to technologically savvy customers who
buy products worldwide.

absolute advantage
An economic theory developed by Adam Smith that holds that when a nation can produce a
certain type of good more efficiently than other countries, it is in its best interest to manufacture
more of those goods than it needs, and to trade with countries that produce other goods more
efficiently than that nation can.

comparative advantage
An economic theory, developed by Robert Torrens and David Ricardo, that holds that nations
will trade with one another as long as they can produce certain goods relatively more efficiently
than one another.

factor endowment
An economic theory, developed by Hecksher and Ohlin, that holds that a country will enjoy a
comparative advantage over other countries if it is naturally endowed with a greater abundance
of one of the factors of economic production, such as land, labor, capital, or entrepreneurship.

international product life cycle

An economic theory, developed by Raymond Vernon, that holds that, over its life cycle, a
product will be manufactured first in the country in which it was first developed, then in other
developed countries, and eventually in developing countries.

cluster
An observation, first made by Michael E. Porter, that a firm can develop a substantial
competitive advantage in manufacturing certain goods when a large number of its competitors
and suppliers are located in close proximity, because the area then attracts the most talented
employees, and the extraordinary competition between the firms generates a greater need to
innovate and become efficient. Such a grouping of companies is called a cluster.
1-8 Chapter 1: Introduction

logistics cluster
An observation, made by Yoshi Sheffi in 2012, that an area can develop a substantial
competitive advantage by providing several logistics service providers in one area. The area then
attracts export- and import-minded manufacturers.

POSSIBLE QUIZ QUESTIONS

1. The total value of international trade (2012) in services and merchandise is about ___.
a. $ 23,000,000,000
b. $ 23,000,000,000,000
c. $ 23,000,000
d. $ 23,000
e. None of the above
ANS: B
Rationale: The total value of international trade was $22.67 trillion in 2012.
REF: 1-1: Table 1-3

2. International trade is still mostly concentrated among the developed countries of the Northern
Hemisphere. Which country is the largest importer of the world?
a. United States
b. Germany
c. China
d. Japan
e. None of the above
ANS: A
Rationale: The United States is the largest importer in the world, and imports about 28 percent
more than China and twice as much as Germany.
REF: 1-3: Figure 1-5

3. The common currency of most of the countries of the European Union is called ___.
a. the euro-dollar
b. the european currency unit (ECU)
c. the thaler
d. the euro
e. None of the above
ANS: D
Rationale: The euro is the currency created in 1999 and placed in circulation in 2002. The term
“euro-dollar” refers to U.S. dollars kept in accounts in [foreign] banks not subject to the
authority of the Federal Reserve Banks, and the ECU is the original name proposed for the euro
and eventually abandoned. The thaler is an old European currency.
REF: 1-2-4
Chapter 1: Introduction
1-9

4. Which of the following entities was created at the Bretton Woods Conference of 1944?
a. International Monetary Fund
b. World Trade Conference
c. Marshall Plan
d. United Nations
e. None of the above
ANS: A
Rationale: The IMF was created at the Bretton Woods Conference.
REF: 1-2-1

5. On occasion, a firm will respond to a competitor’s move by retaliating. For example, Linde
Gas (an American firm producing industrial gasses) entered the French market when Air Liquide
(a French company in the same industry) decided to enter the U.S. market. Such a move is
considered a ___.
a. cost driver
b. competition driver
c. technology driver
d. market driver
e. None of the above
ANS: B
Rationale: Linde and Air Liquide are not mentioned in the text; however, this is a typical
retaliatory action that drives a company to enter a foreign market which it had no intention to
enter in the first place.
REF: 1-4-2

6. Argentina can produce 1 ton of meat (beef) using 0.1 years of labor. It can also produce 1
automobile using 2 years of labor. In order to produce 1 ton of beef, the United States uses 0.2
years of labor. It can produce an automobile using 1.5 years of labor. Argentina has ___.
a. an absolute advantage in the production of automobiles
b. an absolute advantage in the production of beef
c. a comparative advantage in the production of automobiles
d. a comparative advantage in the production of beef
e. None of the above
ANS: B
Rationale: Argentina uses less labor for the production of 1 ton of beef than the United States
does, and therefore it has an absolute advantage in the production of beef.
REF: 1-5-1

7. The Heckscher-Ohlin Theory holds that countries that have an abundance of certain resources
enjoy an absolute or comparative advantage over other countries. Which of the following is NOT
one of the factors that Heckscher and Ohlin considers scarce?
a. land
b. labor
c. capital
d. education
e. None of the above
1-10 Chapter 1: Introduction

ANS: D
Rationale: The four resources that economists consider scarce are “land, labor, capital, and
entrepreneurship.” Depending on the background of the students in economics, this can be an
easy question or a difficult one.
REF: 1-5-3

8. According to the International Product Life Cycle Theory, the country(ies) most likely to
manufacture a product that has been recently developed (one that is the result of a brand-new
design and uses patented technology) and is in its first commercialization year, is (are) ___.
a. the country of innovation only
b. developing countries
c. any country with the manufacturing technology necessary to manufacture it
d. other developed countries
e. None of the above
ANS: A
Rationale: According to Vernon, the only country in which products that are newly developed
are manufactured is the country of innovation. The manufacturing eventually shifts to other
developed countries and then to developing countries.
REF: 1-5-4

9. The international environment presents challenges for the international logistician. Which
aspect of the international business environment is most likely to create frustrations?
a. Cultural differences
b. Economic issues
c. Currency differences
d. Infrastructure constraints
e. None of the above
ANS: A
Rationale: Among all of the issues listed, culture is the one clearly emphasized and explicitly
indicated as the one that is most frustrating.
REF: 1-6

10. Information on foreign countries, including their economic environment, their political
environment and their geography, can easily be found in several publications. Which is not one
of the organizations that publishes background information on countries?
a. The Economist’s Intelligence Unit
b. The Central Intelligence Agency
c. The U.S. Department of Commerce
d. The United Nations’ UNICEF
e. None of the above
ANS: D
Rationale: All of these options are explicitly listed in Section 1-6, except the UNICEF, which is
the United Nations’ Children’s Fund (changed from the United Nations’ International Children’s
Emergency Fund in the 1950s).
REF: 1-6
Chapter 1: Introduction
1-11

POWERPOINT SLIDE LIST

 International Trade Growth (1 slide)

 International Trade Milestones (1 slide)
 Largest Exporting and Importing Countries (2 slides)
 International Trade Drivers (4 slides)
 International Trade Theories (8 slides)
 The International Business Environment (1 slides)

ADDITIONAL RESOURCES

Friedman, Thomas, The World Is Flat: A Brief History of the Twenty-first Century, Farrar,
Strauss and Giroux, New York, New York, 2005.

Porter, Michael E., The Competitive Advantage of Nations, The Free Press, New York, New
York, 1990.

Sheffi, Yossi, Logistics Clusters: Delivering Value and Driving Growth, MIT Press, Cambridge,
Massachusetts, 2012.

Lustig, Myron W. and Jolene Koester, Intercultural Competence: Interpersonal Communication

Across Cultures, 6th Edition, Allyn and Bacon, Pearson Education, Boston, 2009.

Daniels, John, Lee Radebaugh and Daniel Sullivan, International Business: Environment and
Operations, Prentice-Hall, Upper Saddle River, New Jersey, 2010 (13th Edition)

Nicoleta-Lascu, Dana, International Marketing, Cengage Learning, Cincinnati, Ohio, 2009 (3rd
Edition).

as well as a the “classics”:

Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nations, Bantam Classics,
2003.

Ricardo, David, On the Principles of Political Economy and Taxation, Dover Publications, 2004.

Ohlin, Bertil, Interregional and International Trade, 1933, reproduced in Samuelson, Paul A.,
Heckscher-Ohlin International Trade Theory, MIT Press, 1991.

Vernon, Raymond, “International Investment and International Trade in the Product Life Cycle,”
Quarterly Journal of Economics, May 1966, 80(2), pp. 190-207.

and the following Web sites:

1-12 Chapter 1: Introduction

http://www.cia.gov (Central Intelligence Agency)

http://www.wto.org (World Trade Organization)
http://www.imf.org (International Monetary Fund)
http://www. ecb.int (European Central Bank)
http://www.culturegrams.com/ (Brigham-Young’s CultureGrams)
http://www.gapminder.org (Gap minder)
http://www.stat-usa.gov (United States Department of Commerce, some databases require a
subscription)
http://www.euromonitor.com (Euromonitor, subscription required)