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Chapter 06 - International Trade Theory
International Trade Theory

Chapter Outline
OPENING CASE: The Rise of India’s Drug Industry
INTRODUCTION
AN OVERVIEW OF TRADE THEORY
The Benefits of Trade

The Pattern of International Trade
Trade Theory and Government Policy
MERCANTILISM
Country Focus: Is China a Neo-Mercantilist Nation?
ABSOLUTE ADVANTAGE
COMPARATIVE ADVANTAGE
The Gains from Trade

Qualifications and Assumptions
Extensions of the Ricardian Model
Country Focus: Moving U.S. White Collar Jobs Offshore
HECKSCHER-OHLIN THEORY
The Leontief Paradox
THE PRODUCT LIFE CYCLE THEORY
Evaluating the Product Life Cycle Theory
NEW TRADE THEORY
Increasing Product Variety and Reducing Costs

Economies of Scale, First Mover Advantages and the Pattern of Trade
Implications of New Trade Theory
6-1
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This
document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND
Factor Endowments
Demand Conditions
Related and Supporting Industries
Firm Strategy, Structure, Rivalry
Evaluating Porter’s Theory
Management Focus: The Rise (and Fall) of Finland’s Nokia
FOCUS ON MANAGERIAL IMPLICATIONS
Location
First-Mover Advantages
Government Policy
SUMMARY
CRITICAL THINKING AND DISCUSSION QUESTIONS
CLOSING CASE: The Rise of Bangladesh’s Textile Trade
Learning Objectives
1. Understand why nations trade with each other.
2. Summarize the different theories explaining trade flows between nations.
3. Recognize why many economists believe that unrestricted free trade between nations will raise the
economic welfare of all countries that participate in a free trade system.
4. Explain the arguments of those who maintain that government can play a proactive role in promoting
national competitive advantage in certain industries.
5. Understand the important implications that international trade theory holds for business practice.
Chapter Summary
This chapter focuses on the benefits of international trade and introduces several theories that help explain
the patterns of international trade that are observed in practice. The discussion begins with an
explanation of the theory of mercantilism, and then proceeds to discuss the theories of absolute advantage
and comparative advantage. Four additional theories are discussed, including the Heckscher-Ohlin theory,
the product life cycle theory, the new trade theory, and the theory of national competitive advantage.
Each of these theories helps explain why certain goods are (or should be) made in certain countries. The
chapter ends by discussing the link between the theories of international trade and (1) a firm’s decision
about where (in the world) to locate its various productive activities, (2) the importance of establishing
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first-mover advantages, and (3) government trade policies.
Opening Case: The Rise of India’s Drug Industry
Summary
The opening case explores the phenomenal growth of India’s pharmaceutical industry. Over the past
decade, pharmaceutical exports from India have exploded going from just $1 billion in 2000 to almost
$11.5 billion in 2011. Much of this growth can be attributed to the decision by many Western firms to
outsource their manufacturing to the country. India, with its relatively low cost labor, large pool of
English speaking scientists and workers, and knowledge of U.S. and European drug regulations is an
attractive manufacturing location for Western firms. Discussion of the case can revolve around the
following questions:
QUESTION 1: How has free trade and globalization changed the pharmaceutical industry in India? What
factors have contributed to the growth of India’s pharmaceutical industry?
ANSWER 1: India’s pharmaceutical industry has benefitted enormously from free trade globalization.
Prior to the country’s agreement to comply with the World Trade Organization’s (WTO) intellectual
property rules, India’s pharmaceutical industry primarily focused on producing counterfeit and generic
products for the domestic market. Today, because Western companies no longer have to worry about
intellectual property theft, the industry has doubled in size as Western companies have taken advantage of
the country’s lower cost skilled workforce to outsource manufacturing and packaging.
QUESTION 2: Discuss the growth of India’s pharmaceutical industry since 2005. Who are the winner
and who are the losers in this industry transformation?
ANSWER 2: Since India’s 2005 agreement with the WTO to comply with its rules on intellectual property
rights the country’s pharmaceutical industry has taken off. In 2000 for example, pharmaceutical exports
were around $1 billion. By 2011, pharmaceutical exports had surged to $11.5 billion. Most students will
agree that there several winners in the transformation of this industry. Clearly, companies producing and
exporting pharmaceutical products in India should be better off as should their customers. Insurance
companies also benefit from the lower cost production. Similarly, those employed directly or indirectly in
India’s pharmaceutical industry should benefit. In contrast, the United States has seen its domestic
industry, especially manufacturing and packaging, shrink leaving some workers without jobs.
Teaching Tip: For more information on the growth of the pharmaceutical industry in India, go to
{http://www.businessweek.com/ap/2012-05-24/senate-bill-aims-to-increase-drug-import-safety} and
{http://www.businessweek.com/magazine/welcome-to-india-the-land-of-the-drug-reps-09082011.html}.
Chapter Outline with Lecture Notes and Teaching Tips

INTRODUCTION
A) This chapter has two goals. The first goal is to review a number of theories that explain why it is
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beneficial for a country to engage in international trade. The second goal is to explain the pattern of
international trade that is observed in the world economy.
Lecture Note: It is often worth asking students before discussing the theories why countries trade the
products they do. They will frequently – with a little prompting hit upon many of the ideas presented in
this chapter and consequently relate better to the various theories that are discussed.
AN OVERVIEW OF TRADE THEORY
A) 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.
The Benefits of Trade
B) The great strength of the theories of Smith, Ricardo, and Hecksher-Ohlin is that they identify with
precision the specific benefits of trade. Common sense suggests that some trade is beneficial. The theories
of Smith, Ricardo and Hecksher-Ohlin go beyond common sense to show why it is beneficial for a
country to engage in international trade even for products it is able to produce for itself. The gains arise
because international trade allows a country to specialize in the manufacture and export of products that
can be produced most efficiently in that country, while importing products that can be produced more
efficiently in other countries.
The Pattern of International Trade
C) Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oil, Ghana
exports cocoa, and Brazil exports coffee. Yet others are not so obvious or easily explained. Why does
Switzerland export chemicals, pharmaceuticals, watches, and jewelry? Why does Japan export
automobiles, consumer electronics, and machine tools?
D) New trade theory stresses that in some cases countries specialize in the production and export of
particular products not because of underlying differences in factor endowments, but because in certain
industries the world market can support only a limited number of firms. So a country’s pattern of trade
may be a reflection of the ability of firms in that nation to capture first-mover advantages.
E) Michael Porter suggested that a country’s factor endowments as well as domestic demand and domestic
rivalry are important in explaining a nation’s dominance in the production and export of particular
products.
Trade Theory and Government Policy
F) While all of the trade theories discussed in the text agree that international trade is beneficial to a
country, they lack agreement in their recommendations for government policy. Mercantilism makes a
crude case for government involvement in promoting exports and limiting imports. Smith, Ricardo, and
Heckscher-Ohlin all promote the notion of unrestricted free trade. The argument for unrestricted free
6-4
trade is that both import controls and export incentives (such as subsidies) are self defeating and result in
wasted resources. Yet both the new trade theory and Porter’s theory of national competitive advantage can
be interpreted as justifying some limited and selective government intervention to support the
development of certain export-oriented industries.
MERCANTILISM
A) The first theory of international trade emerged in England in the mid-16th century. Referred to as
mercantilism, its principle assertion was that it is in a country’s best interest to maintain a trade surplus,
to export more than it imports. Consistent with this belief, the mercantilist doctrine advocated
government intervention to achieve a surplus in the balance of trade.
Teaching Note: A historical perspective of mercantilism is available at

{http://www.referenceforbusiness.com/encyclopedia/Man-Mix/Mercantilism.html}.
B) The flaw of mercantilism was that it viewed trade as a zero-sum game, one in which a gain by one
country results in a loss by another. It was left to Adam Smith and David Ricardo to show the
shortsightedness of this approach and to demonstrate that trade is a positive-sum game. As an economic
philosophy, mercantilism is problematic and not valid. Yet many political views today have the goal of
boosting exports while limiting imports by seeking only selective liberalization of trade.
Country Focus: Is China a Neo-Mercantilist Nation?
Summary
This feature analyzes claims that China is a neo-mercantilist nation. Exports are largely responsible for
China’s recent rapid economic growth. The country, capitalizing on its cheap labor force, has focused on
converting raw materials into products that are exported to developed countries like the United States. In
2008, China’s trade surplus was a record $280 billion before dropping to $155 billion in 2011. Even so,
some critics have suggested that China is following a neo-mercantilist policy.
Suggested Discussion Questions
1. Are the claims that China is following a neo-mercantilist policy valid? Why or why not?
Discussion Points: Some critics claim that China’s deliberate steps to maintain a low currency relative to
the dollar is indicative of the country’s neo-mercantilist policy which tries to simultaneously increase
exports and limit imports. Many students will probably note that China’s impressive growth in recent
years is largely export led, which would support the claims of the critics. China’s trade surplus in 2008
was $280 billion, and the country had foreign exchange reserves of more than $1.95 trillion, 70 percent of
which were in U.S. dollars. At the same time, the country appears to have implemented an import
substitution policy as it now produces products such as steel and paper that had been formerly imported.
2. What incentive does China have to open its markets to foreign products? Why might China resist such
a move?
6-5
Discussion Points: China is under significant pressure from many countries including the United States to
open its markets to foreign goods. Students will probably recognize that if the country does open its
markets, the impressive economic growth the country has been experiencing would probably be affected.
However, students may also note that the country may have to make some changes to its policies if only to
appease other nations and prevent retaliatory trade measures. Already, the country, in response to
pressure from the United States, has allowed its currency to appreciate relative to the dollar.
3. Is there evidence that China is pursuing an import substitution policy? How would this type of policy
benefit the country?
Discussion Points: Countries following an import substitution policy try to substitute domestic production
for products that were previously imported, regardless of whether it is more efficient to produce them
domestically or not. Most students will probably suggest that in China’s case, this certainly appears to be
occurring. The country used to import steel, aluminum, and paper, but now produces those products
domestically, and in doing so, avoids the cash outflows that would accompany imports. With its greater
reserves of foreign currencies, China gains economic power over other nations.
Lecture Note: For more information on China’s trade policy, students may want to read
{http://www.businessweek.com/magazine/content/10_27/b4185004907871.htm}.
ABSOLUTE ADVANTAGE
A) In his 1776 landmark book The Wealth of Nations, Adam Smith attacked the mercantilist assumption
that trade is a zero-sum game. Smith argued that countries differ in their ability to produce goods
efficiently, and that a country has an absolute advantage in the production of a product when it is more
efficient than any other country in producing it. According to Smith, countries should specialize in the
production of goods for which they have an absolute advantage and then trade these goods for the goods
produced by other countries. The text provides a numerical example of Smith’s theory.
B) When each country has an absolute advantage in one product, it is clear that trade is beneficial. But
what if one country has an absolute advantage in both products?
COMPARATIVE ADVANTAGE
A) David Ricardo took Adam Smith’s theory one step further by exploring what might happen when one
country has an absolute advantage in the production of all goods. Smith’s theory of absolute advantage
suggests that such a country might derive no benefits from international trade. In his 1817 book
Principles of Political Economy, Ricardo showed that this was not the case. According to Ricardo’s
theory of comparative advantage, it makes sense for a country to specialize in the production of those
goods that it produces most efficiently and to buy the goods that it produces less efficiently from other
countries, even if this means buying goods from other countries that it could produce more efficiently
itself. The textbook provides a detailed example to explain the rationale of this theory.
B) The simple example of comparative advantage presented in the text makes a number of assumptions:
6-6
only two countries and two goods; zero transportation costs; similar prices and values; resources are
mobile between goods within countries, but not across countries; constant returns to scale; fixed stocks of
resources; and no effects on income distribution within countries. While these are all unrealistic, the
general proposition that countries will produce and export those goods in which they are most efficient has
been shown to be quite valid.
Teaching Tip: For more on the ideas and philosophies of David Ricardo, go to
{http://www.econlib.org/library/Enc/bios/Ricardo.html}.
The Gains from Trade
C) The theory of comparative advantage argues that trade is a positive sum gain in which all gain. It
provides a strong rationale for encouraging free trade.
Qualifications and Assumptions
D) The simple example of comparative advantage presented in the text makes a number of assumptions:
only two countries and two goods; zero transportation costs; similar prices and values; resources are
mobile between goods within countries, but not across countries; constant returns to scale; fixed stocks of
resources; and no effects on income distribution within countries. While these are all unrealistic, the
general proposition that countries will produce and export those goods in which they are most efficient has
been shown to be quite valid.
Extensions of the Ricardian Model
E) The text explores the effects of relaxing the assumptions that resources are mobile between goods
within a country, and that trade does not change a country’s stock of resources or the efficiency with
which those resources are utilized.
Immobile Resources
F) As illustrated by the example in the test, resources do not always move freely from one economic
activity to another.
Diminishing Returns
G) The model of comparative advantage assumes constant returns to specialization (the units of
resources required to produce a good are assumed to remain constant no matter where one is on a
country’s production possibility frontier). However, it is more realistic to assume diminishing returns to
specialization (more units of resources are required to produce each additional unit).
H) Diminishing returns are more realistic because not all resources are of the same quality, and because
different goods use resources in different proportions. Diminishing returns to specialization suggest that
the gains from specialization will probably be exhausted before specialization is complete. Still,
unrestricted free trade makes sense even if the gains are not as great as suggested by the constant returns
case.
6-7
Dynamic Effects and Economic Growth
I) Opening an economy to trade is likely to generate dynamic gains of two types. First, trade might
increase a country's stock of resources as increased supplies become available from abroad. Second, free
trade might increase the efficiency of resource utilization, and free up resources for other uses.
The Samuelson Critique
J) Samuelson argues that in some cases, the dynamic gains from trade may not be so beneficial. He
argues that the ability to off-shore services jobs that were traditionally not internationally mobile may
have the effect of a mass inward migration into the United States, where wages fall, effectively negating
the gains of international trade.
Video Note: The iGlobe Late Economist Samuelson Bridged Math, Money explores Samuelson’s
contributions to the fields of economics and international business.
Country Focus: Moving U.S. White Collar Jobs Offshore
Summary
This feature goes to the heart of a debate that has been played out many times over the past half century—
the transference of jobs from the United States to lower-wage countries. The difference now however, is
that rather than blue-collar jobs being transferred, the new trend is for white-collar jobs to move, jobs
associated with the knowledge-based economy.
1. Will the United States suffer from the loss of highly skilled and high paying jobs? What does the
transference of white-collar jobs mean to the average American?
Discussion Points: This hot issue is a highly sensitive one for many Americans—especially those who
have seen their once secure jobs being shipped offshore. Many students will probably know someone
who has suffered from this very situation, and may claim that companies have lost all loyalty to their
employees and simply become profit seekers. Other students however, may point that companies are in
business to make a profit, and do well for other stakeholders such as investors. Some students will simply
argue that the loss of white-collar jobs is merely a manifestation of companies viewing the world as a
borderless market—where they seek resources wherever they are cheapest, produce in the optimal
location, and sell wherever there is demand.
2. What does the transference of white-collar jobs mean to recipient countries such as India and the
Philippines?
Discussion Points: For developing countries like India and the Philippines the transference of white-collar
jobs from the United States not only generates new jobs, it also brings new skills and knowledge that
6-8
could be vital to the countries as they continue on the path toward greater economic development.
Students should recognize that greater employment levels will of course have the effect of pushing wages
up, and creating greater economic prosperity in these nations. This in turn should be beneficial for
American companies as new export markets develop.
3. Why do American companies transfer white-collar jobs to countries like India and the Philippines?
Discussion Points: India offers companies a well-educated workforce that is willing to work for a fraction
of what companies would pay in the United States. By transferring skilled jobs to India or the Philippines,
American companies increase their global competitiveness and profitability. Students will probably note
that the trend to outsource is likely to continue as companies seek an edge wherever they can find one.
Already, the trend is being seen in new industries such as healthcare where not only paperwork but even
radiology services are now being routinely outsourced.
Lecture Note: Outsourcing call centers and other white collar jobs is common in many industries today,
however it can also be controversial. To extend the discussion of outsourcing to include this angle,
consider {http://www.businessweek.com/articles/2012-05-18/the-indian-outsourcing-issue-is-back}.
Lecture Note: To extend this discussion, consider {http://www.businessweek.com/articles/2012-03-

15/outsourcing-a-passage-out-of-india}. This multi-country analysis explores the advantages and
drawbacks of outsourcing to several different locations.
Lecture Note: Outsourcing is not always beneficial for companies. To extend this discussion, consider
discussing why outsourcing may not be possible. For more on this topic, go to
{http://www.businessweek.com/smallbiz/content/feb2009/sb2009029_386936.htm}.
Evidence for the Link between Trade and Growth
K) Studies exploring the relationship between trade and economic growth suggest that countries that adopt
a more open stance toward international trade enjoy higher growth rates than those that close their
economies to trade.
HECKSCHER-OHLIN THEORY
A) Hecksher and Ohlin argued that comparative advantage arises from differences in national factor
endowments (land, labor, and capital). As a result, the Heckscher-Ohlin theory predicts that countries
will export goods that make intensive use of those factors that are locally abundant, while importing goods
that make intensive use of factors that are locally scarce.
Teaching Tip: To learn more about Bertil Ohlin go to

{http://www.econlib.org/library/Enc/bios/Ohlin.html}.
The Leontief Paradox
B) Using the Heckscher-Ohlin theory, Leontief, in 1953 postulated that since the United States was
relatively abundant in capital compared to other nations, the United States would be an exporter of capital
6-9
intensive goods and an importer of labor-intensive goods. To his surprise, however, he found that U.S.
exports were less capital intensive than U.S. imports. Since this result was at variance with the predictions
of the theory, it has become know as the Leontief Paradox.
Teaching Tip: A more extensive discussion of Wassily Leontief is available at

{http://www.econlib.org/library/Enc/bios/Leontief.html}.
C) Recent research suggests that the Heckscher-Ohlin theory gains predictive power if the impact of
differences in technology on productivity is controlled for.
THE PRODUCT LIFE CYCLE THEORY
A) Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s. According to the
theory as products mature both the location of sales and the optimal production location will change
affecting the flow and direction of trade.
B) According to Vernon, early in the life cycle of a typical new product, while demand is starting to grow
in the United States, demand in other advanced countries is limited to high-income groups. The limited
initial demand in other advanced countries does not make it worthwhile for firms in those countries to
start producing the new product, but it does necessitate some exports from the United States to those
countries. Over time, however, demand for the new product starts to grow in other advanced countries.
As it does, it becomes beneficial for foreign producers to begin producing for their home markets. In
addition, U.S. firms might set up production facilities in those advanced countries where demand is
growing. Consequently, production within other advanced countries begins to limit the potential for
exports from the United States.
C) As the market in the United States and other advanced nations matures, the product becomes more
standardized, and price becomes the main competitive weapon. One result is that producers based in
advanced countries where labor costs are lower than the United States might now be able to export to the
United States.
D) If cost pressures become intense, the process might not stop there. The cycle by which the United
States lost its advantage to other advanced countries might be repeated once more as developing countries
begin to acquire a production advantage over advanced countries.
E) The consequence of these trends for the pattern of world trade is that the United States (and other
advanced countries) switches from being an exporter of the product to an importer of the product as
production becomes more concentrated in lower-cost foreign locations.
Evaluating the Product Life Cycle Theory
F) While the product life cycle theory accurately explains what has happened for products like
photocopiers and a number of other high technology products developed in the United States in the 1960s
and 1970s, the increasing globalization and integration of the world economy has made this theory less
valid in today's world.
6-10
NEW TRADE THEORY
A) New trade theory suggests that the ability of firms to realize economies of scale (unit cost reductions
associated with a large scale of output) may help explain international trade patterns.
Video Note: The iGlobe U.S. Economist Krugman Wins Nobel Prize in Economics explores Krugman’s
contributions to the fields of economics and international business.
B) New trade theory makes two important points. First, trade can increase the variety of goods available
to consumers and decrease the average cost of those goods. Second, in industries where the output
necessary to attain economies of scale is significant relative to total world demand, only a few companies
may be able to survive. Being a first mover in these industries is important.
Increasing Product Variety and Reducing Costs
C) According to new trade theory, with trade a nation may be able to specialize in producing a narrower
range of products than it would in the absence of trade. By buying goods that it does not make from other
countries, each nation can simultaneously increase the variety of goods available to its consumers and
lower the costs of those goods.
Economies of Scale, First Mover Advantages, and the Pattern of Trade
D) A second theme in new trade theory is that the pattern of trade we observe in the world economy may
be the result of first mover advantages (economic and strategic advantages that accrue to early entrants
into an industry) and economies of scale.
Implications of New Trade Theory
E) New trade theory suggests that nations may benefit from trade even when they do not differ in resource
endowments or technology. The theory also suggests that a country may predominate in the export of a
good simply because it was lucky enough to have first mover firms.
F) New trade theory is at variance with the Hecksher-Ohlin theory, which suggests that a country will
predominate in the export of a product when it is particularly well endowed with those factors used
intensively in its manufacture. New trade theory does not contradict the theory of comparative advantage,
but instead identifies a source of comparative advantage.
G) An obvious and controversial extension of new trade theory is the implication that governments should
consider strategic trade policies. Strategic trade policies would suggest that governments should nurture
and protect firms and industries where first mover advantages and economies of scale are likely to be
important, as doing so can increase the chance that a firm will build economies of scale and eventually
end up a winner in the global competitive race.
6-11
NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND
A) Porter’s 1990 study tried to explain why a nation achieves international success in a particular industry.
This study found four broad attributes – factor endowments, demand conditions, relating and supporting
industries, and firm strategy, structure, and rivalry - that promote or impede the creation of competitive
advantage. These are shown as a diamond in Figure 6.6. Porter argues that firms are most likely to
succeed in industries where the diamond is favorable.
Factor Endowments
B) A nation's position in factors of production such as skilled labor or infrastructure necessary to compete
in a given industry can be critical. These factors can be either basic (natural resources, climate, location)
or advanced (skilled labor, infrastructure, technological know-how). While either can be important,
advanced factors are more likely to lead to competitive advantage.
Demand Conditions
C) The nature of home demand for the industry’s product or service influences the development of
capabilities. Sophisticated and demanding customers pressure firms to be competitive.
Relating and Supporting Industries
D) The presence in a nation of supplier industries and related industries that are internationally
competitive can spill over and contribute to other industries. Successful industries tend to be grouped in
clusters in countries - having world class producers of semi-conductor processing equipment can lead to
(and be a result of having) a competitive semi-conductor industry.
Firm Strategy, Structure, and Rivalry
E) The conditions in the nation governing how companies are created, organized, and managed, and the
nature of domestic rivalry impacts firms' competitiveness. Firms that face strong domestic competition
will be better able to face competitors from other firms.
Evaluating Porter’s Theory
F) In addition to these four main attributes, government policies and chance can impact any of the four.
Government policy can affect demand through product standards, influence rivalry through regulation and
antitrust laws, and impact the availability of highly educated workers and advanced transportation
infrastructure.
G) The four attributes of the diamond, government policy, and chance work as a reinforcing system,
complementing each other and in combination creating the conditions appropriate for competitive
advantage. To date, Porter’s theory has not been subjected to detailed empirical testing.
6-12
Management Focus: The Rise of Finland’s Nokia
Summary
This feature is about the growth of the cellular telephone equipment industry, and more specifically, about
the rise in competitiveness of Nokia, a Finnish cellular telephone company. The feature explains the
reasons that Nokia was particularly well positioned to take advantage of the growth of the global cellular
telephone industry. Nokia is one of the most dominant players in the mobile phone industry, holding
almost 30 percent of the world’s market in 2011.
1. Using the new trade theory and Porter’s theory of national competitive advantage, describe why Nokia
emerged as a leading competitor in the global cellular telephone equipment industry.
Discussion Points: New trade theory suggests that a country may be the dominant exporter of a particular
product simply because it was lucky enough to be a first mover firm for the product. The theory would
suggest that Nokia was able to benefit from its innovations that helped it gain first mover advantages, but
also that it was simply lucky enough to be in the right place at the right time. Porter argues that a nation’s
competitive advantage is dependent on its factor endowments, demand conditions, relating and supporting
industries, and firm strategy, structure and rivalry. Students will probably recognize that Finland’s limited
traditional telephone service (see question 2 below) meant that demand was strong. At the same time, the
company was able to benefit from the fact that the country does not have a national telephone monopoly.
Instead, about 50 companies all battle for market share. For Nokia, that meant a focus on bringing costs
down, while remaining on the leading edge of technology.
2. Explain why the cellular telephone industry caught on in Finland and the other Scandinavian countries
faster than the rest of the world.
Discussion Points: Geography appears to be the key reason why cellular telephone service appears to have
caught on in Scandinavian countries more quickly than in other parts of the world. With its cold climate
and sparse population, Scandinavia found traditional wire-line service costly, and embraced the cheaper
alternative of cellular service. Students will probably recognize that this situation combined with the need
for communication services meant that countries like Finland had a greater incentive to develop the
industry—which of course helped Nokia become a leading player in the industry.
3. Why did the development of the cellular telephone equipment industry not take place in Mexico or
another Central or South American country instead of Finland, Sweden, and the United States? Base your
answer on the international trade theories described in this chapter.
Discussion Points: Students will probably recognize that the conditions in Scandinavia set the stage for
the development of cellular telephone service. Not only were Scandinavians open and able to try new
products, they also needed communications services. Governments like Finland’s also saw the benefits of
developing the industry as a cheaper alternative to traditional services.
6-13
Teaching Tip: For more information on the company, go to Nokia’s homepage at

{http://www.nokia.com/global/about-nokia/}.
FOCUS ON MANAGERIAL IMPLICATIONS
A) There are at least three main implications of the material discussed in this chapter for international
businesses: location implications, first-mover implications, and policy implications.
Location
B) One way in which the material discussed in this chapter matters to an international business concerns
the link between the theories of international trade and a firm’s decision about where to locate its various
productive activities. Underlying most of the theories is the notion that different countries have particular
advantages in different productive activities. Thus, from a profit perspective, it makes sense for a firm to
disperse its various productive activities to those countries where, according to the theory of international
trade, they can be performed most efficiently. Being a first mover can have important competitive
implications, especially if there are economies of scale and the global industry will only support a few
competitors. Firms need to be prepared to undertake huge investments and suffer losses for several years
in order to reap the eventual rewards.
First Mover Advantages
C) Being a first mover can have important competitive implications, especially if there are economies of
scale and the global industry will only support a few competitors. Firms need to be prepared to undertake
huge investments and suffer losses for several years in order to reap the eventual rewards.
Government Policy
D) The theories of international trade also matter to international businesses because business firms are
major players on the international trade scene. Because of their pivotal role in international trade,
business firms can and do exert a strong influence on government trade policy. Government policies with
respect to free trade or protecting domestic industries can significantly impact global competitiveness.
E) One of the most important implications for businesses is that they should work to encourage
governmental policies that support free trade. If a business is able to get its goods from the best sources
worldwide, and compete in the sale of products into the most competitive markets, it has a good chance of
surviving and prospering. If such openness is restricted, a business’s long-term survival will be in greater
question.
Teaching Tip: For information about foreign governments and their approaches to international trade, visit
the Electronic Embassy at {http://www.embassy.org/}. This site provides links to all of the foreign
embassies located in Washington D.C.
Critical Thinking and Discussion Questions
6-14
1. “Mercantilism is a bankrupt theory that has no place in the modern world.” Discuss.
Answer: Mercantilism, in its purest sense, is a bankrupt theory that has no place in the modern world. The
principle tenant of mercantilism is that a country should maintain a trade surplus, even if it means that
imports are limited by government intervention. This policy is bankrupt for at least two reasons. First, it
is inconsistent with the general notion of globalization which is becoming more and more prevalent in the
world. A policy of mercantilism will anger potential trade partners because it will exclude their goods
from free access to the mercantilist country’s markets. Eventually, a country will find it difficult to export
if it imposes oppressive quotas and tariffs on its trading partners. Second, mercantilism is bankrupt
because it hurts the consumers in the mercantilist country. By denying its consumers access to either
“cheaper” goods from other countries or more “sophisticated” goods from other countries, the mercantilist
country’s ordinary consumers suffer.
2. Is free trade fair? Discuss!
Answer: This question is designed to stimulate class discussion. Trade theory suggests that specialization
and free trade benefits all countries. However, a case can be made in some situations for imposing trade
barriers. For example, if a developing country is trying to establish a new industry, trade barriers may be
needed in the short term until the industry can become competitive. While it could be argued that another
country could make the product more efficiently already, is it fair to limit a country’s ability to develop its
industrial base?
3. Unions in developed nations often oppose imports from low-wage countries and advocate trade barriers
to protect jobs from what they often characterize as “unfair” import competition. Is such competition
“unfair?” Do you think that this argument is in the best interests of (a) the unions, (b) the people they
represent, and/or (c) the country as a whole?
Answer: The theory of comparative advantage suggests that a country should specialize in producing
those goods that it can produce most efficiently, while buying goods that it can produce relatively less
efficiently from other countries. Furthermore, the theory suggests that opening a country to free trade
stimulates economic growth, which creates dynamic gains from trade. Therefore, it would follow that if
low-wage countries can make certain products more efficiently than high wage countries, the low wage
countries should produce and export those products. While trade barriers may protect workers and
companies, they are a short-term fix at best. Moreover, by protecting industries, the government is not
encouraging companies to become more efficient. Instead, they are promoting inefficiency. Consumers
lose out because they have higher prices and less choice.
4. What are the potential costs of adopting a free trade regime? Do you think governments should do
anything to reduce these costs? What?
Answer: Students will probably be divided on this question, and a lively debate should ensue. For
example, students will probably recognize that by adopting a free trade regime, jobs will be lost in some
industries, however they may not agree on exactly what should be done about the jobs losses. Some
students might suggest that the government provide retraining programs while others may argue that
people lose their jobs everyday and do not get government assistance to find new ones.
6-15
5. Reread the Country Focus on “Is China a Neo-Mercantilist Nation?”

a) Do you think China is pursuing an economic policy that can be characterized as neo-Mercantilist?
b) What should the United States, and other countries, do about this?
Answer: Many students will probably suggest that indeed, China appears to be following a neo-
mercantilist philosophy. China has run a trade surplus for years. In fact, in 2008, the country hit a record
trade surplus of $280 billion. Some critics have suggested that China is limiting its imports by following
an import substitution policy. Other students however, may note that in 2008, the growth in China’s
imports actually exceeded the growth in its exports. Students may argue that this indicates a change in
China’s policy, and note that in 2011, China’s trade surplus had dropped to $155 billion. Even so, most
students will probably suggest that in order to continue to correct the country’s massive trade surplus,
foreign countries like the United States should continue to pressure China to allow its currency to
appreciate, and maintain open markets.
6. Reread the country focus feature on moving white collar jobs off shore.
a) Who benefits from the outsourcing of skilled white collar jobs to developing nations? Who are the
losers?
b) Is there a difference between the transference of high paying white collar jobs such as computer
programming and accounting, to developing nations, and low paying blue collar jobs? If so, what is the
difference, and should government do anything to stop the flow of white collar jobs out of the country to
countries like India?
Answer: This question is likely to generate a lively debate. Many students will suggest that the outward
flow of white-collar jobs is indeed a serious issue, one that should be the focus of government attention.
Students taking this perspective are likely to suggest that white-collar jobs are more important to the
nation’s future, and therefore they should remain at home. Other students however, may argue that
companies cannot afford to pay the higher wages commanded by white-collar jobs and still remain
profitable. Therefore, the argument might be that by taking these jobs outside the country, the company is
able to remain viable, and keep other people employed.
7. Drawing upon the new trade theory and Porter’s theory of national competitive advantage, outline the
case for government policies that would build national competitive advantage in biotechnology. What
kind of policies would you recommend that the government adopt? Are these policies at variance with the
basic free trade philosophy?
Answer: Porter’s theory of national competitive advantage argues that four broad attributes of a nation
shape the environment in which local firms compete, and that these attributes promote or impede the
creation of competitive advantage. These attributes are: factor endowments, demand conditions, related
and supporting industries, and firm strategy, structure, and rivalry. Porter goes on to argue that firms are
most likely to succeed in industries in which the diamond (which are the four attributes collectively) is
favorable. Porter adds two factors to the list of attributes described above: chance and government policy.
The New Trade theory addresses a separate issue. This theory argues that due to the presence of
substantial scale economies, world demand will support only a few firms in many industries.
Underpinning this argument is the notion of first-mover advantages, which are the economic and strategic
6-16
advantages that accrue to early entrants into an industry. One could argue that when the attributes of a
nation are conductive to the production of a product, and when the manufacturers of that product have
experienced some “chance” events that have provided them first-mover advantages, the governmental
policies of that nation should promote the building of national competitive advantage in that particular
area. This could be accomplished through government R&D grants, policies that favor the industry in
capital markets, policies towards education, the creation of a favorable regulatory atmosphere, tax
abatements, and the like. Ask students whether they think this policy is at variance with the basic free
trade philosophy. One could argue that it is, because the government intervention is creating the basis for
comparative advantage. Conversely, one could argue that if a country establishes a comparative
advantage in a particular area that is based on a unique set of attributes (such as Swiss production of
watches), world output will be favorably impacted by letting that country pursue its area of comparative
advantage.
8. The world’s poorest countries are at a competitive disadvantage in every sector of their economies.
They have little to export. They have no capital; their land is of poor quality; they often have too many
people given available work opportunities; and they are poorly educated. Free trade cannot possibly be in
the interests of such nations! Discuss.
Answer: This is a difficult question. Certainly, most students will recognize that these countries are in
dire straights and need assistance from richer countries. Most students will probably be sympathetic to
their cause and suggest various aid programs including education and monetary support to help the
countries develop. However, others may be more cautious and promote the notion that assistance would
have to come in an organized form with multiple nations working together. The question is an interesting
one that should provide students with an eye-opening discussion.
Closing Case: The Rise in Bangladesh's Textile Trade

Summary
The closing case explores discusses Bangladesh’s competitive advantage in the production of textile
products. Bangladesh, a very poor country, has been able to grow even during the most recent global
recession thanks to its strong textile industry. Bangladesh, with its low wages, large investments in textile
technology, and strong network of supporting industries, is now one of the world’s lowest cost producers
of textiles. The country has been able to capitalize on these advantages to increase its exports of textiles
to $10.7 billion up from $9.3 billion in 2009. Discussion of the case can revolve around the following
questions:
QUESTION 1: Why was the shift to a free trade regime in the textile industry good for Bangladesh?
ANSWER 1: Until 2005, Bangladesh’s opportunities in the developed nations were governed by a quota
system. However, when the quota system was replaced with free trade policies Bangladesh was able to
increase its exports. The country’s low cost, productive labor force and its strong network of supporting
industries give it a competitive advantage in the production of textiles. Western importers looking to
diversify their supplier base are also attracted to the country.
6-17
QUESTION 2: Who benefits when retailers in the United States source textiles from low wage countries
such as Bangladesh? Who might lose? Do the gains outweigh the losses?
ANSWER 2: During the 2008-2009 global recession, Wal-Mart and other retailers increased their
purchases from Bangladesh to take advantage of the country’s low cost garments. Bangladesh’s low cost,
but highly productive workforce and strong supporting industries give the country a competitive
advantage in the textile industry allowing it to sell garments at lower prices which can then be passed
along to consumers. However, this of course would imply that fewer garments are being purchased
locally and that U.S. workers could find their higher cost jobs are threatened. Many students though will
probably conclude that because more people probably benefits from the lower prices, overall the benefits
of importing from Bangladesh outweigh the negatives.
QUESTION 3: What international trade theory, or theories, best explain the rise of Bangladesh as a textile
exporting powerhouse?
ANSWER 3: The move of Bangladesh to become a dominant player in the global textile industry in the
last decade is a direct result of the country’s relatively low wage rates, investments in boosting
productivity levels, and vibrant network of supporting industries. Most students will probably suggest
that the theory of comparative advantage and Porter’s theory of competitive advantage could be used to
help explain Bangladesh’s rapid rise to the top.
QUESTION 4: How secure is Bangladesh’s textile industry from foreign competition? What factors
could ultimately lead to a decline?
ANSWER 4: At the moment, Bangladesh is attractive to importers not only because of its low cost
garments, but also because it offers a chance for diversification. Importers, worried that relying on China
as a sole source of goods could be too risky, see Bangladesh as an attractive alternative. However, despite
it strong position in the market, Bangladesh is still facing several challenges especially with regard to its
infrastructure that could prove to be problematic for its exporters. Many students will probably suggest
that it is imperative that the country address these shortcomings and make the necessary investments to
correct the problems or risk that there could be disruptions in the industry. If importers find that
infrastructure problems disrupt their supplies, they could begin to look for new source countries.
Teaching Tip: To extend this discussion, consider {http://www.businessweek.com/articles/2012-04-

26/pakistans-textile-industry-is-dangerously-fragile}.
Continuous Case Concept

In the last few decades, the auto industry has shifted from one in which a few, large companies primarily
manufactured in their domestic markets and sold in their domestic markets, to one in which a few large
companies serve the world market, manufacturing around the globe to capture competitive advantages
wherever they can.
6-18
• Ask students to reflect on the changes in the industry. Why do companies like Toyota and Nissan
have large operations in the U.S. market? Why don’t American companies have a large presence
in Japan?
• Next, consider why BMW and Mercedes have established manufacturing operations in the U.S.
market, while American companies are shifting their production to places like Mexico. Similarly,
reflect on the new agreement between Toyota and Mazda whereby Mazda will produce cars at its
plant in Mexico for Toyota to sell in the United States.
• Finally, ask students to use the theories presented in the chapter to explain the changes in the
industry, and to predict what may occur in the next decade. Volkswagen, for example, has
increased production in Russia, and the Chennai region of India is now being referred to as the
Detroit of India because so many automakers and suppliers have established operations there.
The first two parts of this exercise can be used either at the beginning of a discussion of trade theory, or
threaded through the discussion of the material. The last question works well as a way of applying the
theories to a real world situation, and makes a nice conclusion to the discussion of the theories.
globalEDGE Exercises
Use the globalEDGE Resource Desk {http://globalEDGE.msu.edu/ResourceDesk/} to complete the

following exercises.
Exercise 1
The data can be accessed by searching the term "statistics on economic factors" at
http://globaledge.msu.edu/Reference-Desk. Geohive: Global Statistics is a resource that provides a wide
variety of economic and other data for much of the world. By following the link to "Economic Data" and
looking under the "Economy II" heading, the desired data (Internet Users) is available.
Search Phrase: "statistics on economic factors"

Resource Name: Geohive
Resource Link: http://globaledge.msu.edu/global-resources/resource/198
globalEDGE Categories: "Global" and "Statistical Data Sources"
Exercise 2
The quickest way to reach this information would be to search globalEDGE using the phrase "FAOSTAT"
at http://globaledge.msu.edu/Reference-Desk. FAOSTAT provides a wide array of country-level time-
series data on food, agriculture, and other related products. Once at the FAOSTAT website, click on
6-19
"Trade" at the top of the webpage, and then click on "Trade". In the Trade page, click on "Detailed Trade
Matrix," and then search as per the guidelines in the question.
Search Phrase: "FAOSTAT"

Resource Name: FAOSTAT
Resource Link: http://globaledge.msu.edu/global-resources/resource/197
globalEDGE Categories: "Global" and "Statistical Data Sources"
Additional Readings and Sources of Information
Outsourcing: A Passage Out of India

http://www.businessweek.com/articles/2012-03-15/outsourcing-a-passage-out-of-india
How Nebraska is Winning Foreign Business

http://www.businessweek.com/articles/2012-08-23/how-nebraska-is-winning-foreign-business
Where Free Trade Hurts

http://www.businessweek.com/magazine/content/03_50/b3862007.htm
Economists Rethink Free Trade

http://www.businessweek.com/magazine/content/08_06/b4070032762393.htm?chan=search
Pakistan's Textile Industry Is Dangerously Fragile
http://www.businessweek.com/articles/2012-04-26/pakistans-textile-industry-is-dangerously-fragile
Leo Hindery: CEO Shortsightedness
http://www.businessweek.com/managing/content/jun2010/ca2010068_513255.htm#p1
6-20
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Societies, literary and scientific, 249, 264
Society, state and classes of, in Paris, 53, 74
Spectacle, definition of the word, 41
Spectacles, general account of, 116
Stables of Chantilly, 8
of Versailles, 202
Statues, gallery of, 16
Sueur, le, Eustache, paintings of, 24
T.
Tallien, madame, 95
Talma, 116
Taxes, 56
Tea assemblies, 74
Temple of Mars, 233
Teniers, the elder and the younger, paintings of, 31
Texier, 133
Theatre, general account of, 116
Comique, rue Feydeau, 125
de la Gaieté, 131
de l’Ambigu Comique, 130
de la République et des Arts, 123
de Molière, 129
des jeunes Artistes, 130
des jeunes Élèves, 131
du Marais, ib.
François de la République, 116
Italian Opera, 42, 128
Louvois, 127
Montansier, 129
sans Pretension, 121
Vaudeville, 126
Thuilleries, 10
Tintoret, paintings of, 173
Titian, paintings of, 39, 172
Tivoli, the gardens of, 232
Tom Jones, a french play, 127
Traiteurs, a list of the principal, 278
Trial at Versailles, 199
Trianon, le Grand, 203
le Petit, Hôtel at Versailles, exorbitant charges, 198
garden of, 202
Tribunal de Cassation, 223
de la Police Correctionelle, ib.
Tribunals of justice, 222
Tribunal, sitting of, 87
Turenne, tomb of, 245, 247
Turnpikes, 8
V.
Van Loo, Carlo, paintings of, 25
John Baptist, paintings of, ib.
Lewis Michael, paintings of, ib.
Venetian horses at the gates of the Thuilleries, 11
Veronese, Alexander, paintings of, 38
Paul, paintings of, ib.
Versailles, 192, 194
Vestris, 163
Vinci, Leonardo da, 38, 173
Visits, 284
Vivacity wanted in french society, 80
Volney, mademoiselle, 116
Voltaire, tomb of, 186
W.
Walse, description of this dance, 142
Wild boy of Aveyron, 109
Y.
York Hotel, Dover, 1
ERRATA.
Transcriber’s Note: the errata have been corrected. In addition, accents in the French
have been standardized, and obvious typographical errors have been amended.
Page 14, l. 17, for chefs d’œuvre, read chefs d’œuvres.

⸺ 33, No. 713, for occupation, read vocation.
⸺ 45, l. 21, for merits, read talents.
⸺ 56, l. 20, for public offices hereditary in their families,
read public offices which had become
almost hereditary in their families.
⸺ 79, l. 9, for c’est moi qui a traduit, read c’est moi qui
ai traduit.
⸺ 91, l. 3, for ce climate, read ce climat.
⸺ 93, l. 6, for nor, read or.
⸺ 102, l. 19, for Monteaussier,” read Montansier.”
⸺ 105, l. 6, the word illness ought not to have been in
italics.
⸺ 114, l. 8, for that too, read those too.
⸺ 119, l. 21, for “Morvel,” read “Monvel.” [Transcriber’s
Note: also changed in the index.]
⸺ 159, l. 23, for count, read marquis.
⸺ 160, l. 13, for des Anglois, read d’Anglois.
⸺ 171, No. 61, for Justus, Lipsius, read Justus Lipsius.
⸺ 182, l. 8, for even, read ever.
⸺ 184, l. 15, for it was proposed to confer immortality by
burying in its vaults, read it was
proposed, by burying in its vaults, to
confer immortality.
⸺ 195, note, l. 1, put on before ne.
⸺ 203, last line, for moderate, read moderately.
⸺ 218, l. 9, for Thoulouse, read Tours. [Transcriber’s
Note: also changed in the index.]
l. 17, the words in the same pulpit, should be
omitted.
⸺ 224, l. 19, for Seine, read la Seine.
⸺ 231, l. 10, for Prince de Condé, read Comte D’Artois.
⸺ 234, l. 4, for infinitely, read much.
⸺ 246, l. 9, for statues, read tombs.
⸺ 257, l. 8, for Perpignan, read Pompignan.
l. 18, for publique,” read public.”
⸺ 260, l. 1, read “Colin d’Harleville.”
⸺ 268, l. 15, and note l. 1, read baignoir.”
⸺ 280, l. 3, after and, add the.
⸺ 285, l. 8, of the note, add that, after that.
⸺ 294, l. 1, for affords, read afford.
⸺ 303, l. 1, for having, read have. [Transcriber’s Note:
This change didn’t need making. The
original text already read “have”,
correctly.]
⸺ 307, l. 19, read Lyons, Switzerland, and Italy.
⸺ 318, l. 18, read Montansier. [Transcriber’s Note: Also
changed twice on page 129, to which
this index entry refers.]
G. Woodfall, Printer, Paternoster-row.

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Instant Download PDF Global Business Today 8th Edition Hill Solutions Manual Full Chapter

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International Trade Theory

AN OVERVIEW OF TRADE THEORY

The Benefits of Trade

Country Focus: Is China a Neo-Mercantilist Nation?

The Gains from Trade

The Leontief Paradox

THE PRODUCT LIFE CYCLE THEORY

Evaluating the Product Life Cycle Theory

NEW TRADE THEORY

Increasing Product Variety and Reducing Costs

NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND

FOCUS ON MANAGERIAL IMPLICATIONS

CRITICAL THINKING AND DISCUSSION QUESTIONS

CLOSING CASE: The Rise of Bangladesh’s Textile Trade

2. Summarize the different theories explaining trade flows between nations.

first-mover advantages, and (3) government trade policies.

Opening Case: The Rise of India’s Drug Industry

Chapter Outline with Lecture Notes and Teaching Tips

AN OVERVIEW OF TRADE THEORY

The Benefits of Trade

The Pattern of International Trade

Trade Theory and Government Policy

Teaching Note: A historical perspective of mercantilism is available at

Country Focus: Is China a Neo-Mercantilist Nation?

Suggested Discussion Questions

The Gains from Trade

Qualifications and Assumptions

Dynamic Effects and Economic Growth

The Samuelson Critique

Country Focus: Moving U.S. White Collar Jobs Offshore

Suggested Discussion Questions

Lecture Note: To extend this discussion, consider {http://www.businessweek.com/articles/2012-03-

Evidence for the Link between Trade and Growth

Teaching Tip: To learn more about Bertil Ohlin go to

The Leontief Paradox

Teaching Tip: A more extensive discussion of Wassily Leontief is available at

THE PRODUCT LIFE CYCLE THEORY

Evaluating the Product Life Cycle Theory

NEW TRADE THEORY

Increasing Product Variety and Reducing Costs

Economies of Scale, First Mover Advantages, and the Pattern of Trade

Implications of New Trade Theory

NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND

Relating and Supporting Industries

Firm Strategy, Structure, and Rivalry

Management Focus: The Rise of Finland’s Nokia

Suggested Discussion Questions

Teaching Tip: For more information on the company, go to Nokia’s homepage at

FOCUS ON MANAGERIAL IMPLICATIONS

First Mover Advantages

Critical Thinking and Discussion Questions

2. Is free trade fair? Discuss!

5. Reread the Country Focus on “Is China a Neo-Mercantilist Nation?”

Closing Case: The Rise in Bangladesh's Textile Trade