International Trade Theory

International Trade Theory

What is international trade?

Exchange of raw materials and manufactured

goods (and services) across national borders

Classical trade theories:

explain national economy conditions--country

advantages--that enable such exchange to happen

New trade theories:

explain links among natural country advantages,

government action, and industry characteristics that enable such exchange to happen

Implications for International Business

Classical Trade Theories

Mercantilism (pre-16th century)

Takes an us-versus-them view of trade Other countrys gain is our countrys loss

Free Trade theories

Absolute Advantage (Adam Smith, 1776) Comparative Advantage (David Ricardo, 1817) Specialization of production and free flow of goods

benefit all trading partners economies

Free Trade refined

Factor-proportions (Heckscher-Ohlin, 1919)
International product life cycle (Ray Vernon, 1966)

The New Trade Theory

As output expands with specialization, an industrys ability to realize economies of scale increases and unit costs decrease Because of scale economies, world demand supports only a few firms in such industries (e.g., commercial aircraft, automobiles) Countries that had an early entrant to such an industry have an advantage:
Fist-mover advantage
Barrier to entry

New Trade Theory

Global

Strategic Rivalry

Firms gain competitive advantage through:

intellectual property, R&D, economies of scale and scope, experience

National

Competitive Advantage (Porter, 1990)

Classical Trade Theory

Absolute Advantage Adam Smith: The Wealth of Nations, 1776 A country Should specialize in production of and export products for which it has absolute advantage; import other products Has absolute advantage when it is more productive than another country in producing a particular product Comparative Advantage David Ricardo: Principles of Political Economy, 1817 Country should specialize in the production of those goods in which it is relatively more productive... even if it has absolute advantage in all goods it produces Absolute Advantage is a special case of Comparative Advantage

Heckscher (1919)-Ohlin (1933)

Factors Endowments Theory Differences in factor endowments not on differences in productivity determine patterns of trade Absolute amounts of factor endowments matter Leontief paradox:
US has relatively more abundant capital yet imports

goods more capital intensive than those it exports Explanation(?): US has special advantage on producing new products made with innovative technologies These may be less capital intensive till they reach massproduction state

Theory of Relative Factor Endowments (Heckscher-Ohlin)

Factor endowments vary among countries

Products differ according to the types of factors that they need as inputs
A country has a comparative advantage in producing products that intensively use factors of production (resources) it has in abundance Factors of production: labor, capital, land, human resources, technology

International Product Life-Cycle (Vernon)

Most new products conceived / produced in the US in 20th century

US firms kept production close to their market initially

Aid decisions; minimize risk of new product introductions Demand not based on price; low product cost not an issue

Limited initial demand in other advanced countries initially

Exports more attractive than overseas production

When demand increases in advanced countries, production follows

With demand expansion in secondary markets

Product becomes standardized production moves to low production cost areas Product now imported to US and to advanced countries

New Trade Theories

Increasing returns of specialization due to economies of scale (unit costs of production decrease)

First mover advantages (economies of scale such that barrier to entry crated for second or third company)

Luck... first mover may be simply lucky. Government intervention: strategic trade policy

National Competitive Advantage

(Porter, 1990)

Factor endowments

land, labor, capital, workforce, infrastructure (some factors can be created...)

large, sophisticated domestic consumer base: offers an innovation friendly environment and a testing ground local suppliers cluster around producers and add to innovation competition good, national governments can create conditions which facilitate and nurture such conditions

Demand conditions

Related and supporting industries

Firm strategy, structure, rivalry

So What for business?

First

mover implications Implications

Location Foreign

Investment Decisions

Government

Policy implications

What is a Trade Barrier Types: -Import duties -Import quotas -Import licenses -Tariffs -Export licenses -Subsidies -Non-tariff barriers to trade -Voluntary Export Restraints

-Economic Effect of Trade Barriers

-Common Arguments -Jobs Are Destroyed by Trade -Worker Wages Are Hurt by Trade. -National Security Is Threatened by Trade. -Special Industries with Unique and Substantial Economic Potential will not mature without Protection from Trade. -Unfair Competition Undermines the Benefits of Trade.

Indias Foreign Trade

Composition of Trade
Elastic and Inelastic nature of Export and Import

Direction of Trade EXIM Policy

GATT and WTO

The Uruguay round

World Trade Organization Lower tariffs for industrial products Agriculture Textiles and clothing Services Intellectual Property Dispute settlement

WTO World Trade Organization

Permanent institution to perform GATT functions - first ministerial meeting in Singapore December 1996 Standing councils for goods, services, and TRIPS, with continuous negotiations on further liberalization More efficient dispute settlement

Tariff reductions

Developed country tariffs reduced by a third within 5-10 years, to about 3% Tariff binding national lists to include almost all products

Eliminated tariffs
Pharmaceuticals Paper Steel Construction machinery Agricultural machinery Medical equipment Furniture Toys Beer & brown alcohol

Agriculture

Tariffization of agricultural protection Tariff reductions

36% average reduction in first round

Market access guarantees

imports at least 3% of domestic consumption

Reductions in public subsidies

cuts by 20-36 % of subsidy levels

Textiles and clothing

Phasing out of MFA over ten-year period Integration of half of imports into GATT system during transition process Liberalization of remaining quotas during transition process

General Agreement on Trade in Services - GATS

Framework of GATT-related rules

National treatment, MFN, transparency, progressive

liberalization, dispute settlement

National schedules
liberalization commitments exceptions from GATS principles

Annexes with rules for specific sector: successfully completed negotiations on telecom and finance

TRIPS and TRIMS

Protection of trade-related intellectual property (TRIPS) - copyrights, trade marks, patents Including trade-related investment measures (TRIMS) under GATT rules
prohibitions for investment rules that distort

trade patterns, eg. local content and export requirements

Clearer principles for use of safeguards

The Doha Development Round

Agriculture and services: implementation of Uruguay round decisions + further liberalization Development perspective: particular concern for interests of developing countries Working groups for tough questions: environment, competition policy, investment rules, social issues

What is special about developing countries?

Weak competitiveness in industry Inefficient customs and trade administration Fiscal pressure: tariff revenue important for government budget

Still a need to participate in international trade

technology, competition, economies of scale
revenue for necessary imports

What does WTO do for developing countries?

Special and differential treatment such as preferential market access more scope for national policies, e.g. export subsidies for poorest countries technical and financial support more liberal use of safeguards more time to reduce trade barriers

Special and differential treatment in the WTO

Aims to give developing countries improved market access more scope for national policies, eg. export subsidies technical and financial support more liberal use of safeguards more time to reduce trade barriers

GATT and goods trade

Enhanced market access through GSP Higher domestic protection accepted: average bound tariff over 20% Longer adjustment period to meet Uruguay round targets Immunity from countervailing measures if import share is less than 4% Right to use export subsidies for LLDCs

Textiles and garments

MFA phased out by 2005 Expected increase in exports to OECD between 1995-2005: USD 175 billion But...
liberalization back-loaded

tough rules of origin

China main beneficiary? Quotas may have protected

other exporters

Swedish experiences: China and Bangladesh main winners, Portugal main loser

Agriculture

Tariffization and reduction of subsidies positive for many developing countries

developing countries can keep higher protection large export potential for some developing exporters although many developing countries are importers:

Marrakesh agreement

... but remaining imbalances are serious

over 95% of all agricultural support goes to the 4% of

farmers that live in developing countries total value of support over USD 250 billion: 5 times the value of global development assistance

Services

Some positive features

smorgasbord character where sectors can be

excluded

Significant potential even for developing countries

see Korean and Chinese construction

companies, call centers in Costa Rica and India, computer programming in Bangalore, health care in Cuba

Problems with labor mobility, particularly when entering developed countries

TRIPS and TRIMS

TRIPS not well liked by developing countries requires complex legal structure unwillingness to pay high prices for medicines worries about patenting of biological organisms TRIMS benefits foreign MNCs in bargaining with local governments FDI incentives can no longer be balanced by requirements

EU trade policy towards developing countries

GSP: ~50% lower tariffs for 170 developing countries Lom Conventions 1975-1999: further preferences for 77 ACP countries Cotonou agreement 2000: extension of Lom conventions, ACP countries Everything But Arms 2001: complete tariff elimination for 49 Least Developed Countries
except arms, bananas (all duties eliminated by 2006),

rice (2009), and sugar (2009)

US trade policy towards developing countries

GSP for about 140 developing countries

more tariff peaks in industrial products around 30 countries excluded from GSP

Preferences through bilateral and regional agreements

Andean Pact, Caribbean Community Bilateral agreements, eg with Vietnam

Remaining problem areas in WTO framework

High levels of protection outside OECD Undisciplined use of contingent protection, + agressive unilateralism (EU and US) Gray zone of Non-Tariff Barriers (NTBs) that are not fully addressed by the GATT framework Dispute resolution?