International Trade

and Factor-Mobility
Theory
 Learning Objectives
 Understand how different approaches to
international trade theories
 To analyse the effect of trade theories on
the world output

5-2
 Poll 1
 Ethnocentric orientation is a predisposition
towards —
a) the home country
b) the host country
c) have mixed approach

6-3
 Poll 2
 If the power distance is high that means
 (a) superior interacts frequently with
subordinate
 (b) superior interacts very less with
subordinate
 ( c) there is no interaction between
superior and subordinate
 (d)None of these

6-4
 Poll3
 To motivate a collectivist individual :
 (a) A challenging task should be given
 (b) A low risk task should be given
 (c)Should provide safe work environment

6-5
 Important Terms
 Factors of production
 resources, or inputs are what is used in
the production process to produce output
i.e. land, labor and capital.
 Per capita income
 the average income earned per person in
a given area (city, region, country, etc.) in
a specified year. It is calculated by dividing
the area's total income by its total
population.
6-6
 Important Terms
 Balance of trade
The balance of trade (BOT) is the difference between a
country's imports and its exports for a given time period
 Trade Deficit
 the amount by which the cost of a country's imports
exceeds the value of its exports.

 Trade Surplus
 the amount by which the value of a country's exports
exceeds the cost of its imports.

6-7
 Benefits of Trade
 The products which a country cannot
produced can be imported from other
country
 The products which cannot be produced at
low cost can be imported from another
country
 Ghana –Cocoa
 Brazil-Coffee

6-8
Trade theory helps to answer
 What products should we import and export?
 How much should we trade?
 With whom should we trade?
 Trade theory -Approaches
 Intervention approach
 Laissez-faire approach

6-10
 Interventionist Theories
 Theories that support government
intervention in the flow of trade
 Mercantilism
 Neomercantilism

5-11
 Mercantilism: 1500-1800
 A nation’s wealth depends on accumulated
treasure
 Gold and silver are the currency
of trade.
 Theory says you should have
a trade surplus.
 Maximize exports through
subsidies.
 Minimize imports through tariffs
and quotas.
 Mercantilism
 Mercantilism countries should export
more than they import
 Maintain a favorable balance of trade
 trade surplus
 Avoid an unfavorable balance of trade
 trade deficit
Flaw: “Zero-sum game”.
 Neomercantilism
 Neomercantilism run an export surplus
to achieve social or political objectives
 Since 2001 the need to boost Chinese domestic
economic growth has further driven China’s
interest in sub-Saharan Africa’s natural resources.

 Examining what drives Chinese aid allocation to

sub-Saharan Africa, empirical evidence suggests
that China provides more foreign aid to oil rich
sub-Saharan African countries than those that are
not oil rich.
 Almost half of the top 10 recipients of Chinese aid in the last
10 years gave access to oil wells and granted first rights to
prospect for oil in return.
 Examples include Angola and Nigeria.

 Providing billions in debt relief from 2000 onwards China

further cemented itself as a major aid role player in Africa.

 It established the forum on China-Africa cooperation

(FOCAC) which included 44 African countries.

 Financing for debt relief, training programmes and

investments.

6-16
 This conclusion is drawn from looking at
the determinants of American and Chinese
foreign aid to 31 countries in sub-Saharan
Africa.
 In the case of the US, both political rights
and civil liberty are considerations in its
aid allocation decisions to the region.
 For China, political rights are more
important than civil liberty in influencing
who receives aid.
6-17
 Free Trade Theories
 Two theories that support free trade
 Absolute advantage theory
 Comparative advantage theory
 Market forces should determine trade
 specialization

5-18
 COSTA RICAN TRADE, FOREIGN INVESTMENT,
AND ECONOMIC TRANSFORMATION
 Costa Rica
 Central American country of barely 4 million people
 successfully transformed its primarily agricultural
economy to one that includes strong technology and
tourism sectors as well.
 Bordering both the Pacific Ocean and the Caribbean arm
of the Atlantic,
 Costa Rica used international trade and factor mobility
policies to help achieve its economic objectives.
 Although exports of coffee and bananas are still
important, high-tech manufactured products
(electronics, software, and medical devices) are now the
backbone of Costa Rica’s economy and export earnings.

6-19
Like all countries, Costa Rica’s policies continually evolved,
but generally fall into four periods and categories:
 1800s–1960:
 a liberal trade regime
 promoted the exports of coffee and bananas

 1960–1982:
 a more protectionist regime that promoted import
substitution,
 i.e., a policy of developing domestic industries to
manufacture goods and provide services that would
otherwise be imported.
6-20
 1983–Early 1990s:
 a less protectionist regime
 promoted the liberalization of imports
 encouraged export promotion
 provided incentives to attract foreign capital and
expertise
 Early 1990s-Present:
 a liberal trade regime
 seeks the production of electronics, software, and
medical devices via strategic trade policy,
 i.e., the identification and development of targeted
domestic industries in order to improve their
competitiveness at home and abroad
6-21
 Theory of Absolute
Advantage
 Adam Smith: Wealth of Nations (1776).
 Different countries produce some goods more
efficiently than others
 Produce only goods where you are most
efficient, trade for those where you are not
efficient.
 Trade between countries is, therefore,
beneficial.
 Theory of Absolute Advantage
 Free trade brings
 Specialization
 natural advantage

 acquired advantage

 product technology
 process technology
 Greater efficiency
 Higher global output
6-24
Theory of Absolute Advantage
Production Possibilities under Conditions of Absolute Advantage

5-25
6-26
 Theory of Comparative Advantage

 David Ricardo: Principles of Political

Economy (1817).
 What happens when one country can produce
all products at an absolute advantage?
 Should import even if country is more efficient
in the product’s production than country from
which it is buying.
 Trade is a positive-sum game.
Theory of Comparative Advantage
 Theory of comparative advantage
 free trade can increase global output even if
one country has an absolute advantage in the
production of all products
 David Ricardo in 1817 discovered that gains
from trade occur if the country gives up less
efficient output in order to focus on more
efficient output
6-29
Theory of Comparative Advantage
Production Possibilities under Conditions of Comparative Advantage

5-30
. 6-31
 Factor Mobility Theory
Detect why production factors, especially
labor and capital, move internationally

5-36
 Capital Movement
 Short term Capital movements are more than
Long term Capital movements
 High Return low risk
 Interest rate differences across countries
 Political and economic conditions impact risk
 Companies invest for long term to reduce
operating cost,tap new market,improve quality
 Government give aid and loans
 Individuals remit funds to families and relatives

6-37
 People Movements
 gain more income
 flee adverse political situations
 Immigrant,Tourist,Student

6-38
Effects of Factor Movements
 Factor movements alter factor
endowments
 Effect on population
 Add skills
 Foreign capital –infrastructure and natural
resources

5-39
 Trade and Factor Mobility
 There are pressures for the most abundant
factors to move to areas of scarcity
 Mexico Vs US
 Ratio of land vs Labour
 Russia Vs China
 The lowest costs occur when trade and
production factors are both mobile

5-41
Trade and Factor Mobility
Unrestricted Trade, Factor Mobility, and the Cost of Tomatoes

5-42
6-43
 Lecture Objectives
 To understand FDI importance
 To analyse the recent trends of FDI inflows
and outflows
 To understand the reasons of FDI flows
 FDI
 Foreign direct investment (FDI) occurs
when a firm invests directly in new
facilities to produce and/or market in a
foreign country
 the firm becomes a multinational enterprise

 FDI can be in the form of

 greenfield investments - the establishment of a
wholly new operation in a foreign country
 acquisitions or mergers with existing firms in
the foreign country
 Stock Of FDI
 The stock of FDI - the total accumulated
value of foreign-owned assets at a given
time
 The Patterns Of FDI
 Both the flow and stock of FDI have
increased over the last 35 years
 Most FDI is still targeted towards developed
nations
 United States, Japan, and the EU
 but, other destinations are emerging
 South, East, and South East Asia
especially China
 Latin America
 The Source Of FDI
 Since World War II, the U.S. has been the
largest source country for FDI
 the United Kingdom, the Netherlands, France,
Germany, and Japan are other important
source countries
 together, these countries account for 60% of
all FDI outflows from 1998-2011
 FDI Growth -Reasons
1. a fear of protectionism
 want to circumvent trade barriers
2. political and economic changes
 deregulation, privatization, fewer restrictions on FDI
3. new bilateral investment treaties
 designed to facilitate investment
4. the globalization of the world economy
 many companies now view the world as their market
 need to be closer to their customers
 Patterns Of FDI
 Gross fixed capital formation - the total
amount of capital invested in factories,
stores, office buildings, and the like
 the greater the capital investment in an
economy, the more favorable its future
prospects are likely to be
 Acquisition Versus Greenfield
Investments?
 Most cross-border investment is in the
form of mergers and acquisitions rather
than greenfield investments
 between 40-80% of all FDI inflows per annum
from 1998 to 2011 were in the form of
mergers and acquisitions
 Acquisition Versus Greenfield
Investments?
 Firms prefer to acquire existing assets
because
 mergers and acquisitions are quicker to
execute than greenfield investments
 it is easier and perhaps less risky for a firm to
acquire desired assets than build them from
the ground up
 firms believe that they can increase the
efficiency of an acquired unit by transferring
capital, technology, or management skills
 Exports Vs FDI
 Question: Why does FDI occur instead of
exporting or licensing?
1. Exporting - producing goods at home
and then shipping them to the receiving
country for sale
 exports can be limited by transportation
costs and trade barriers
 FDI may be a response to actual or
threatened trade barriers such as import
tariffs or quotas
 Licensing Vs FDI
2. Licensing - granting a foreign entity the
right to produce and sell the firm’s product
in return for a royalty fee on every unit that
the foreign entity sells
 Internalization theory (aka market imperfections
theory) - compared to FDI licensing is less attractive
 firm could give away valuable technological
know-how to a potential foreign competitor
 does not give a firm the control over
manufacturing, marketing, and strategy in the
foreign country
 the firm’s competitive advantage may be based
on its management, marketing, and
manufacturing capabilities
 What Is The Pattern Of FDI?
 Question: Why do firms in the same
industry undertake FDI at about the same
time and the same locations?

 FDI flows are a reflection of strategic

rivalry between firms in the global
marketplace
 multipoint competition -when two or more
enterprises encounter each other in different
regional markets, national markets, or
industries
 Pattern Of FDI
 Question: Why is it profitable for firms to
undertake FDI rather than continuing to export
from home base, or licensing a foreign firm?
 Dunning’s eclectic paradigm - it is important to
consider
 location-specific advantages - that arise from using
resource endowments or assets that are tied to a
particular location and that a firm finds valuable to
combine with its own unique assets
 externalities - knowledge spillovers that occur when
companies in the same industry locate in the same
area
 The Theoretical Approaches To FDI
 The radical view - the MNE is a tool for
exploiting host countries

 The free market view - international

production should be distributed among
countries according to the theory of
comparative advantage
 embraced by advanced and developing nations
including the United States and Britain, but no
country has adopted it in its purest form
 Theoretical Approaches To FDI
 Pragmatic nationalism - FDI has both
benefits (inflows of capital, technology,
skills and jobs) and costs (repatriation of
profits to the home country and a negative
balance of payments effect)
 FDI should be allowed only if the benefits
outweigh the costs
 FDI Benefit
The Host Country
 There are four main benefits of inward
FDI for a host country
1. Resource transfer effects - FDI brings
capital, technology, and management
resources
2. Employment effects - FDI can bring jobs
 FDI Benefit
The Host Country
3. Balance of payments effects - FDI can
help a country to achieve a current
account surplus

4. Effects on competition and economic

growth - greenfield investments increase
the level of competition in a market,
driving down prices and improving the
welfare of consumers
 Costs Of
FDI To The Host Country
 Inward FDI has three main costs:
1. Adverse effects of FDI on competition
within the host nation
 subsidiaries of foreign MNEs may have
greater economic power than indigenous
competitors because they may be part of
a larger international organization
 The Costs Of
FDI To The Host Country
2. Adverse effects on the balance of payments
 when a foreign subsidiary imports a substantial
number of its inputs from abroad, there is a
debit on the current account of the host
country’s balance of payments

3. Perceived loss of national sovereignty and

autonomy
 decisions that affect the host country will be
made by a foreign parent that has no real
commitment to the host country, and over which
the host country’s government has no real
control
 FDI Benefit TO
The Home Country
 The benefits of FDI for the home country
include
1. The effect on the capital account of the
home country’s balance of payments from
the inward flow of foreign earnings
2. The employment effects that arise from
outward FDI
3. The gains from learning valuable skills from
foreign markets that can subsequently be
transferred back to the home country
 The Costs Of
FDI To The Home Country
1. The home-country’s balance of payments
can suffer
 from the initial capital outflow required to
finance the FDI
 if the purpose of the FDI is to serve the home
market from a low cost labor location
 if the FDI is a substitute for direct exports
 The Costs Of
FDI To The Home Country
2. Employment may also be negatively
affected if the FDI is a substitute for
domestic production
 offshore production
 MCQ1
 Which of the following statements is true
about the growth of foreign direct
investment in the world economy over the
last few decades? 
MCQ2
MCQ3
 How Does Government
Influence FDI?
 Governments can encourage outward FDI
 government-backed insurance programs to
cover major types of foreign investment risk

 Governments can restrict outward FDI

 limit capital outflows, manipulate tax rules, or
outright prohibit FDI
 How Does Government
Influence FDI?
 Governments can encourage inward FDI
 offer incentives to foreign firms to invest in
their countries
 gain from the resource-transfer and employment
effects of FDI, and capture FDI away from other
potential host countries

 Governments can restrict inward FDI

 use ownership restraints and performance
requirements
 How Do International
Institutions Influence FDI?
 Until the 1990s, there was no consistent
involvement by multinational institutions
in the governing of FDI

 Today, the World Trade Organization is

changing this by trying to establish a
universal set of rules designed to promote
the liberalization of FDI
 What Does FDI
Mean For Managers?
 Managers need to consider what trade
theory implies about FDI, and the link
between government policy and FDI

 The direction of FDI can be explained

through the location-specific advantages
argument associated with John Dunning
 however, it does not explain why FDI is
preferable to exporting or licensing, must
consider internalization theory
 What Does FDI
Mean For Managers?
A Decision Framework
 What Does FDI
Mean For Managers?
 A host government’s attitude toward FDI
is important in decisions about where to
locate foreign production facilities and
where to make a foreign direct investment
 firms have the most bargaining power when
the host government values what the firm has
to offer, when the firm has multiple
comparable alternatives, and when the firm
has a long time to complete negotiations