Chapter 5 Notes - Summary International Business PDF

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MGNT389 CHAPTER 5 Theories of International Trade and Investment

If countries did not trade  no access to products / services made elsewhere  pay higher prices for offerings – other nations can produce more economically  waste scarce resources – making products other countries could produce more efficiently Free trade – allows consumers to access the products they want at lower costs, which helps increase living standards worldwide Concept of comparative advantage / competitive advantage Comparative advantage – country-specific advantage - superior features of a nation – that provide unique benefits in global competition - derived from either (1) natural endowments / (2) deliberate national policies Includes  Inherited resources - labor, climate, arable land, petroleum reserves - e.g. Middle East  Advantages acquired over time - entrepreneurial orientation - availability of venture capital - innovative capacity Competitive advantage – firm-specific advantage - assets / capabilities of a company – that are difficult for competitors to imitate - typically derived from – (1) specific knowledge, (2) competencies, (3) skills, (4) superior strategies - e.g. innovativeness, close relationships with suppliers Nation-level theories - classical theories Why do nations trade? 1. 2. 3. 4. 5. 6.

Mercantilism Absolute advantage principle Comparative advantage principle Factor proportions theory International product life cycle theory New trade theory

How can nations – enhance their competitive advantage? 1. Competitive advantage of nations 2. Michael Porter’s diamond model 3. National industrial policy

MGNT389 CHAPTER 5 Theories of International Trade and Investment

Firm-level theories - contemporary theories Why / how do firms internationalize? 1. Firm internationalization How can internationalizing firms gain / sustain competitive advantage? FDI-based explanations  Internationalization process of the firm  Born globals and international entrepreneurship Non-FDI-based explanations  International collaborative ventures  Networks and relational assets Why do nations trade? Specialization - trade enables countries to use their national resources more efficiently - enables industries / workers to be more productive Classical theories Mercantilism – earliest explanation - national prosperity is the result of – a positive balance of trade - achieve by maximizing exports – and minimizing imports Trade surplus – to export more goods than they import Neo-mercantilism – belief that running a trade surplus is beneficial - e.g. labor unions – protect home-country jobs - e.g. farmers – keep crop prices high - e.g. manufacturers – rely heavily on exports Mercantilism tends to harm  Firms that import - import raw materials / parts used in the manufacture of finished products  Consumers - restricting imports – reduces choice of products - product shortages – lead to higher prices – inflation - beggar-thy-neighbor policies – promote benefits of one country – at the expense of others Free trade – generally superior approach - relative absence of restrictions to the flow of goods / services between nations Outcomes of free trade  Consumers / firms can more readily – buy the products they want  Imported products may be cheaper – than domestically produced products  Lower-cost imports – help reduce company expenses – raise profits  Lower-cost imports – help consumers save money – increase living standards

MGNT389 CHAPTER 5 Theories of International Trade and Investment

 Unrestricted international trade – increase the overall prosperity of poor countries Absolute advantage principle - countries differ in national endowments - each country is more efficient in the production of some products – and less efficient in the production of other products - the idea that a country benefits by producing only those products it can produce using fewer resources Adam Smith - nations have much to benefit from free trade - mercantilism deprives individuals of the ability to trade freely and to benefit from voluntary exchange - country wastes much of its national resources by having to product products it is not suited to produce efficiently – end up reducing the wealth of the nation as a whole Comparative advantage principle David Ricardo – The Principles of Political Economy and Taxation, 1817 - foundational logic for free trade Definition - it will be beneficial for two countries to trade with each other as long as - one is relatively more efficient at producing goods / services needed by the other - a country only needs to be relatively capable in producing various types of goods - e.g. United States – pharmaceuticals – abundant supply of knowledge workers / technology - e.g. China – producing shoes – abundant supply of labor / low wages National differences in efficiency  Inherited / natural resource advantages - e.g. fertile land, minerals, climate - e.g. South Africa – mineral deposits, diamonds - e.g. Brazil – wheat, beef  Create / acquire comparative advantages - e.g. capital, specialized knowledge, capabilities in quality assurance etc. - e.g. Japan – consumer electronics industry – Hitachi, Panasonic, Sony - e.g. South Korea – LG, Samsung Limitations of Absolute / Comparative Advantage Theory  Government restrictions – hamper international trade - e.g. tariffs (taxes on imports), import barriers, regulations  Governments may target / invest in certain industries - e.g. build infrastructure, provide subsidies - to boost the competitive advantages of home-country firms  Large-scale production in certain industries may provide economies of scale - EOS – tend to compensate weak national comparative advantages - modern communications / Internet – reduce cost / complexity of cross-border trade

MGNT389 CHAPTER 5 Theories of International Trade and Investment

 The main participants in the international trade are individual firms that differ in significant ways - highly entrepreneurial / innovative firms - have access to exceptional human talent – support international business success  International shipping and insurance - relatively costly – make imported goods more expensive – for cross-border trade  Traded products are not just commodities anymore - most traded goods are relatively complex – characterized by strong branding / differentiated features  Many services cannot be exported in the usual sense - e.g. banking, retailing - must be internationalized through FDI Factor proportions theory – factor endowments theory Eli Heckscher, Bertil Ohlin 1920 Two premises 1. Products - differ in the types / quantities of factors – required for their production - e.g. labor, natural resources, capital 2. Countries - differ in the types / quantities of production factors – they possess Each country should  Export products that intensively use relatively abundant factors of production  Import goods that intensively use relatively scarce factors of production - e.g. United States – capital-intensive products – pharmaceuticals, commercial aircraft - e.g. Argentina – land-intensive products – e.g. wine, sunflower seeds In addition to difference in the efficiency of production - differences in the quantity of production factors – determine international trade patterns - country possesses an abundance of a given production factor – obtains per-unit-cost advantage – in the production of goods – that use that factor intensively - e.g. Russia – has large workforce in numerous industries Leontief Paradox - numerous factors determine the composition of a country’s exports and imports - main contribution – international trade is complex / cannot be fully explained by a single theory - other country-level assets – e.g. knowledge, technology, capital – are instrumental - e.g. Taiwan – sizable population of knowledge workers – strong in electronics technology

MGNT389 CHAPTER 5 Theories of International Trade and Investment

International product life cycle theory – Raymond Vernon 1966 - each product and its manufacturing technologies go through - national advantages do not last forever - exporting product – cause underlying technology – widely known / standardized around the world - IPLC has become much shorter – new products diffuse much more quickly - e.g. rapid spread of new consumer electronics – e.g. smartphones, tablets 3 stages of evolution 1. Introduction - new product typically originated in an advanced economy - countries possess abundant capital, R&D capabilities – key advantages in the invention of new goods – e.g. Germany, United States - high-income consumers – willing to try expensive, new products - inventing country enjoy temporary monopoly 2. Maturity - product’s inventors mass produce it – seek to export to other advanced economies - manufacturing become more routine – foreign firms produce alternative versions - competition intensifies – export orders from lower-income countries – lead to narrow profit margin 3. Standardization - knowledge – how to produce product is widespread - mass production become dominant activity – accomplished using cheaper inputs / lower-cost labour - production shifts – to low-income countries – competitors enjoy low-cost advantages – economically serve export markets worldwide - inventing countries become – net importer New trade theory – Paul Krugman 1970 - argues that economies of scale are an important factor in some industries for superior international performance – even in the absence of superior comparative advantages - e.g. commercial aircraft industry - some industries succeed best – as their volume of production increases - national markets are small – solve by exporting / gaining access to much larger global marketplace - effect of increasing returns to scale allows the nation to specialize in a smaller number of industries in which it may not necessarily hold factor or comparative advantages - trade is beneficial even for countries that produce only a limited variety of products How can nations enhance their competitive advantage? Globalization of markets – foster new type of competition - race among nations to reposition themselves – as attractive for business / investment National competitiveness - the sum of national comparative advantages + competitive advantage of a nation’s firms collectively

MGNT389 CHAPTER 5 Theories of International Trade and Investment

3 contemporary perspectives (national competitive advantage) 1. The competitive advantage of nations 2. The determinants of national competitiveness 3. National industrial policy The competitive advantage of nations Michael Porter 1990 - depends on the collective competitive advantages of the nation’s firms - reciprocal relationship - competitive advantages that the nation holds – tend to drive the development of new firms / industries with these same competitive advantages E.g. United States - has national competitive advantage in professional services – because of Goldman Sachs (investment banking), Marsh & McLennan (insurance) - presence of strong services firms – provide overall national competencies in the global services sector Innovation - key source of competitive advantage – at firm / national levels The firm innovates in four major ways - develop 1. A new product / improve an existing product (product design) 2. New ways of manufacturing (production processes) 3. New ways of marketing 4. New ways of organizing company operations (training etc.) Innovation results primarily from R&D Firms spend on R&D for several reasons 1. Gain access to talent – gifted engineers reside around the world 2. To cut costs – lower-paid to replace higher-paid 3. To relocate certain R&D activities abroad – gain insights on specific target markets Innovation promotes productivity Productivity - output per unit of labor or capital - the more productive a firm is, the more efficiently it uses its resources - the more productive the firms in a nation are, the more efficiently the nation uses its resources - key determinants of nation’s – long-run standard of living - basic source of national per-capital income growth – e.g. Columbia, South Korea

MGNT389 CHAPTER 5 Theories of International Trade and Investment

Determinants of National Competitiveness Porter Diamond Model - comprises 4 major elements 1. Demand conditions - nature of home-market demand – for specific products / services - presence of demanding customers – firms innovate faster / better products - e.g. United States – senior citizens with health problems – create market for quality medical equipment 2. Firm strategy, structure, rivalry - nature of domestic rivalry / conditions in a nation - determine how firms are – created, organized, managed - compete for market share – also human talent, technical leadership, superior product quality - presence of strong competitors in a nation – create / maintain national competitive advantage - e.g. Japan – consumer electronics industries – Hitachi, Nintendo, Sony, Toshiba 3. Factor conditions - nation’s resources – e.g. labor, natural resources – e.g. capital, technology, know-how etc. - each nation has a – relative abundance – of certain factor endowments - determine the nature of its national competitive advantage - e.g. Germany – workers with strong engineering skills – global engineering / design 4. Related and supporting industries - the presence of clusters of – suppliers, competitors, skilled workforce Industrial cluster - concentration of businesses, suppliers, supporting firms in the same industry – located at particular geographic location - characterized by a critical mass of – human talent, capital, or other factor endowments Advantages  information / knowledge exchange  cost-savings – economies of scale / scope Examples  Italy – fashion  Switzerland – pharmaceutical  Vietnam - footwear  Singapore – medical technology  Stockholm, Sweden – Wireless Valley  Japan – consumer electronics Knowledge and skills - most important sources of national advantage - deciding where companies will locate – e.g. Silicon Valley (California), Bangalore (India) - most important source of sustainable long-run competitive advantage

MGNT389 CHAPTER 5 Theories of International Trade and Investment

National industrial policy - proactive economic development plan – a government initiates to build / strengthen a particular industry - often in collaboration with the private sector Governments design policies to support high value-adding industries - favored traditional industries – e.g. automobiles, shipbuilding, heavy machinery etc. High value-adding industries - typical knowledge-intensive industries – e.g. IT, biotechnology, medical technology, financial service - yield higher corporate profits, better wages, tax revenues Examples of national industrial policy  Dubai - to become international commercial center – information / communication technology sector  Singapore’s Innovation Manisfesto  - to become world-class center of excellence in – nuclear technology Government – either positively / negatively – influence each of the four components of the Porter diamond  Demand - related / supporting industries through regulations  Factor - supporting educational initiatives, capital markets  Firm strategy, structure, rivalry - government tax policies / regulations Features of National Industrial Policies 1. Tax incentives - save / invest money – used as capital for public / private investment in R&D 2. Monetary / fiscal policies - low-interest loans – stable supply of capital 3. Educational systems - steady stream of competent workers 4. Infrastructure - IT, communication system, transportation – enhance productivity 5. Legal / regulatory systems - ensure stability od national economies National Industrial Policy in Practice - New Zealand (refer to textbook) Why and how do firms internationalize? Internationalization process of the firm - 1970 Exporting – simplest foreign market entry strategy Foreign direct investment – most complex market entry strategy Slow nature of internationalization

MGNT389 CHAPTER 5 Theories of International Trade and Investment

- results from – uncertainty / uneasiness, lack of foreign market information, increasing levels of control and risk Stages in the Internationalization Process of the Firm 1. Domestic Focus - management unable / unwilling to start – concerns over readiness / perceived obstacles 2. Pre-export stage - receive unsolicited product orders from abroad – investigate feasibility 3. Experimental involvement - limited international activity – through basic exporting 4. Active involvement - systematic exploration of international options - commitment of resources / managerial time – to achieve international success 5. Committed involvement - genuine interest / commitment of resources – make international business part of profit-making, value-chain activities Example – Samsung Corporation (refer to textbook) Born global firms - innovative start-ups that – initiate international business soon after their founding - e.g. Instagram – only 12% customers are located in North America (based) - early internationalizing firm – more common 2 main reasons  Globalization - doing international business – easier than before  Advances in communication / transportation technologies - reduce costs of operating internationally How can internationalizing firms gain and sustain competitive advantage? FDI-based explanations FDI – preferred entry strategy of MNEs - conduct business through the networks of – production facilities, marketing subsidiaries, regional headquarters, other operations around the world - traditionally – Western Europe, United States, Japan - emerging markets – China, India, Russia – greatly increased FDI investments – 1/3 of global GDP - Africa – receive little FDI – hinder living standards FDI stock - the total value of assets that MNEs invest abroad  Even smaller economies are popular destinations for direct investment  Both developed / developing economies are – major recipients of FDI  Hong Kong / Singapore – considerable FDI as important entrepot ports - merchandise can be imported without paying import duties - China – world’s largest emerging market

MGNT389 CHAPTER 5 Theories of International Trade and Investment

3 alternative theories 1. Monopolistic advantage theory 2. Internalization theory 3. Dunning’s Eclectic Paradigm Monopolistic advantage theory - firms that use FDI as an internationalization strategy must own or control – certain resources / capabilities not easily available to competitors - this give them – a degree of monopoly power over local firms – in the foreign markets - monopolistic advantage should be specific to the MNE – e.g. proprietary technology / brand name 2 conditions  Returns accessible in the foreign market should be superior - to those available in the home market  Returns achievable in the foreign market should be superior - to those earned by existing domestic competitors – in the foreign market Example – Samsung Corporation (refer to textbook) Internalization theory - explains the process by which – firms acquire / retain one or more – value-chain activities inside the firm - minimize disadvantages of – dealing with external partners - allows for greater control over foreign operations - e.g. MNE – internalize manufacturing – by acquiring / establishing own plant in the foreign market - control proprietary knowledge – critical to the development, production, sales of products / services Procter & Gamble – enter Japan through FDI – instead of exporting 3 reasons 1. trade barriers imposed by the Japanese government 2. strong market power of local Japanese firms 3. risk of losing control over proprietary knowledge Samsung Dunning’s Eclectic Paradigm - most comprehensive of FDI theories - framework to explain – the extent / pattern of the value chain operations – that companies should own abroad 3 conditions – determine whether a company will internationalize through FDI 1. Ownership-specific advantages 2. Location-specific advantages 3. Internalization advantages Ownership-specific advantages - MNE should hold – knowledge, skills, capabilities, key relationships – owns...