Lecture International trade and investment (2/e): Chapter 3 - John Gionea

Chapter 3
International trade theory

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–1


Lecture plan
• Mercantilism
• Absolute advantage
• Comparative advantage
• Comparative advantage versus
competitive advantage
• Factor endowments
• The new trade theory
• Porter’s diamond
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–2


Mercantilism: mid-16th century
• A nation’s wealth depends on accumulation of
precious metals (e.g. holdings of gold and silver).

• Theory says you should have a trade surplus
– maximise exports through subsidies
– minimise imports through tariffs and quotas.
• David Hume (1752): persistent trade surplus will
affect money supply and in the long run close the
trade surplus.
• Key problem: ‘zero-sum game’.
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–3


Theories of international trade:
absolute advantage
• Exporting country holds superiority in availability of
certain goods. Reasons:
– climate, quality of land, and natural resources
– differences in labour, capital, technology and
– entrepreneurship
Beef
Computer Printers
(tonnes)
(units)
Australia
800
200
Japan

400
500
• Australia has an absolute advantage in beef, while
Japan has an absolute advantage in printers.
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–4


Theory of competitive advantage
• David Ricardo (1817)
• One country has a comparative advantage
over another in the production of a certain
commodity if its opportunity cost of
producing that commodity is lower.

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–5


Alternative production possibilities
from 100 units of resources
 

Commodity Cheese
Country
(tonnes)

Cloth
(bolts)

Australia

200

160

UK

80

120

 

Source: Table 3.2

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–6

Opportunity cost and comparative
advantage
 

Production Australia
1 tonne of
cheese

0.8 bolts
of cloth

1 bolt of cloth 1.25 tonne
of cheese

UK
1.5 bolts of
cloth
0.67 tonnes
of cheese

 

Source: Table 3.3
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–7


Diversified production before trade
production/consumption
 

Resources
(units)

Cloth
(bolts)

Australia

100

37.5 x 1.6 = 60

UK

100

120

 

Source: adapted from Table 3.4
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–8


Theory of comparative advantage
and the gains from trade
Australia
UK
Total production

Production and Consumption without Trade
Cheese (tonnes) Cloth (bolts)
125
60
40
60
165
120

Australia
UK
Total production

Production with Trade Specialisation
200
120
200
120

Consumption after UK trades 60 bolts of cloth for 60 tons of Australian cheese
Australia
140
60
UK
60
60
Total consumption
200
120
Increase in consumption as a result of specialisation and trade
Australia
15
0
UK
20
0
Total consumption
35
0
Source: adapted from Table 3.5
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–9

Comparative vs competitive
advantage
• Comparative advantage is a concept
based on relative costs of production (and
opportunity cost) between nations.
• Competitive advantage is a concept used
to compare the ability of two companies to
compete in the same business.

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–10


Factor Endowments (Heckscher
and Ohlin)
• Explains differences
difference ininopportunity
opportunitycosts.
costs.
• Factor endowment: a country’s share of factors of
production (e.g. land,capital, labour, enterprise).
• Countries will specialise in those goods which
make more intensive use of abundant/cheap
factors.
– cheese: land-intensive
– cloth: labour-intensive

• The theory can explain Australia-Japan trade
patterns.
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–11


Limitations of the trade theory
• The theory disregards a number of  
considerations:
– the difficulty in moving resources in the 
desired industries
– fluctuations in demand
– trade barriers
– other political restraints

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–12


The new trade theory
• Began to be recognised in 1970s.
• Deals with returns on specialisation where

substantial economies of scale are present.
– Specialisation increases output; ability to
enhance economies of scale increase.
– In some industries there are likely to be only a
few profitable firms.

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–13


The new trade theory cont.
• Thus firms with first mover advantages
will develop economies of scale and
create barriers to entry for other firms.
• The commercial aircraft industry is an
excellent example (e.g. Boeing, Airbus).
• New trade theory does NOT contradict
the theory of comparative advantage, but
instead identifies a source of comparative
advantage.
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–14

Implications from the application of
new trade theory
• Typically, requires industries with high,
fixed costs.
• World demand will support few competitors.
• Competitors may emerge because ‘they got
there first—first-mover advantage.
• Some argue that it generates government
intervention and strategic trade policy
(e.g. the need to nurture and protect ‘first
movers’).

Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–15


National competitive advantage:
Porter’s diamond
(Harvard Business School, 1990)

• Looked at 100 industries in 10 nations
– thought existing theories didn’t go far
enough.
• Results contained in The Competitive

Advantage of Nations.
• Question: ‘Why does a nation achieve
international success in a particular
industry?’ (e.g. Switzerland in watches and
pharmaceuticals; Finland in mobile
phones).
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–16


Determinants of national
competitive advantage
Chance

Firm Strategy
Structure, and
Rivalry
Demand 
Conditions  
  

Factor   
Endowments
Related and    
Supporting 
Industries   

Source: Fig. 3.1
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

Government
3–17


Porter’s diamond
• Success occurs where these attributes
exist.
• More/greater the attribute, the higher
chance of success.
• The four attributes, government policy and
chance work as a reinforcing system.
• Nokia is a good example of a firm which
has built its competitive advantage as a
result of factors in Porter’s diamond.
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–18


Evaluating Porter’s theory
• If Porter is right, his model is expected to

predict the pattern of international trade in
the real world:
– a country’s exports should reflect the
presence of the four ‘diamond’
components
– countries will import in those areas where
the components are not favorable.
• This theory is too new; requires
independent empirical testing.
Copyright 2006 McGraw-Hill Australia Pty Ltd. PPTs t/a International Trade and Investment:
An Asia-Pacific Perspective 2e by Gionea. Slides prepared by John Gionea..

 

3–19