International Trade
India's Economic Policy Shift and International Business Concepts
Barriers to internationalization
Based on a survey
Categorized as:
Capabilities:
Inadequate quantity of untrained personnel,
lack of managerial time to deal with internationalization,
inability to contact potential overseas customers
developing new products for foreign markets
meeting export product quality or standards.
Finance:
Shortage of working capital to finance exports.
Access:
Limited information to locate or analyze markets
identifying foreign business opportunities
unfamiliar exporting procedures or paperwork.
Business Environment:
Unfamiliar foreign business practices in the host country
Bartlett and Ghoshal Model
This model indicates that strategic options for managing international operations are based on two pressures or forces on firms competing internationally
The two forces are
Local Responsivenes
Refers to the extent to which a company adapts its products, services, and marketing to meet the specific needs of local markets
global Integration
refers to the process of merging a company's operations and strategies across different countries, creating a cohesive global entity. This involves leveraging worldwide resources and ideas to enhance efficiency and global competitiveness
These pressures determine four grids in a matrix
The Four Categories are:
Global Companies:
high Pressure for Global Integration & Low pressure for Local Responsiveness
Transnational Company:
High pressure for global integration and high pressure for local responsiveness
International Structure:
Low pressure for global integration and low pressure for local responsiveness
Multi-domestic or MNC:
Low pressure for global integration and high pressure for local responsiveness.
The model suggests companies need to "act local, be global," emphasizing the need to understand local tastes, preferences, and consumer needs to be successful in a host country
India's New Economic Policy (NEP) of 1991
The NEP refers to economic liberalization
Before 1991, India was a more closed market with several issues, notably the "license raj permit" system, which hindered business growth, especially for foreign firms. Bureaucrats controlled licenses required for almost everything.
The NEP involved liberalization or relaxation in import tariffs, deregulation of markets (opening up for private and foreign players), and reduction of taxes.
This policy, also known as the LPG framework (Liberalization, Privatization, Globalization), was started by Dr. Manmohan Singh, the former Prime Minister, who is considered the father of the New Economic Policy of India
Objectives of the New Economic Policy
Taking india towards arena of globalization
Bring down rate of inflation
Move towards higher economic Growth rate
Build Sufficient Foreign Exchanges reserves
Achieve Economic Stabilization
To convert the economy into a market economy by removing unnecessary restrictions (like the permit system and permissions required previously
To permit the international flow of goods, services, capital, human resources, and technology without many restrictions
To increase the participation of private players in all sectors.
Major highlights of the 1991 reforms
De-reservation of industries from the public sector.
Liberalization: Abolition of the industrial licensing system.
Privatization: Of public sector enterprises. The government felt it was "none of our business to be to do business".
Globalization: Welcoming globalization
LPG Framework
Liberalization
Refers to the relaxation of government regulations and restrictions in the economy.
Aims for free flow of goods and services between countries and greater participation of private entities
Key aspects of liberalization included:
Abolition of Licensing
Liberalization of Foreign Investment
Moving from requiring prior approval for foreign companies to automatic approvals for FDI (Foreign Direct Investment) in many cases. A list of high priority/investment intensive industries were delicensed and could invite up to 100% FDI (though percentages vary by sector, e.g., 49%, 20%
Relaxation of locational Restrictions
No central government approval required for setting up industries anywhere, except for those needing compulsory licensing or in cities over 1 million population (where polluting industries had to be located 25km away
Liberalization of Foreign Technolog Impports:
Automatic licenses given for foreign technology imports up to 2 million US dollars for business projects requiring imported capital goods, technology, or raw materials. No permission needed for hiring foreign technicians or foreign testing of indigenously developed technologies
Abolition of Phased Manufacturing Programmes (PMP)
Foreign Investment Promotion Board (FIPB):
Setup to speed up approval for foreign investment proposals. This allowed Indian companies to import and foreign companies to easily set up plants in India
Privatization
Defined as the transfer of ownership and management of an enterprise from the public sector to the private sector
Often applied to ill or unhealthy public sectors that the government thought should be sold off, except in sensitive sectors like defense
Objectives of privatization:
Improve the financial situation of the government (capital saved used for social development).
Reduce the workload of PSUs (Public Sector Units).
Raise funds from disinvestment (selling government stocks in PSUs).
Increase the efficiency of government organizations.
Provide better and improved goods and services, driven by growing market demand and competition from international firms
Types of privatization:
Delegation: Government keeps responsibility, private enterprise handles delivery of product/services (fully or partly).
Disinvestment: Government surrenders responsibility completely to the private sector.
Displacement: Private enterprise expands and gradually displaces the government entity
Globalization
Globalization helps countries join hands and increase cross-border transactions
India signed agreements with the WTO (World Trade Organization) affirming commitment to liberalized trade, such as TRIPs (Trade Related Intellectual Property Rights), TRIMs (Trade Related Investment Measures), and Agreement on Agriculture
Steps taken for globalization:
Reduction in tariffs: Customs duty on imports and exports reduced gradually to make India attractive to global investors.
Long term trade policy: Trade policy enforced for longer durations, as short-term policies are less beneficial.
Increase in equity limit of foreign investment: Raised in specific sectors; up to 100% allowed in many areas.
Partial convertibility of the Indian currency: Allows converting Indian currency into other currencies
Theories & Patterns of International Trade
Some trade patterns are easily understandable based on resource endowments.
Examples of resource-based exports include:
Saudi Arabia exporting oil (due to large oil reserves).
Ghana exporting cocoa.
Brazil exporting coffee.
Sri Lanka exporting spices
However, other trade patterns are less obvious and raise questions, such as:
Why does Switzerland export chemicals, pharmaceuticals, watches, and jewellery?
Why does Japan export automobiles, consumer electronics, and machine tools?
Why does the U.S. import significant amounts of textiles from countries like Honduras, Guatemala, and Bangladesh?
Understanding how these trade decisions happen is a key topic
Types of Patterns of World Trade
The patterns of world trade can be classified into three main types: intra-industry trade, inter-industry trade, and resource-based trade.
Intra-Industry Trade: This refers to the exchange of similar goods between countries. Intra-industry trade is common among developed countries that produce similar goods, such as automobiles or electronics.
Inter-Industry Trade: This refers to the exchange of dissimilar goods between countries. Inter-industry trade is common between developed and developing countries, where the developed country exports manufactured goods, and the developing country exports raw materials.
Resource-Based Trade: This refers to the exchange of natural resources between countries. Resource-based trade is common among developing countries that export raw materials, such as oil or minerals, to developed countries.
Reasons for International Trade
Differences in Technology: Countries with an advantage in specific technologies can produce more products and export them
Differences in Resources Endowments: Resource endowments include factors like land, labor, capital, and entrepreneurship. Differences in these endowments give countries advantages in producing certain goods
Differences in Demand:Consumer needs and preferences differ across countries, leading to different demand patterns
Scope for Economies of Scale in Production: Economies of scale occur when the cost of production per unit decreases as the volume of production increases. This inverse relationship is due to factors like becoming an expert in handling raw materials, negotiating lower raw material prices, and reduced wastage or switching costs
Supportive Government Policies
What International Trade Allows a Country?
Specialize in manufacturing and exporting products it can produce efficiently
Import products that can be produced more efficiently in other countries.
Example: India may export textiles where it has expertise but import machine tools or technology from countries like Germany or Sweden where they are more efficient
Helps in creating jobs and boosting economic growth.
Example: Companies like Ford and Samsung setting up operations in India create local jobs.
Companies gain a competitive advantage in global trade. This competitive advantage can stem from various factors.
Example: India's competitive advantage comes from its English-speaking population, large demography, huge population, and growing skill sets
Approaches to Exports & Imports
Laissez-Faire Approach
refers to a policy of minimal government intervention in economic affairs, where the market is left to operate freely with limited regulation
Laissez-faire translates to "leave alone" or "let do" in French, and it advocates for a hands-off approach to economic management.
This means reducing taxes, regulations, and tariffs, allowing the market to be driven by supply and demand
Associated with this approach are free trade theories, such as the Absolute Advantage theory (Adam Smith) and the Comparative Advantage theory (David Ricardo). These theories generally prescribe that the government should not intervene directly to affect trade
Interventionist Approach (Command Economy)
In this approach, the government determines what to produce, how to produce, and for whom to produce
refers to the practice of a state or group of states actively interfering in the internal affairs of another state to influence its policies or actions
Countries fall on a spectrum between these extremes (e.g., North Korea and, to a large extent, China are closer to command economies, while Hong Kong and the USA are closer to laissez-faire)
Associated with this approach are theories like Mercantilism and Neo-mercantilism, which prescribe a great deal of government intervention to affect trade
Free Trade Theories (Laissez-faire Approach)
Then we introduce two calssical Free trade throries
Absolute Advantage Theory by Adam Smith.
Comparative Advantage Theory by David Ricardo
Both theories hold that nations should neither artificially limit imports nor promote exports. Artificial means using subsidies or barriers that distort the market mechanism. They align with Adam Smith's concept of the "invisible hand," where individuals pursuing their own interests benefit the nation as a whole, allowing consumers to determine which producers succeed based on providing the best products
Absolute Advantage Theory (Adam Smith)
Core Idea: A country should specialize in producing goods where it is more efficient than any other country (has an absolute advantage) and then trade these goods for products in which other countries have an absolute advantage.
Advantage Source: Absolute advantage can be natural (climate, resources, labor force availability) or acquired (product or process technology).
Examples:
Saudi Arabia's oil is a natural advantage;
India's population and climate are natural advantages
the U.S. and Russia's arms technology is an acquired advantage.
View of Trade: A positive-sum game, where both countries benefit from specializing and trading
Example of Absolute Advantage (Ghana & South Korea: Cocoa & Rice)
The lecture uses an example with two countries, Ghana and South Korea, each with 200 units of resources, producing either rice or cocoa.
Production Efficiency:
Ghana: 10 units of resources for 1 ton of cocoa; 20 units for 1 ton of rice.
South Korea: 40 units of resources for 1 ton of cocoa; 10 units for 1 ton of rice.
Analysis of Absolute Advantage:
Ghana is more efficient at producing cocoa (takes only 10 resources per ton compared to South Korea's 40).
South Korea is more efficient at producing rice (takes only 10 resources per ton compared to Ghana's 20).
Scenario 1: No Trade (Using 100 units for each product):
Ghana: 10 tons cocoa (100/10) and 5 tons rice (100/20).
South Korea: 2.5 tons cocoa (100/40) and 10 tons rice (100/10).
Total Production (Without Trade): 12.5 tons cocoa (10+2.5) and 15 tons rice (5+10).
Scenario 2: Specialization and Trade (Using all 200 units for the product of absolute advantage):
Ghana specializes in cocoa: Produces 20 tons cocoa (200/10) and 0 tons rice.
South Korea specializes in rice: Produces 0 tons cocoa and 20 tons rice (200/10).
Total Production (With Specialization): 20 tons cocoa and 20 tons rice.
Comparison: Total cocoa production increased from 12.5 to 20 tons. Total rice production increased from 15 to 20 tons. This shows a gain in total output due to specialization.
Consumption After Trade: If Ghana trades 6 tons of cocoa to South Korea for 6 tons of rice:
Ghana: Starts with 20 tons cocoa, gives 6 away -> 14 tons cocoa left. Starts with 0 tons rice, receives 6 -> 6 tons rice gained.
South Korea: Starts with 20 tons rice, gives 6 away -> 14 tons rice left. Starts with 0 tons cocoa, receives 6 -> 6 tons cocoa gained.
Consumption (After Trade): Ghana has 14 tons cocoa and 6 tons rice. South Korea has 6 tons cocoa and 14 tons rice.
Comparison to No Trade Consumption:
Ghana: Consumes more cocoa (14 vs 10) and more rice (6 vs 5). (+4 cocoa, +1 rice).
South Korea: Consumes more cocoa (6 vs 2.5) and more rice (14 vs 10). (+3.5 cocoa, +4 rice).
Conclusion: Both countries end up consuming more of both goods than they could without specialization and trade. This demonstrates that trade is a positive-sum game.
Comparative Advantage Theory (David Ricardo)
Ricardo asked: what happens if one country has an absolute advantage in producing both goods? Should there still be trade?
Core Idea: Even if a country is more efficient at producing all goods than another, it should still specialize in producing the good in which it is relatively more efficient or has the lower opportunity cost. It should then import the good in which it is relatively less efficient.
Opportunity Cost: The cost of passing up the next best alternative when making a decision. The country with the comparative advantage has a lower opportunity cost for the good it specializes in.
View of Trade: Also a positive-sum game where participating countries realize economic gains
Trade Pattern Theories
Objectives of Trade Pattern Theories?
To answer the 3 key questions
How much does a country trade? What volume of trade occurs?
What kinds of products does a country trade? Does it trade all types or is it specialized (e.g., capital-intensive, labor-intensive, natural goods)?
With whom does a country trade? Are trade relationships decided based on close ties or equal affinity
How Much Does a Country Trade?
factors that determine the volume of a country's trade
Theory of Country Size:
This theory suggests that countries with large land areas, vast natural resources, and varied climates tend to be more self-sufficient than smaller countries
Large countries like India, China, and Russia can produce most of what they need due to their size and diverse resources
An important point related to size is that in large countries, production and market centers might be located further from other countries, potentially raising transportation costs
Size of the Economy:
The economic size of a country also impacts its trade volume.
Data shows that China, the United States, and Germany together account for over 30% of world merchandise trade
The top 10 merchandise traders (large sellers) account for over 52% of the world's total trade
What Types of Products does a Country Trade?
theories and factors influencing the types of products a country exports and imports
Factor Proportions Theory (Heckscher-Ohlin Theory):
countries tend to export goods that utilize their abundant, cheaper factors of production intensively and import goods that require their scarce, more expensive factors
Examples provided illustrate this:
India has a huge coastline (fish production),
cultivable land (wheat/rice production), and cheap labor.
Iran has natural oil.
Bangladesh has cheap labor, leading to textile exports.
Australia and Canada have large land resources, enabling high production of wool and wheat
The theory applies to both labor-intensive and capital-intensive production
Countries with abundant capital, like the US, Germany, or Switzerland, tend to produce and export capital-intensive goods, depending less on labor
Countries with abundant labor, like Iran or Bangladesh, excel in labor-intensive products such as handmade carpets or textiles
People and Land: This point is connected to the Factor Proportions Theory, reiterating how abundant land resources in countries like Australia and Canada support high production of products like wool and wheat
Availability of Capital, Labor Rate, and Specialization: This further elaborates on the Heckscher-Ohlin concepts, highlighting how countries with significant capital invest in capital-intensive industries
Manufacturing Location: A country's ability to provide space and a favorable environment (like allowing FDI and providing freedom) influences the types of industries it can host and thus the products it manufactures
Product Technology: Most new products originate in developed countries which have attained high levels of technological growth
Process Technology: Different methods can be used to produce the same product. For example, rice production in India or Bangladesh might be labor-intensive due to cheap labor, while in Italy, it is increasingly mechanized due to less available manpower
With Whom Does a Country Trade?
factors that influence a country's choice of trade partners
Country Similarity Theory:
This theory suggests that most trade today occurs among high-income countries with similar market segments, consumer behavior, and culture
Trading with similar markets allows for standardization of products, leading to economies of scale for companies
Specialization and Acquired Knowledge:
Countries tend to trade with those who need their specialized products or services.
Examples include Germany's strength in manufacturing luxury cars being traded in markets with demand, and India's advantage in IT leading to outsourcing business from countries like the US, Australia, or Canada
Product Differentiation:
Consumers' changing tastes and preferences can lead to a demand for imported products, even if similar goods are produced domestically.
If consumers dislike domestic products (e.g., Indian designer watches), they might seek similar but differentiated products from other markets, facilitated by global connectivity
Effect of Cultural Similarity:
Shared cultural elements, often resulting from historical ties (like India being a former British colony, influencing language, lifestyle, and even driving customs), can create a basis for trade relationships
Effect of Political Relationship:
The political relationship between countries significantly impacts trade
Effect of Distance:
Countries often trade with geographically close neighbors to minimize transportation costs
Import Theories & Paradoxes
Leontief's Paradox
Objective: Leontief's initial interest was to empirically prove the correctness of the Heckscher-Ohlin (H-O) model. Specifically, he wanted to demonstrate that U.S. exports were capital intensive, as the H-O model would predict for a capital-abundant country like the U.S.
Heckscher-Ohlin (H-O) Theory Recap (Context for the Paradox): The H-O model posits that a country will export goods that intensively use factors (like capital or labor) that are locally abundant and import goods that intensively use factors that are locally scarce
Leontief's Findings (The Paradox): Leontief found the exact opposite result of what the H-O model predicted.
He calculated the capital requirement per man-year for U.S. exports (KX/LX) and for import substitutes (KM/LM).
For U.S. exports, the ratio was 13,991 per man-year.
For U.S. import substitutes, the ratio was 18,184 per man-year.
Dividing these, he got a ratio of 0.77 (KX/LX divided by KM/LM).
This meant that U.S. exports used a lower capital-labor ratio than its import substitutes. In other words, U.S. exports were less capital-intensive (and thus relatively more labor-intensive) than the goods the U.S. imported or produced domestically to substitute imports
The Paradoxical Conclusion: Leontief reached the profound conclusion that the U.S., the most capital-abundant country in the world, was exporting labor-intensive commodities and importing capital-intensive commodities. This finding was directly contrary to the H-O model's predictions.
Significance: Leontief's Paradox is considered a very significant and famous empirical investigation in economics, challenging a major established trade theory.
Product Life Cycle (PLC) Theory of Trade
Core Idea: The theory states that the location of production for certain kinds of products shifts as they move through their life cycle. This life cycle consists of four stages: Introduction, Growth, Maturity, and Decline
The Four Stages and Their Characteristics
Introduction Stage:
Product: Marked by evolving product characteristics and innovation in response to an observed need. Products are newly introduced.
Location of Production: Usually in the innovating country (typically a developed country).
Market Location: Mostly focused on the home market.
Competitive Factors: Characterized by a monopoly situation or very few competitors. Sales are based on the uniqueness and demand for the product, not primarily on price.
Production Technology: Involves short production runs because demand is uncertain. Evolving production methods coincide with product evolution. Requires high labor inputs and labor skills relative to capital because it's a new, unfamiliar product. Companies don't make much profit yet.
Trade: Exporting occurs by the innovating country, though perhaps limited by factors like high transportation costs
Growth Stage:
Product: The product is becoming more standardized.
Location of Production: Shifts to include the innovating country and other industrial (developed) countries. Some foreign production starts to cater to demand in other markets, especially where transportation costs are high.
Market Location: Mainly in industrial countries. Exports shift towards foreign production replacing exports in some markets.
Competitive Factors: Characterized by fast-growing demand and an increasing number of competitors. Some competitors start price cutting. Competition increases as profitability rises.
Production Technology: Capital input increases. Production methods become more standardized. Companies become expert and gain specialization in production. Production is cheaper and more efficient.
Trade: Increase in exports by the innovating country
Maturity Stage:
Product: The product is becoming more standardized.
Location of Production: Shifts to include the innovating country and other industrial (developed) countries. Some foreign production starts to cater to demand in other markets, especially where transportation costs are high.
Market Location: Mainly in industrial countries. Exports shift towards foreign production replacing exports in some markets.
Competitive Factors: Characterized by fast-growing demand and an increasing number of competitors. Some competitors start price cutting. Competition increases as profitability rises.
Production Technology: Capital input increases. Production methods become more standardized. Companies become expert and gain specialization in production. Production is cheaper and more efficient.
Trade: Increase in exports by the innovating country
Decline Stage:
Product: Overall demand starts to decline.
Location of Production: There is a concentration of production in developing countries. The innovating country finds it uneconomical to produce and stops producing this product, moving to new products instead.
Market Location: Most market location shifts to the developing countries. Some developing countries start exporting in a large way, including exporting to the developed nations (the innovating country).
Competitive Factors: Price is the key weapon. The number of producers continues to decline.
Production Technology: Often uses unskilled labor or is mechanized with long production runs, typically in developing countries.
Trade: The innovating country becomes a net importer and stops exporting the product completely.
Limitations of the PLC Theory:
It doesn't hold if transportation costs are very high.
It doesn't apply well to products with very rapid innovation, where a new design emerges frequently
It doesn't apply to luxury products where cost is of little concern to consumers. The assumption of price decline throughout the stages doesn't hold for these products
Porter's National Competitve Advantage (Porter's Diamond)
Core Idea: Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes contribute to a nation's competitive advantage in specific industries. Think of these four attributes as forming a "diamond."
The Four Attributes (The Diamond):
Factor Endowments:
This refers to a nation's position in factors of production (like land, labor, capital, infrastructure) needed to compete in a given industry
Basic Factors: These are naturally endowed or God-given, such as natural resources, climatic conditions, location (e.g., access to ports), and demographics
Advanced Factors: These are products of investment by individuals, companies, and governments. Examples include sophisticated communication infrastructure, skilled labor, research facilities, and technical know-how
Demand Conditions:
This concerns the nature of home demand for the country's products or services
A nation's firms gain competitive advantage if their domestic consumers are sophisticated and demanding
Demanding consumers pressure firms for innovation and quality improvements
Related and Supporting Industries:
This refers to the presence (or absence) of internationally competitive supplier industries and other related industries
Successful industries often cluster geographically
Competitive supporting industries can create spillover effects and contribute to the competitiveness of the main industry. If auxiliary parts or services needed to produce a main product are readily available locally and competitive, it provides an advantage
Firm Strategy, Structure, and Rivalry:
This considers how companies are created, organized, and managed within a nation, and the nature of domestic rivalry
Different nations have different management ideologies. Example: Japanese focus on 100% correctness vs. U.S. focus on being close to 100%. These ideologies can influence competitive advantage. Example: German excellence in machines is linked to how their companies are created and managed
Dynamic domestic rivalry induces firms to constantly look for ways to improve efficiency, innovate, and improve quality. This pressure helps reduce costs and encourages investment in upgrading advanced factors
Policy Implications of Porter's Diamond:
Porter suggests that it is in the best interest of businesses to:
Invest in upgrading advanced factors of production (e.g., better training for employees, increasing R&D commitment).
Lobby the government to adopt policies favorable to each component of the national diamond.
Businesses should urge governments to:
Increase investment in education, infrastructure, and basic research. India's recent growth is partially attributed to investment in infrastructure and education.
Adopt policies that promote strong competition within the domestic market. China's government support creating pressure/efficiency is cited as an example of a government's role
Limitations of Porter's Diamond:
The existence of the four favorable conditions does not guarantee that an industry will necessarily develop in a given location
The increased international mobility of factors (capital, managers, materials, components) is a challenge to the theory
Porter's theory has not yet been sufficiently tested empirically to fully confirm its validity
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