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Theories of International Trade
and Investment: Driving Global
Competitiveness
Theories of International Trade and
Investment
Comparative Advantage
Comparative advantage refers to the superior features of a country that provide unique benefits in global competition, typically derived from either natural endowments or deliberate national policies. Comparative advantage includes inherited resources, such as labor, climate, arable land, and petroleum reserves. Countries should specialize in the production of what they are most efficient at, even if other countries can do the same thing better. Importing goods produced comparatively less efficiently will lead to efficient utilization of resources, resulting in more productivity. Comparative advantage focuses on relative differences among nations in their efficiency of use of factors of production.
Competitive Advantage
Competitive advantage refers to the distinctive assets or competencies of a firm that are difficult for competitors to imitate and are typically derived from specific knowledge, capabilities, skills, or superior strategies. Competitive advantage is a foundation concept that explains how individual firms gain and maintain distinctive competencies, relative to competitors, that lead to superior performance. The collective competitive advantages held by the firms in a nation are the basis for the competitive advantage of the nation at large.
Why Do Nations Trade?
The belief that national prosperity is the result of a positive balance of trade, achieved by maximizing exports and minimizing imports. The neo-mercantilist doctrine has supporters, such as labor unions, farmers, and some manufacturers.
Free Trade
Free trade refers to the relative absence of restrictions to the flow of goods and services between nations.
Free trade allows consumers and firms to more readily buy the products they want, and imported products tend to be cheaper than domestically produced products. Lower-cost imports help reduce the expenses of firms, thereby raising their profits, and help reduce the expenses of consumers, thereby increasing their living standards. Unrestricted international trade generally increases the overall prosperity of poor countries.
Absolute Advantage Principle
The absolute advantage principle states that a country benefits by producing only those products in which it has absolute advantage or that it can produce using fewer resources than another country. Given the amount of input (factors of production such as land, labor, capital), a country that is able to generate the largest amount of output has an absolute advantage. Countries should specialize in the production of goods they are most efficient at, and trade them for those goods where they are less efficient.
Comparative Advantage Principle
The comparative advantage principle states that it can be beneficial for two countries to trade without barriers as long as one is relatively more efficient at producing goods or services needed by the other. What matters is not the absolute cost of production but rather the relative efficiency with which a country can produce the product.
Limitations of Early Theories
Early theories did not consider transportation costs, trade restrictions (tariffs), currency exchange issues, perfectly mobile resources, perfectly comparable and tradable products and services, and the fact that existing advantages/disadvantages may not last forever.
Factor Proportions (Endowments) Theory
Comparative advantages arise from differences in the types and quantities of factors required for goods production (efficiency) and the type and quantity of factors available. Countries should export goods that intensively use abundant factors and import goods made from locally scarce factors.
International Product Life Cycle Theory
Stage I (Introduction): Innovative, labor-intensive, changing. Easiest to design and manufacture close to headquarters, high costs not a problem. Demand elsewhere too small for anything but export. Stage II (Maturity): Progressing standardization. Growing demand => local production more worthwhile. Emerging competition.
Related and supporting industries refer to the presence of clusters of suppliers, competitors, and complementary firms that excel in particular industries.
National Industrial Policy
A proactive economic development plan initiated by the government, often in collaboration with the private sector, that aims to develop or support particular industries within the nation. Examples include tax incentives, monetary and fiscal policies, rigorous educational systems, development and maintenance of strong national infrastructure, and creation of strong legal and regulatory systems.
Why Internationalize?
Competition: Exploitation
Monopolistic advantage over local firms (e.g., brand, know-how). Pre-empting or mimicking competitors' moves, especially in concentrated (oligopolistic) industries.
Business Development: Exploration
To leverage existing capabilities. To exercise an investment opportunity. To access resources (collaborative ventures, networks, acquisitions).
Market Imperfections: Risk-Hedge
Securing inputs. Minimizing transaction costs. Circumventing impediments to the transfer of know-how and protecting know-how.
FDI to Internationalize
FDI is an important entry strategy, and scholars provide three alternative theories of how firms can use it to gain and sustain competitive advantage: the monopolistic advantage theory, internalization theory, and Dunning's eclectic paradigm.
Monopolistic Advantage Theory
A monopolistic advantage is one or more resources or capabilities a company possesses that few other firms have and that it leverages to generate profits and other returns. Monopolistic advantage theory suggests that firms which use FDI as an internationalization strategy must own or control certain resources and capabilities not easily available to competitors, that give them a degree of monopoly power over local firms in foreign markets.
Internalization Theory
An explanation of the process by which firms acquire and retain one or more value-chain activities inside the firm, minimizing the disadvantages of dealing with external partners and allowing for greater control over foreign operations.
Dunning's Eclectic Paradigm ('OLI Advantages')
'O' (Ownership advantages): Knowledge, skills, capabilities, relationships, or physical assets that the firm owns and which are the basis of its competitive advantages. 'L' (Location-specific advantages): Arise from using resources tied to a particular location, including knowledge (e.g., Silicon Valley), and economic, political, legal, technological, environmental, social, and cultural factors (PESTEL). 'I' (Internalization advantage): The control or coordination of value chains to conduct value-added activities.
Siemens Bribery Scandal
Allegations and Consequences
The United States found that Siemens allegedly spent more than $ billion bribing government officials around the world to win infrastructure contracts. The SEC claimed that Siemens made more than 4,000 bribe payments over seven years. In 2008, Siemens' profits declined, and in 2009, the World Bank required Siemens to pay $100 million to help global anti-corruption efforts and to forego bidding on World Bank development projects for two years. As a result, Siemens' two top executives, the chairman and the CEO, were forced to resign. In Germany, Siemens executives indicted in the scandal received only suspended prison sentences, and the company was ordered to pay a modest fine of $284 million.
Remedial Actions
In the wake of the scandal, Siemens management took steps to prevent further bribery. The company appointed a law firm to conduct an independent review of its compliance system and uncover possible improprieties. Siemens' own internal investigation identified more than $1.5 billion in suspicious transactions worldwide between 2000 and 2006. Siemens hired an independent ombudsman, strengthened its business- conduct code, and established a task force to improve internal controls over international funds transfers, reduce the number of bank accounts, and supervise the opening and maintaining of bank accounts.
Next, Hyundai opened a plant in India and within a few years became the country's bestselling brand of imported car. In 2002, Hyundai launched a factory in China, doubling production, and is aiming for 20 percent share of the Chinese car market. Hyundai uses FDI to develop key operations around the world, choosing locations based on the advantages they bring to the firm. By 2006, Hyundai had established plants in Iran, Sudan, Taiwan, Vietnam, Venezuela, and numerous other countries, and recently opened plants in the U.S. states of Alabama and Georgia. Hyundai also has R&D centres in Europe, Japan, and North America.
Competitive Strategies
To remain competitive, Hyundai employs inexpensive, high-quality labour, sources key inputs from low-cost suppliers, and enters various collaborative ventures to cooperate in R&D, design, manufacturing, and other value-adding activities. While Japanese auto giants such as Toyota and Honda rely heavily on U.S. sales for their profits, Hyundai is more diversified, with the U.S. market accounting for only 14 percent of its total sales in 2008, while China, India, Russia, and Latin America represented a combined 35 percent of sales.
Recent Events
Like other carmakers, Hyundai has problems with excess capacity. In 2009, due to unwanted inventory, the firm slowed production at its Alabama plant and laid off hundreds of employees at regional headquarters in the United States. Hyundai cut production by some 25 percent at plants in Korea but continues to launch new marketing campaigns and replaced General Motors as the official automotive sponsor of the Academy Awards.
