Ricardo theory of international trade ppt

Global Business Today 6e

by Charles W.L. Hill

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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Teaching Tip: It is often worth asking students before discussing the theories why countries trade the products they do. They will frequently – with a little prompting hit upon many of the ideas presented in this chapter and consequently relate better to the various theories that are discussed.

Chapter 5

International

Trade Theory

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Introduction

International trade theory
explains why it is beneficial for countries to engage in international trade
helps countries formulate their economic policy
explains the pattern of international trade in the world economy
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An Overview of Trade Theory

Question: What is free trade?

Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country
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An Overview of Trade Theory

Question: How has international trade theory evolved?

Mercantilism (16th and 17th centuries) promoted the idea of encouraging exports and discouraging imports
In 1776, Adam Smith promoted the idea of unrestricted free trade
In the 19th century, David Ricardo built on Smith ideas, and in the 20th century, Eli Heckscher and Bertil Ohlin refined Ricardo’s work
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The Benefits of Trade

Question: Why is it beneficial for countries to engage in free trade?

The theories of Smith, Ricardo and Heckscher-Ohlin show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself
International trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, and import products that can be produced more efficiently in other countries
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The Pattern of
International Trade

International trade theory helps explain trade patterns
Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oil, Ghana exports cocoa, and Brazil exports coffee
But, why does Switzerland export chemicals, pharmaceuticals, watches, and jewelry? Why does Japan export automobiles, consumer electronics, and machine tools?
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The Pattern of
International Trade

Ricardo’s theory of comparative advantage suggests that existing trade patterns are related to differences in labor productivity
Heckscher and Ohlin’s theory explains trade through the interplay between the proportions in which the factors of production are available in different countries and the proportions in which they are need for producing particular goods
Ray Vernon suggested that trade patterns could be explained by looking at a product’s life cycle
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The Pattern of
International Trade

Paul Krugman developed new trade theory which suggests that the world market can only support a limited number of firms in some industries, and so trade will skew toward those countries that have firms that were able to capture first mover advantages
Michael Porter focused on the importance of country factors to explain a nation’s dominance in the production and export of certain products
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Trade Theory
and Government Policy

While the theories all suggest that trade is beneficial, they lack agreement in their recommendations for government policy
Mercantilism makes a case for government involvement in promoting exports and limiting imports
Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade
New trade theory and Porter justify limited and selective government intervention to support the development of certain export-oriented industries
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Mercantilism

Mercantilism (mid-16th century) asserted that it is in a country’s best interest to maintain a trade surplus, to export more than it imports
it advocated government intervention to achieve a surplus in the balance of trade
it viewed trade as a zero-sum game (one in which a gain by one country results in a loss by another)
Mercantilism is problematic and not economically valid, yet many political views today have the goal of boosting exports while limiting imports by seeking only selective liberalization of trade
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Absolute Advantage

In 1776, Adam Smith attacked the mercantilist assumption that trade is a zero-sum game and argued that countries differ in their ability to produce goods efficiently, and that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it
According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods produced by other countries
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Country Focus: Is China a Neo-Mercantilist Nation?

Summary

This feature analyzes claims that China is a neo-mercantilist nation. Exports are largely responsible for China’s recent rapid economic growth. The country, capitalizing on its cheap labor force, has been focused on converting raw materials into products that are exported to developed countries like the United States. In 2007, China’s trade surplus was a record $262 billion, and its holdings of foreign exchange reserves were over $1.5 trillion. Some critics have suggested that China is following a neo-mercantilist policy.

Suggested Discussion Questions

1. Are the claims that China is following a neo-mercantilist policy valid? Why or why not?

Discussion Points: Some critics claim that China’s deliberate steps to maintain a low currency relative to the dollar is indicative of the country’s neo-mercantilist policy which tries to simultaneously increase exports and limit imports. Many students will probably note that China’s impressive growth in recent years is largely export led, which would support the claims of the critics. China’s trade surplus in 2007 was $262 billion, and the country had foreign exchange reserves of more than $1.5 trillion, 70 percent of which were in U.S. dollars. At the same time, the country appears to have implemented an import substitution policy as it now produces products such as steel and paper that had been formerly imported.

2. What incentive does China have to open its markets to foreign products? Why might China resist such a move?

Discussion Points: China is under significant pressure from many countries including the United States to open its markets to foreign goods. Students will probably recognize that if the country does open its markets, the impressive economic growth the country has been experiencing would probably be affected. However, students may also note that the country may have to make some changes to its polices if only to appease other nations and prevent retaliatory trade measures from being taken. Already, the country, in response to pressure from the United States, has allowed its currency to appreciate relative to the dollar.

3. Is there evidence that China is pursuing an import substitution policy? How would this type of policy benefit the country?

Discussion Points: Countries following an import substitution policy try to substitute domestic production for products that were previously imported, regardless of whether it is more efficient to produce them domestically or not. Most students will probably suggest that in China’s case, this certainly appears to be occurring. The country used to import steel, aluminum, and paper, but now produces those products domestically, and in doing so, avoids the cash outflows that would accompany imports. With its greater reserves of foreign currencies, China gains economic power over other nations.

Lecture Note: For more information on China’s trade policy, students may want to read {http://www.businessweek.com/globalbiz/content/aug2007/gb20070823_646159.htm?chan=search}.

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Absolute Advantage

Assume that two countries, Ghana and South Korea, both have 200 units of resources that could either be used to produce rice or cocoa
In Ghana, it takes 10 units of resources to produce one ton of cocoa and 20 units of resources to produce one ton of rice
So, Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of rice and cocoa between the two extremes
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Absolute Advantage

In South Korea it takes 40 units of resources to produce one ton of cocoa and 10 resources to produce one ton of rice
So, South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and no cocoa, or some combination in between
Ghana has an absolute advantage in the production of cocoa
South Korea has an absolute advantage in the production of rice
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Absolute Advantage

Without trade
Ghana would produce 10 tons of cocoa and 5 tons of rice
South Korea would produce 10 tons of rice and 2.5 tons of cocoa
If each country specializes in the product in which it has an absolute advantage and trades for the other product
Ghana would produce 20 tons of cocoa
South Korea would produce 20 tons of rice
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Absolute Advantage

Suppose
Ghana could trade 6 tons of cocoa to South Korea for 6 tons of rice
After trade
Ghana would have 14 tons of cocoa left, and 6 tons of rice
South Korea would have 14 tons of rice left and 6 tons of cocoa
Both countries gained from trade
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Absolute Advantage

The Theory of Absolute Advantage

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Absolute Advantage

Absolute Advantage and the Gains from Trade

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Comparative Advantage

In 1817, David Ricardo explored what might happen when one country has an absolute advantage in the production of all goods
According to Ricardo’s theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself
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Comparative Advantage

Assume
Ghana is more efficient in the production of both cocoa and rice
In Ghana, it takes 10 resources to produce one tone of cocoa, and 13 1/3 resources to produce one ton of rice
So, Ghana could produce 20 tons of cocoa and no rice, 15 tons of rice and no cocoa, or some combination of the two
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Comparative Advantage

In South Korea, it takes 40 resources to produce one ton of cocoa and 20 resources to produce one ton of rice
So, South Korea could produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of the two
If each country specializes in the production of the good in which it has a comparative advantage and trades for the other, both countries will gain
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Comparative Advantage

With trade
Ghana could export 4 tons of cocoa to South Korea in exchange for 4 tons of rice
Ghana will still have 11 tons of cocoa, and 4 additional tons of rice
South Korea still has 6 tons of rice and 4 tons of cocoa
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Comparative Advantage

The Theory of Comparative Advantage

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Classroom Performance System

Which theory did not suggest that there could be gains from specialization and trade?

Mercantilism

Absolute advantage

Comparative advantage

Heckscher-Ohlin theory

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Classroom Performance System Answer: a

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The Gains from Trade

The theory of comparative advantage argues that trade is a positive sum gain in which all gain
Potential world production is greater with unrestricted free trade than it is with restricted trade
The theory of comparative advantage provides a strong rationale for encouraging free trade
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Qualifications and Assumptions

The simple example of comparative advantage assumes
only two countries and two goods
zero transportation costs
similar prices and values
resources are mobile between goods within countries, but not across countries
constant returns to scale
fixed stocks of resources
no effects on income distribution within countries
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Extensions of
the Ricardian Model

Suppose the following assumptions are relaxed
1. Resources move freely from the production of one good to another within a country

2. There are constant returns to scale

3. Trade does not change a country’s stock of resources or the efficiency with which those resources are utilized

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Country Focus: Moving U.S. White Collar Jobs Offshore

Summary

This feature goes to the heart of a debate that has been played out many times over the past half century—the transference of jobs from the United States to lower-wage countries. The difference now however, is that rather than blue-collar jobs being transferred, the new trend is for white-collar jobs to move, jobs associated with the knowledge-based economy.

Suggested Discussion Questions

1. Will the United States suffer from the loss of highly skilled and high paying jobs? What does the transference of white-collar jobs mean to the average American?

Discussion Points: This hot issue is a highly sensitive one for many Americans—especially those who have seen their once secure jobs being shipped offshore. Many students will probably know someone who has suffered from this very situation, and may claim that companies have lost all loyalty to their employees and simply become profit seekers. Other students however, may point that companies are in business to make a profit, and do well for other stakeholders such as investors. Some students will simply argue that the loss of white-collar jobs is merely a manifestation of companies viewing the world as a borderless market—where they seek resources wherever they are cheapest, produce in the optimal location, and sell wherever there is demand.

2. What does the transference of white-collar jobs mean to recipient countries such as India and the Philippines?

Discussion Points: For developing countries like India and the Philippines, the transference of white-collar jobs from the United States not only generates new jobs, it also brings new skills and knowledge that could be vital to the countries as they continue on the path toward greater economic development. Students should recognize that greater employment levels will of course have the effect of pushing wages up, and creating greater economic prosperity in these nations. This in turn should be beneficial for American companies as new export markets develop.

3. Why do American companies transfer white-collar jobs to countries like India and the Philippines?

Discussion Points: India offers companies a well-educated workforce that is willing to work for a fraction of what companies would pay in the United States. By transferring skilled jobs to India or the Philippines, American companies increase their global competitiveness and profitability. Students will probably note that the trend to outsource is likely to continue as companies seek an edge wherever they can find one. Already, the trend is being seen in new industries such as healthcare where not only paperwork but even radiology services are now being routinely outsourced.

Lecture Note: Outsourcing is not always beneficial for companies. To extend this discussion, consider discussing why outsourcing may not be possible. For more on this topic, go to {http://www.businessweek.com/smallbiz/content/jul2007/sb20070720_787886.htm}.

Lecture Note: Outsourcing call centers is common in many industries today, however it can also be controversial. Many people dislike speaking to foreigners who may not have a complete grasp of their language, and get frustrated with the responses they receive. To extend the discussion of outsourcing to include this angle, consider {http://www.businessweek.com/managing/content/sep2007/ca20070927_836850.htm?chan=search}.

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Extensions of
the Ricardian Model

1. Immobile Resources

Resources do not always move freely from one economic activity to another
Governments may help retrain displaced workers
2. Diminishing Returns

The simple model assumes constant returns to specialization (the units of resources required to produce a good are assumed to remain constant), but an assumption of diminishing returns is more realistic since not all resources are of the same quality and different goods use resources in different proportions
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Extensions of
the Ricardian Model

3. Dynamic Effects and Economic Growth

Trade might increase a country's stock of resources as increased supplies become available from abroad
Free trade might increase the efficiency of resource utilization, and free up resources for other uses
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Extensions of
the Ricardian Model

The Samuelson Critique

Paul Samuelson argued that in some cases, dynamic gains can lead to less beneficial outcomes
He is concerned that the ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages would then fall
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Extensions of
the Ricardian Model

The Link between Trade and Growth

Studies exploring the relationship between trade and economic growth suggest that countries that adopt a more open stance toward international trade enjoy higher growth rates than those that close their economies to trade
Higher growth rates raise income levels and living standards
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Heckscher-Ohlin Theory

Heckscher and Ohlin argued that comparative advantage arises from differences in national factor endowments (the extent to which a country is endowed with resources such as land, labor, and capital)
The more abundant a factor, the lower its cost
Countries will export goods that make intensive use of those factors that are locally abundant, and import goods that make intensive use of factors that are locally scarce
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The Leontief Paradox

Wassily Leontief (1953) argued that since the U.S. was relatively abundant in capital, it would be an exporter of capital intensive goods and an importer of labor-intensive goods.
Leontief found however, that U.S. exports were less capital intensive than U.S. imports
Possible explanations for these findings include
that the U.S. has a special advantage in producing products made with innovative technologies that are less capital intensive
differences in technology lead to differences in productivity which then drives trade patterns
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Classroom Performance System

Which theory viewed trade as a zero sum game?

Mercantilism

Absolute advantage

Comparative advantage

Heckscher-Ohlin theory

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Classroom Performance System Answer: a

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The Product Life Cycle Theory

Raymond Vernon (mid-1960s ) proposed the product life-cycle theory suggesting that as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade
In the mid-1960s, the wealth and size of the U.S. market gave a strong incentive to U.S. firms to develop new products
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The Product Life Cycle Theory

According to Vernon, in the early stages of a product’s life cycle demand may grow in the U.S., but demand in other advanced countries is limited to high-income groups
Therefore, it is not worthwhile for firms in those countries to start producing the new product, but it does necessitate some exports from the U.S. to those countries
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The Product Life Cycle Theory

Over time, demand for the new product starts to grow in other advanced countries making it worthwhile for foreign producers to begin producing for their home markets
U.S. firms might also set up production facilities in those advanced countries where demand is growing limiting the exports from the U.S.
As the market in the U.S. and other advanced nations matures, the product becomes more standardized, and price becomes the main competitive weapon
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The Product Life Cycle Theory

Producers based in advanced countries where labor costs are lower than the United States might now be able to export to the U.S.
If cost pressures become intense, developing countries begin to acquire a production advantage over advanced countries
The United States switches from being an exporter of the product to an importer of the product as production becomes more concentrated in lower-cost foreign locations
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The Product Life Cycle Theory

The Product Life Cycle

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Evaluating The
Product Life Cycle Theory

While the product life cycle theory accurately explains what has happened for products like photocopiers and a number of other high technology products developed in the US in the 1960s and 1970s, the increasing globalization and integration of the world economy has made this theory less valid in today's world
Today, many new products are initially introduced in Japan or Europe, or are introduced simultaneously in the U.S., Japan, and Europe
Production may also be dispersed to those locations where it is most favorable
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New Trade Theory

New trade theory (1970s) suggests

Because of economies of scale (unit cost reductions associated with a large scale of output), trade can increase the variety of goods available to consumers and decrease the average cost of those goods

In those industries when the output required to attain economies of scale represents a significant proportion of total world demand, the global market may only be able to support a small number of firms

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Increasing Product Variety
and Reducing Costs

Without trade
a small nation may not be able to support the demand necessary for producers to realize required economies of scale, and so certain products may not be produced
With trade
a nation may be able to specialize in producing a narrower range of products and then buy the goods that it does not make from other countries
each nation then simultaneously increases the variety of goods available to its consumers and lowers the costs of those goods
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Economies of Scale, First Mover Advantages and the Pattern of Trade

Firms with first mover advantages (the economic and strategic advantages that accrue to many entrants into an industry) will develop economies of scale and create barriers to entry for other firms
The pattern of trade we observe in the world economy may be the result of first mover advantages and economies of scale
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Implications of New Trade Theory

New trade theory suggests
nations may benefit from trade even when they do not differ in resource endowments or technology
a country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good
Thus, new trade theory provides an economic rationale for a proactive trade policy that is at variance with other free trade theories
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National Competitive Advantage: Porter’s Diamond

Porter (1990) tried to explain why a nation achieves international success in a particular industry
Porter identified four attributes he calls the diamond that promote or impede the creation of competitive advantage
Factor endowments

Demand conditions

Related and supporting industries

Firm strategy, structure, and rivalry

In addition, Porter identified two additional variables (chance and government) that can influence the diamond in important ways
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National Competitive Advantage: Porter’s Diamond

Determinants of National Competitive Advantage: Porter’s Diamond

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Factor Endowments

A nation's position in factor endowments (factors of production) can lead to competitive advantage
These factors can be either basic (natural resources, climate, location) or advanced (skilled labor, infrastructure, technological know-how)
Basic factors can provide an initial advantage that is then reinforced and extended by investment in advanced factors
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Demand Conditions

Demand conditions refers to the nature of home demand for an industry’s product or service
Demand conditions influence the development of capabilities
Sophisticated and demanding customers pressure firms to be more competitive and to produce high quality, innovative products
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Related and Supporting
Industries

Related and supporting industries refers to the presence supplier industries and related industries that are internationally competitive
Investing in these industries can spill over and contribute to success in other industries
Successful industries tend to be grouped in clusters in countries which them prompts knowledge flows between firms
Having world class manufacturers of semi-conductor processing equipment can lead to (and be a result of having) a competitive semi-conductor industry
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Classroom Performance System

Economies of scale and first mover advantages are central to which theory of trade

Porter’s diamond of competitive advantage

New trade theory

Vernon’s product life cycle

Comparative advantage

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Classroom Performance System Answer: b

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Firm Strategy, Structure, and Rivalry

Firm strategy, structure, and rivalry refers to the conditions in the nation governing how companies are created, organized, and managed, and the nature of domestic rivalry
Different nations are characterized by different management ideologies which influence the ability of firms to build national competitive advantage
There is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry
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Evaluating Porter’s Theory

Porter suggests that the four attributes of the diamond together with government policy, and chance work as a reinforcing system, complementing each other and in combination creating the conditions appropriate for competitive advantage
Porter believes that government policy can affect demand through product standards, influence rivalry through regulation and antitrust laws, and impact the availability of highly educated workers and advanced transportation infrastructure
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Evaluating Porter’s Theory

Question: Is Porter right?

If Porter is correct, his model should predict the pattern of international trade in the real world
Countries should export products from industries where the diamond is favorable
Countries should import products from areas where the diamond is not favorable
So, far there has been little empirical testing of the theory
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Management Focus: The Rise of Finland’s Nokia

Summary

This feature is about the growth of the cellular telephone equipment industry, and more specifically, about the rise in competitiveness of Nokia, a Finnish cellular telephone company. The feature explains the reasons that Nokia was particularly well positioned to take advantage of the growth of the global cellular telephone industry. Nokia is one of the most dominant players in the mobile phone industry, holding 39 percent of the world’s market in 2007.

Suggested Discussion Questions

1. Using the new trade theory and Porter’s theory of national competitive advantage, describe why Nokia emerged as a leading competitor in the global cellular telephone equipment industry.

Discussion Points: New trade theory suggests that a country may be the dominant exporter of a particular product simply because it was lucky enough to a first mover firm for the product. The theory would suggest that Nokia was able to benefit from its innovations that helped it gain first mover advantages, but also that it was simply lucky enough to be in the right place at the right time. Porter argues that a nation’s competitive advantage is dependent on its factor endowments, demand conditions, relating and supporting industries, and firm strategy, structure and rivalry. Students will probably recognize that Finland’s limited traditional telephone service (see question 2 below) meant that demand was strong. At the same time, the company was able to benefit from the fact that the country does not have a national telephone monopoly. Instead, about 50 companies all battle for market share. For Nokia, that meant a focus on bringing costs down, while remaining on the leading edge of technology.

2. Explain why the cellular telephone industry caught on in Finland and the other Scandinavian countries faster than the rest of the world.

Discussion Points: Geography appears to be the key reason why cellular telephone service appears to have caught on in Scandinavian countries more quickly than in other parts of the world. With its cold climate and sparse population, Scandinavia found traditional wire-line service costly, and embraced the cheaper alternative of cellular service. Students will probably recognize that this situation combined with the need for communication services meant that countries like Finland had a greater incentive to develop the industry—which of course helped Nokia become a leading player in the industry.

3. Why didn’t the development of the cellular telephone equipment industry take place in Mexico or another Central or South American country rather than Finland, Sweden, and the United States? Base your answer of the international trade theories described in this chapter.

Discussion Points: Students will probably recognize that the conditions in Scandinavia set the stage for the development of cellular telephone service. Not only were Scandinavians open and able to try new products, they also needed communications services. Governments like Finland’s also saw the benefits of developing the industry as a cheaper alternative to traditional services.

Teaching Tip: For more information on the company, go to Nokia’s homepage at {http://www.nokia.com/}.

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Implications for Managers

Question: What are the implications of international trade theory for international businesses?

There are at least three main implications for international businesses
Location implications

First-mover implications

Policy implications

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Location

Different countries have advantages in different productive activities
These differences influence a firm’s decision about where to locate productive activities
It makes sense for a firm to disperse its various productive activities to those countries where they can be performed most efficiently
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First-Mover Advantages

Firms that establish a first-mover advantage in the production of a new product may later dominate global trade in that product
It can be worthwhile for a firm to invest resources in trying to build first-mover advantages, even if it means losses for a few years before a venture becomes profitable
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Government Policy

Government policies with respect to free trade or protecting domestic industries can significantly impact global competitiveness
Businesses should work to encourage governmental policies that support free trade
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Internet Extra: To learn more about government policy towards international trade, and how it might affect companies go to Electronic Embassy {http://www.embassy.org}. The site provides links to all of the foreign embassies located in Washington D.C.

Go to the site and click on Embassies. Select the country you are interested, for example Japan.

Then click on the URL for the Japanese embassy. To learn more about Japan’s policies on trade, click on Japan’s Foreign Policy.

Consider the information and what it means for managers as they make their decisions on where to export, where to produce, and so on.

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Classroom Performance System

Porter’s Diamond is made up of all of the following except

Factor endowments

Related and supporting industries

Firm strategy, structure, and rivalry

Supply conditions

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Classroom Performance System Answer: d

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Critical Discussion Question

1. “Mercantilism is a bankrupt theory that has no place in the modern world.” Discuss.

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Answer: Mercantilism, in its purest sense, is a bankrupt theory that has no place in the modern world. The principle tenant of mercantilism is that a country should maintain a trade surplus, even if it means that imports are limited by government intervention. This policy is bankrupt for at least two reasons. First, it is inconsistent with the general notion of globalization which is becoming more and more prevalent in the world. A policy of mercantilism will anger potential trade partners because it will exclude their goods from free access to the mercantilist country’s markets. Eventually, a country will find it difficult to export if it imposes oppressive quotas and tariffs on its trading partners. Second, mercantilism is bankrupt because it hurts the consumers in the mercantilist country. By denying its consumers access to either “cheaper” goods from other countries or more “sophisticated” goods from other countries, the mercantilist country’s ordinary consumers suffer.

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Critical Discussion Question

2. Is free trade fair? Discuss!

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Answer: This question is designed to stimulate class discussion. Trade theory suggests that specialization and free trade benefits all countries. However, a case can be made in some situations for imposing trade barriers. For example, if a developing country is trying to establish a new industry, trade barriers may be needed in the short term until the industry can become competitive. While it could be argued that another country could make the product more efficiently already, is it fair to limit a country’s ability to develop its industrial base?

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Critical Discussion Question

3. Unions in developed nations often oppose imports from low-wage countries and advocate trade barriers to protect jobs from what they often characterize as “unfair” import competition. Is such competition “unfair?” Do you think that this argument is in the best interests of (a) the unions, (b) the people they represent, and/or (c) the country as a whole?

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Answer: The theory of comparative advantage suggests that a country should specialize in producing those goods that it can produce most efficiently, while buying goods that it can produce relatively less efficiently from other countries. Furthermore, the theory suggests that opening a country to free trade stimulates economic growth, which creates dynamic gains from trade. Therefore, it would follow that if low-wage countries can make certain products more efficiently than high wage countries, the low wage countries should produce and export those products. While trade barriers may protect workers and companies, they are a short-term fix at best. Moreover, by protecting industries, the government is not encouraging companies to become more efficient. Instead, they are promoting inefficiency. Consumers lose out because they have higher prices and less choice.

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Critical Discussion Question

4. What are the potential costs of adopting a free trade regime? Do you think governments should do anything to reduce these costs? What?

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Answer: Students will probably be divided on this question, and a lively debate should ensue. For example, students will probably recognize that by adopting a free trade regime, jobs will be lost in some industries, however they may not agree on exactly what should be done about the jobs losses. Some students might suggest that the government provide retraining programs while others may argue that people lose their jobs everyday and don’t get government assistance to find new ones.

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Critical Discussion Question

5. Reread the Country Focus on “Is China a Neo-Mercantilist Nation?”

a) Do you think China is pursuing an economic policy that can be characterized as neo-Mercantilist?

b) What should the United States, and other countries, do about this?

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Answer: This question is likely to generate a lively debate. Many students will suggest that the outward flow of white-collar jobs is indeed a serious issue, one that should be the focus of government attention. Students taking this perspective are likely to suggest that white-collar jobs are more important to the nation’s future, and therefore they should remain at home. Other students however, may argue that companies cannot afford to pay the higher wages commanded by white-collar jobs and still remain profitable. Therefore, the argument might be that by taking these jobs outside the country, the company is able to remain viable, and keep other people employed.

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Critical Discussion Question

6. Drawing upon the new trade theory and Porter’s theory of national competitive advantage, outline the case for government policies that would build national competitive advantage in biotechnology. What kind of policies would you recommend that the government adopt? Are these policies at variance with the basic free trade philosophy?

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Answer: Porter’s theory of national competitive advantage argues that four broad attributes of a nation shape the environment in which local firms compete, and that these attributes promote or impede the creation of competitive advantage. These attributes are: factor endowments, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry. Porter goes on to argue that firms are most likely to succeed in industries in which the diamond (which are the four attributes collectively) is favorable. Porter adds two factors to the list of attributes described above: chance and government policy. The New Trade theory addresses a separate issue. This theory argues that due to the presence of substantial scale economies, world demand will support only a few firms in many industries. Underpinning this argument is the notion of first-mover advantages, which are the economic and strategic advantages that accrue to early entrants into an industry. One could argue that when the attributes of a nation are conductive to the production of a product, and when the manufacturers of that product have experienced some “chance” events that have provided them first-mover advantages, the governmental policies of that nation should promote the building of national competitive advantage in that particular area. This could be accomplished through government R&D grants, policies that favor the industry in capital markets, policies towards education, the creation of a favorable regulatory atmosphere, tax abatements, and the like. Ask your students whether they think this policy is at variance with the basic free trade philosophy. One could argue that it is, because the government intervention is creating the basis for comparative advantage. Conversely, one could argue that if a country establishes a comparative advantage in a particular area that is based on a unique set of attributes (such as Swiss production of watches), world output will be favorably impacted by letting that country pursue its area of comparative advantage.

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Critical Discussion Question

7. The world’s poorest countries are at a competitive disadvantage in every sector of their economies. They have little to export. They have no capital; their land is of poor quality; they often have too many people given available work opportunities; and they are poorly educated. Free trade cannot possibly be in the interests of such nations! Discuss.

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Answer: This is a difficult question. Certainly, most students will recognize that these countries are in dire straights and need assistance from richer countries. Most students will probably be sympathetic to their cause and suggest various aid programs including education and monetary support to help the countries develop. However, others may be more cautious and promote the notion that assistance would have to come in an organized form with multiple nations working together. The question is an interesting one that should provide students with an eye-opening discussion.

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Teaching Tip: It is often worth asking students before discussing the theories why countries trade the products they do. They will frequently – with a little prompting hit upon many of the ideas presented in this chapter and consequently relate better to the various theories that are discussed.

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Country Focus: Is China a Neo-Mercantilist Nation?

Summary

This feature analyzes claims that China is a neo-mercantilist nation. Exports are largely responsible for China’s recent rapid economic growth. The country, capitalizing on its cheap labor force, has been focused on converting raw materials into products that are exported to developed countries like the United States. In 2007, China’s trade surplus was a record $262 billion, and its holdings of foreign exchange reserves were over $1.5 trillion. Some critics have suggested that China is following a neo-mercantilist policy.

Suggested Discussion Questions

1. Are the claims that China is following a neo-mercantilist policy valid? Why or why not?

Discussion Points: Some critics claim that China’s deliberate steps to maintain a low currency relative to the dollar is indicative of the country’s neo-mercantilist policy which tries to simultaneously increase exports and limit imports. Many students will probably note that China’s impressive growth in recent years is largely export led, which would support the claims of the critics. China’s trade surplus in 2007 was $262 billion, and the country had foreign exchange reserves of more than $1.5 trillion, 70 percent of which were in U.S. dollars. At the same time, the country appears to have implemented an import substitution policy as it now produces products such as steel and paper that had been formerly imported.

2. What incentive does China have to open its markets to foreign products? Why might China resist such a move?

Discussion Points: China is under significant pressure from many countries including the United States to open its markets to foreign goods. Students will probably recognize that if the country does open its markets, the impressive economic growth the country has been experiencing would probably be affected. However, students may also note that the country may have to make some changes to its polices if only to appease other nations and prevent retaliatory trade measures from being taken. Already, the country, in response to pressure from the United States, has allowed its currency to appreciate relative to the dollar.

3. Is there evidence that China is pursuing an import substitution policy? How would this type of policy benefit the country?

Discussion Points: Countries following an import substitution policy try to substitute domestic production for products that were previously imported, regardless of whether it is more efficient to produce them domestically or not. Most students will probably suggest that in China’s case, this certainly appears to be occurring. The country used to import steel, aluminum, and paper, but now produces those products domestically, and in doing so, avoids the cash outflows that would accompany imports. With its greater reserves of foreign currencies, China gains economic power over other nations.

Lecture Note: For more information on China’s trade policy, students may want to read {http://www.businessweek.com/globalbiz/content/aug2007/gb20070823_646159.htm?chan=search}.

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Classroom Performance System Answer: a

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Country Focus: Moving U.S. White Collar Jobs Offshore

Summary

This feature goes to the heart of a debate that has been played out many times over the past half century—the transference of jobs from the United States to lower-wage countries. The difference now however, is that rather than blue-collar jobs being transferred, the new trend is for white-collar jobs to move, jobs associated with the knowledge-based economy.

Suggested Discussion Questions

1. Will the United States suffer from the loss of highly skilled and high paying jobs? What does the transference of white-collar jobs mean to the average American?

Discussion Points: This hot issue is a highly sensitive one for many Americans—especially those who have seen their once secure jobs being shipped offshore. Many students will probably know someone who has suffered from this very situation, and may claim that companies have lost all loyalty to their employees and simply become profit seekers. Other students however, may point that companies are in business to make a profit, and do well for other stakeholders such as investors. Some students will simply argue that the loss of white-collar jobs is merely a manifestation of companies viewing the world as a borderless market—where they seek resources wherever they are cheapest, produce in the optimal location, and sell wherever there is demand.

2. What does the transference of white-collar jobs mean to recipient countries such as India and the Philippines?

Discussion Points: For developing countries like India and the Philippines, the transference of white-collar jobs from the United States not only generates new jobs, it also brings new skills and knowledge that could be vital to the countries as they continue on the path toward greater economic development. Students should recognize that greater employment levels will of course have the effect of pushing wages up, and creating greater economic prosperity in these nations. This in turn should be beneficial for American companies as new export markets develop.

3. Why do American companies transfer white-collar jobs to countries like India and the Philippines?

Discussion Points: India offers companies a well-educated workforce that is willing to work for a fraction of what companies would pay in the United States. By transferring skilled jobs to India or the Philippines, American companies increase their global competitiveness and profitability. Students will probably note that the trend to outsource is likely to continue as companies seek an edge wherever they can find one. Already, the trend is being seen in new industries such as healthcare where not only paperwork but even radiology services are now being routinely outsourced.

Lecture Note: Outsourcing is not always beneficial for companies. To extend this discussion, consider discussing why outsourcing may not be possible. For more on this topic, go to {http://www.businessweek.com/smallbiz/content/jul2007/sb20070720_787886.htm}.

Lecture Note: Outsourcing call centers is common in many industries today, however it can also be controversial. Many people dislike speaking to foreigners who may not have a complete grasp of their language, and get frustrated with the responses they receive. To extend the discussion of outsourcing to include this angle, consider {http://www.businessweek.com/managing/content/sep2007/ca20070927_836850.htm?chan=search}.

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Classroom Performance System Answer: a

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Classroom Performance System Answer: b

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Management Focus: The Rise of Finland’s Nokia

Summary

This feature is about the growth of the cellular telephone equipment industry, and more specifically, about the rise in competitiveness of Nokia, a Finnish cellular telephone company. The feature explains the reasons that Nokia was particularly well positioned to take advantage of the growth of the global cellular telephone industry. Nokia is one of the most dominant players in the mobile phone industry, holding 39 percent of the world’s market in 2007.

Suggested Discussion Questions

1. Using the new trade theory and Porter’s theory of national competitive advantage, describe why Nokia emerged as a leading competitor in the global cellular telephone equipment industry.

Discussion Points: New trade theory suggests that a country may be the dominant exporter of a particular product simply because it was lucky enough to a first mover firm for the product. The theory would suggest that Nokia was able to benefit from its innovations that helped it gain first mover advantages, but also that it was simply lucky enough to be in the right place at the right time. Porter argues that a nation’s competitive advantage is dependent on its factor endowments, demand conditions, relating and supporting industries, and firm strategy, structure and rivalry. Students will probably recognize that Finland’s limited traditional telephone service (see question 2 below) meant that demand was strong. At the same time, the company was able to benefit from the fact that the country does not have a national telephone monopoly. Instead, about 50 companies all battle for market share. For Nokia, that meant a focus on bringing costs down, while remaining on the leading edge of technology.

2. Explain why the cellular telephone industry caught on in Finland and the other Scandinavian countries faster than the rest of the world.

Discussion Points: Geography appears to be the key reason why cellular telephone service appears to have caught on in Scandinavian countries more quickly than in other parts of the world. With its cold climate and sparse population, Scandinavia found traditional wire-line service costly, and embraced the cheaper alternative of cellular service. Students will probably recognize that this situation combined with the need for communication services meant that countries like Finland had a greater incentive to develop the industry—which of course helped Nokia become a leading player in the industry.

3. Why didn’t the development of the cellular telephone equipment industry take place in Mexico or another Central or South American country rather than Finland, Sweden, and the United States? Base your answer of the international trade theories described in this chapter.

Discussion Points: Students will probably recognize that the conditions in Scandinavia set the stage for the development of cellular telephone service. Not only were Scandinavians open and able to try new products, they also needed communications services. Governments like Finland’s also saw the benefits of developing the industry as a cheaper alternative to traditional services.

Teaching Tip: For more information on the company, go to Nokia’s homepage at {http://www.nokia.com/}.

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Internet Extra: To learn more about government policy towards international trade, and how it might affect companies go to Electronic Embassy {http://www.embassy.org}. The site provides links to all of the foreign embassies located in Washington D.C.

Go to the site and click on Embassies. Select the country you are interested, for example Japan.

Then click on the URL for the Japanese embassy. To learn more about Japan’s policies on trade, click on Japan’s Foreign Policy.

Consider the information and what it means for managers as they make their decisions on where to export, where to produce, and so on.

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Classroom Performance System Answer: d

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Answer: Mercantilism, in its purest sense, is a bankrupt theory that has no place in the modern world. The principle tenant of mercantilism is that a country should maintain a trade surplus, even if it means that imports are limited by government intervention. This policy is bankrupt for at least two reasons. First, it is inconsistent with the general notion of globalization which is becoming more and more prevalent in the world. A policy of mercantilism will anger potential trade partners because it will exclude their goods from free access to the mercantilist country’s markets. Eventually, a country will find it difficult to export if it imposes oppressive quotas and tariffs on its trading partners. Second, mercantilism is bankrupt because it hurts the consumers in the mercantilist country. By denying its consumers access to either “cheaper” goods from other countries or more “sophisticated” goods from other countries, the mercantilist country’s ordinary consumers suffer.

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Answer: This question is designed to stimulate class discussion. Trade theory suggests that specialization and free trade benefits all countries. However, a case can be made in some situations for imposing trade barriers. For example, if a developing country is trying to establish a new industry, trade barriers may be needed in the short term until the industry can become competitive. While it could be argued that another country could make the product more efficiently already, is it fair to limit a country’s ability to develop its industrial base?