PART THREE

THEORIES AND INSTITUTIONS: TRADE AND INVESTMENT

CHAPTER SIX
INTERNATIONAL TRADE
AND FACTOR MOBILITY THEORY

OBJECTIVES
• To understand theories of why countries should trade
• To comprehend how global efficiency can be increased through free trade
• To become familiar with factors affecting countries’ trade patterns
• To realize why countries’ export capabilities are dynamic
• To discern why the production factors of labor and capital move internationally
• To grasp the relationship between foreign trade and international factor mobility

CHAPTER OVERVIEW
Chapter Six provides a conceptual foundation for the exploration of the international
trade process. First, it examines the basic theories of mercantilism, absolute advantage,
and comparative advantage. Then it explores patterns of trade in light of the theories of
country size, factor proportions, and country similarity. It also considers the role of
distance and explains the relevance of Product Life Cycle Theory and Porter’s Diamond
of national competitive advantage. The chapter concludes with a discussion of factor
mobility and its relationship to the international trade process.

CHAPTER OUTLINE

OPENING CASE: COSTA RICAN TRADE, FOREIGN INVESTMENT,

AND ECONOMIC TRANSFORMATION
[See Map 6.1.]
Costa Rica, a Central American country of barely 4 million people, has successfully
transformed its primarily agricultural economy to one that includes strong technology and
tourism sectors as well. Bordering both the Pacific Ocean and the Caribbean arm of the
Atlantic, Costa Rica used international trade and factor mobility policies to help achieve
its economic objectives. Although exports of coffee and bananas are still important,
high-tech manufactured products (electronics, software, and medical devices) are now the
backbone of Costa Rica’s economy and export earnings. As in all countries, Costa Rica’s
policies continually evolved, but generally fall into four periods and categories:

59
 • 1800s–1960: a liberal trade regime that promoted the exports of coffee and
bananas
• 1960–1982: a more protectionist regime that promoted import substitution, i.e.,
a policy of developing domestic industries to manufacture goods and provide
services that would otherwise be imported (although results were mixed, the
processing of coffee and cotton seeds increased the value of Costa Rican
exports, and considerable substitution occurred in the pharmaceutical industry)
• 1983–Early 1990s: a less protectionist regime that promoted the liberalization
of imports, encouraged export promotion, and provided incentives to attract
foreign capital and expertise
• Early 1990s-Present: a liberal trade regime that seeks the production of
electronics, software, and medical devices via strategic trade policy, i.e., the
identification and development of targeted domestic industries in order to
improve their competitiveness at home and abroad

TEACHING TIPS: Carefully review the PowerPoint slides for Chapter Six, as well
as the opening case regarding Costa Rican Trade, which is cited throughout the
chapter.

I. INTRODUCTION
Trade theory helps managers and government policymakers focus on three critical
questions: What products should be imported and exported, how much should be
traded, and with whom should they trade? While descriptive (free trade) theories
suggest a laissez-faire treatment of trade, prescriptive (interventionist) theories
suggest that governments should influence trade patterns. Trade in goods and
services and the movement of production factors links countries internationally.
[See Fig. 6.1.]

II. INTERVENTIONIST THEORIES

Interventionist trade theories prescribe government action with respect to the
international trade process.
A. Mercantilism
The concept of mercantilism (a zero-sum game) served as the foundation of
economic thought for nearly three hundred years (1500–1800). It purports that a
country’s wealth is measured by its holdings of treasure (usually gold). To
amass a surplus (a favorable balance of trade), a country must export more
than it imports and then collect gold and other forms of wealth from countries
that run a deficit (an unfavorable balance of trade).
B. Neomercantilism
Neomercantilism represents the more recent strategy of countries that use
protectionist trade policies in an attempt to run favorable balances of trade
and/or accomplish particular social or political objectives.

60
II. FREE TRADE THEORIES
The explanatory power of the theories of absolute and comparative advantage is
limited to the demonstration of how economic growth can occur via specialization
and trade. The concept of free trade (a positive-sum game) purports that nations
should neither artificially limit imports nor artificially promote exports. The
invisible hand of the market will determine which competitors survive, as customers
buy those products that best serve their needs. Free trade implies specialization—
just as individuals and firms efficiently produce certain products that they then
exchange for things they cannot produce efficiently, nations as a whole specialize in
the production of certain products, some of which will be consumed domestically,
and some of which may be exported; export earnings can then in turn be used to pay
for imported goods and services.
A. Theory of Absolute Advantage
In 1776 Adam Smith asserted that the wealth of a nation consisted of the goods
and services available to its citizens. His theory of absolute advantage holds
that a country can maximize its own economic well being by specializing in the
production of those goods and services that it can produce more efficiently than
any other nation and enhance global efficiency through its participation in
(unrestricted) free trade. Smith reasoned that: (i) workers become more skilled
by repeating the same tasks; (ii) workers do not lose time in switching from the
production of one kind of product to another; and (iii) long production runs
provide greater incentives for the development of more effective working
methods. Smith also asserted that country-specific advantages can either be
natural or acquired.
1. Natural Advantage. A country may have a natural advantage in the
production of particular products because of given climatic conditions,
access to particular resources, the availability of labor, etc. Variations in
natural advantages among countries help to explain where particular
products can be produced most efficiently.
2. Acquired Advantage. An acquired advantage represents a distinct
advantage in skills, technology, and/or capital assets that yields
differentiated product offerings and/or cost-competitive homogeneous
products. Technology, in particular, has created new products, displaced
old products, and altered trading-partner relationships.
3. Resource Efficiency Example. Real income depends on the output of
products as compared to the resources used to produce them. By defining
the cost of production in terms of the resources needed to produce a
product, the production possibilities curve shows that through the use of
specialization and trade, the output of two countries will be greater, thus
optimizing global efficiency. [See Fig. 6.2.]
B. Comparative Advantage
In 1817 David Ricardo reasoned that there would still be gains from trade if
a country specialized in the production of those things it can produce most
efficiently, even if other countries can produce those same things even more
efficiently. Put another way, Ricardo’s theory of comparative advantage holds
that a country can maximize its own economic well-being by specializing in the

61
 production of those goods and services it can produce relatively efficiently and
enhance global efficiency through its participation in (unrestricted) free trade.
1. An Analogous Explanation. Would it make sense for the best
physician in town, who also happens to be the most talented medical
secretary, to handle all of the administrative duties of an office? No. The
physician can maximize both output and income by working as a physician
and employing a less skilled secretary. In the same manner, a country will
gain if it concentrates its resources on the production of the goods and
services it can produce most efficiently.
2. Production Possibility Example. A country can simultaneously
have a comparative advantage and an absolute advantage in the production
of a given product. Assume that the United States is more efficient than
Costa Rica in the production of both wheat and tea; however, the U.S. has a
comparative ad-vantage in wheat production. By concentrating on the
production of the product in which it has the greater advantage (wheat) and
allowing Costa Rica to produce the product in which the United States is
comparatively less efficient (coffee), global output can be increased, and
specialization and trade will benefit both countries. [See Fig. 6.2.]
C. Some Assumptions and Limitations of the Theories of Specialization
The theories of absolute and comparative advantage are based upon the
economic gains from specialization, i.e., concentration on the production of a
limited number of products. Each holds that specialization will maximize output
and that subsequent trade will maximize consumer welfare. However, both
theories make certain assumptions that may not always be valid.
1. Full Employment. Both theories assume that resources are fully
employed. When countries have many unemployed or underemployed
resources, they may seek to restrict imports in order to employ their own
available workers and other assets.
2. Economic Efficiency Objective. Individuals and countries often
pursue objectives other than economic efficiency. Individuals may prefer
activities and/or occupations that are economically less productive, and
nations may choose to avoid overspecialization because of the vulnerability
created by potential changes in technology and price fluctuations.
3. Division of Gains. Although specialization does maximize output, it is
unclear how those gains will be divided. If one country believes that a
trading partner is receiving too large a share of the benefits, it may choose
to forego its relatively smaller gains in order to prevent the partner country
from receiving larger gains.
4. Two Countries, Two Commodities. The world is comprised of
multiple countries and multiple commodities. Nonetheless, the theories are
still useful; economists have applied the same reasoning and demonstrated
the economic efficiency advantages in multi-product and multi-country
production and trade relationships.
5. Transport Costs. If it costs more to deliver products than can be saved
via specialization, then the gains from trade are negated.

62
 6. Statics and Dynamics. Although the theories of absolute and
comparative advantage consider gains at a given time (a static view), the
relative conditions that surround a country’s particular advantage or
disadvantage are dynamic (constantly changing). Thus, one cannot assume
that future advantages will remain constant. (This idea will also be relevant
to the discussion of the dynamics of the location of production and export
sources.)
7. Services. Although the theories of absolute and comparative advantage
were developed from the perspective of trade in commodities, much of the
same reasoning can be applied to trade in services.
8. Mobility. Neither the assumption that resources can move domestically
from the production of one good to another and at no cost, nor the
assumption that resources cannot move internationally, is entirely valid.
Nonetheless, domestic mobility is greater than the international mobility of
resources. Clearly, the movement of resources such as capital and labor is a
very real alternative to trade.

III. THEORIES EXPLAINING TRADE PATTERNS

The explanatory power of the theories of absolute and comparative advantage is
limited to the demonstration of how economic growth can occur via specialization
and trade. The theories of country size, factor proportions, and country similarity all
contribute to the explanation of what types of products are traded and with which
partner nations countries will primarily trade.
A. How Much Does a Country Trade?
Apart from nontradable products, i.e., goods and services that are impractical
to export, country size helps to explain why some countries are more dependent
on trade than others and why some account for larger portions of world trade
than others.
1. Theory of Country Size. The theory of country size holds that large
countries tend to export a smaller portion of their output and import a
smaller portion of their consumption. Large countries are more apt to have
varied climates and a greater assortment of natural resources than smaller
economies, thus making the large countries more self-sufficient. Further,
given the same types of terrain and modes of transportation, the greater the
distance, the higher the associated transport costs. Thus, firms in large
countries often face higher transportation costs in terms of sourcing inputs
from and delivering output to distant foreign markets than do their closer
foreign competitors.
2. Size of Economy. Counties can be compared on the basis of their
economic size, using indicators that include the value and share of world
trade. [See Table 6.2.] Ten of the world’s top trading nations are high-
income countries. Despite its low per capita income, China also has a large
economy because of its very large population. Together, the top ten nations
account for more than one-half of all of the world’s trade.

63
B. What Types of Products Does a Country Trade?
The composition of a country’s trade depends on both its natural and acquired
advantages. With respect to the latter, both production and product technology
can be very important.
1. Factor-Proportions Theory. Developed by Eli Heckscher (1919) and
Bertil Ohlin (1933), the factor-proportions theory holds that (i)
differences in a country’s relative endowments of land, labor, and capital
explain differences in the cost of production factors and (ii) a country will
tend to export products that utilize relatively abundant factors of production
because they are relatively cheaper than scarce factors; e.g., countries with
rich and abundant land tend to be large exporters of agricultural products,
whereas countries with capital-intensive production lines tend to be large
exporters of manufactured goods. Nonetheless, production factors are not
homogenous, and variations (particularly in labor) have led to international
specialization by task; e.g., countries with less skilled and lower paid
workers tend to export products that embody a higher intensity of labor.
2. Production Technology. Factor proportions analysis becomes more
complicated when the same product can be produced by different methods,
such as different mixes of labor and capital. The optimum location will
depend on comparisons of the production cost in each potential locale.
Although larger nations tend to depend more on longer production runs,
companies may locate long-run production facilities in small countries if
export barriers to other markets are relatively low. In addition, firms tend to
locate longer-run production facilities in just a few countries. However,
when long runs are less important, there is a greater tendency to scatter
production units around the world in a way that will minimize the
transportation cost associated with exports.
3. Product Technology. While manufacturing comprises the largest sector
of world trade, commercial services is the fastest-growing sector. [See Fig.
6.4.] Because manufacturing depends on acquired advantages (largely
technology) plus large amounts of capital investment, most new products
tends to be developed in high-income countries. On the other hand, lower-
income countries depend more on the production of primary products,
which in turn depend more on natural advantages.
C. With Whom Do Countries Trade?
High-income countries trade primarily with each other, and emerging economies
primarily export primary and labor-intensive products. Nonetheless, it is also
true that economic and cultural similarities, political interests, and distance
affect the determination of trading partners.
1. Country-Similarity Theory. The country-similarity theory states that
when a firm develops a new product in response to observed conditions in
its home market, it is likely to turn to those foreign markets that are most
similar to its domestic market when commencing its initial international
expansion activities. So much trade takes place among industrialized
countries because of the growing importance of acquired advantages, i.e.,

64
 skills and technology. In addition, markets in most industrialized countries
are large enough to support new product introductions and the subsequent
variants across the product life cycle. At the same time, trade in
differentiated products occurs because over time firms in different countries
develop product variants for particular market segments. Cultural similarity
also facilitates trade. In particular, a common language and a common
religion represent two major facilitators of the international trade and
investment process. Historical and political relationships, as well as
economic agreements, may encourage or discourage trade with particular
countries.
2. Distance Among Countries. Countries that are near to one another
enjoy relatively lower transportation costs than those that are more distant.
While the disadvantages of distance can often be overcome through
innovative technology and marketing methods, such gains are difficult to
maintain in the long run.

DOES GEOGRAPHY MATTER?

Variety Is the Spice of Life

Geography plays a major role in many theories and decisions concerning international
trade. Part of a nation’s advantage is embedded in its natural advantages—climate,
terrain, arable land, and natural resources. Factor proportions theory helps explain where
certain goods and services may be more efficiently produced. Many small countries need
to trade relatively more than larger nations because small countries often lack a wide
variety of natural advantages and resources. In addition, distance, culture, and political/
economic relationships also play major roles in the process.

IV. THE DYNAMICS OF TRADE

Both the product life cycle theory and Porter’s Diamond of national competitive
advantage help to explain how countries develop, maintain, and possibly lose their
competitive advantages.
A. Product Life Cycle (PLC) Theory
Product life cycle theory states that the optimal location for the production of
certain types of goods and services shifts over time as they pass through the
stages of market introduction, growth, maturity, and decline. [See Table 6.3.]
1. Changes Through the Cycle. A great majority of the new
technology that results in new products and production methods originates
in industrial countries.
• Introduction. Innovation, production, and sales occur in the domestic
(innovating) country. Because the product is not yet standardized, the
production process tends to be relatively labor-intensive, and
innovative customers tend to accept relatively high introductory prices.

65
 • Growth. As demand grows, competitors enter the market. Foreign
demand, competition, exports, and often direct investment activities
also begin to accelerate.
• Maturity. Global demand begins to peak, production processes are
relatively standardized, and global price competition forces production
site relocation to lower-cost developing countries.
• Decline. Market factors and cost pressures dictate that almost all
production occur in developing countries. The product is then imported
by the country where it was initially developed—the importing firm
may or may not be the innovating firm.
2. Verification and Limitations of PLC Theory. Exceptions to the
typical pattern of the product life cycle theory would include: products
that have very short life cycles, luxury goods and services, products
that require specialized labor, products that can be differentiated from
direct competitors, and product for which transportation costs are
relatively high.
B. The Porter Diamond
Introduced by Michael Porter in 1990, the Diamond of National Competitive
Advantage, i.e., the Porter Diamond, theorizes that national competitive
advantage is embedded in four determinants: (i) demand conditions, (ii) factor
conditions, (iii) related and supporting industries, and (iv) firm strategy,
structure, and rivalry. All four determinants are interlinked and generally need
to be favorable if a given national industry is going to attain global
competitiveness. At times, determinants can be affected by the roles of chance
and government.
1. Explanation of the Porter Diamond
• Demand Conditions. The nature and level of demand in the home
market lead to the establishment of production facilities to meet that
demand.
• Factor Conditions. Resource availability (inputs, labor, capital, and
technology) contributes to the competitiveness of both firms and
countries that compete in particular industries.
• Related and Supporting Industries. The local presence of inter-
nationally competitive suppliers and other related industries contributes
to both the cost effectiveness and strategic competitiveness of firms.
• Firm Strategy, Structure, and Rivalry. The creation and
persistence of national competitive advantage requires leading-edge
product and process technologies and business strategies.
2. Limitations of the Porter Diamond. The existence of the four
favorable conditions may represent a necessary but insufficient condition
for the development of a particular national industry. Even when abundant,
resources are ultimately limited; thus, firms must make choices regarding
their pursuit of existing opportunities. Further, given the ability of firms to
gain market information and production inputs from abroad, the absence of
favorable conditions within a country may be overcome by their existence
internationally.

66
 3. Using the Diamond for Transformation. Understanding and having
the necessary conditions to be globally competitive are important, but these
conditions are neither static nor purely domestic. As shown in the opening
case regarding Costa Rica’s economic transformation, the Costa Rican
government altered its educational system to tailor the country’s human
resource development to fit the needs of targeted industries. Likewise, it
developed local supplies and attracted sufficient numbers of foreign firm so
that their combined presence assured a vibrant competitive environment.

POINT—COUNTERPOINT:
Should Countries Follow Strategic Trade Policies?

POINT: Given the importance of acquired advantage in world trade, a country must
develop and maintain industries that will grow and earn sufficient revenues so that its
domestic economy thrives and grows. Targeting industries has proven particularly
important for emerging economies such as Costa Rica, and small countries such as
Singapore. At the same time, there are numerous examples of the failure of laissez faire
trade policies in Africa—given all of their economic inadequacies, government guidance
and intervention is their best hope for better results.

COUNTERPOINT: There are few circumstances where targeting will work, and even if
governments are able to identify future growth industries in which their countries can
likely succeed, it does not follow that firms within those industries should receive
government assistance. A better policy would be to alter the conditions that affect a
country’s attractiveness to firms in general, rather than specific targeted industries. This
would improve the investment environment for all industries without the need for
government officials to choose which industries to support.

V. FACTOR MOBILITY
Over time factor conditions change in both quality and quantity. Concomitantly, the
mobility of capital, technology, and people also affects the relative capabilities of
countries.
A. Why Production Factors Move
Factor mobility concerns the free movement of factors of production, such as
labor and capital, across national borders. While capital is the most
internationally mobile factor, short-term capital is the most mobile of all.
Capital is primarily transferred because of differences in expected returns,
although firms may also respond to government incentives. People transfer
internationally in order to work abroad, either on a temporary or a permanent
basis. It may be difficult to distinguish between economic and political motives
associated with international labor mobility, because poor economic conditions
often accompany repressive and/or uncertain political conditions.

67
 B. Effects of Factor Movements
Although capital and labor are in fact different production factors, they are
intertwined. Further, neither international capital nor population movements are
new occurrences. Immigrants bring human capital, thus adding to the base of a
country’s skills and enabling competition in new areas. Likewise, inflows of
capital to those same countries can be used to develop infrastructure and natural
and other acquired advantages, thus enabling increased participation in the
international trade arena. Countries lose potentially productive resources when
educated people leave, a situation known as brain drain, but they may in turn
gain from the remittances that citizens who are working abroad send home.
C. The Relationship of Trade and Factor Mobility
Factor movement is an alternative to trade that may or may not be a more
efficient allocation of resources.
1. Substitution. When factor proportions vary widely among countries,
pressures exist for the most abundant factors to move to countries with
greater scarcity. Thus, in countries where labor is relatively abundant
compared to capital, workers tend to be poorly paid; many will attempt to
go to countries that enjoy full employment and offer higher wages.
Likewise, capital tends to move away from countries where it is abundant to
those where it is relatively scarce. [See Fig. 6.6.] However, the inability to
gain sufficient access to foreign production factors may stimulate efficient
methods of domestic substitution, such as the development of alternatives
for traditional production methods.
2. Complementarity. Factor mobility via foreign direct investment may in
fact stimulate foreign trade because of the need for equipment, components,
and/or complementary products in the destination country. Alternatively,
trade may be restricted by local content laws, or when foreign direct
investment leads to import substitution.

LOOKING TO THE FUTURE: Will Conditions for Trade Change?

Firms have greater opportunities to pursue global strategies and capture economies of
scale by serving markets in more than one country from a single base of production if
those countries have relatively few restrictions on foreign trade and investment activities.
However, uncertainties exist as to whether the current trend toward the freer movement
of trade and production factors will continue. Four factors that might cause merchandise
trade to become relatively less significant in the future are:
• the growing tide of protectionist sentiment
• the possibility of more efficient country-by-country production
• increasingly flexible and efficient small-scale production methods
• the rapid growth of services as a portion of production and consumption within
the industrialized nations

68
 CLOSING CASE: LUKoil [See Map 6.2.]

LUKoil was one of several firms created in 1991 out of Russia’s state-owned petroleum
monopoly. While both Russia and LUKoil must export to meet their economic
objectives, political relations within and outside of Russia could impair LUKoil’s future
ability to export. Thus, foreign investment and ties to Western oil companies are very
important to the firm’s ultimate success. Controlling 19 percent of Russia’s oil
production and refining capacity and employing more than 120,000 people in its
operations worldwide, LUKoil has become Russia’s largest oil company. It is also the
first Russian oil company to integrate from “oil wells to filling stations.” High market
prices have enabled LUKoil to amass sufficient capital to make substantial foreign
investments. While much of its FDI has been directed to nearby countries, LUKoil has
also acquired 100 percent of Getty Petroleum in the United States, as well as 800 U.S.
stations from ConocoPhillips. Forward integration into filling stations will guarantee
LUKoil market access and enable the company to sell its crude oil during times of global
oversupply. Further, LUKoil sees its foreign acquisitions as a means of gaining
experienced personnel, technology, and competitive know-how to help it compete more
efficiently and effectively both at home and abroad.

Questions
1. What theories of trade help to explain Russia’s position as an oil exporter? Which
ones do not, and why?
Both the theories of absolute and competitive advantage help to explain Russia’s
position as an oil exporter. Prices in the global oil market are driven by the laws of
supply and demand. Given the fact that Russia now has 15 more proven reserves
than Saudi Arabia and its oil companies have become major global competitors, the
country enjoys both natural and acquired advantages with respect to oil. Thus, factor
proportions theory is applicable. The fact that a preponderance of its foreign
expansion has been to countries of the former Soviet Union supports the country
similarity theory. The Porter Diamond of national competitive advantage also helps
to explain Russia’s position as an oil exporter. Global demand conditions are
favorable; and Russian oil companies are making significant strides in the areas of
factors conditions, related and supporting industries, and firm strategy, structure, and
rivalry. Neither the interventionist theory of mercantilism nor the theories of country
size apply. Further, product life cycle theory does not apply because petroleum is
not an appropriate type of product for that model.

2. How do global political and economic conditions affect world markets and prices of
oil?
Global political and economic conditions affect world markets and prices because of
their real and perceived effects on global supply. In spite of their general upward
trend, oil prices have fluctuated widely in response to events during the twenty-first

69
 century. OPEC’s supply quotas, general economic uncertainty, China’s economic
expansion, political unrest in Venezuela, and the war in Iraq have all contributed to
the favorable market conditions that have led to record-setting prices and profits in
the global oil industry.

3. Discuss the following statement as it applies to Russia and LUKoil. “Regardless of

the advantages a country may gain by trading, international trade will begin only if
companies within that country have competitive advantages that enable them to be
viable traders—and they must foresee profits in exporting and importing.”
Given the globalization of the world’s oil industry on the one hand, and the massive
capacity of Russia’s oil producers on the other, it is vital that Russia’s domestic
companies have competitive advantages that enable them to operate profitably in
global markets. Otherwise, foreign competitors that can do so would be in a position
not just to serve the world’s markets, but to enter the Russian market via foreign
direct investment, if such action were permissible. Thus, it is critical that both
LUKoil and other Russian oil companies become as efficient as the major global
competitors, either by developing or acquiring the latest petroleum technology,
marketing skills, and operating efficiencies that will yield the efficiencies required to
effectively compete at both the global and local levels.

4. In LUKoil’s situation, what is the relationship between factor mobility and exports?
Capital, technology, and skilled employees are all critical factors in the global oil
industry. Even in Russia oil production and processing are capital-intensive
activities that require massive amounts of highly valuable and highly specialized
capital equipment manned by skilled laborers. Investment naturally flows to those
sites where oil is abundant and production activities are the most efficient. Because
oil is a limited resource and demand exists the world over, competitors such as
LUKoil serve their global customers via production sites that are scattered across the
world. Whereas LUKoil’s European customers will likely be served from its
European reserves, other customers are more likely to be served by oil sourced from
its holdings in other parts of the world.

5. Compare the role of the Costa Rican government in the chapter’s opening case with
the role of the Russian government in their use of trade to meet national economic
objectives.
The roles of the two governments are quite different in the sense that Costa Rica set
about developing acquired advantages in targeted industries, while Russia chose to
exploit its given natural resources in order to compete in global export markets as it
transitioned to a market-based economy. Although exports of coffee and bananas are
still important to Costa Rica, high-tech manufactured products (electronics, software,
and medical devices) are now the backbone of that country’s economy and export
earnings. On the other hand, as Russia moved through the transition from a
centrally-planned to a market-based economy, it fashioned competitive enterprises
such as LUKoil from its state-owned assets. Those firms have since had to rely on
their earnings in order to develop or acquire needed products, processes, facilities,
and/or employees.

70
WEB CONNECTION

Teaching Tip: Visit www.prenhall.com/daniels for additional information and

links relating to the topics presented in Chapter Six. Be sure to refer your students to
the online study guide, as well as the Internet exercises for Chapter Six.

_________________________

CHAPTER TERMINOLOGY:
strategic trade policy, p.201 statics, p.210
interventionist trade theories, p.203 dynamics, p.210
mercantilism, p.203 nontradable products, p.211
favorable balance of trade, p.204 theory of country size, p.211
unfavorable balance of trade,p.204 factor proportions theory, p.212
neomercantilism, p.204 country similarity theory, p.215
free trade, p.205 product life cycle theory, p.217
invisible hand, p.205 Porter diamond, p.219
absolute advantage, p.205 demand conditions, p.219
natural advantage, p.205 factor conditions, p.219
acquired advantage, p.206 factor mobility, p.223
production possibilities curve, p.206 brain drain, p.224
comparative advantage, p.207 substitution, p.225
complementarity, p.226
_________________________

ADDITIONAL EXERCISES: International Trade and Factor Mobility

Exercise 6.1. The theories of absolute and comparative advantage and the
product life cycle all contribute to the explanation of the international trade process.
Select two to three different types of products and ask students to discuss the
likelihood that (a) an innovating country, (b) a rapidly developing country, and (c) an
emerging country would enjoy an absolute advantage, a comparative advantage, or
no particular advantage as each of the products moves through the four stages of the
product life cycle. Be sure they cite examples and explain their reasoning.

Exercise 6.2. The factor-proportions theory and the country-similarity theory both
address patterns of trade, i.e., partner nations. Ask students to compare and contrast
the two theories. In what ways are they complementary and in what ways do they
differ? Then select two to five home countries of students in your class and ask the
class to identify the natural and acquired advantages of those countries and to
compare their various economic, cultural, and political similarities.

71
Exercise 6.3. Porter’s Diamond deals with the competitive advantages of nations.
Select two to five countries and lead the class in a comparative analysis of the four
points of the diamond, as well as the recent roles of government and chance, in those
nations. Conclude the discussion by exploring the associated competitive advantages
that may accrue to foreign firms that choose to operate in each of those countries.

Exercise 6.4. Select two large multinational enterprises that are known to the
students, one consumer-oriented (e.g., McDonald’s) and one industrial (e.g.,
Newmont Mining). Then ask students to discuss the concept of complementarity
within the context of the operations of those two firms. What equipment,
components, and/or complementary products are needed in host countries as a result
of their foreign operations that may stimulate foreign trade in both the short and the
long run?

72