Theoretical Framework of

International Finance
“International trade is treated as a different
subject because of tradition, because of
urgent and important problems presented by
international economic questions in the real
world, because it follows different laws from
domestic trade and because it studies ,
illuminates and enriches our understanding of
economics as a whole.”
- KINDLEBERGER
 Reasons for the increasing importance
of International Finance

There are broadly six aspects of world economy

which have provided importance to international
finance, viz.
2) Specialization of nation and trade
3) Opening of economies
4) Globalization of firms
5) Emergence of new forms of business
organizations
6) Growth of world trade
7) Need of development process of nations.
 1). Specializations of nation and trade

a) Mercantilist’s view
b) Absolute advantage theory
c) Comparative advantage theory
d) Hecksher-ohlin-samuelson model/
Factor endowment
e) Newer explanations of comparative
advantages
f) Strategic trade theories.
2).Opening of economies

Most of the developed nations opened up because

of the state of the art technologies in the production
process which increased their production capacities.
Thus, they globalized in search of new markets.

The developing nations globalize as a result of

economic pressures being generated by deficient
resources.
As a consequence of opening up, the world is
integrating and is becoming smaller and
intedependent.
3). Globalization of firms
Why do firms globalize:-
 A firm may globalize as a raw material
seeker.
 As a technology seeker

 To obtain a competitive edge over its

domestic counterparts.
 As a knowledge seeker.
 Three main explanations

1).The theory of competitive advantage

 Research and development
 Innovation in production
 Specialization in management style
 Technological development
 The firm’s location
 Strategic policy of government

2).Theory of imperfect market.

3).The product life cycle theory.

4).Emergence of new forms business
organizations
 International Trade
 Licensing
 Franchising
 Joint ventures
 Acquisitions of existing operations
 Establishing foreign subsidiaries

5). Growth of world trade

> Increased production capacities of nations
(developed economies)
> Necessity of ..
(developing nations)
 6).Development process of Nations.

(i) Internalized – economy totally depends on

internal resources , internal R&D,
development of indigenous technology and
input substitution.

(ii) Externalized – large investment – saving in

economy, external borrowings, foreign
investments and foreign trade promoted,
foreign technology sought to enhance
production and lower the cost.