CH05 International Trade

Chapter 5 International Trade
Chapter Preview
Discuss the volume and patterns of world trade
Identify the inherent flaws of mercantilism Explain the absolute and comparative advantage theories Describe the factor proportions and international product life cycle theories Explain the new trade and national competitive advantage theories
International Business 4e
Chapter 5 - 2
International Trade
Purchase, sale, or exchange of goods and services across national borders
People have larger selection of products Important engine for job creation
Chapter 5 - 3
Trade and World Output

World trade
80% merchandise 20% services
World output impacts trade

Growing output = growing trade Sluggish output = sluggish trade
World trade grows faster than world output

Chapter 5 - 4

Trade is impacted by the global business cycle.
Trade slows in a recession as people are uncertain about the future and buy less. Also, when an economy is in recession the currency is weak; slowing imports because they are more expensive.
World trade


Chapter 5 - 5

Example: The US economy is in a recession and the US dollar has fallen some 34% since its peak in 2002 against a basket of currencies.
World trade


Chapter 5 - 6
100
110
120
60 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07
70
80
90
Major Currency Index

FRB
Jan-08 Jan-09 Jan-10
34% drop

Example: That decline is helping to shrink its external deficit. As of Nov 10 trade showed exports growing at a 15% annual rate, whereas imports grew by 13.6%.
World trade


Chapter 5 - 8
It
seems that the majority of the offset from the US trade deficit comes from developing economies.
Chapter 5 - 10

World trade
This means that economies are more interconnected via trade.


Chapter 5 - 11
Worlds Top Exporters
Chapter 5 - 12
trade volume as a % of GDP
Worlds Trade
100.1% and up 75.1% to 100.0%
50.1% to 75.0% 25.1% to 50.0%

Up to 25.0%
Question:
Why do the top two economies have the smallest percentages?
Chapter 5 - 13
Trade Patterns
Merchandise trade among:
Low- and middle-income nations
6%
Western European trade is mostly intraregional trade
High-income nations
60%
34%
High-income and low- and middle-income nations
North America imports twice as much from Asia as it exports to Asia

Chapter 5 - 14
Trade Patterns
Merchandise trade among:
Low- and middle-income nations
6%
High-income nations
60%
This low figure reveals the low purchasing power of the poor nations and lack of development
34%
High-income and low- and middle-income nations
Chapter 5 - 15
Who Trades with Whom?

Who trades with whom?
Chapter 5 - 16

Intra-regional trade accounts for over 74 percent of Europes exports
2973
Chapter 5 - 17

and 56% of North Americas exports.
742
Chapter 5 - 18

This data also shows the trade imbalance between Asia and North America (and reasons for friction)
Chapter 5 - 19

North America exports $249 billion to Asia
249
Chapter 5 - 20

While Asia exports $533 billion to North America
533
Chapter 5 - 21
Trade and the Dependent Nation

Total dependence Total independence
Potential effects of dependence:
+ Infuses needed capital + Creates jobs and raises wages + Imports technology and skills Economic problems transferred Political turmoil can spill over
Chapter 5 - 22

Total dependence
Developing and transition nations often depend on

their developed neighbors with whom they share borders. Germany is the single most important trading partner of central and eastern European nations. Mexico is extremely dependent on the US for its exports.
If a nation experiences economic recession or

political turmoil, the dependent nation can experience economic problems.
Chapter 5 - 23

How connected are the NAFTA countries?
8%
Annual Change in GDP

6%
4%
Annual Percent Change Annual Percent Change
2%
Canada USA
0%
-2%
US
$, constant prices, constant PPPs, OECD base year, millions
-4%
Chapter 5 - 24

10.0%
8.0%
6.0%
Annual Change in GDP
4.0%
2.0%
USA Mexico
0.0% 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
-2.0%
-4.0%
-6.0%
-8.0%
US
$, constant prices, constant PPPs, OECD base year, millions
Chapter 5 - 25

Total dependence
Is your country overly export-dependant on one or

two countries?
Which country represents the largest export market?
Chapter 5 - 26
Trade Theory Timeline
Chapter 5 - 27
Mercantilism
Nations accumulate financial wealth by encouraging exports and discouraging imports
Three pillars
Maintain trade surplus Government intervention Exploit colonies
Inherent flaws
World trade is zero-sum game Constrains output and consumption Limits colonies market potential
Chapter 5 - 28
Mercantilism
Is China a mercantilist state?
Chinas trade frictions with the rest of the world is heating up.
Foreigners insist that the main reason for Chinas growing market share is that the government in Beijing has kept its currency weak.
Chapter 5 - 29
Mercantilism
But there are several other reasons why Chinas exports held
up better than those of its competitors during the global recession: Lower incomes encouraged consumers to trade down to cheaper goods Elimination of global textile quotas in January 2009 allowed China to increase its slice of that market
Chapter 5 - 30
Mercantilism
How high could Chinas market share

go?
Over the ten years to 2008 Chinas exports grew by an annual average of 23% in dollar terms, more than twice as fast as world trade.
Projections in the IMFs World Economic Outlook imply that Chinas exports will account for 12% of world trade by 2014.
Chapter 5 - 31
Mercantilism
An IMF working paper published in 2009 calculated that if

China remained as dependent on exports as in recent years, then to sustain annual GDP growth of 8% its share of world exports would rise to about 17% by 2020. w high could Chinas market share go? They concluded that to achieve the required export growth, China would have to reduce prices, which would be increasingly hard to manage, whether through productivity gains or a squeeze in profits.
Chapter 5 - 32
Mercantilism
Nations accumulate financial wealth by encouraging exports and discouraging imports
Inherent flaws
World trade is zero-sum game A nation benefits only at the expense of other nations
But if all nations barricade their markets from imports and push their exports onto others, international trade would be severely restricted. It kept colonial markets poor.
Chapter 5 - 33
Absolute Advantage
Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources)
Adam Smith reasoned that international trade should not be burdened by tariffs and quotas, but should flow according to market forces. A country should produce the goods in which it holds an absolute advantage and trade with others to obtain the goods it needs but does not produce efficiently.
Chapter 5 - 34
Absolute Advantage
Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources)
Riceland
Tealand
1 resource unit = 1 ton rice or 1/5 ton tea
1 resource unit = 1/6 ton rice or 1/3 ton tea
Specialization and trade allows each to produce and consume more

Chapter 5 - 35
Absolute Advantage
Lets say that Riceland uses one resource unit to produce 1 ton of rice and trades for 1 ton of tea
Riceland
Tealand
1 ton rice
1 ton tea
Chapter 5 - 36
Absolute Advantage
We see that Riceland is better off because if it used its one resource unit to produce tea it would have received only 1/5 ton.
Riceland
Tealand
1 ton tea
1 ton rice
Chapter 5 - 37
Absolute Advantage
What about Tealand? Lets say that Tealand uses one resource unit to produce 1/3 ton of tea and trades for 1/3 ton of rice
Riceland
Tealand
1/3 ton rice

1/3 ton tea

Chapter 5 - 38
Absolute Advantage
We see that Tealand is also better off because if it used its one resource unit to produce rice it would have received only 1/6 ton.
Riceland
Tealand
1/3 ton tea
1/3 ton rice

Chapter 5 - 39
Comparative Advantage
Comparative advantage is the ability of a country to produce a specific good at a lower opportunity cost than its trading partners.
Chapter 5 - 40
Lets say China and US can produce the same car but at different costs. Assume that the car retails for $10,000. China US
$4,000
cost
$3,500
Should the US produce the car or trade for a Chinese model?

Chapter 5 - 41
It depends. What is the US giving up if it produces its own car? The opportunity cost will determine if it is a good idea for the US to produce or trade.
Chapter 5 - 42
Since the US can produce the car for less, it seems logical that it should produce, consume, and/or trade it with China. But by producing this car it is denying resources to the production process of other goods.
Chapter 5 - 43
Lets say that if China did not produce the car, its most valued alternative is to produce rice valued at $10 a bushel. China
or
$10
$10,000
Chapter 5 - 44
Lets say that if the US did not produce the car, its most valued alternative is to produce a jumbo jet valued at $5,000.000. US
or
$10,000
$5,000,000
Chapter 5 - 45
So, even though the US can produce a car at a lower cost than China, it would be in its own best interest to produce planes and trade China for cars.
Chapter 5 - 46
Assumptions and Limitations

1.
Nations strive only to maximize production and consumption

Only two countries produce and consume just two goods
2.
3.
No transportation costs of trading goods

Labor is the only resource used to produce goods Ignores efficiency and improvement gains from producing just one good
Chapter 5 - 47
4.
5.
International Product Life Cycle

A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle
Chapter 5 - 48

In new product stage, stage 1, the high purchasing power and demand of spur a company to design and introduce a new product concept
Consumption
Chapter 5 - 49

Although initially there is virtually no export market, exports increase late in the new product stage.
Exports are small Because the import markets are small
Chapter 5 - 50
In the maturing product stage, stage 2, the domestic market and markets abroad become fully aware of the existence of the product and its benefits.
Imports are growing
Chapter 5 - 51
In the maturing product stage, stage 2, the domestic market and markets abroad become fully aware of the existence of the product and its benefits.
Which, in turn, drives exports
Chapter 5 - 52
In the standardized product stage, stage 3, competition from other companies selling similar products pressures companies to lower prices in order to maintain sales levels.
Look at the levels of production in countries
Chapter 5 - 53

An aggressive search for low-cost production bases abroad begins and the home market may begin importing.
And other countries become net exporters
Chapter 5 - 54

The theory is challenged by the fact that more companies are operating in international markets from their inception.
The Internet has made this easier particularly for small and midsize companies.
Also, small companies are more often teaming up with companies in other markets to develop new products or production technologies.
Yet the theory retains explanatory power when applied to technology-based products that are eventually massproduced.
Chapter 5 - 55
Chapter Review
Discuss the volume and patterns of world trade
Identify the inherent flaws of mercantilism Explain the absolute and comparative advantage theories Describe the factor proportions and international product life cycle theories Explain the new trade and national competitive advantage theories
Chapter 5 - 56

CH05 International Trade

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Chapter 5 International Trade

Trade and World Output

World output impacts trade

World trade grows faster than world output

Trade and World Output

World output impacts trade

World trade grows faster than world output

Trade and World Output

World output impacts trade

World trade grows faster than world output

Major Currency Index

Jan-08 Jan-09 Jan-10

Trade and World Output

Trade and World Output

World output impacts trade

World trade grows faster than world output

Trade and World Output

Trade and World Output

Trade and World Output

World output impacts trade

World trade grows faster than world output

Worlds Top Exporters

trade volume as a % of GDP

100.1% and up 75.1% to 100.0%

50.1% to 75.0% 25.1% to 50.0%

Western European trade is mostly intraregional trade

High-income and low- and middle-income nations

North America imports twice as much from Asia as it exports to Asia

High-income and low- and middle-income nations

Who Trades with Whom?

Who Trades with Whom?

Who Trades with Whom?

Who Trades with Whom?

Who Trades with Whom?

Who Trades with Whom?

Trade and the Dependent Nation

Potential effects of dependence:

Trade and the Dependent Nation

Developing and transition nations often depend on

If a nation experiences economic recession or

Trade and the Dependent Nation

Annual Change in GDP

Annual Percent Change Annual Percent Change

$, constant prices, constant PPPs, OECD base year, millions

Trade and the Dependent Nation

Annual Change in GDP

$, constant prices, constant PPPs, OECD base year, millions

Trade and the Dependent Nation

Is your country overly export-dependant on one or

Which country represents the largest export market?

Trade Theory Timeline

How high could Chinas market share

An IMF working paper published in 2009 calculated that if

1 resource unit = 1 ton rice or 1/5 ton tea

1 resource unit = 1/6 ton rice or 1/3 ton tea

Specialization and trade allows each to produce and consume more

1 resource unit = 1 ton rice or 1/5 ton tea

1 resource unit = 1/6 ton rice or 1/3 ton tea

1 resource unit = 1 ton rice or 1/5 ton tea

1 resource unit = 1/6 ton rice or 1/3 ton tea

1 resource unit = 1 ton rice or 1/5 ton tea

1 resource unit = 1/6 ton rice or 1/3 ton tea

1/3 ton rice