Chapter Discussion

Understand the theories that attempt to explain why certain goods are traded internationally.
Why do nations trade? Mercantilists did so to build up storehouses of gold. Later, Adam Smith showed that a nation would export goods that it could produce with less labor than other nations. Ricardo then proved that even though it was less efficient than other nations, a country could still profit by exporting goods if it held a comparative advantage in the production of those goods.

The idea that a nation would tend to export products requiring a large amount of a relatively abundant factor was offered by Heckscher and Ohlin in their theory of factor endowment. The international product life cycle theory states that many products first produced in the United States or other developed countries are eventually produced in less developed nations and become imports to the very countries in which their production began.

In the 1920s, economists realized the economies of scale affect international trade because they permit the industries of a nation to become low-cost producers without having an abundance of a class of production factors. As in the case of comparative advantage, nations specialize in the production of a few products and trade to supply the rest. The Linder theory of overlapping demand states that because customers’ tastes are strongly affected by income levels, a nation’s income level per capita determines the kind of goods they will demand. The kinds of goods produced to meet this demand reflect the country’s income per capita level. International trade in manufactured goods will be greater between nations with similar levels of per capita income. Porter claims that four classes of variable affect a country’s ability to gain a competitive advantage: demand conditions, factor conditions, related and supporting industries, and firm strategy, structure, and rivalry.

Comprehend the arguments for imposing trade restrictions.
Special interest groups demand protection for defense industries so that this country will have their output in wartime and will not depend on imports that might not be available. Critics say that it would be far more efficient to subsidize some firms, that is, pay them to be ready. Taxpayers would know exactly what the cost is, as we do in the case of American steamship companies. New industries in developing nations frequently request barriers to imports of competing products from developed countries. The argument is that the infant industry must have time to gain experience before having to confront world competition. Protectionists argue for protection from cheap imports by claiming that countries with lower hourly labor rates than their nation’s rates can flood the United States with low-priced goods and put Americans out of work. However, hourly labor rates are just a small part of production costs. There are legislated fringe benefits that are a much higher percentage of the direct wages than is the case in developed nations. Productivity per worker may be considerably lower in the developing nations so that less is produced for a given hourly rate. Commonly, also, the costs of other factors of production that must be included in the cost of production often are higher in developing nations. Others want “fair” competition, that is, an import duty to raise the cost of the imported good to the price f the imported article to eliminate any “unfair” advantage that the foreign competitor may have. This, of course, nullifies the comparative advantage. Companies will also demand that their government retaliate against dumping and subsidies offered by their competitors in other countries.

Explain the two basic kinds of import restrictions: tariff and nontariff trade barriers.
In response to demands for protection, governments impose import duties (tariff barriers) and nontariff barriers, such as quotas, voluntary export restraints, and orderly marketing arrangements, and nonquantitative nontariff barriers, such as direct government participation in trade, customs and other administrative procedures and standards for health, safety, and product quality.

State the agreements reached during the Uruguay Round.
As a result of negotiations during the Uruguay Round, governments agreed to eliminate nontariff barriers, such as quotas, VERs, and orderly marketing agreements and bring textiles and agricultural products under the general trading rules for all products during a 10-year period.

Appreciate the relevance of the changing status of tariff and nontariff barriers to businesspeople.
Exporting firms may find that because tariff and nontariff barriers have been eliminated or lowered, they can now enter markets that were closed to them. It also is easier for firms to locate production activities in lower-cost nations to improve the efficiency of their manufacturing systems. Multidomestic firms may be able to close less efficient plants and supply those markets by exporting from more efficient ones.

Recognize the weaknesses of GNP/capita as an economic indicator.
For a number of reasons, GNP/capita is a weak market indicator. Transactions worth billions of dollars go unrecorded because people do business in the underground economy, paying cash without demanding receipts and invoices. Exchange rates for converting economic data usually do not reflect consumer purchasing power. International institutions such as the World Bank and the United Nations have developed a method of comparing GNPs that is based on purchasing power parity.

Identify the common characteristics of developing nations.
Developing nations have certain common characteristics: unequal distribution of income, technological and regional dualism, large percentage of the population in agriculture, high population growth, high illiteracy rate, insufficient education, and low saving rates.

Understand the new definition of economic development, which includes more than economic growth.
The human-needs approach defines economic development as the reduction of poverty, unemployment, and inequality in the distribution of income.

Understand why some governments are changing from an import substitution strategy to one of export promotion and the implications of this change for businesspeople.
Governments are changing from using an import substitution strategy to one of export promotion to become less dependent on developed nations. Also, governments are opening their borders to imports to force local producers to raise quality and improve prices so that they can enter world markets. Managers of foreign-owned affiliates can be expected to export even though the company may prefer to keep exporting and keep the profits for the home office.

Explain some of the theories of foreign direct investment.
International investment theory attempts to explain when foreign direct investment (FDI) takes place. Product and factor market imperfections provide firms, primarily in oligopolistic industries, with advantages not open to indigenous companies. The international product life cycle theory explains international investment as well as international trade. Some firms follow the industry leader, and the tendency of European firms to invest in the United States and vice versa seems to indicate that cross investment is done for defensive reasons. The internalization theory states that firms will seek to invest in foreign subsidiaries rather than license their superior knowledge to receive a better return on the investment used to develop that knowledge.

There are two financially based explanations of foreign direct investment. One holds that foreign exchange market imperfections attract firms from nations with overvalued currencies to invest in nations with undervalued currencies. The second theory postulates the FDI is made to diversify risk. Empirical tests reveal that most FDI is made by large, research-intensive firms in oligopolistic industries.

The eclectic theory of international production explains an international firm’s choice of its overseas production facilities. The firm must have location and ownership advantages to invest in a foreign plant. It will invest where it is most profitable to internalize its monopolistic advantage.