🪁Multinational Corporate Strategies Unit 5 – International Trade Theories & Policies

Key Concepts in International Trade

• International trade involves the exchange of goods, services, and capital across international borders or territories
• Absolute advantage refers to the ability of a country to produce a particular good or service at a lower absolute cost than another country
• Comparative advantage occurs when a country can produce a particular good or service at a lower opportunity cost than another country
• Factor endowments, such as land, labor, and capital, play a crucial role in determining a country's comparative advantage
• Heckscher-Ohlin model suggests that countries will export goods that use their abundant factors intensively and import goods that use their scarce factors intensively
• Intra-industry trade involves the exchange of similar products belonging to the same industry between countries (automobiles, electronics)
• Trade barriers, such as tariffs, quotas, and subsidies, are used by governments to protect domestic industries or to raise revenue
• Free trade agreements (NAFTA, EU) aim to reduce or eliminate trade barriers and promote economic integration among member countries

Historical Development of Trade Theories

• Mercantilism, prevalent in the 16th-18th centuries, emphasized the importance of a positive balance of trade and the accumulation of gold and silver
• Adam Smith's theory of absolute advantage (1776) argued that countries should specialize in producing goods they can produce most efficiently
• David Ricardo's theory of comparative advantage (1817) demonstrated that countries can benefit from trade even if they have an absolute disadvantage in producing all goods
• Heckscher-Ohlin model (1933) focused on the role of factor endowments in determining trade patterns
• New trade theory, developed in the 1970s and 1980s, incorporated economies of scale, product differentiation, and imperfect competition into trade models
• Michael Porter's diamond model (1990) identified four determinants of national competitive advantage: factor conditions, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry
• Gravity model of trade suggests that trade flows between countries are positively related to their economic sizes and negatively related to the distance between them

Comparative Advantage and Its Modern Interpretations

• Comparative advantage arises from differences in opportunity costs of production between countries
• Opportunity cost measures the amount of one good that must be given up to produce an additional unit of another good
• A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than another country
• Modern interpretations of comparative advantage consider factors such as technological differences, economies of scale, and product differentiation
• Dornbusch-Fischer-Samuelson model (1977) introduced the concept of a continuum of goods and showed how comparative advantage determines the range of goods a country exports and imports
• Krugman's new trade theory (1979) demonstrated that economies of scale and product differentiation can lead to intra-industry trade and specialization even in the absence of comparative advantage
• Grossman-Helpman model (1991) incorporated innovation and product cycles into the analysis of comparative advantage and trade patterns

Trade Models and Their Applications

• Ricardian model focuses on technological differences as the main determinant of comparative advantage and trade patterns
• Heckscher-Ohlin model emphasizes the role of factor endowments (land, labor, capital) in determining comparative advantage and trade patterns
  • Stolper-Samuelson theorem predicts that trade liberalization will increase the real returns to the abundant factor and decrease the real returns to the scarce factor
  • Rybczynski theorem states that an increase in the endowment of one factor will lead to a more than proportional increase in the output of the good that uses that factor intensively
• Specific-factors model assumes that some factors (capital, land) are specific to particular industries, while labor is mobile across industries
• Gravity model of trade is an empirical model that relates trade flows between countries to their economic sizes and the distance between them
• New trade theory models incorporate economies of scale, product differentiation, and imperfect competition (monopolistic competition, oligopoly)
• Melitz model (2003) introduces firm heterogeneity and shows how trade liberalization leads to the reallocation of resources towards more productive firms

Trade Policies and Instruments

• Tariffs are taxes imposed on imported goods, which raise the price of imports and protect domestic industries
  • Ad valorem tariffs are expressed as a percentage of the value of the imported good
  • Specific tariffs are expressed as a fixed amount per unit of the imported good
• Quotas are quantitative restrictions on the amount of a good that can be imported
• Subsidies are financial assistance provided by governments to domestic producers, which can help them compete with foreign producers
• Voluntary export restraints (VERs) are agreements between countries in which the exporting country voluntarily limits its exports to the importing country
• Non-tariff barriers include regulations, standards, and bureaucratic procedures that can hinder trade
• Trade remedies, such as anti-dumping duties and countervailing duties, are used to counter unfair trade practices
• Export promotion policies, such as export subsidies and export credit guarantees, aim to encourage exports

Global Trade Organizations and Agreements

• World Trade Organization (WTO) is a global organization that deals with the rules of trade between nations, aiming to ensure a level playing field for all members
  • WTO agreements cover goods, services, and intellectual property
  • Dispute Settlement Body resolves trade disputes between member countries
• General Agreement on Tariffs and Trade (GATT) was a multilateral agreement that preceded the WTO, focusing on reducing tariffs and other trade barriers
• Regional trade agreements (RTAs) are reciprocal trade agreements between two or more countries (NAFTA, EU, ASEAN)
  • Customs unions involve the elimination of tariffs among members and the adoption of a common external tariff (EU)
  • Free trade areas eliminate tariffs among members but allow each member to maintain its own external tariff (NAFTA)
• Preferential trade agreements (PTAs) provide preferential market access to certain products from participating countries (Generalized System of Preferences)
• Bilateral trade agreements are negotiated between two countries to reduce trade barriers and promote trade (US-Korea Free Trade Agreement)

Impact of Trade on Multinational Corporations

• Multinational corporations (MNCs) are firms that operate in multiple countries and engage in foreign direct investment (FDI)
• Trade liberalization and the reduction of trade barriers have facilitated the expansion of MNCs and the globalization of production
• MNCs can take advantage of differences in factor prices, technology, and market access across countries to optimize their production and distribution networks
• Intra-firm trade, which involves trade between different units of the same MNC, accounts for a significant share of global trade
• Vertical FDI occurs when an MNC fragments its production process across countries to take advantage of differences in factor prices (labor costs)
• Horizontal FDI occurs when an MNC replicates its production facilities in multiple countries to serve local markets and avoid trade costs (tariffs, transportation costs)
• Trade policies and agreements can influence the location and investment decisions of MNCs
• MNCs can also influence trade policies through lobbying and political contributions

Current Challenges and Future Trends in International Trade

• Trade tensions and the rise of protectionism, as exemplified by the US-China trade war, pose challenges to the global trading system
• The COVID-19 pandemic has disrupted global supply chains and highlighted the need for greater resilience and diversification in trade relationships
• The increasing importance of services trade, particularly in the digital economy, requires new rules and frameworks to address issues such as data flows and e-commerce
• The growing emphasis on sustainable development and environmental protection has led to the incorporation of environmental provisions in trade agreements (CPTPP)
• The proliferation of regional and bilateral trade agreements has raised concerns about the fragmentation of the global trading system and the marginalization of the WTO
• The emergence of new technologies, such as automation and artificial intelligence, is likely to reshape comparative advantage and trade patterns in the future
• The rise of global value chains (GVCs) has increased the interconnectedness of economies and the complexity of trade relationships
• Addressing income inequality and ensuring the benefits of trade are widely shared remain important challenges for policymakers and businesses alike