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Flashcards in International Trade Deck (60):

Why do firms engage in foreign trade?

- Profitability
* Export incentives
* Import Incentives


What export incentives are there for foreign trade?

- Reduced per unit production costs
- Use of excess production capacity
- Price premium in foreign market
- Risk spreading


What import incentives are there for foreign trade?

- Cheaper supplies
- Additions to product line
- Reducing risk in the supply chain


What is the continuum of trade interdependence?

- High dependence at one end ( mainly small nations: Singapore, HK, Netherlands)
- High interdependence at the other end (Autarkical/poor countries: NKorea, Myanmar, Bhutan, Cuba)


What are the issues concerning trade interdependence?

- Neighbouring countries trade more
- Effect on developing and transition economies
- Dangers of trade dependency
- Balance between dependence-independence


What do trade theories?

- Shows why it is beneficial for a country to engage in international trade even for pdocuts it is able to produce itself
- Helps to explain patterns of trade between countries


What are the key trade theories?

* Mercantilism
* Absolute Advantage
* Comparative Advantage
* Huckster & Ohlin theory of factor endowments
* Vernons Product Life-Cycle Theory
* New trade theory
* Porters’ National Competitive Advantage


What is Mercantilism?

- Advocates encouraging exports and limiting imports
- See’s no virtue in large volume of trade
- Flaw is that trade is viewed as zero sum
- Neo-mercantilism equates political power with economic power and economic power with a balance of trade surplus


What is Hume's critique of Mercantilism?

- A trade surplus will swell domestic money and create inflation, whereas the trade partner will see its money supply contract and prices fall
- This change in relative prices will encourage trade partner to buy fewer domestic goods as they are more expensive, and the domestic consumers to buy more foreign goods as they are becoming cheaper
- The result is a decoration in the domestic balance of trade and an improvement in the partners balance until the original surplus is eliminated


What is Absolute Advantage?

- Adam Smith - attacked the notion that trade is zero sum
- Countries should specialise in the production of goods in which they have an absolute advantage and then trade these goods for those produced by others


What is comparative advantage?

- David Ricardo
- Smith’s theory suggests that a country that has an absolute advantage in all goods may garner no benefit from trade
- Ricardo suggests that country’s should specialise in the production of those goods that it produces more efficiently and to buy the others, even if they could produce said goods themselves
- Leads to the fact that potential world trade production is greater with unrestricted trade than it is with restricted trade
- Stressed that comparative advantage arises from differences in productivity - particularly labour


What are the qualifications and assumptions of Comparative Advantage theory?

- Assumes only two countries
- Assumed away transport costs
- Assumed away differences in the prices of resources in different countries and exchange rates
- Assumed free movement of resources from the production of one good to another
- Assumed constant returns to scale
- Assumed fixed stock of resources and that free trade does not change the efficiency with which a country uses its resources
- Assumed away the effects of trade on income distribution


What are the extensions of comparative advantage theory?

* Immobile resources
* Diminshing returns
* Dynamic Effects & Economic Growth
* Samuelson Critique


What is the immobile resources extension of comparative advantage theory?

- Resources do not always move easily from one economic activity to another
- Process can create friction and human suffering


What is the diminishing returns extension of comparative advantage theory?

- It is more realistic to assume DRS because not all resources are the same quality and different goods use resources in different proportions
- DRS means that it is not feasible for a country to speicialise to the extreme - gains from specialisation are likely to be exhausted before specialisation is complete


What is the dynamic effects & economic growth extension of comparative advantage theory?

- Free trade may increase a country’s stock of resources as increased supply of labour and capital from abroad become available
- Free trade might also increase the efficiency with which a country uses its resources - economies of scale


What is the Samuelson Critique extension of comparative advantage theory?

- The lower price a rich country’s consumer pay for goods imported from a poor country may not be enough to produce a net fain for the rich country if the dynamic effect of free trade is to lower wages in the right country
- Outsourcing etc. may have similar effects to mass inward migration into the rich country - will lower market clearing wage rate, possibly by enough to outweigh the benefits of trade
- Evidence exists in support - however in the long run trade is undeniably a benefit


What is Huckster & Ohlin theory of factor endowments?

- Questions Ricardo’s assumption that labour productivity differences underlie comparative advantages
- Argues that it instead arises from national factor endowments
- Most economists prefer Heckscher-Ohlin’s theory to Ricardo’s because it makes fewer simplifying assumptions s
- Leontief Paradox
- Assumes that tech is the same across countries
- Once tech is controlled for across countries, empirically is sound


What is the Leontief Paradox and what is it a factor in?

- Huckster & Ohlin theory of factor endowments
- Postulated that because the US was relatively abundant in capital compared to other nations, the US would be an exporter of capital intensive goods and an importer of labour intensive ones
- This is not the case
- One possible explanation is the US has a special advantage in producing new products made with innovative tech. Such products may be less capital-intensive than those that have matured and become more suitable for mass production
- Some studies confirm this


What is Vernons Product Life-Cycle Theory?

- Wealth and size of the US gives firms a strong incentive to develop new products - high cost of labour gives them incentive to develop cost saving process innovations
- Most new products are initally produced in America as production facilities are better kept close to market and decision making given the uncertainty and risks in producing new products
- Further, the demand for most new products tends to be based on nonprice factors, therefore firms can charge relatively high prices which obviates the need to look for low cost production alternatievs
- Early in the cycle, when demand is growing in the US it is limited to high income groups in other countries - not making it worthwhile for firms in those countries to start production, but does necessitate some exports
- As demand in other advanced countries begins to grow, it become worthwhile for foreign producers to begin production or for US firms to set up foreign production facilities
- Consequently, production within other advanced countries begins to limit the potential for US exports
- As the product becomes more standardised, price becomes the main competitive weapon
- The cycle by which the US lost its advantage to other advanced countries might be repeated once more as developing countries begin to acquire a production advantage
- Overall, US moves from being an exporter to an importer of the same product


What is the empiricism of Vernons Product Life-Cycle Theory?

- Seems to be an accurate explanation of internatioal trade patterns
- However recently the US has not been the only driver of product innovation - S Korea, Japan
- Further, increased globalisation means that an increasing number of new products are introduced simultaneously worldwide


What is New Trade Theory?

- Krugman
- Is at variance with Heckscher-Ohlin theory, factor endowment not important
* Product variety and costs
* First mover advantage
- Empirically valid


What is product variety and costs in New Trade Theory?

- Through it’s impact on economies of scale, trade can increase the variety of goods and decrease the average costs
- As the size of the market expands due to trade, firms will attain better e.o.s, allowing for (1) lower costs and (2) production of goods that are too expensive to produce in the absence of these trade e.o.s’s
- This implies that each nation may be able to specialise in producing a narrower range of products that it would in the absence of trade, yet by buying goods that it does not make, each nation can simultaneously increase the variety of goods and lower the costs of those goods
- Thus trade offers an opportunity for mutual gain even when countries do not differ in their resource endowments or technology


What are first mover advantages in New Trade Theory?

- In industries where the output required to attain economics of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of firms
- First movers can gain a scale-based cost advantage that later entrants find almost impossible to match


What are the implications of New Trade Theory?

- Nations may benefit from trade even when they do not differ in resource endowments or tech
- Suggest that a country may predominate in the export of a good simply because it was a first mover
- May generate government intervention and strategic trade policy - subsidies for first movement advantages - i.e. contra free trade


What is Porter's National Competitive Advantage Theory?

- Porter theories that four attributes shape the environment in which local firms compete and these attributes promote or impede the creation of competitive advanages
* Diamond
- “Diamond” is a mutually reinforcing system - the effect of one attribute is contingent on the state of others
- Argues that presence of all four components is usually required for boosts to completive performance
* Two additional variables


What is the diamond in Porter's National Competitive Advantage Theory?

* Factor endowments
* Demand conditions
* Related and supporting industries
* Firm strategy, structure and rivalry


What are factor endowments in Porter's National Competitive Advantage Theory?

- Nation’s position in factors of production e.g. skilled labour or infrastructure
- Basic factors
- Climate, location, demographics, natural resources
- Advanced factors
- Infrastructure, skilled labour, tech
- Argues advanced factors are more significant for competitive advantage - therefore gov’t investments can upgrade competitiveness
- Basic factors can provide an initial advantage, disadvantaes in basic factors can spurn investment in advanced ones


What are demand conditions in Porter's National Competitive Advantage Theory?

- Home country demand for product or service
- Creates pressure for innovation and quality
- Porter argues that firms gain competitive advantage if their domestic consumers and sophisticated and demanding


What are related and supporting industries in Porter's National Competitive Advantage Theory?

- Presence of absence of supplier industries and related industries that are internationally competitive
- Successful industries within a country tend to be grouped into clusters of related industries
- Knowledge can flow betters firms benefting all


What are firm strategy, structure and rivalry in Porter's National Competitive Advantage Theory?

- The conditions governing how companies are created, organised and managed and the nature of domestic rivalry
- Different nations are characterised by different management ideologies, which can either help or hinder competitive advantage
- German & Japanese firms make engineers executives
- US firms make financiers executives
- There is also a strong association between vigorous domestic rivalry and the creation of persistent competitive advantage


What are the two additional variables to Porter's National Competitive Advantage Theory?

- Chance evetns
- Major innovations etc
- Government
- Choice of policies can effect all 4 aspects of diamond


What is the evaluation of Porter's National Competitive Advantage Theory?

- Has yet to be extensively testd
- Much of the theory is sound


What are both absolute and competitive advantage theories based on?

Both absolute and comparative advantage theories are based on specialisation


Broadly, why do governments intervene in trade?

* Poltical arguments
* Economic arguments


What are the political arguments for government intervention in international trade?

- Jobs argument
- National Security argument
- Retaliation for unfair competition
- Protecting consumers from dangerous goods
- Furthering foreign policy goals
- Protecting human rights in exporting countries
- Protecting the environment


What are the economic arguments for government intervention in international trade?

- Raising revenue, particularly in low income countries
* Infant industry argument
* Strategic trade policy


What is true of the infant industry argument?

- GATT has recognised this as a legitimate reason for protection
- Does no good unless it can make the industry efficient
- Relies on the assumption that firms are unable to make efficient long-term investments by borrowing money from domestic or international capital markets


What is true of the strategic trade policy argument?

- It is argued that by appropriate actions, a government can help raise national income if it can somehow ensure that domestic firms gain a first mover advantage
- Secondly, it may pay for a government to intervene in an industry by helping domestic firms overcome the barriers to entry created by foreign first mover advantages\
- Krugman - beggar thy neighbour policy - will provoke retaliation, and such policies are almost certain to be captured by special interest groups within the economy which will distort it to their own ends


What are the tools for trade promotion?

* Subsidies
* Export financing
* Foreign trade zones
* Export promotion agencies


What are subsidies?

- Finanical assistant to domestic producers
- Cash payments, tax breaks, low-interest loans, price support
- Nation, province/state, city levels
- Lower costs to compete against cheaper imports and/or to gain export markets


What is export financing?

- Loans to finance export sales
- Loans, loan guarantees, export credit insurance


What are foreign trade zones?

- Designated geographic regions in which merchandise can pass through with lower customs duties and/or fewer customs prodedures
- Encourages investment and trade, regional development
- aka Export Processing Zone, Free trade zone, Special economic zones


What are export promotion agencies?

- Promote exports
- Organise trade missions
- Trade offices in other countries: promotion of home country’s exports
- Advertising


What are the tools for trade restriction?

* Tariffs
* Non-tariff barriers
- Currency controls


What are tariffs?

- Government levy on products entering or leaving a coutnry
- Imports, exports, transit tariffs
- Specific ($) or ad valorem (%)
- Export tariffs
- To raise revenue for government and reduce exports from a sector, often for political reasons


What are the gains from tariffs?

- Short run only
- Government
- Domestic manufacturers/producers
- Employees of protected industries


What are the loses from tariffs?

- Short and long run
- Cosnumers
- Overall economy
- Employees of protected industries


What are the non-tariff barriers?

* Quotas
* Subsidies
* Embargoes
* Local content requirements
* Anti-dumping policies
* Administrative delays
- Trend towards NTB minimisation
* Wide variety still remain


What are quotas?

- Restriction is usually enforce by issuing import license to a group of individuals or firms
- In some cases, the right to sell is given directly to the governments of exporting countries
* Quota rent
* Tariff rate quota
* Voluntary export restraint


What is quota rent?

The extra profit that producers make when supply is artificially limited by an import quota


What is a tariff rate quota?

- A lower tariff rate is applied to imports within the quota than those over
- Common in agriculture


What is voluntary export restraints?

- A quota on trade imposed by the exporting country, typically at the request the the importing country’s government
- Agreed to to avoid most costly measures


What are subsidies?

- Cash grants, low-interest loans, tax breaks, government equity partipcation in domestic firms
- New trade theory advocate it as a strategic trade policy for first mover advantages
- Tend to be found protecting the inefficient and promote excess production


What are embargoes?

- Complete ban on trade in one or more products
- Most restrictive NTB, generally politically motivated
- Decreed either by individual nations or by supranational organisations
- Difficult to enforce, not so popular today


What are local content requirements?

- Can either be in physical or value terms
- Percentage of a good must be manufactured domestically using local raw materials and labour
- Force foreign firms to employe local resources
- Strategic use by LDCs
- Technology and skills transfer
- Shift manufacturing base to a higher technological level
- Similar effect to those of import quotas


What is dumping and what are anti-dumping policies?

- Dumping
- Selling goods in a foreign market at below their costs of
production or below their “fair” value
- Dumping is viewed as a method by which firms unload excess production in foreign markets
- Some may be the result of predatory behaviour, with producers using home market profits to subsidise prices in a foreign market with a view to driving local competitors out

- aka countervailing duties - punish foreign firms that engage in dumping and protect domestic producers from ‘unfair’ foreign competition


What are administrative delays?

- Regulatory controls or beuracratic rules imparting flow of imports
- Includes
- International air carriers must land at inappropriate airports
- Product inspections damaging product itself
- Understaffed customs offices
- Special permits


What other non-tariff barriers are there?

- Product standards
- Distribution restrictions
- Quarantine and sanitary certificates
- Foreign ownership controls


What is the oldest argument for government intervention in free trade?

Infant industry