Lecture 8 - Trade Theory

New trade theories Lecture 8

Modern Firm-Based Trade Theories • Product Life Cycle Theory • New trade theory • Porter’s National Competitive Advantage

PRODUCT LIFE CYCLE THEORY

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Raymond Vernon 1966 Vernon’s Product Life Cycle Theory differs from previous trade theories because it puts less emphasis on  comparative cost doctrine and more upon the timing of innovation the effects of scale economies the roles of ignorance and uncertainty in influencing trade patterns

• Product Life Cycle Theory of Trade

(PLC) Raymond Vernon—The production location for many products moves from one country to another depending on the stage in the product’s life cycle.

4 stages in a product life cycle • 1. INTRODUCTION • 2. GROWTH • 3.MATURITY • 4 DECLINE

Product life cycle theory

Stage in product life cycle Stage 1: Introduction : Innovation of a product with some exports Stage 2 Growth: Production in innovating country and other industrial countries due to increase in sales, more competition. Stage 3 Maturity- product standardization Production in multiple countries Stage 4 Decline –Production in developing countries, Innovating country becoming net importer.

New trade theory • In 1980s Paul krugman • It stress that in some cases countries specialize in

• • • •

production and export of particular product not because of difference in factor endowments but because in certain industries world market can support only limited number of industries. Specialization due to Economies of scale First movers advantage: chemical industry, computer software, tire industry. Learning effects-comes by learning by doing, learns by repetition.

Example :commercial aerospace dominated by two firms: Boeing and airbus • Boeing spends $5 billion to • • •

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develop its Boeing 777. If Boeing makes 199 Boeing 777 then fixed cost =$5billion/100=$50 million Variable cost per aircraft$80 million Total cost of each aircraft$50 million+$80million=$130 million If it makes 500 aircraft: Total cost=$90 million

MICHAEL PORTER…Originator of the THEORY OF NATIONAL COMPETITIVE ADVANTAGE •

Michael Porter’s Theory of National Competitive Advantage/Porter’s Diamond published in 1990 was based on a study of 100 firms in 10 developed nations

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Porter questions how Switzerland and Japan could become success stories without assumed prerequisites.

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Determinants of National Competitive Advantage Chance

Two external factors that influence the four determinants.

Company Strategy, Structure, and Rivalry Factor Conditions

Government

McGraw-Hill/Irwin

Demand Conditions Related and Supporting Industries

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Factor conditions Factor endowments can be divided into two parts: 1)Basic factors• Natural resources • climate, • Location • Demographics 2)Advanced factors• Communication • Infrastructure • Skilled labor • Research facilities • Technological know-how  Advanced factors are product of investment by individuals. Companies, government

Demand conditions These include : • The size and growth rate of the home demand; • The ways through which domestic demand is internationalized and pulls a nation’s products and services abroad.

Firm strategy, structure, and rivalry These include: 1. Different nations are chartericed by different management idelogies 2. The ways in which firms are managed and choose to compete; 3. The goals that companies seek to attain as well as the motivations of their employees and managers; 4. The amount of domestic rivalry and the creation and persistence of competitive advantage in the respective industry .

Related and supporting industries These include: •

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The presence of internationally competitive supplier industries that create advantages in downstream industries through efficient , early , or rapid access to cost-effective inputs. Internationally competitive related industries that can coordinate and share activities in the value chain when competing or those that involve complementary products.

The role of chance Chance events can nullify the advantages of some competitors and bring about a shift in overall competitive position because of developments such as: 3. new inventions and innovations 5. significant shifts in world financial markets or exchange rates; 6. discontinuities in input costs such as oil shocks

The role of government Government can i nfluence all 4 of the major determinants through actions such as: 3. SUBSIDIES 4. EDUCATION POLICIES; 5. THE REGULATION OR DEREGULATION OF CAPITAL MARKETS; 6. THE ESTABLISHMENT OF LOCAL PRODUCT STANDARDS AND REGULATIONS; 7. THE PURCHASE OF GOODS AND SERVICE; 8. TAX LAWS; 9. ANTITRUST REGULATION.

Question • WHICH THEORIES OF

INTERNATIONAL TRADE PREDICTS THE RISE OF INDIAN SOFTWARE INDUSTRIES?

Implications for Business • Location implications:makes sense to disperse • •

production activities to countries where they can be performed most efficiently. First-mover implications:It pays to invest substantial financial resources in building a firstmover, or early-mover, advantage. Policy implications:promoting free trade is generally in the best interests of the homecountry, although not always in the best interests of the firm. Even though, many

firms promote open markets.