Theories of International Business

The Theories of International Business

1.1 INTERNATIONAL INTERNATIONAL BUSINESS

Internatio International nal business business comprises comprises all commercial commercial transactio transactions ns (private (private and governmental governmental,, sales, sales, investments, logistics, and transportation) that take place between two or more regions, countries and nation nationss beyond beyond their their polit politica icall boundar boundaries ies.. Usuall Usually y, privat privatee compan companies ies underta undertake ke such such transactions for profit; governments undertake them for profit and for political reasons. It refers to all those those busine business ss activi activiti ties es which which involv involvee cross cross border border transa transacti ctions ons of goods, goods, servic services, es, resources between two or more nations. Transaction of economic resources include capital, skills, people etc. for international production of physical goods and services such as finance, banking, insurance, construction etc. 1.2 INTERNATIONAL INTERNATIONAL BUSINESS AROUND US

 multination multinational al enterprise enterprise (!"#) is a company company that has a worldwide worldwide approach to markets markets and production or one with operations in more than a country. n !"# is often called multinational corporation (!"$) or transnational company (T"$). %ell known !"$s include fast food companies such as !c&onald's and um rands, vehicle manufacturers such as *eneral !otors, +ord !otor $ompany and Toyota, consumer electronics companies like amsung, -* and ony, and energy companies such as #on!obil, hell and /. !ost of the largest corporations operate in multiple national markets. reas of study within this topic include differences in legal systems, political systems, economic policy, language, accounting standards, labor standards, living standards, environmental standards, local culture, corporate culture, foreign echange market, tariffs, import and eport regulations, trade agreements, climate, education and many more topics. #ach of these factors re0uires significant changes in how individual business units operate from one country to the net. 1.3THEORIS OF INTERNATIONAL INTERNATIONAL BUSINESS

International trade is the purchase, sale or echange of goods and services across national border. Internatio International nal trade produces many benefits benefits to countries both eporting eporting and importing products. +or countries importing products, the benefits are that they get goods or services they cannot produce enough of on their own. -ikewise, for the eporter, one of the benefits is though the trade they can also get either the goods or services they need or the money in which to purchase these goods from another country or source. International trade also helps the economic of the countries. International trade encompasses many aspects in relation to various countries. There are many theories regarding international trade. ome of these include mercantilism, absolute advantage, 1


comparative advantage, factor proportions theory, international product life cycle, new trade theory and national competitive advantage.

2.1Objective o t!e "t#$% The study aims to gather comprehensive knowledge on the theories of international business. To knowabout postulates of the theories, origin, main considerable factors, assumptions, criticism of the theories of international business. ut the specific ob1ectives of this study are22 1. Primary Objective : To analy3e and understandthe perspectives of advantages and constraints of •

thetheories

of

International

usiness

such

as

!ercantilism,

bsolute

dvantage,comparative dvantage,4eckcher25hlin !odel, /orter6s &iamond Theory. 2. Secondary Objectives : To know about the theories of international business • To epand our knowledge about their statements ,origins • To know about the assumptions of the theories • To know more details how the theories works on real life business • 4owever, the overall ob1ective is to understanding the concept of these theories and also know the criticisms of its.

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3.1 &et!o$o(o)% o t!e "t#$% The data of the report has been collected mainly from secondary sources. y eploring the different websites, tet of prominent authors, different international business related articlesI have prepared the report on following theories of international business. I have also collected critics of the theories from monthly issued 1ournals of prominent business schools. This report is analy3ed in 0uantitative basis and in simplified forms. The report is created on the basis of three parts. 5ne is introduction part, second is the main body of the report and the last consists of the conclusions and references.

*.1 DEFINITION OF &ERCANTILIS&

!ercantilism is an economic theory and practice common in #urope from the 78th to the 79th century that promoted governmental regulation of a nation6s economy for the purpose of augmenting state power at the epense of rival national powers. In particular, it demands a positive balance of trade. It was the economic counterpart of political absolutism. The main goal was to increase a nation's wealth by imposing government regulation concerning all of the nation's commercial interests. It was believed that national strength could be maimi3ed by limiting imports via tariffs and maimi3ing eports. !ercantilism was a cause of fre0uent #uropean wars in that time and motivated colonial epansion. *.2 ORI'IN OF &ERCANTALIS&

!ost of the #uropean economists who wrote between 7: and 7<: are today generally considered mercantilists; originally the tandard #nglish term was =mercantile system=. #nglish merchant Thomas !un (7:<7>78?7) as a ma1or creator of the mercantile system, especially for his Treasure by +oreign Trade (788?) and /erhaps the last ma1or mercantilist work was @ames teuart6s /rinciples of /olitical #conomy published in 7<8<.

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*.3 +OLICIES OF &ERCANTILIS&

4igh tariffs, especially on manufactured goods, are an almost universal feature of mercantilist policy. 5ther policies have includedA B B B B B B B B

uilding a network of overseas colonies; +orbidding colonies to trade with other nations; anning the eport of gold and silver, even for payments; +orbidding trade to be carried in foreign ships; #port subsidies; /romoting manufacturing with research or direct subsidies; !aimi3ing the use of domestic resources; Cestricting domestic consumption with non2tariff barriers to trade.

!ercantilism in its simplest form was bullionism, but mercantilist writers emphasi3ed the circulation of money and re1ected hoarding. Their emphasis on monetary metals accords with current ideas regarding the money supply, such as the simulative effect of a growing money supply. *.* CRITICIS&S OF &ERCANTILIS&

dam mith and &avid 4ume were the founding fathers of anti2mercantilist thought.  number of scholars found important flaws with mercantilism long before dam mith developed an ideology that could fully replace it. $ritics like 4ume, &udley "orth, and @ohn -ocke undermined much of mercantilism, and it steadily lost favor during the 79th century. !ercantilism contained many interlocking principles. /recious metals, such as gold and silver, were deemed indispensable to a nation6s wealth. If a nation did not possess mines or have access to them, precious metals should be obtained by trade. It was believed that trade balances must be Dfavorable,E meaning an ecess of eports over imports. -ater, mercantilism was severely critici3ed. dvocates of laisse32faire argued that there was really no difference between domestic and foreign trade and that all trade was beneficial both to the trader and to the public. They also maintained that the amount of money or treasure that a state needed would be automatically ad1usted and that money, like any other commodity, could eist in ecess. They denied the idea that a nation could grow rich only at the epense of another and argued that trade was in reality a two2way street. -aisse32faire, like mercantilism, was challenged by other economic ideas. $ompare laisse32faire.

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,.1 DEFINITION OF -ABSOLUTE ADVANTA'E-

The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service. #ntities with absolute advantages can produce something using a smaller number of inputs than another party producing the same product. s such, absolute advantage can reduce costs and boost profits. In economics, the principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. dam mith first described the principle of absolute advantage in the contet of international trade, using labor as the only input. ince absolute advantage is determined by a simple comparison of labor productivities, it is possible for a party to have no absolute advantage in anything; in that case, according to the theory of absolute advantage, no trade will occur with the other party. It can be contrasted with the concept of comparative advantage which refers to the ability to produce a particular good at a lower opportunity cost. ,.2 ORI'IN OF THE THEORY

The main concept of absolute advantage is generally attributed to dam mith for his 7<<8 publication n In0uiry into the "ature and $auses of the %ealth of "ations in which he countered mercantilist ideas. mith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the eport of one nation is another nation6s import and instead stated that all nations would gain simultaneously if they practiced free trade and speciali3ed in accordance with their absolute advantage. mith also stated that the wealth of nations depends upon the goods and services available to their citi3ens, rather than their gold reserves. %hile there are possible gains from trade with absolute adva ntage, the gains may not be mutually beneficial. $omparative advantage focuses on the range of possible mutually beneficial echanges.

.1 DEFINITION OF CO&+ARATIVE ADVANTA'E

$omparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. #ven if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies. +or eample, if, using machinery, a worker in one country can produce both shoes and shirts at 8 per hour, and a worker in a country with less machinery can produce either F shoes or ? shirts in ,


an hour, each country can gain from trade because their internal trade2offs between shoes and shirts are different. The less2efficient country has a comparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more2efficient country for shoes. The net benefits to each country are called the gains from trade. .2 ORI'INS OF THE THEORY

The idea of comparative advantage has been first mentioned in dam mith's ook The %ealth of "ationsA =If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.= ut the law of comparative advantages has been formulated by &avid Cicardo who investigated in detail advantages and alternative or relative opportunity in his 797< book 5n the /rinciples of /olitical #conomy and Taation in an eample involving #ngland and /ortugal. .3 EFFECTS ON THE ECONO&Y

This section needs additional citations for verification. /lease help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. $onditions that maimi3e comparative advantage do not automatically resolve trade deficits. In fact, many real world eamples where comparative advantage is attainable may re0uire a trade deficit. +or eample, the amount of goods produced can be maimi3ed, yet it may involve a net transfer of wealth from one country to the other, often because economic agents have widely different rates of saving. .* CONSIDERATIONS OF THE THEORY 6.4.1 Development Economics

The theory of comparative advantage, and the corollary that nations should speciali3e, is critici3ed on pragmatic grounds within the import substitution industriali3ation theory of development economics, on empirical grounds by the inger>/rebisch thesis which states that terms of trade between primary producers and manufactured goods deteriorate over time, and on theoretical grounds of infant industry and Geynesian economics. In older economic terms, comparative advantage has been opposed by mercantilism and economic nationalism. These argue instead that while a country may initially be comparatively disadvantaged in a given industry (such as @apanese cars in the 7H:s), countries should shelter and invest in industries until they become globally competitive. 6.4.2 Free mobility of capital in a globalied !orld

Cicardo eplicitly bases his argument on an assumed immobility of capitalA= ... if capital freely flowed towards those countries where it could be most profitably employed, there could be no 


difference in the rate of profit, and no other difference in the real or labor price of commodities, than the additional 0uantity of labor re0uired to convey them to the various markets where they were to be sold.= ., CRITICIS&S OF THE THEORY

#conomist 4a2@oon $hang critici3ed the comparative advantage principle, contending that it may have helped developed countries maintain relatively advanced technology and industry compared to developing countries. In his book Gicking way the -adder, $hang argued that all ma1or developed countries, including the United tates and United Gingdom, used interventionist, protectionist economic policies in order to get rich and then tried to forbid other countries from doing the same. +or eample, according to the comparative advantage principle, developing countries with a comparative advantage in agriculture should continue to speciali3e in agriculture and import high2technology widgets from developed countries with a comparative advantage in high technology.

<. .1 DEFINITION OF HECHCHER0OHLIN &ODEL THEORY

The 4eckscher>5hlin model (4>5 model) is a general e0uilibrium mathematical model of international trade, developed by #li 4eckscher and ertil 5hlin at the tockholm chool of #conomics. It builds on &avid Cicardo's theory of comparative advantage by predicting patterns of commerce and production based on the factor endowments of a trading region. The model essentially says that countries will eport products that use their abundant and cheap factor(s) of production and import products that use the countries' scarce factor(s). .2 FEATURES OF THE &ODEL

Celative endowments of the factors of production (land, labor, and capital) determine a country's comparative advantage. $ountries have comparative advantages in those goods for which the re0uired factors of production are relatively abundant locally. This is because the profitability of goods is determined by input costs. *oods that re0uire inputs that are locally abundant will be cheaper to produce than those goods that re0uire inputs that are locally scarce. +or eample, a country where capital and land are abundant but labor is scarce will have comparative advantage in goods that re0uire lots of capital and land, but little labor  grains. If capital and land are abundant, their prices will be low. s they are the main factors used in the production of grain, the price of grain will also be lowand thus attractive for both local consumption and eport. -abor intensive goods on the other hand will be very epensive to produce since labor is scarce and its price is high. Therefore, the country is better off importing those goods. 


.3 THEORETICAL DEVELO+&ENT OF THE &ODEL

The Cicardian model of comparative advantage has trade ultimately motivated by differences in labour productivity using different technologies. 4eckscher and 5hlin didn't re0uire production technology to vary between countries, so (in the interests of simplicity) the 425 model has identical production technology everywhere. Cicardo considered a single factor of production (labour) and would not have been able to produce comparative advantage without technological differences between countries (all nations would become autarkic at various stages of growth, with no reason to trade with each other). The 425 model removed technology variations but introduced variable capital endowments, recreating endogenously the inter2country variation of labour productivity that Cicardo had imposed eogenously. %ith international variations in the capital endowment (i.e. infrastructure) and goods re0uiring different factor proportions, Cicardo's comparative advantage emerges as a profit2maimi3ing solution of capitalist's choices from within the model's e0uations .* ASSU&+TIONS OF THE THEORY

The original, FFF model was derived with restrictive assumptions, partly for the sake of mathematical simplicity. ome of these have been relaed for the sake of development. These assumptions and developments are listed here. 4.1.1

"ot# co$ntries #ave identical prod$ction tec#nology

This assumption means that producing the same output of either commodity could be done with the same level of capital and labour in either country. ctually, it would be inefficient to use the same balance in either country (because of the relative availability of either input factor) but, in principle this would be possible. 4.1.2

Prod$ction o$tp$t m$st #ave constant ret$rn to scale

oth of the countries in the simple 45 model produced both commodities, and both technologies have constant returns to scale ($C). ($C production has twice the output if both capital and labour inputs are doubled, so the two production functions must be 'homogeneous of degree 7'). These conditions are re0uired to produce a mathematical e0uilibrium. %ith increasing returns to scale it would likely be more efficient for countries to speciali3e, but speciali3ation is not possible with the 4eckscher25hlin assumptions. 4.1.%

&#e tec#nologies $sed to prod$ce t#e t!o commodities differ

The $C production functions must differ to make trade worthwhile in this model. +or instance if the functions are $obb2&ouglas technologies the parameters applied to the inputs must vary. n eample would beA rable industryA  J KKGLMK7NOLLKK-LMKFNOLL 


+ishing industryA + J KKGLMK7NFLL KK-LMK7NFLL %here  is the output in arable production, + is the output in fish production, and G, - are capital and labour in both cases. 4.1.4

'abor mobility !it#in co$ntries

%ithin countries, capital and labor can be reinvested and re2employed to produce different outputs. -ike the comparative advantage argument of Cicardo, this is assumed to happen costlessly. 4.1.(

)apital mobility !it#in co$ntries

It is further assumed that capital can shift easily into either technology, so that the industrial mi can change without ad1ustment costs between the two types of production. *.2 CRITICIS& A'AINST THE HEC/SCHEROHLIN &ODEL

lthough 425 model is normally thought to be basic for international trade theory, there are many points of criticism against the model. <.:.7 Poor predictive po!er The original 4eckscher>5hlin model and etended model such as the Panek model performs poorly, as it is shown in the section =#conometric testing of 425 model theorems=. &aniel Trefler and usan $hun Qhu summarises their paper that =It is hard to believe that factor endowments theory Reditor's noteA in other words, 4eckscher>5hlin>Panek !odelS could offer an ade0uate eplanation of international trade patterns.=R8S *.(.2

Factor e+$aliation t#eorem

4eckscher>5hlin theory is badly adapted to the analy3e outh2"orth trade problems. The assumptions of 45 are unrealistic with respect to "orth2outh trade. Income differences between "orth and outh is the concern that third world cares most. The factor price e0uali3ation theorem has not shown a sign of reali3ation, even for a long time lag of a half century.R7S *.(.%

,dentical prod$ction f$nction

The standard 4eckscher>5hlin model assumes that the production functions are identical for all countries concerned. This means that all countries are in the same level of production and have the same technology. This is highly unrealistic. Technological gap between developed and developing countries is the main concern for the development of poor countries. *.(.4

)apital as endo!ment

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In the modern production system, machines and apparatuses play an important role. %hat is named capital is nothing other than these machines and apparatuses, together with materials and intermediate products which will be consumed in the production process. $apital is the most important of factors, or one should say as important as labor. y the help of machines and apparatuses, the human being got a tremendous production capability.. *.(.(

-o room for firms

tandard 4eckscher>5hlin theory assumes the same production function for all countries. This implies that all firms are identical. The theoretical conse0uence is that there is no room for firms in the 45 model. y contrast, the "ew Trade Theory emphasi3es that firms are heterogeneous. *.(.6

Political bacgro$nd for /O0odel

+rom the middle of the 7Hth century to 7HOs, giant flow of immigration took place from #urope to "orth merica. It is estimated that more than 8 million people crossed the tlantic 5cean. ome politicians worried if these immigrants may cause various troubles (including cultural conflicts). +or those politicians 452theory provided a good reason Din support of both restrictions on labor migration and free trade in goods.E

.1 &E +ORTER5S DIA&OND THEORY

The diamond model is an economical model developed by !ichael /orter in his book The $ompetitive dvantage of "ations, where he published his theory of why particular industries become competitive in particular locations. fterwards, this model has been epanded by other scholars. The &iamond !odel of !ichael /orter for the competitive advantage of "ations offers a model that can help understand the comparative position of a nation in global competition. The model can also be used for ma1or geographic regions. /orter's diamond model suggests that there are inherent reasons why some nations, and industries within nations, are more competitive than others on a global scale. The argument is that the national home base of an organi3ation provides organi3ations with specific factors, which will potentially create competitive advantages on a global scale. .2 TRADITIONAL COUNTRY ADVANTA'ES

Traditionally, economic theory mentions the following factors for comparative advantage for regions or countriesA 16


7. -and F. -ocation O. "atural resources (minerals, energy) ?. -abor, and :. -ocal population si3e. ecause these : factors can hardly be influenced, this fits in a rather passive (inherited) view regarding national economic opportunity. .3 FOUR DETER&INANTS OF NATIONAL ADVANTA'E7 .%.1 Factor )onditions

+actor conditions include those factors that can be eploited by companies in a given nation. +actor conditions can be seen as advantageous factors found within a country that are subse0uently build upon by companies to more advanced factors of competition. +actors not normally seen as advantageous, such as workforce shortage, can also be seen as a factor potentially strengthening competitiveness, because this factor may heighten companies' focus on automation and 3ero defects. .%.2 Demand conditions

If the local market for a product is larger and more demanding at home than in foreign markets, local firms potentially put more emphasis on improvements than foreign companies. This will potentially increase the global competitiveness of local eporting companies.  more demanding home market can thus be seen as a driver of growth, innovation and 0uality improvements. +or instance, @apanese consumers have historically been more demanding of electrical and electronic e0uipment than western consumers. This has partly founded the success of @apanese manufacturers within this sector.  more demanding local market leads to national advantage.  strong trend setting local market helps local firms anticipate global trends.

.%.% 3elated and S$pporting ,nd$stries

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%hen local supporting industries and suppliers are competitive, home country companies will potentially get more cost efficient and receive more innovative parts and products. This will potentially lead to greater competitiveness for national firms. -ocal competition creates innovations and cost effectiveness. This also puts pressure on local suppliers to lift their game. .%.4 Firm Strategy Str$ct$re and 3ivalry

The structure and management systems of firms in different countries can potentially affect competitiveness. y using /orter's diamond, business leaders may analy3e which competitive factors may reside in their company's home country, and which of these factors may be eploited to gain global competitive advantages. usiness leaders can also use the /orter's diamond model during a phase of internationali3ation, in which leaders may use the model to analy3e whether or not the home market factors support the process of internationali3ation, and whether or not the conditions found in the home country are able to create competitive advantages on a global scale. +inally, business leaders may use this model to asses in which counties to invest and to assess which countries are most likely to be able to sustain growth and development. .* THE ROLE OF THE 'OVERN&ENT IN THIS &ODEL • • •

To encourage To stimulate To help to create growth in industries

., CRITICIS&S OF +ORTER5S DIA&OND &ODEL

In his famous book, The $ompetitive dvantage of "ations, /orter studied eight developed countries and two newly industriali3ed countries ("I$s). The latter two are Gorea and ingapore. /orter is 0uite optimistic about the future of the Gorean economy. 4e argues that Gorea may well reach true advanced status in the net decade (p. O9O). In contrast, /orter is less optimistic about ingapore. /orter has used the diamond model when consulting with the governments of $anada and "ew Qealand. %hile the variables of /orter's diamond model are useful terms of reference when analy3ing a nation's competitiveness, a weakness of /orter's work is his eclusive focus on the 'home base' concept. In the case of $anada, /orter did not ade0uately consider the nature of multinational activities. In the case of "ew Qealand, the /orter model could not eplain the success of eport2dependent and resource2based industries. Therefore, applications of /orter's home2based diamond re0uire careful consideration and appropriate modification.

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. CONCLUSION The theories of international business are so much helpful to know and perform their international business effectively and perfectly. This report can also be helpful to know about how to deal for international parties for eport and importing products and services.

4. REFERANCES 7. @oha &. &anials $harles %.-.4ill, ,nternational "$siness. F. www.wikipedia.org O. www.investopedia.com ?. www.freedictionary.com :. #ncyclopedia of ritannica 8. httpANNwww.citehr.comN <. httpANNwww.sparknotes.comN 9. httpANNwww.answers.comNTNusinessand+inance H. www.businessmate.org

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Theories of International Business

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