MODULE 3

INTERNATIONAL BUSINESS

International Trade
&
Factor Mobility Theory

Dr. Rajesh P Ganatra

(M.Com, Ph.D., UGC_NET, C.S.(I) Certified)
Asst. Professor & H.O.D (Accounts & Finance)
Sabarmati Arts & Commerce College,
Constituent of Gujarat University
Gujarat University, Ahmedabad-380009
 Flow
• Why do nation trade?

• Theories of International Trade

– Mercantilism
– Absolute advantage theory
– Comparative advantage theory
– Heckscher-Ohlin trade theory
– Product lifecycle theory
– Porter’s diamond model
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 3
 Why do nation trade?

Basic Motives

• Price Differentials

• Supply Differentials

• Difference in Preferences

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 4

 Mercantilism
• Mercantilism theory of international trade has its origin in England in the
middle of 16th century.

• Mercantilism theory is based on the principle assertion that government

control of foreign trade is of paramount importance for ensuring the
prosperity and military security of the state.

• The main tenet of this theory was that gold and silver were the mainstays
of national wealth and government should endeavour to increase the
inflow of gold and silver. This is to be achieved by exporting more and
importing less, thus having a surplus balance of trade.

• Between mid-16th century and 18th century, governments world over

that had consistent belief in mercantilism, advocated and executed policy
interventions to achieve a surplus in the balance of trade.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 5

 Mercantilism
• The mercantilists have a belief that it is not important to increase the
volume of foreign trade but to maximise exports and minimise imports.

• Mercantilist advocated policy interventions such as tariffs and quotas

on imports and subsidies for exports.

• Thus, mercantilism becomes ‘zero sum game’ whereby economic

growth/prosperity of a country is dependent on the cost of other
economies.

• Mercantilism theory suffered from many flaws and inconsistencies

which were rightly pointed out by the classical economist David Hume
in 1752.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 6

 Absolute Advantage Theory

• In one of the most notable book ’Wealth of Nations‘ in 1776, Adam Smith attacked
the mercantilism and argued that countries differ in their ability to produce goods
and services efficiently due to variety of reasons

• Smith argued that countries should specialise in production and manufacturing of

goods and services in which they have an absolute advantage. Such cost effective
and efficient products can be traded with goods from other countries in which
that country has an absolute advantage.

• The crux of Smith’s absolute advantage theory is that a country should not produce
goods at home in which it does not have cost advantage; instead it should import
from other countries.

• Absolute advantage theory was based on ‘positive sum game’ where countries
benefit from trade unlike mercantilism theory which was based on ‘zero game’.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 7

 Comparative Advantage Theory
• David Ricardo, in his notable book ‘Principles of Political Economy’ published
in 1817 came up with an improvement on Adam Smith’s ‘absolute advantage
theory’.

• Ricardo argued what might happen if one country has an absolute advantage in
the production of all goods. Adam Smith’s theory suggests that such a country
might not have benefitted from international trade as trade is positive sum game
and countries prosper only if they exchange the goods in which they have absolute
advantage.

• Ricardo argued that it was not the case and showed that countries should trade
goods with each other where they have comparative cost advantage.

• For a sustainable economic system, Ricardo argued that a country should specialise
in the production of those goods that it can produce most efficiently and
import the goods which it produces less efficiently even if it has absolute cost
advantage in the production of those goods.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 8

The Heckscher-Ohlin Trade Theory

The H-O Trade Theory

Meaning
& Example Assumptions
Concept

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 9

 Meaning
• The Heckscher-Ohlin (H-O) theory further improvises on
the absolute cost advantage and comparative cost
advantage theory.

• It tries to explain the crucial question of why countries

trade goods and services with each other.

• The theory is based on the hypotheses that countries

trade with each other as they differ with respect to the
availability of the factors of production i.e. land, labour
and capital.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 10
 Concept
• H-O theory explains that a country will specialise in the
production of goods and services that it is particularly
endowed with and are suited for production in that country.

• Countries that have abundant capital but are scarce in labour

force, therefore specialise in production of goods and services
that, in particular, require more capital.

• H-O theory propounds that specialisation in production and

trade among countries generates higher economies of scale
and scope and ensures higher standard of living for the
countries involved
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 11
 Example

US is a capital rich country hence its exports basket will be dominated by

capital intensive products like, aeroplanes, submarines, tanks, space system,
nuclear plants, super computer, high-end servers etc.

Whereas India has labour abundance, so its export basket is dominated by

product with labour contents like gems and jewellery, textiles, handicrafts,
sports toys, handlooms, apparel, electronics and information technology
services.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 12

 Assumptions
• Countries worldwide are endowed with different factors of production, i.e.
land, labour and capital may not be in equal proportion in all countries.
Some are abundant with land, some capital and some with labour.

• Production of goods either requires relatively more capital or land or labour.

• Factors of production do not move between two countries.

• Theory has assumption that there is no transport cost for trade

between two countries.

• The consumers and users in two trading countries may have the same
needs.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 13

 Product Lifecycle Theory

PLC Theory

Concept Stages

Maturing Standardised
New Product
Product Product
Stage
Stage Stage

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 14

 Concept
• This theory was proposed by Raymond Vernon in the mid-1960s.

• It was based on the observation that in the 20th century, a very large proportion
of the world’s new products were developed by American firms and sold there
first.

• He argued that the wealth and size of the market gave American firms a strong
incentive to develop new consumer products and in addition, the high cost of
labour was an incentive to develop cost-saving innovations.

• He did not agree with earlier theories and emphasised on information, risk, and
economies of scale, rather than on cost.

• He focused on the lifecycle of the product and came up with his theory which
identified three distinct stages:
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 15
 Stages
New product stage –
The need for a new product in the domestic market is identified and it is developed,
manufactured and marketed in limited numbers. It is not exported in sizeable quantities, since
it is primarily for the national market.

Maturing product stage –

Once the product has become popular in the domestic market, foreign demand increases and
manufacturing facilities abroad may be set up to meet demand there. After success in the
foreign markets and towards the end of the product maturity stage, the manufacturers try and
produce it in the developing countries.

Standardised product stage –

• In the last stage of the life-cycle theory, the product becomes a commodity, the price
becomes optimised and the makers look for countries where it can be made with the least
production costs.
• One of the results of this is the product being imported into the firm’s home country.
• Dell manufactures hardware in Asia, which is then transported to the US, its country
of origin. Hence a product which started as export commodity of a country may end up
becoming an import product.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 16

 Porters Diamond Model

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 17

 Porters Diamond Model
In 1990, Michael Porter analysed the reason behind some nations’ success and
others’ failure in international competition. His thesis outlined four broad
attributes that shape the environment in which local firms compete and these
attributes promote the creation of competitive advantage. They are explained
as follows:

Factor endowments – Characteristics of production were analysed in detail.

There are basic factors like natural resources, climate, and location and so
on and advanced factors like communications infrastructure, research facilities.

Demand conditions – The role of home demand in improving competitive

advantage is emphasised since firms are most sensitive about the needs of
their closest customers. For example, the Japanese camera industry which
caters to a sophisticated and knowledgeable local market.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 18

 Porters Diamond Model
Relating and supporting industries – The presence of suppliers
or related industries is advantageous since the benefits of
investment in advanced factors of production spill over to these
supporting industries. Successful industries within a country
tend to be grouped into clusters of related industries. For
example Silicon Valley.

Firm strategy, structure and rivalry – Domestic rivalry

creates pressure to innovate, improve quality, and reduce costs
which in turn helps create world-class competitors.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 19

 Porters Diamond Model
• He said that these four attributes constituted the diamond
and he argued that firms are most likely to succeed in
industries where the diamond is most favourable.

• He also stated that the diamond is a mutually reinforcing

system and the effect of one attribute depends on the state
of others.

• For example, favourable demand conditions will not result

in a competitive advantage unless the state of rivalry is
enough to elicit a response from the firms.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 20
 Case Study – “Logitech”
Best known as one of the world's largest producers of computer mice, Logitech
is in many ways the epitome of the modern global corporation. Founded in
1981 in Apples, Switzerland, by two Italians and a Swiss, the company now
generates annual sales of more than $1 billion, most from products such as
mice, keyboards, and low-cost video cameras that cost under $100. Logitech
made its name as a technological innovator in the highly competitive business
of personal computer peripherals. Among other things, it was the first
company to introduce a mouse that used infrared tracking, rather than a
tracking ball, and the first to introduce wireless mice and keyboards. Logitech
is differentiated from competitors by its continuing innovation—in 2003 it
introduced 91 new products—its high brand recognition, and its strong retail
presence. Less obvious to consumers, but equally important, has been the way
the company has configured its global value chain to lower production costs
while maintaining the value of those assets that lead to differentiation.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 21

 Case Study – “Logitech”
Logitech still undertakes basic R&D work (primarily software
programming) in Switzerland where it has 200 employees. The
company is still legally Swiss, but the corporate headquarters
are in Fremont, California, close to many of America's high-
technology enterprises, where it has 450 employees. Some
R&D work (again, primarily software programming) is also
carried out in Fremont. Most significantly, though, Fremont is
the headquarters for the company's global marketing, finance,
and logistics operations. The ergonomic design of Logitech's
products—their look and feel—is done in Ireland by an
outside design firm. Most of Logitech's products are
manufactured in Asia.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 22
 Case Study – “Logitech”
Logitech's expansion into Asian manufacturing began in the late 1980s when it
opened a factory in Taiwan. At the time, most of its mice were produced in the
United States. Logitech was trying to win two of the most prestigious OEM
customers—Apple Computer and IBM. Both bought their mice from Alps, a
large Japanese firm that supplied Microsoft. To attract discerning customers
such as Apple, Logitech not only heeded the capacity to produce at high
volume and low cost, but it also had to offer a better designed product. The
solution: manufacture in Taiwan. Cost was a factor in the decision, but it was
not as significant as might be expected, since direct labor accounted for only 7
percent of the cost of Logitech's mouse. Taiwan offered a well-developed
supply base for parts, qualified people, and a rapidly expanding local computer
industry. As an inducement to fledgling innovators, Taiwan provided space in its
science-based industrial park in Hsinchu for the modest fee of $200,000. Sizing
this up as a deal that was too good to pass up, Logitech signed the lease.
Shortly afterward, Logitech won the OEM contract with Apple. The Taiwanese
factory was soon out producing Logitech's U.S. facility. After the Apple contract,
Logitech's other OEM business started being served from Taiwan; the plant's
total capacity increased to 10 million mice per year.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 23
 Case Study – “Logitech”

By the late 1990s, Logitech needed more production capacity. This time it turned to
China. A wide variety of the company's retail products are now made there. Take
one of Logitech's biggest sellers, a wireless infrared mouse called Wanda. The
mouse itself is assembled in Suzhou, China, in a factory that Logitech owns. The
factory employs 4,000 people, mostly young women such as Wang Yan, an 18-year-
old employee from the impoverished rural province of Anhui. She is paid $75 a
month to sit all day at a conveyer belt plugging three tiny bits of metal into circuit
boards. She does this about 2,000 times each day. The mouse Wang Yan helps
assemble sells to American consumers for about $40. Of this, Logitech takes about
$8, which is used to fund R&D, marketing, and corporate overhead. What remains
of the $8 after that is the profit attributable to Logitech's shareholders. Distributors
and retailers around the world take a further $15. Another $14 goes to the suppliers
who make Wanda's parts. For example, a Motorola plant in Malaysia makes the
mouse's chips and another American company, Agilent Technologies, supplies the
optical sensors from a plant in the Philippines. That leaves just $3 for the Chinese
factory, which is used to cover wages, power, transport, and other overhead costs.

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 24

 Case Study – “Logitech”
Logitech is not alone in exploiting China to manufacture products.
According to China's Ministry of Commerce, foreign companies
account for three-quarters of China's high-tech exports. China's top
10 exporters include American companies with Chinese operations,
such as Motorola and Seagate Technologies, a maker of disk drives
for computers. Intel now produces some 50 million chips a year in
China, the majority of which end up in computers and other goods
that are exported to other parts of Asia or back to the United States.
Yet Intel's plant in Shanghai doesn't really make chips; it tests and
assembles chips from silicon wafers made in Intel plants abroad,
mostly in the United States. China adds less than 5 percent of the
value. The U.S. operations of Intel generate the bulk of the value
and profits.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 25
 Question 1
Use the theory of comparative advantage to
explain the way in which Logitech has
configured its global operations. Why does the
company manufacture in China and Taiwan,
undertake basic R&D in California and
Switzerland, design products in Ireland, and
coordinate marketing and operations from
California?

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 26

 Answer 1
Logitech has broken the manufacturing process up into a series of steps and
scanned the globe for the best places to locate these discreet steps. China
and Taiwan have specialized in the low cost, high quality manufacture of the
type of products Logitech makes.

In fact, Taiwan courted their involvement. R&D in California and

Switzerland is to be near the cluster of knowledge bases in Fremont
(comparative advantage) and in Switzerland perhaps because of the
company’s historical roots.

Designing the products in Ireland draws of strengths in the Irish economy

and perhaps keep costs low. Running operations from Fremont makes sense
because it is near Apple, it is in their largest market, the U.S., and the
expertise is there as well.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 27
 Question 2

To what extent can Porter’s diamond help

explain the choice of Taiwan as a major
manufacturing site for Logitech?

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 28

 Answer 2

• According to Porter’s theory, there are four conditions that shape the
competitive environment: factor endowments, demand conditions,
relating and supporting industries, and the firm attributes of strategy,
structure and rivalry.

• In Taiwan, the factor endowments of skilled labor at low cost and

government-subsidized infrastructure supported the Logitech decision to
manufacture there.

• In addition, firms were designed to meet Logitech’s needs, so firm

strategy and structure also contributed to Logitech’s decision. Because of
rivalry in the industry, Logitech needed low-cost, high quality production.
Taiwan was able to provide such production.
12/15/2023 PREPARED BY DR. RAJESH P GANATRA 29
 THANK YOU

12/15/2023 PREPARED BY DR. RAJESH P GANATRA 30