International Trade and Factor-Mobility Theory

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IM 535 International Operations Management 5 International Trade and

Professor of Industrial Engineering College of Engineering and

Alexandria, Egypt Main reference: International Business: Environment

Ed), 2013 Pearson Higher Education Lecture handout site: http://ind.aast.

com/ 5-1 Learning Objectives Understand theories of international trade

affecting trade patterns Explain why a country s export capabilities are

1 IM 535 International Operations Management 5 International Trade and Factor-Mobility Theory Prof. Aziz Ezzat ElSayed, Ph.D. Professor of Industrial Engineering College of Engineering and Technology Arab Academy for Science and Technology Abu-Kir Campus, Alexandria, Egypt Main reference: International Business: Environment and Operations, John Daniels, Lee Radebaugh, and Daniel Sullivan (14 th Ed), 2013 Pearson Higher Education Lecture handout site: Learning Objectives Understand theories of international trade Explain how free trade improves global efficiency Identify factors affecting trade patterns Explain why a country s export capabilities are dynamic Understand why production factors, especially labor and capital, move internationally Explain the relationship between foreign trade and international factor mobility 5-2 1

2 What is a Trade Theory? For any country a Trade theory helps answer 3 Questions? 1. What products should we import and export? 2. How much should we trade? 3. With whom should we trade? 5-3 Example 1 Pattern of International Trade USA 18% UK 8% Italy 14% France 4% India 4% Other 52% Egypt Main Exports (Trade Partners) 5-4 2

Example 2 Pattern of International Trade Europe 4% US 14% Mediterranean 5% Far East 57% Others 20% Saudi Arabia Crude Oil Exports (2009) Source of Data: http://www.eia.

3 Example 2 Pattern of International Trade Europe 4% US 14% Mediterranean 5% Far East 57% Others 20% Saudi Arabia Crude Oil Exports (2009) Source of Data: (Accessed: 16/06/2011) 5-5 Example 3 Pattern of International Trade OPEC's oil flows around the world (2016)

4 Endowments = Gifts What s Factor Mobility Theory? A country s competitiveness depends on quality and quantity of Production Factors: Land, Labor, Capital, and Technology Factory Mobility Theory focuses on addressing the issue of why production factors move and the effect of that move on trade and country s factor endowments One global concern is the relative population. At present rates, 33 countries (e.g. Japan, Italy,..) are projected to have smaller populations. 5-7 Laissez-Faire vs. Intervention International Operations and Economic Connections Balance of Trade 5-8 4

5 Trade Theories Intervention Theories 1. Mercantilism 2. Neomercantilism Free trade theories 3. Absolute advantage 4. Comparative advantage Laissez-faire approach 5-9 Theories of Trade Patterns Trade Pattern Theories 5. country size 6. factor proportions 7. country similarity Theories explore competitiveness 8. Product life cycle 9. Porter s Diamond of national advantage

6 Interventionist Theories Theories that support government intervention in the flow of trade: 1. Mercantilism 2. Neo-mercantilism Source: (Accessed 13/05/2012) Mercantilism (16 th to late 18 th Century) Countries should export more than they import Maintain a favorable balance of trade to achieve Trade surplus and avoid Trade deficit European View to Trade British Empire French Colonies

com/mercantilist (Accessed 13/05/2012) 5-13 Mercantilism (16th to the late -18th century ) Mercantilism trade surplus was achieved mainly by

7 Mercantilism (16th to the late -18th century) Mercantilism was the dominant school of Economic thought in Europe throughout the late Renaissance and early modern period (from the 15th-18th century) Source: (Accessed 13/05/2012) 5-13 Mercantilism (16th to the late -18th century ) Mercantilism trade surplus was achieved mainly by military power to achieve monopoly by building overseas colonies (e..g. British Empire and French Colonies) Source: (Accessed 16/6/2011)

8 Mercantilism (16 th to the late -18 th Century ) century) Mercantilism was usually a cause of frequent European wars in that time. It also was a motive for colonial expansion. Source: Mercantilism (16 th to the late -18 th Century ) Why Do you think England Invaded India?

Monopoly India: 1- Sends raw materials to England 2- Purchases finished goods from England.

9 Mercantilism (16 th to the late -18 th Century ) England: 1- Turns raw materials into finished goods 2- Sends finished goods to Indian market for sale. Monopoly India: 1- Sends raw materials to England 2- Purchases finished goods from England Neomercantilism Neomercantilism run an export surplus to achieve social or political objectives (Full employment political influence merchandize loans or granting aids to foreign governments) Give examples

Smith Challenged the mercantilist philosophy and its Zero-Sum game approach to trade Country s wealth is based on its available

10 Free Trade Theories Two theories that support free trade 1. Absolute advantage theory 2. Comparative advantage theory Market forces should determine trade through specialization Theory of Absolute Advantage Adam Smith Challenged the mercantilist philosophy and its Zero-Sum game approach to trade Country s wealth is based on its available goods and services and not on Gold He argued that, a country s Absolute advantage in a product exists when it produces it more efficient than any other country. Adam Smith

11 3- Theory of Absolute Advantage 1. Different countries produce some goods more efficiently than others, so : 2. Specialization occurs because: Natural advantage Acquired advantage product technology process technology 3. Free trade environment leads to: 4. Greater efficiency leads to: 5. Higher global output Theory of Absolute Advantage

6-23 5-23 4- Theory of Comparative Advantage Ricardo s theory of comparative advantage suggests that countries should specialize

12 4- Theory of Comparative Advantage David Ricardo asked what might happen when one country has an absolute advantage in the production of all goods? Theory of Comparative Advantage Ricardo s theory of comparative advantage suggests that countries should specialize in the production of those goods they produce most efficiently and buy goods that they produce less efficiently from other countries, even if this means buying goods from other countries that they could produce more efficiently at home

13 4- Theory of Comparative Advantage 5-25 Theories of Specialization: Assumptions and Limitations Theories of specialization make assumptions that may not be valid full employment economic efficiency division of gains two countries, two commodities transport costs statics and dynamics services production networks mobility

Large countries differ in several ways from smaller countries, they usually Export a smaller portion of output

14 5- Theory of Country Size How Much Does A Country Trade? Large countries depend less on trade than small countries, why? Large countries differ in several ways from smaller countries, they usually Export a smaller portion of output and import a smaller part of consumption Have higher transportation costs for foreign trade. Conclusion: Large countries trade less 5-27 Which of the Two World will have better Trade? C D B A World (A) World (B)

6- Factor proportions theory 1. Factors in relative large quantity are cheaper than factors than factors that are relatively scarce. (e.g. if labor is available while capital and land are scarce, then labor cost is low relative to land and capital).

High income countries have large capital and higher levels of professionals. So they maintain export lead in Capital intensive production.

15 6- Factor proportions theory 1. Factors in relative large quantity are cheaper than factors than factors that are relatively scarce. (e.g. if labor is available while capital and land are scarce, then labor cost is low relative to land and capital). 2. Low income countries have little capital available while investment per worker is low and cheap labor rates. So they maintain export competitiveness in labor intensive production. 3. High income countries have large capital and higher levels of professionals. So they maintain export lead in Capital intensive production Factor proportions theory Hong Kong Netherlands Countries with many people relative to land (e.g. Hong Kong & Netherlands), Land price is very high because of demand. Regardless of weather and soil conditions, neither countries excel in the production of goods requiring land like wheat or wool

5-31 6- Factors Proportions Theory Labor-intensive Farming The Wheat

16 6- Factors Proportions Theory Capital-intensive Farming The Wheat harvesting is Capital intensive in USA because of high labor costs Factors Proportions Theory Labor-intensive Farming The Wheat harvesting is labor intensive in Pakistan because of low labor costs

17 What Does A Country Trade? Worldwide Trade by Major Sectors Country Similarity Theory Choosing a trade partner Most trade occurs among developed countries Share similar market characteristics Produce and consume much more than developing countries Trading partners are affected by Cultural similarity Political relations between countries Distance

Sales 2/15/2018 The static and Dynamics of Trade 8- Product Life Cycle (PLC) Theory The production location of certain manufactured products shifts as they go through their life cycle which consists

18 Sales 2/15/2018 The static and Dynamics of Trade 8- Product Life Cycle (PLC) Theory The production location of certain manufactured products shifts as they go through their life cycle which consists of 4 Stages: 1- Introduction 2- Growth 3- Maturity 4- Decline Time Diamond of National Advantage The diamond of national advantage Four conditions are important for gaining and maintaining competitive superiority (advantage) 1. Demand conditions 2. Factor conditions 3. Related and supporting industries 4. Firm strategy, structure, and rivalry

9- Diamond of National Advantage Rivalry = Competition 4 The Porter Diamond 1 2 3 Competitive advantage of an industry depends on 4 conditions that need to be favorable: 5-37 Why Production Factors

19 9- Diamond of National Advantage Rivalry = Competition 4 The Porter Diamond Competitive advantage of an industry depends on 4 conditions that need to be favorable: 5-37 Why Production Factors Move? Factor mobility theory Focuses on why production factors move, the effects of that movement on transforming factor endowments, and the impact of international factor mobility on world trade Capital and labor move internationally to : gain more income. flee adverse political situations

20 Trade and Factor Mobility There are pressures for the most abundant factors to move to areas of scarcity The lowest costs occur when trade and production factors are both mobile 5-39 Example: Trade and factor Mobility 1 Case: Production of Tomatoes Countries: USA and Mexico Assumptions: Cost per bushel USA MEXICO US labor $1.25 Mexican labor $0.25 US Capital $0.30 Mexican Capital $0.50 $1.55 Mexican Labor $1.15 US labor Mexican Capital US Capital $0.4 Transport Cost $0.75 Transport Cost $0.75 $0.75 Scenario 1: No trade or Factor Mobility Production Cost (Mexico) = $ $0.50 = $0.75 per bushel Production Cost (USA) = $ $0.30 = $1.55 per bushel

21 Example: Trade and factor Mobility Case: Production of Tomatoes Countries: USA and Mexico Assumptions: Cost per bushel 2 USA MEXICO US labor $1.25 Mexican labor $0.25 US Capital $0.30 Mexican Capital $0.50 $1.50 Mexican Labor $1.15 US labor Mexican Capital US Capital $0.4 Transport Cost $0.75 Transport Cost $0.75 $0.75 Scenario 2: Trade Mobility But NO Factor Mobility Production Cost (Mexico) = $ $0.50 = $0.75 per bushel Transport Cost to (USA) = $ $0.75 = $1.50 per bushel 5-41 Example: Trade and factor Mobility 3 Case: Production of Tomatoes Countries: USA and Mexico Assumptions: Cost per bushel USA MEXICO US labor $1.25 Mexican labor $0.25 US Capital $0.30 Mexican Capital $0.50 Mexican Labor $1.15 US labor Labor Mexican Capital US Capital $0.4 Transport Cost $0.75 Transport Cost $0.75 $1.45 $0.65 Capital Scenario 3: Factor Mobility But NO Trade Mobility Production Cost (Mexico) = $ $0.25 = $0.65 per bushel Production Cost (USA) = $ $1.15 = $1.45 per bushel

22 Example: Trade and factor Mobility Case: Production of Tomatoes Countries: USA and Mexico Assumptions: Cost per bushel 4 USA MEXICO US labor $1.25 Mexican labor $0.25 US Capital $0.30 Mexican Capital $0.50 Mexican Labor $1.15 US labor Mexican Capital US Capital $0.4 Transport Cost $0.75 Transport Cost $0.75 $1.40 $0.65 Capital Scenario 4: Both Trade and Factor Mobility Production Cost (Mexico) = $ $0.25 = $0.65 per bushel Transport Cost to (USA) = $ $0.75 = $1.40 per bushel 5-43 Example: Trade and factor Mobility 5 Case: Production of Tomatoes Countries: USA and Mexico Results: Cost per bushel Scenario Cost in Mexico Cost in USA No Trade or Factor mobility $0.75 $1.55 Trade Mobility But NO Factor Mobility $0.75 $1.50 Factor Mobility But NO Trade Mobility $0.65 $1.45 Both Trade and Factor Mobility $0.65 $1.40 Conclusion: Min Costs per bushel occur when trade and production factors (labor + capital) are both mobile

23 In What Direction Will Trade Winds Blow? Issues to consider 1. Displacement of jobs as developed countries shift production to more rapidly developing countries 2. Relationships among land, labor, and capital will continue to evolve 3. Continued trend toward a more finely tuned specialization of production among countries

International Business: Environments and Operations, 14e (Daniels et al.) Chapter 6 International Trade and Factor-Mobility Theory

International Business: Environments and Operations, 14e (Daniels et al.) Chapter 6 International Trade and Factor-Mobility Theory 1) Which of the following is NOT a reason that international trade theory