UNIT 2.
1 IBM
Overview of trade theory
• Free trade refer to a situation where a government
doesn’t attempt to influence through quotas or
duties, what its citizen can buy from another
country or what they can produce and sell to
another country
• The theories of Smith, Ricardo and Heckscher-Ohlin
help to explain the pattern of international trade
Trade theories
• Absolute advantage
• Comparative advantage
• Heckscher-Ohlin theory
• The Leontief paradox
• The product life-cycle theory
• New trade theory
• National competitive advantage – Porter’s
diamond
Mercantilism
• The first theory of international trade emerged in
England in the mid 16th century The main tenet of
Mercantilism was that it was in a country’s best
interests to maintain a trade surplus
• Comparative theory
• Comparative advantage is an economic
theory about the potential gains from trade
for individuals, firms or nations that arise from
the differences in their factors endowments or
technological progress
• David Ricardo developed the classical theory
of comparative advantage in 1817
2*2*2 Model
• The original H-O model assumed that the only
difference between countries was the relative
abundances of labor and capital
• The model contains two countries (homogenous
factors of production) 2*2*2 model
• The model has “variable factors proportions”
between countries – highly developed countries
have a comparatively high capital: labor ratio
than developed countries
FDI – Foreign Direct Investment
• FDI refers to the purchase of a significant number
of shares of a foreign company in order to gain
certain degree of management control
• FDI flows:
• 1. Capital formation
• 2. Formation of new firms and factories
• 3. Increase in equity holdings in the existing firms
• 4. Mergers and acquisition of existing firms and
factories
Factors influencing FDI
Supply Factors
• 1. Production costs
• 2. Logistics
• 3. Natural resources
• 4. Key technology
Demand Factors
• 1. Customer access
• 2. Competitive advantage
• 3. Follow the clients
• 4. Follow the rivals
Political Factors
• 1. Economic priorities
• 2. Avoidance of trade barriers
• 3. Development incentives
• FDI policy initiatives
• FDI not allowed
• 1. Retail trading except single brand retailing
• 2. Atomic energy
• 3. Lottery business
• 4. Gambling and betting sector
• 5. Business of chit fund and Nidhi company
• FDI up to 24 percent allowed
• 1. Manufacture of items reserved for small sector
• FDI up to 26 percent allowed
1. FM broadcasting
2. Up linking news and TV channels
3. Defense production with prior government
approval
4. Insurance
• FDI up to 49 percent allowed
• 1. Broadcasting
• 2. Scheduled air transport services
• FDI up to 51 percent allowed
• 1. Single brand product retailing subject to prior
approval
• FDI up to 74 percent allowed
• 1. Private sector banking
• 2. Telecommunication services
• FDI up to 100 percent allowed
• 1. Trading
• 2. Courier services
• 3. Cigar and cigarette manufacture
1. European union :( EU)
The largest and most comprehensive of the regional economic groups
is the European Union. To abolish internal tariffs in order to more
closely integrate EU and hopefully allow economic co-operation to
help avoid further political conflicts. It includes European Economic
Community later it is called as European Community.
2. North American Free Trade Agreement :( NAFTA):
It came into being on January 1, 1994. The most affluent nations of
the world I.e., USA and Canada with Mexico – a developing country
joined together, to eliminating all tariffs and trade barriers among
these countries.
• 3. South Asian Association for Regional Cooperation (SAARC):
December 1985
• The successful performance of this trade block is, for economic
development of the member countries and in improving the
employment opportunities, incomes and living standards of the
people of the region gave impetus for the formation of SAARC.
– Afghanistan
– Bangladesh
– Bhutan
– India
– Maldives
– Nepal
– Pakistan
– Sri Lanka
• There are currently nine Observers to SAARC, namely: (i) Australia; (ii)
China; (iii) the European Union; (iv) Iran; (v) Japan; (vi) the Republic of
Korea; (vii) Mauritius; (viii) Myanmar; and (ix) the United States of
• 4. SAARC Preferential Trading Arrangement
(SAPTA):
The member states realizing the fact that
expansion of intra-regional trade could act as
a stimulus to the development of their
economics, by expanding investment and
production,decided to establish and promote
regional preferential trading agreement.
December 7, 1995.
• 5. South Asian Free Trade Area (SAFTA):
• The SAFTA agreement came into force fro January
1, 2006. The agreement promotes mutual trade
and economic cooperation among the contracting
states, through exchange of concessions in
accordance with it. In general, the agreement
requires the completion of trade liberalization
program.
The Association of Southeast Asian Nations (ASEAN)
• ASEAN is a geo-political and economic organization
of 10 countries located in Southeast Asia. It was
established on 8 August 1967 in Bangkok, Thailand,
with the signing of the ASEAN Declaration by the 5
original members, namely Indonesia, Malaysia,
Philippines, Singapore and Thailand.
• Brunei Darussalam then joined in January 1984,
Vietnam in July 1995, Lao PDR and Myanmar in July
1997, and Cambodia in April 1999, making up what
is today the ten Member States of ASEAN.
Advantages of trading blocks
Advantages of trading blocks
• Tariff removal leads to trade creation – lower prices
for consumers and greater opportunity for exporters.
• Increased trade enables increased specialisation –
which gives benefits of economies of scale (lower
average costs from increased output)
• Catch-up effects. Countries joining a rich trading
block can benefit from inward investment and
increased trade opportunities. Countries in Eastern
Europe have made considerable progress in catching
up with average income levels in Western Europe.
• 1.Foreign Direct Investment: An increase in foreign
direct investment results from trade blocs and
benefits the economies of participating nations.
Larger markets are created, resulting in lower costs
to manufacture products locally.
2. Economies of Scale: The larger markets created via
trading blocs permit economies of scale. The
average cost of production is decreased because
mass production is allowed.
• 3. Competition: Trade blocs bring manufacturers in
numerous countries closer together, resulting in
greater competition. Accordingly, the increased
competition promotes greater efficiency within firms.
• 4. Trade Effects Trade blocs eliminate tariffs, thus
driving the cost of imports down. As a result, demand
changes and consumers make purchases based on the
lowest prices, allowing firms with a competitive
advantage in production to thrive.
• Market Efficiency: The increased consumption
experienced with changes in demand combines
with a greater amount of products being
manufactured to result in an efficient market. The
disadvantages, on the other hand, include:
regionalism vs. multinationalism,loss of
sovereignty, concessions, and interdependence.
• 6. Regionalism vs. Multinationalism: Trading blocs
bear an inherent bias in favor of their participating
countries. For example, NAFTA, a free trade
agreement between the United States, Canada and
Mexico, has contributed to an increased flow of trade
among these three countries. Trade among NAFTA
partners has risen to more than 80 percent of
Mexican and Canadian trade and more than a third of
U.S. trade, according to a 2009 report by the Council
on Foreign Relations.
• DIS ADVANTAGES
• Loss of Sovereignty: A trading bloc, particularly
when it is coupled with a political union, is likely to
lead to at least partial loss of sovereignty for its
participants. For example, the European Union,
started as a trading bloc in 1957 by the Treaty of
Rome, has transformed itself into a farreaching
political organization that deals not only with trade
matters, but also with human rights, consumer
protection, greenhouse gas emissions and other
issues only marginally related to trade.
• Concessions: No country wants to let foreign firms
gain domestic market share at the expense of local
companies without getting something in return. Any
country that wants to join a trading bloc must be
prepared to make concessions.
• For example, in trading blocs that involve developed
and developing countries, such as bilateral
agreements between the U.S. or the EU and
relatively poor Asian, Latin American or African
countries, the latter may have to allow multinational
corporations to enter their home markets, making
some local firms uncompetitive.
• Interdependence: Because trading blocs increase
trade among participating countries, the
countries become increasingly dependent on
each other. A disruption of trade within a trading
bloc as a result of a natural disaster, conflict or
revolution may have severe consequences for the
economies of all participating countries.
• Increased influence of multinationals. In a bilateral
deal between the US and South-East Asian trading
block. Free trade may come at the price of allowing
free movement of capital. This can have benefits in
terms of inward investment. But, can also have
costs for higher-cost domestic producers.
• Free trade can lead to structural unemployment as
resources shift from uncompetitive industries to
newer industries.
CHALLENGES FOR GLOBAL BUSINESS:
CHALLENGES FOR GLOBAL BUSINESS:
• Entering new country markets unprepared can
often lead to disappointing results as well as
detract from efforts in your domestic marketplace.
One of the first challenges is how to appraise the
success of any global business activity.
• We have all too often found that a global business
quite literally “takes on a life of its own” and grows
with specific strategy, management, and no
specific performance metrics. Measuring the ROI is
a complex activity that involves analyzing the many
variables particular to global expansion.
• There are additional costs in developing products to
be used in global markets, and there are additional
administrative costs in creating marketing and sales
materials, or obtaining special export licenses.
There are also longer sales cycles, longer cash
conversion cycles, and the difficulty of trying to
determine return on investments when there are
multiple currencies involved.
Compliance and Regulations
• Whether you are a small business shipping homemade
handbags through a website or a consulting firm
offering your services to multinational corporations,
you must understand andfollow various rules and
regulations that govern your goods and services.
• You must comply with the tax laws of different
countries as well as statutory export regulations. Some
countries have strict policies about the types of
business practices allowed in their countries that often
include human resource and pension restrictions and
rules if you hire a foreign workforce.
Culture and Language
• One of the advantages of a global economy is that
more small businesses can compete competitively.
However, few small businesses are prepared to
handle the customer service calls from China,
Vietnam and other emerging markets key to the
success of a global competitor.
• If your sales are increasingly going overseas, you
have to find ways to navigate the language
barriers that may crop up in emails and phone
calls. At the same time, cultural differences can
play a big role in your success in the global market.
• For example, in China, the color red is a symbol of
luck, while in other countries, it represents a
warning sign. Religious and cultural boundaries
must be understood to run effective marketing
campaigns abroad.
Environmental Impact
• Recycling is rapidly becoming a common practice in
most U.S. companies as business leaders realize the
impact their behavior has on global environmental
issues. You may be challenged to incorporate
successful recycling programs because they may be
cost-prohibitive or just inconvenient.
• Energy-saving devices such as compact
fluorescent light bulbs make a dent in world
energy consumption, but they may not be viable
for your office.
• Challenges abound for developers looking to
build new factories or office space. Food, energy
and transportation companies all face
environmental pressures to use fewer natural
resources and offer products made with
recyclable materials.
Technology and Communication
• One of the biggest challenges facing globally
competitive marketplaces is the communication
issues that crop up when technology doesn’t keep
up in every sector. When your company relies on
disparate systems that can’t communicate with
each other, your bookkeeping gets bogged down,
and orders slow or cease.
• Access to vital information may be compromised
when technological systems are not standardized.
You’ve got to rely on translations and reports from
foreign staff members instead of using a
centralized system when the technology you rely
on to run your business isn’t compatible with the
technology used by your buyers, foreign offices
and global sales force.
