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V. END OF CHAPTER QUESTIONS
● TEST YOUR COMPREHENSION
5.9. Describe the classical theories of international trade. Which theories do you
believe are relevant today?
(LO 5.1; AACSB: Application of knowledge)
There are five classical perspectives explaining the underlying rationale for trade among
nations:
● The Mercantilist View- exports are good, imports are bad, thus explaining a nation’s
● Absolute Advantage Principle- Each country benefits by producing only those
● Comparative Advantage Principle- It can be beneficial for two countries to trade
● Factor Proportions Theory- Each country should export products that concentrate
● International Product Cycle Theory- As a product evolves through its life cycle-
● New Trade Theory- Industries prosper that leverage economies-of-scale. Increasing
5-10. What is the difference between the concepts of absolute advantage and
comparative advantage?
Visit MyManagementLab for suggested answers.
(LO 5.1; AACSB: Application of knowledge)
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5-11. Summarize factor proportions theory. What factors are most abundant in the
following countries: China, Japan, Germany, Saudi Arabia, and United States?
Visit globalEDGE™ for helpful information.
(LO 5.1; AACSB: Application of knowledge; Diverse and multicultural work
environments)
● Factor Proportions Theory- Each country should export products that concentrate
China- possesses an ample labor supply; it specializes in the production and export of
Japan- manufactures some of the best automobiles in the world
5.12. What are the main sources of national competitive advantage? Think about
a successful product in your country; what are the sources of competitive
advantage that explain its success?
(LO 5.2; AACSB: Application of knowledge)
The U.S. is considered to possess national competitive advantages in service industries
5.13. Do you believe your country should adopt a national industrial policy?
Why or why not?
(LO 5.2; AACSB: Reflective thinking)
■ Porter’s Diamond Model implies that any country can attain economic prosperity by
systematically cultivating new/superior factor endowments- factors of production, such
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◘ Ireland, Japan, Singapore, and South Korea are examples of countries that
5-14. Describe the internationalization process of the firm? Review the
background of major MNEs by visiting their Websites. What is the nature of
internationalization in these firms? What is the nature of internationalization in
born-global firms?
Visit MyManagementLab for suggested answers.
(LO 5.3; AACSB: Reflective thinking)
5.15. FDI-based explanations of international business evolved over time.
Describe the evolution of these explanations from monopolistic advantage theory,
through internalization theory, to the eclectic paradigm.
(LO 5.3; AACSB: Application of knowledge)
FDI-Based Explanations
■ Total value of MNE investment abroad now constitutes some 20% of global GDP,
which is a significant amount.
■ Historically- most of the world’s FDI was invested both by and in Western Europe, the
Monopolistic Advantage Theory
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■ This theory suggests that firms that use FDI as an internationalization strategy tend to
■The advantages (specific to the MNE) that arise from this monopoly power enable the
■ The most important monopolistic advantage is superior knowledge, which includes
Internalization Theory
■ The Internalization Theory explains the process by which firms acquire and retain
one or more value-chain activities inside the firm, minimizing the disadvantages of
dealing with external partners and allowing for greater control over foreign operations
and its proprietary knowledge.
Dunning's Eclectic Paradigm
■ This is a framework for determining the extent and pattern of the value-chain
operations for global firm.
5.16. What are ownership-specific advantages, location-specific advantages,
and internalization advantages?
(LO 5.4; AACSB: Application of knowledge)
■ The Eclectic Paradigm specifies three conditions that determine whether or not a
company will engage in FDI: ownership-specific advantages, location-specific
advantages, and internalization advantages.
Ownership-specific advantages
■ Refer to firm-specific competitive advantages, e.g. proprietary technology, unique
Location-specific advantages
■ Refer to host country comparative advantages, e.g. natural resources, skilled labor,
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Internalization advantages
■ Refer to the competitive advantages that the firm derives from internalizing
foreign-based manufacturing, distribution, or other stages in its value chain.
● APPLY YOUR UNDERSTANDING
5-17. South Africa is home to huge reserves of coal, gold, diamonds, and natural
gas. In addition to their intrinsic value, gold and diamonds have many industrial
uses. Precious mineral mining has transformed South Africa into a major
emerging market economy. To handle international shipping, the government
developed major ports that connect South Africa to markets worldwide. South
Africa is also home to a large pool of low-wage workers in mining and related
industries. The government has devised a collection of plans that support
specific industries, especially mining. These developments support a cluster of
highly specialized firms in the mining and extractive industries. Some of the
world’s most knowledgeable firms in these industries are concentrated in South
Africa, especially De Beers SA (www.debeers.com). De Beers has substantial
capabilities in marketing and international strategy and a near-monopoly in the
global diamond industry. The firm collaborates with MNEs that hold major
financial resources. Use the theories discussed in this chapter to explain the
advantages held by South Africa and De Beers. What insights emerge from these
theories that shed light on South Africa and De Beers?
(LO 5.1; AACSB: Application of knowledge; Diverse and multicultural work
environments)
See also Doing Business in Africa module from Michigan State University:
http://www.southafrica.doingbusinessguide.co.uk/
What is interesting to note here is that almost all of the theories from this chapter may
be applied to this example. Furthermore, the potential overlap in theories is exemplified
as more than one theory may be used to explain the same business phenomenon.
Thus, the same case fact may be interpretation with more than one theory, e.g. absolute
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new firms and industries with these same competitive advantages, just as South Africa
has done for De Beers and the mining industry.
Finally, in an effort to be complete in our consideration of international trade theories, all
of the theories from Exhibit 5.1 are included below, with a No designation next to it if
the theory does not apply to this particular example.
South Africa ■ Nation-level – (Explains international trade)
1. Classical Theories
◘ Mercantilism- NO
◘ Absolute Advantage Principle
In addition to their intrinsic value, diamonds and gold have numerous industrial uses, in
which South Africa is the world leader.
◘ Comparative Advantage Principle
■ Each country benefits by specializing in producing the product at which it has a
comparative or relative advantage and then securing the other product through trade.
■ Natural advantages - fertile land, abundant minerals, and favorable climate- were the
◘ Factor Proportions Theory
● Factor Proportions Theory- Each country should export products that concentrate
◘ International Product Life Cycle Theory- NO
◘ New Trade Theory
■ New Trade Theory argues that increasing returns to scale, especially economies
2. Contemporary theories
◘ Competitive Advantage of Nations
Michael Porter argues that the competitive advantage of a nation is dependent upon the
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◘ Michael Porter’s Diamond Model
Related and Supporting Industries refers to the presence of clusters of suppliers,
■ Industrial Cluster: A concentration of businesses, suppliers, and supporting firms in
the same industry at a particular location, characterized by a critical mass of human
◘ National Industrial Policy
The government has devised various plans that support particular industries, especially
DeBeers S.A. ■ Firm-level – (Explains international business)
1. Firm Internationalization
◘ Internationalization Process of the Firm - NO
2. FDI-Based Explanations
◘ Monopolistic Advantage Theory
Mining precious minerals has transformed South Africa into Africa’s leading industrial
state.
3. Non-FDI-Based Explanations
◘ International Collaborative Ventures
De Beers has partnerships with large MNEs that hold major financial resources. The
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■ Networks and relational assets represent the stock of the firm’s economically
beneficial long-term relationships with other business entities, such as manufacturers,
5-18. Economist Lester Thurow once posed the following question: “If you were
the president of your own country and could specialize in one of two industries,
computer chips or potato chips, which would you choose?” When faced with this
question, many people choose potato chips, because “everybody can use potato
chips, but not everybody can use computer chips.” But the answer is much more
complex. Whether to choose computer chips or potato chips depends on such
factors as the relationship between national wealth and the amount of value
added in manufacturing products; whether the country can benefit from
monopoly power (few countries can make computer chips); and the likelihood of
spin-off industries (computer chip technology gives rise to other technologies,
such as computers). In light of these and other possible considerations, which
would you choose: computer chips or potato chips? Justify your answer.
(LO 5.1; AACSB: Reflective thinking)
Computer chips may create the foundation for comparative and competitive
advantages.
Comparative Advantage (Country)
■ Comparative advantage- Superior features of a country that provide it with unique
benefits in global competition, derived from either natural endowments or deliberate
national policies.
Competitive Advantage (Firm)
■ Competitive advantage- Distinctive assets or competencies of a firm -- derived
typically from cost, size, or innovation strengths -- that are difficult for competitors to
replicate or imitate.
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Under the Monopolistic Advantage Theory:
■ Firms that use FDI as an internationalization strategy tend to control certain resources
and capabilities that give them a degree of monopoly power. Although this theory is an
FDI-based explanation of internationalization, the central concept, i.e. that the most
important monopolistic advantage is superior knowledge, is applicable here and
underscores the specialization of computer chips over potato chips, because such
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