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International Trade Theory
Table of Contents
Learning Objectives
Chapter Summary
Chapter Opening Activity
Chapter Outline
Opening Case: “Trade Wars Are Good and Easy to Win”
Introduction
An Overview of Trade Theory
Mercantilism
National Competitive Advantage: Porter’s Diamond
Focus on Managerial Implications: Location, First-Mover Advantages, and Government
Policy
End-of-Chapter Resources
Critical Thinking and Discussion Questions
globalEDGE™ Research Task
Closing Case: The Trans Pacific Partnership (TPP) Is Dead; Long Live the CPTPP!
Continuous Case Concept
Additional Readings and Sources of Information
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Learning Objectives
6-1 Understand why nations trade with each other.
6.2 Summarize the different theories explaining trade flows between nations.
6-3 Recognize why many economists believe that unrestricted free trade between nations will
raise the economic welfare of countries that participate in a free trade system.
6-4 Explain the arguments of those who maintain that government can play a proactive role in
promoting national competitive advantage in certain industries.
6-5 Understand the important implications that international trade theory holds for management
practice.
Chapter Summary
This chapter focuses on the benefits of international trade and introduces several theories that
help explain the patterns of international trade that are observed in practice. The discussion
begins with an explanation of the theory of mercantilism, and then proceeds to discuss the
theories of absolute advantage and comparative advantage. Four additional theories are
discussed, including the Heckscher-Ohlin theory, the product life cycle theory, the new trade
theory, and the theory of national competitive advantage. Each of these theories helps explain
why certain goods are (or should be) made in certain countries. The chapter ends by discussing
the link between the theories of international trade and (1) a firm’s decision about where (in the
world) to locate its various productive activities, (2) the importance of establishing first-mover
advantages, and (3) government trade policies.
Chapter Opening Activity
In groups of four or five, give each group ten minutes to share their ideas about one of the
several theories discussed in this chapter (e.g., mercantilism, absolute advantage, comparative
advantage, Heckscher-Ohlin, product life cycle, new trade, and Porter’s diamond).
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Chapter Outline
“Trade Wars Are Good and Easy to Win”
opening case
Summary
The opening case explores Donald Trump’s perspective on trade and the actions he has taken on
trade while President of the United States. Trump’s isolationist views are in stark contrast to U.S.
trade policy of the past 70 years. Trump appears to be under the impression that trade agreements
are zero-sum games and further that other countries can be bullied into making concessions to
the United States. Trump has boasted that “trade wars are good and easy to win” indicating that
he intends to impose widespread tariffs as part of his effort to make America great again.
Discussion Questions
1. Do you agree with Donald Trump’s assessment that trade wars are good and easy to win? Do
you agree with his approach to trade?
2. For the last 70 years, the United States has been the leader in promoting a free trade
environment. What role will the United States play under Donald Trump and what does that
mean for the United States going forward?
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Teaching Tip: To further explore the role of the United States under Trump, go to
https://www.usatoday.com/story/tech/2018/02/13/bill-gates-warns-china-other-powers-fill-void-
if-u-s-foreign-aid-cuts-could-cede-leadership-china-ot/322177002.
Introduction
A) The long-held belief espoused by the United States and other nations that free trade is a
positive-sum game under which all nations win is under threat from Donald Trump. Trump is
rapidly working to dismantle 70 years of American-led policy to lower trade barriers, believing
that trade is a zero-sum game, where some countries win at the expense of others.
Lecture Note: It is often worth asking students before discussing the theories why countries
trade the products they do. They will frequently, with a little prompting, hit upon many of the
ideas presented in this chapter and consequently relate better to the various theories that are
discussed.
An Overview of Trade Theory
A) Free trade refers to a situation where a government does not attempt to influence through
quotas or duties what its citizens can buy from another country or what they can produce and sell
to another country.
THE BENEFITS OF TRADE
B) The great strength of the theories of Smith, Ricardo, and Hecksher–Ohlin is that they identify
with precision the specific benefits of trade. Common sense suggests that some trade is
beneficial. The theories of Smith, Ricardo, and Hecksher–Ohlin go beyond common sense to
show why it is beneficial for a country to engage in international trade even for products it is able
to produce for itself. The gains arise because international trade allows a country to specialize in
the manufacture and export of products that can be produced most efficiently in that country,
while importing products that can be produced more efficiently in other countries.
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CONNECT
Video Case
EU to Remain Open For International Trade
Summary
This activity explores why nations trade with each other and in particular looks at the European
Union’s trade policy and its efforts to form a free trade agreement with Japan.
forming a free trade agreement with Japan?
Did You Know Video Clip
The video clip asks: “Did you know that sugar prices in the United States are much higher than
sugar prices in the rest of the world?”
Discussion Questions
1. Why are sugar prices in the U.S. nearly double the average world price of sugar?
2. Do you agree that U.S. taxpayers should protect U.S. sugar farmers against less expensive
imports?
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3. Do you agree that U.S. consumers should keep paying twice as much for sugar than people in
other parts of the world?
CONNECT
Video Case
Sugar Prices
Summary
This activity explores sugar prices in the United States as compared to the rest of the world.
Various protectionist prices keep sugar prices in the United States substantially higher than the
rest of the world.
Activity
THE PATTERN OF INTERNATIONAL TRADE
C) Some patterns of trade are easy to explain. It is obvious why Saudi Arabia exports oil, Ghana
exports cocoa, and Brazil exports coffee. Yet others are not so obvious or easily explained.
D) New trade theory stresses that in some cases countries specialize in the production and
export of particular products not because of underlying differences in factor endowments, but
because in certain industries the world market can support only a limited number of firms. So a
country’s pattern of trade may be a reflection of the ability of firms in that nation to capture first-
mover advantages.
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TRADE THEORY AND GOVERNMENT POLICY
F) While all the trade theories discussed in the text agree that international trade is beneficial to a
country, they lack agreement in their recommendations for government policy. Mercantilism
makes a crude case for government involvement in promoting exports and limiting imports.
Mercantilism
A) The first theory of international trade emerged in England in the mid-16th century. Referred to
as mercantilism, its principle assertion was that it is in a country’s best interest to maintain a
trade surplus, to export more than it imports. Consistent with this belief, the mercantilist doctrine
advocated government intervention to achieve a surplus in the balance of trade.
country FOCUS: Is China Manipulating Its Currency in Pursuit
of a Neo-Mercantilist Policy?
Summary
This feature analyzes claims that China is a neo-mercantilist nation. Exports are largely
responsible for China’s recent rapid economic growth and for decades, the country’s exports
have grown faster than its imports. In 2017, the trade deficit between the United States and China
reached a record $375 billion, prompting renewed criticism that China has been artificially
keeping the value of its currency low, making its exports cheaper. However, this claim is not
supported by the evidence, which shows instead that China’s currency has strengthened relative
to the dollar and that China has actually taken actions to allow the value of its currency to
appreciate.
Discussion Questions
1. Are the claims that China is manipulating its currency and following a neo-mercantilist policy
valid? Why or why not?
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2. What incentive does China have to open its markets to foreign products? Why might China
resist such a move?
3. Why does China’s trade surplus with the United States persist despite the country’s efforts to
keep the value of its currency from declining?
Absolute Advantage
A) In 1776, Adam Smith attacked the mercantilist assumption that trade is a zero-sum game,
arguing that countries differ in their ability to produce goods efficiently, and that a country has
an absolute advantage in the production of a product when it is more efficient than any other
country in producing it. According to Smith, countries should specialize in the production of
goods for which they have an absolute advantage and then trade these goods for the goods
produced by other countries.
Comparative Advantage
A) In 1817, David Ricardo took Adam Smith’s theory one step further by exploring what might
happen when one country has an absolute advantage in the production of all goods. Smith’s
theory of absolute advantage suggests that such a country might derive no benefits from
international trade. Ricardo showed that this was not the case. According to Ricardo’s theory of
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THE GAINS FROM TRADE
B) The theory of comparative advantage argues that trade is a positive-sum gain in which all
benefit. It provides a strong rationale for encouraging free trade.
QUALIFICATIONS AND ASSUMPTIONS
C) The simple example of comparative advantage presented in the text makes a number of
assumptions: only two countries and two goods; zero transportation costs; similar prices and
values; resources are mobile between goods within countries, but not across countries; constant
returns to scale; fixed stocks of resources; and no effects on income distribution within countries.
While these are all unrealistic, the general proposition that countries will produce and export
those goods in which they are most efficient has been shown to be quite valid.
EXTENSIONS OF THE RICARDIAN MODEL
D) The text explores the effects of relaxing the assumptions that resources are mobile between
goods within a country, and that trade does not change a country’s stock of resources or the
efficiency with which those resources are utilized.
Immobile Resources
E) As illustrated by the example in the text, resources do not always move freely from one
economic activity to another.
Diminishing Returns
F) The model of comparative advantage assumes constant returns to specialization (the units
of resources required to produce a good are assumed to remain constant no matter where one is
on a country’s production possibility frontier). However, it is more realistic to assume
diminishing returns to specialization (more units of resources are required to produce each
additional unit).
Dynamic Effects and Economic Growth
H) Opening an economy to trade is likely to generate dynamic gains of two types. First, trade
might increase a country’s stock of resources as increased supplies become available from
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abroad. Second, free trade might increase the efficiency of resource utilization, and free up
resources for other uses.
Trade, Jobs and Wages: The Samuelson Critique
I) Samuelson argues that in some cases, the dynamic gains from trade may not be so beneficial.
He argues that the ability to off-shore services jobs that were traditionally not internationally
mobile may have the effect of a mass inward migration into the United States, where wages fall,
effectively negating the gains of international trade.
country FOCUS: Moving U.S. White-Collar Jobs Offshore
Summary
This feature goes to the heart of a debate that has been played out many times over the past half
century—the transference of jobs from the United States to lower-wage countries. The difference
now however, is that rather than blue-collar jobs being transferred, the new trend is for white-
collar jobs to move—jobs associated with the knowledge-based economy.
Discussion Questions
1. Will the United States suffer from the loss of highly skilled and high paying jobs? What does
the transference of white-collar jobs mean to the average American?
2. What does the transference of white-collar jobs mean to recipient countries such as India and
the Philippines?
3. Why do American companies transfer white-collar jobs to countries like India and the
Philippines?
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Lecture Note: To extend the discussion of outsourcing to include Wall Street jobs, go to
https://qz.com/853075/goldman-sachs-and-other-wall-street-banks-moved-thousands-of-jobs-
out-of-the-us-will-trump-go-after-them-too.
Evidence for the Link between Trade and Growth
J) Studies exploring the relationship between trade and economic growth suggest that countries
that adopt a more open stance toward international trade enjoy higher growth rates than those
that close their economies to trade.
Heckscher–Ohlin Theory
A) Heckscher and Ohlin argued that comparative advantage arises from differences in national
THE LEONTIEF PARADOX
B) Using the Heckscher–Ohlin theory, Leontief, in 1953, postulated that since the United States
was relatively abundant in capital compared to other nations, the United States would be an
exporter of capital-intensive goods and an importer of labor-intensive goods. To his surprise,
however, he found that U.S. exports were less capital-intensive than U.S. imports. Since this
result was at variance with the predictions of the theory, it has become known as the Leontief
Paradox.
Teaching Tip: A more extensive discussion of Wassily Leontief is available at
http://www.econlib.org/library/Enc/bios/Leontief.html.
C) Recent research suggests that the Heckscher–Ohlin theory gains predictive power if the
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The Product Life-Cycle Theory
A) Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s.
According to the theory, as products mature, both the location of sales and the optimal
production location will change affecting the flow and direction of trade.
B) According to Vernon, early in the life cycle of a typical new product, while demand is starting
to grow in the United States, demand in other advanced countries is limited to high-income
groups. The limited initial demand in other advanced countries does not make it worthwhile for
firms in those countries to start producing the new product, but it does necessitate some exports
from the United States to those countries. Over time, however, demand for the new product starts
to grow in other advanced countries. As it does, it becomes beneficial for foreign producers to
begin producing for their home markets. In addition, U.S. firms might set up production facilities
in those advanced countries where demand is growing. Consequently, production within other
advanced countries begins to limit the potential for exports from the United States.
E) The consequence of these trends for the pattern of world trade is that the United States (and
other advanced countries) switches from being an exporter of the product to an importer of the
product as production becomes more concentrated in lower-cost foreign locations.
PRODUCT LIFE-CYCLE THEORY IN THE TWENTY-FIRST CENTURY
F) While the product life cycle theory accurately explains what has happened for products like
photocopiers and a number of other high technology products developed in the United States in
the 1960s and 1970s, the increasing globalization and integration of the world economy has
made this theory less valid in today’s world. In fact, the product life-cycle as introduced by
Vernon could be considered ethnocentric, as well. As such, this approach may be best suited to
explain the pattern of international trade during the period of American global dominance.
New Trade Theory
A) New trade theory suggests that the ability of firms to realize economies of scale (unit cost
reductions associated with a large scale of output) may help explain international trade patterns.
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INCREASING PRODUCT VARIETY AND REDUCING COSTS
C) According to new trade theory, with trade a nation may be able to specialize in producing a
narrower range of products than it would in the absence of trade. By buying goods that it does
not make from other countries, each nation can simultaneously increase the variety of goods
available to its consumers and lower the costs of those goods.
ECONOMIES OF SCALE, FIRST-MOVER ADVANTAGES, AND THE PATTERN OF
TRADE
D) A second theme in new trade theory is that the pattern of trade we observe in the world
economy may be the result of first-mover advantages (economic and strategic advantages that
accrue to early entrants into an industry) and economies of scale.
IMPLICATIONS OF NEW TRADE THEORY
E) New trade theory suggests that nations may benefit from trade even when they do not differ in
resource endowments or technology. The theory also suggests that a country may predominate in
the export of a good simply because it was lucky enough to have first-mover firms.
F) New trade theory is at variance with the Heckscher-Ohlin theory, which suggests that a
country will predominate in the export of a product when it is particularly well endowed with
those factors used intensively in its manufacture. New trade theory does not contradict the theory
of comparative advantage, but instead identifies a source of comparative advantage.
CONNECT
Case Analysis
New Trade Theory and Aircraft Production
Summary
This activity explores new trade theory and how it can explain the success of Boeing and Airbus
in the global aircraft industry. Both companies have benefitted from favorable government
actions.
Activity