What is Globalization

• Globalization refers t o the increased interconnectedness and

interdependence of people and countries .
• The open ing of international borders to increase fast flows of
goods, services, finance, people, and ideas.
• The changes in institutions and policies at national and
international levels facilitate or promote such flows.

IMF : "The growing economic interdependence of countries worldwide through

increasing volume and variety of cross-border transactions in goods and
services and of international capital flows, and also through the more rapid and
widespread diffusion of technology"

Phases of Globalization
Phase of Approximate
Globallzatlon Period Triggers Key Characteristics
First phase I 830 to late 1800s. Introduction of railroada Rise of manufacturing: cross-
pcakina in 1880 and ocean transpon border uade o f commodities.
largely by trading companies
Second phase 1900 l o 1930 Rise of e lectricity and steel Emergence and dominance
production of early M NEs (mainl y from
E u rope and Nonh Ame rica)
in manufacturing. extractive.
and agricultural industries

Third phase 1948 lo 1970s Formation of General Focu s by industrializin g

A greement o n Tariff and W estern countries t o reduce
T rade (GATO; conclusio n trade barricn;: rise o f MNEs
of World War Il: M arsh a ll frorn Japan: development o f
Plan Lo n:conslrUcl Europe global capilal markets: rise
of global trade names
Fou rth phase 198 0 s lo present Privati7.,;alion of stale Rapid growth in cross-
e nterprises in t.m.n.._c.ition border trade of products.
economies:. revolution in serv ices.. and capital; rise
infonn.at.ion.. communication.. or internat.ionally active
and Lransportmion SMEs and services firms:
technologies: rcmariwblc ri s i ng prosperity of e m ergin g
arowth of crnc:qiing nuukets markets

Economic Reforms 1991

• In order to lessen the burdens of the control regime (the

licensing Raj)
• it pushed India's GDP growth in the 1980s to over 5.5
percent, breaking the previous record of 5 percent growth
known as the "Hindu rate of Growth" that had stood for the
preceding three decades.
Long-term structural vulnerabilities developing in the
system as a result or widespread industrial control through
the license raj, Monopolies and Restrictive Trade Practices
Act (MRTP) or 1969, nationalization or banks and other
industries, self-sufficiency and an inward-looking trade
strategy, as well as Import Substitution Industrialization (ISi).
• Imports were nearly two times as high as exports, there was
a massive trade deficit in the seoond haft of the 1980s
• Large amounts of debt to support various development
programs and maintain growth, which caused issues in the
late 1980s and early 1990s.
• fiscal deficit of 8.4%, current acoount deficit of 3.14%, high
inflation of 17%, huge foreign debt, etc. in 1990--1991; this
puts a lot of pressure on the Balance of Payment (BoP) front
 Facets of Globalization
Globalization of "aritets
•
The merging of historically distinct and
separate national markets into one huge
•• .
global marketplace. 1
-
Significant diffel euces still exist
among notional morlc:ets along
many relevant dimensions: r 1l.. --
··-
ri...• fin $
consumer tostes ond preferences,
distribution channels,
culturolly embedded volue systems,
business systems,
legal re9ulot1ons.

Facets of Globalization

Globalization of Production fI , Chips ~

G ♦1:):\frlfl*
The sourcing of goods and services. from Battery
locations around the globe tD toke
advantage of notional differences in the Carema SONY
cost and quality of factors of production Accelerometer BOSCH
(such OS Lobar. Energy. l.cn1. en! Capital).

" anufacturing Activities

"~Jobal Products"
Do Not Push Too Far!
Service Activities l
COVID-19

The Drivers of Market Globalization

• International Trade (reduction of barriers to trade and more

competition)

• Financial Flows (FDI, portfolio investment)

• Communication (traditional media and the internet)

• Advances in technology

• Population mobility

Dimensions of Market Globalization

• Integration and interdependence of national economies

• Rise of regional economic integration blocs

• Growth of global investment and financial flows

• Convergence of buyer lifestyles and preferences

• Globalization of production activities

• Globalization of services
 Module I: Understanding
Globalization and Global
business environment

Session 2: Globalization and Businesses

NehaJain
Assistant Professor (SS)

WHAT DOES IT MEAN TO BE AN INTERNATIONAL

BUSINESS?
An international business is any company that operates and produces or
sells goods between two or more countries. There are three ways a business
can be considered international:

l .lt produces goods domestically and sells domestically and internationally.

2.lt produces goods in a different country but sells domestically.
3.lt produces goods in a different country and sells domestically and
internationally.

Two types of international business models

to consider:
Transnational corporations Multinational corporations
have offices ln multiple countries, each responsible for a also have of fices In multiple countries, but unlike
different facet of the organization. For instance, marketing transnational corporations, each Is a microcosm of the
may be based In London, resea rch and development in l arger organization. This means each office has, for
Bogota, and software development In New York. example, its own leader'Vlip, marketing, sates, research
and development, technology, and human resources
An example of a successful transnational corporation is
teams. An example of a multinatlonal corporation Is
Nestli6, which splits business operations for each of its brands
PepsiCo, wh ich has 32 offices across 24 countr ies.
by reglon. There are over 100 Nesti~ offices worldwide with
distinct responsibilities. For instance, the Nesti~ Research Multinational companies may not beget this same
Cente r is located in Switzerland, whk:h acts as the hub that mindset, but they benefit from having someone from
oversees each brand.specific research and development every team present in each office. This can enable them
center, of which there are 23. All Nestle offices operate under t o collaborate and tailor efforts to the audience In their
the company's headquarters in Switzerland. specific location without juggling time differences and
l anguage barriers to collaborate with other teams.
Transnational corporations typically have the benefit of
everyone on a specific team being located in the same office,
although this may change with the rise of remote work. Being
in the same office can decrease miscommunication and
reinforce the idea that each office is an integral part of the
larger company.

• BuslnHs Freedom: (import restriction, restrictions on sourcing

finance or other factors from abroad, foreign investments etc.)
The economic liberalization is regarded as a first step.
• FaclUtles: for example, the infrastructural facilities.
• Government Support: Support may take the form of policy and
ESSENTIAL procedural reforms, development of common facilities such as
infrastructural facilities, R&D support, financial market reforms
CONDITIONS and so on.
FOR • Resources: Such as, Finance, technology, R&D capabilities,
GLOBALISATION managerial expertise, company and brand image, human
resource etc.)
• Competitiveness: such as, low costs and price, product quality,
product differentiation, technological superiority, after sales
service, marketing strength etc. Sometimes small firms may have
an edge over others in certain aspects or times of business.
Orientation: A global orientation on part of the business firms
and suitable globalization strategies are essential for
globalization.
 Pros
1. Economic Growth

Acctn to labo r: Globalfzatlon gives all nations access to a wider labor pool.
Developing nations with a shortage of knowledge workers might, for example,
"Import" labor to kickstart Industry. Wealthier nations. on the other hand, might
Pros and Cons ou tsou rce low-skill work to developlng nations with a l ower cost of living to reduce the
cost of goods sold and pass those savings on to the customer.
of Access to Jobs: This point is directly related to labor. Through globa lization, developing
nations often gain access to jobs in the form of work that's been outsourced by
Globalization wealthier nations.
Access to resourcu: One of the primary reasons nations trade is to gain access to
resou rces they otherwise wouldn' t have. Without this flow of resources across
borders, many modern luxuries would be impossible to manufacture or produce.
Smartphones, for example, are dependent on rare earth metals found in limited areas
around the world.
The ablllty for nations to "speciall1.-: Global and regional cooperat ion allow nations
to heavily lean into their economic strengths, knowing they can trade products for
other resources. An example is a tropica l nation that specializes in exporting a certain
fruit. It's been shown that when nations specialize in the production of goods or
services In which they have an advantage, trade benefits both parties.

2. Increased Global Cooperation

• For a gtobalized economy to exist, nations must be willing to put their differences
aside and work toget her. Therefore, increased globalization has been linked to a
reduction- tho ugh not an elimination-of conrtict.
• •or course. as tong as there have been nations. they've been connected with each
other th rough the exchange of l ethal force-through war end conquest-end this
threat hes never gone away,".

3. Increased Cross-Border Investment

• Globetizetion hes led to en inc rease in cross-border investment. At the
macroeconomic tevet, this international investment has been shown to enhance
welfare on both sides of the equation.
• The country that's the source of the capital benefits because it can often earn a
higher return abroad than domestically. The country that receives the inflow of capital
benefits because that capital co ntribute s to investment end, therefore. to
productivity. Foreign investmen t also often comes with, or in the form of, technology,
know-how, or access to distribution channels that can help the recipient nation.

, . Increased Competition
• When vie\Wd as a v.t\ole, global free trade is beneficial to the entini system. Individual
companies, organizations. and workers can be disadvantaged. however. by g\obat competit!on.
This is similar to how these parties might bedisadvan1aged bydomesi1c competition: The pool
has simptywidened.
• With this ln mind, some firms, Indu stries. and citizens may elect governments to pursue
prolectionlsl poticles desig:ned to buffer domestic firms or workers from foreign oompetiUon.
Protectionism often takes the form of tariffs, quotas, or non-tariff barriers, such as quality Of
sanitation requirements that make it mo111 difficult for a competing nation or business to justify
Cons of doing business In the country. These ettortscan often be detrimental to the overall economic
performance or both parties.

Globalization 2. Disproportionate Growth

• Another Issue of globalization !a that it can inlroducedl sproponionete grOW1h both betMen
and witliin nations. These effects must be carefully managed economically and lllOf&lly.
• Within countries, gtobatliatlon often has lhe effect or lncreasi rc l mmlgre1\on.
Macroeconomic ally, 1mmigra1lon Increases gross domes1lc product (GOP), which can be an
economic boon to the recip ient nation . lmmigra11on may, h<M'ever, 111duce GOP per capita in the
short run It Immigrants' income Is tower than the SYerage income or lhOse elreadyUvtng in the
country.

3. Environmental Concerns
• Increased gtobatiz.atk>n has been llnked to various emlironmental challenges, many otwhich
are serious, lnduding:
• Deforestation and loss o f biodiversity caused by economic speciaU1ation and lnfrastructwe
development
• Greenhouse gas emissions and other forms of pollution caused by increased iransportation of
goods

GLOBALISATION OF INDIAN BUSINESS

Obstacles to Globalisation Favourable Factors of Globalisation

• Government Policy and Procedures Human Resources
• High Cost Wide Base
Poor Infrastructure Growing Entrepreneurship
• Obsolescence Growing Domestic Market
• Resistance to Change • Expanding Markets
• Poor Quality Image Economic Liberalisation
• Supply Problems NRls
• Limited R&D • Competition
• Growing Competition
• Trade Barriers
 Module I: Understanding
Globalization and Global business
environment
Session 2: Global Businesses Environment

Neha Jain
Assistant Professor (SS)

I Global Business Environment

The environment of international business refers to the complex and

dynamic set of factors that influence and shape business activities across
national borders. These factors can be broadly categorized into several key
components:
• Economic Environment
• Political and Legal Environment
• Socio-Cultural Environment
• Technological Environment

Economic
Environment ,

-~
~
• Economic Systems: Varies from free-market economies . ....
to command economies. It affects the ea.~e of doing .o...
business, the level of government intervention, and the
role of private enterprise.
• Economic Conditions: Includes the overall health of
economies (like GDP growth rates, inflation, interest
. •,l/ - -
rates, and employment levels) and impacts business
strategy. market entry, and investment decisions.
• Currency Exchange Ratu: Fluctuations in exchange
rates affect international trade, invesunenL~. and ~ .o
profitability. Businesses must manage risks associated ~,l
with currency volatility. \0\,
\0\
\0
 Economic pol ides refer to the s1r.itcgies and action.~ that
governments use 10 manage and influence 1heir country's
economy. These policies are implcmcn1e<l 10 achieve specific
economic goals such as growth. S1abili1y, and equi1y. Economic
policies can be broadly ca1egorize<l inio 1he following 1ypes:

1. Fiscal Polley: Fiscal policy involves government decisions

on taxation and public spending to influence the economy.

Components:
Economic Taxation: Adjusting tax rates to control inflation. encourage
investment. or redistribute income.
Policies Govc.-nm,nt Spending: Changing levels of govemmenl
spending on infrastructure. social progr.un,;;, defense. etc., to
stimulate economic uc.:tivi1y or reduce public debt.
Purposo: To control inflalion. manage public deb~ pro1♦1e
economic grow1h. and reduce inequali1y.
Example: During a rcces.,;;ion. a government may rcdu1
taxes
and incrca.,;;c public spending to boost economic dcma (known
as expansionary fiscal policy).

(lll1'f't<r,11t C/OtfP1"_.,\Qfl l llut~l1("1ltd -

Economic Policies
cont..

Monetary PoUcy: Monelary policy involves managing lhe

money supply and interest rates to innuencc c<."Onomic at1ivity.
Components:
Interest Rates: Central banks adjust in1eres1 ra1es 10 control
borrowing and spending. Lower ra1es generally encourage
borrowing and invesunen1. while higher ra1es help redU<.-e
inflation.
Monoy Supply: Adjusiing 1he amounl of money circula1ing
in the economy, often through mechanism" like open market
operations, reserve requirements. and quantitative ea.~ing.
Purpose: To control infla1ion. Slabilize the currency, and
promo1e full employmenl.
Example: A cen1ral bank migh1 lower in1ere<1 ra1es 10
encourage borrowing and invesuneni during a period of slow
economic growth.
C~l,it O 2017 ~ - - (ct.,ation, ltd.

Economic Policies
cont..

Trade Policy: Trade policy governs inlemational 1rade and

includes tariffs. trade agreements. quotas, and trade restrictions.
Components:
Tariffs: Taxes on imponed goods 10 pro1ec1 domestic

l
. industries or generate revenue.
Quotas: Limiis on 1he quan1i1y of a produc1 1ha1 can be

-' . imponed, pro1ec1ing domestic industries.

Trade Agreem,nts: Nego1ia1ed deals between countries 10
reduce trade barriers and prom01e mu1ual economic benefi1s
(e.g.. NAFfA. EU trade agreements).
Purpose: To pro1ec1 domestic indusiries. reduce trade deficilS,
promote exports, and foster international economic relationships.
Example: Imposing lariffs on imponed s1eel 10 pro1ec1 1he
domestic s1eel industry.
Coc:,,rlf'lt C 2017 ~•son fcl.lation, Ud.

Economic Policies
cont ..
 Political and Legal Environment

Pollllcal StabUlty: Stable political environments are conducive 10 b usiness. whereas

instubility (due 10 war. corruption, or frequent c hanges in government policies) poses risks.

Legal Systems and Rtgulallons: Different countries h ave varying laws regarding trade.
labor. environmental regulations, intellectual property, and taxation. Compliance with these
laws is critical for avoiding legal penalties and protecting a blL~iness's interests.

Couvr,l(t1t O 1011 Pt;ir\On[(kH,UIOf'l,l !d

Socio-Cultural Environment

Cultural DilTtrences: Differences in language. religion. values, customs, and social nonns inOucnce
consumer behavior, marketing strategics. and management pr.u..-iiccs.
Socia) Structures: C lass systems. social mobility. demographic.< (like age distribution and populaiion
growth). and lifestyle trend., affect demand for products and services and inOuence bosines, operation.,.

Consumer Behavior: Understanding local consumer preferences. buying behavior, and altitudes towards
foreign product-. is crucial for success in di verse markets.

For cxumplc: Com,u111p1111n of nk:oholk d rinL~ i!-. acccpcahlc in Wc,1 hut nol !'l(M..:iully ucccpl.ihlc in India :md
even illcg:il in Sm1di l\rnhi:t, Lifetime or pe rmanent cmploymclll in J:ipan.

(OUVf,l(lll Cl 101 1 f>t,"61,0n(llu<,U,on 11(1

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.,... ~--
PINMI ~ ~ lJIM.._

~ .A~lL-,--~- :.~......
....._.,_. --
Culture
as an
Iceberg
-- --------
-
Cuttu«ttMak.up
w..... l.lnltwlw• Of
--
--
( ---
Technological Advancements: Innovations in
communication, transportation, and manufacturing
processes impact efficiency, costs, and
competitiveness. Rapid technological change requires
businesses to adapt continuously.
• Digitalization and E-Commerce: The growth of
Technological digital platfonns and online marketplaces enables
En,·inmment businesses to reach global customers but also requires
adaplation to different digital ecosystems and
regulatory frameworks.
• Intellectual Property Protection: Different countries
have varying levels of protection for intellectual
property, which affects R&D investtnents and the risk
of imitation.
 Starbucks

Copyr11!,h1 01011 Pt-.irloOn [due.won Lld

Starbucks-a company renowned for its international presence and strategic adaptations.

Background and Global Presence-

Starbucks, founded in 1971 In Seattle,
washlngton, has evolved into one of
the world's leading coffeehouse chains.
With over 30,000 stores in more than
80 countries, Starbucks has successfully Socio-Cultural Environment-
navigated a variety of global business •Menu Localization: local tastes and
environments. preferences. In Japan, it offers matcha lattes,
while in India, It provides beverages with local
spices.
•Store Design and Atmosphere: For instance, in
Italy, Starbucks has embraced a more
traditional cafe feel to resonate w ith local
coffee culture.
Copyr,ght CIZ011Pt-,i.on[dua1,on Lid I]

Economic Factors Regulatory and Legal Considerations

•Economic Fluctuations: Starbucks adjusts Its pricing and -tompllance with local Resulatlons: Starbucks navigates
product offerings based on economic conditions In different d iverse regulatory environments. Including health and safety
regions. For example, during economic downturns, It might standards, labor laws, and environmental regulations. Its ability
Introduce more affordable options to maintain customer to comply with local regulations Is crucial for smooth
lavalty. operat ions.
-CurNnCy Risks: With operations In numerous countries. •Intellectual Property: Protecting Its brand and Intellectual
Starbucks laces currency exchange risks. It uses hedging p roperty Is a priority for Starbucks, especially as It expands Into
strategies to manage these risks and stabilize its financial n ew m arkets where counterfeiting and trademark issues mfeht
performance. arise.

Social and Environmental Responsibility

•Sustalnabilty Initiatives: Starbucks is committed to
su stainability. with initiatives such as reducing waste. Improving
energy efficiency. and supporting ethical sourcing. Its global
environmental strategy helps build a positive brand image.
•Community Engapment: The company engages in various
social responsibility programs. Including supporting local
communities and promoting diversity and Inclusion within Its
workforce.
(0!¥ •1\hl Co JOI/ P1',lf\o0f\ ldu1.1hon. l id

1. Market Entry Strategies

•Joint Ventures and Ucensing: In many markets, Starbucks has entered through joint ventures or licensing agreements.
For example, In China, Starbucks partnered with local firms to navigate regulatory and market complexlties.
•Direct Investment: In mature markets like the UK and Canada, Starbucks typically opts for direct investment, owning and
operating its stores to maintain control over brand experience and quality.

2. Competitive Positioning
•Premium Branding: Starbucks positions itself as a premium brand globally, focusing on high-quality coffee, a
comfortable store environment, and a strong customer experience. This branding helps it differentiate itself from local
competitors.
•Global Supply Chain: Starbucks maintains a robu st global supply chain to ensure consistent quality. It sources coffee
beans from multiple countries and invests in ethical sourcing p ractices, such as its Coffee and Farmer Equity (C.A.F.E.)
Practices.
Trade Theories
• Trade theories provides the conceptual base
for
• international trade and
• shifts in trade patterns.
. l ..
.,

• They also facilitate in understanding the

basic reasons behind the evolution of a
country as a supply base or market for
specific products.

❖ Theory of Mercaotilism

► Mercantilism: A belief popular in the 16th century

that national prosperity results from maximizing
exports and minimizing imports.

► The theory attributes and measures the wealth of a nation

by the size of its qccumulaltd treasuw,

► It
aims at accumulating financial wealth in terms of gold by
encouraging exports and discouraging imports.

Theory of Mercantilism
• Mercantilism refers to the views of a h_eterogeneous grou~
inJ!.uential P:!,_op_le (merchants. bankers. government officials and
even philosophers) as to how a nation could regulate its domestic
and international affairs to promote its own interests.

• The principal assertion of mercantilism was that a nations wealth

and prosperity reflected in its !lack oferecious metals (gold and
!J!ver).

• At that time, as gold and silver were the currency of trade between
~ tions. a country could accumulate gold and silver 'f!y exporting
nd importins less

Theory of Mercantilism

• In other words, according to mercantilism economic

activity was a ~ero-sum game (i.e. one's gain is the
loss of another).

I•The mercantilists, therefore, argued that government

should ~o everything possible lo maximize exports
fnd minimi;,e imports. Imports were to be restricted by
such measures as tariffs and quotas and exports were to
be subsidized.
 Theory of Mercantilism

• Today, some argue for neomercantilism - the idea that

the nation should run a trade surplus.

• Supporters of neomercantilism include:

• Labor unions (who want to protect domestic jobs),
• Farmers (who want to keep crop prices high), and
• Some manufacturers (that rely on exports).

❖ Flaws / Criticism of Mercantilism

• Suppose that country A has a favorable trade balance. This will result
in an inflow of gold and silver resulting in an increase in the money
supply in country A.
• This will cause an increase in price and wages in that country and
will adversely affect exports and encourage imports, ultimately
wiping out the trade surplus.
• Mercantilism tends to harm firms that import, especially those that
import raw materials and parts used in the manufacture of finished
products
• Mercantilism also harms consumers because restricting imports
reduces the choice of products they can buy

❖ Flaws / Criticism of Mercantilism

• Another flaw of mercantilism is that it viewed trade as a

zero-sum game.

• This view was challenged by Adam Smith and Da~ d

Ricardo who demonstrated that trade was a positive sum
game in which all trading nations can gain even if some
benefit more than others.

' ',I I '

!,
❖ Theory of Absolute Advantage (Adam Smith)

► Absolute advantage may be defined as ability of a

nation to produce the goods more efficiently and
cost effectively than any other country.

► According to the theory, each country should

specialize in producing those goods that it can
produce more efficiently, instead of producing all
products.
 ❖ Theory of Absolute Advantage (Adam Smith)

According to his theory, trade between two countries would be mutually beneficial if
one country could produce one commodity at an absolute advantage (over the other
country) and the other country could, in turn, produce another commodity at an
absolute advantage over the first.

No. of llils of .tieal per lliof labcu 10 4

No. of llils of dolh P! Iii of labcu 3 7

• The basis of International trade is the absolute difference In the cost ofprodudlon of different
commodities betwttn nations.

❖ ffieory of Comparaiivi cos or comparative Aclvantag•

cDavid Rkardo J

• The comparative cost theory was first systematically formulated by the English
economist David Ricardo
• Comparative Advantage may be defined as the inability of a nation to produce a
good more efficiently than other nations, but its abilily to produce one good more
efficiently compared to the other good.
• Thus, the country may be at an absolute disadvantage with respect to both the
commodities, but the absolute disadvantage is lower in one commodity than
another.
• Therefore, a country should specialize in the production and export of a commodity
in which the absolute disadvantage is less than that of another commodity or in
other words, the country has got a comparative advantage in terms of more
production efficiency.

,,

❖ T1leary vl Cciii@itiff A........1

• Two-country-two-commodity model.
• Labour is perfectly mobile between various industries.
• Free and unrestricted trade among countries

Counlry No. ofuniu oflabour No. ofllllia ofialNNr Exchange ratio

per unit ofcloth per IMil o/wille bc-t..-een wine and cloth
Englanl 100 120 1 wine = 1.2 cloth
Portugal 90 80 1 wine = 0.88 cloth

• Portugal will gain if it can get anything more than 0.88 units of cloth in exchange
for one unit of wine, and England will gain if it has to part with less than 1.2 units
of cloth against one unit of wine

• Cridcipm o(Jbsoa a( C,-,,nlm As!!PP!W

• As the theory is based on the labogr {cop) tb,oa o[raiHtJt has inherited all the defects
of the labour theory of value. Labour is certainly not the only element of cost.
• In a money economy it is not proper to express the cost of production in real terms
(labour units). Differences in wages may alter the price ratios from the ratios of labour
units expended, particularly between countries. !lifijt. wag( liffmncu is the reason
for an important part of the global trade.
• The assumptions about the ijabjlity and lunnecmm oflabin,r are also incorrect. There
rarely is perfect mobility of labour from one branch of production to another.
• The assumptions of lvR ,mploJl!fa/ and pgfttt Ci9fflRClitioa,
"'"™\vhich are characteristics
of classical economic theories, are also wrong.
• Similarly, it is highly unrealistic to assume that international trade is free and does ,wt
involve cost of transpor1.
• By taking a (w'l:(011nl1y;:two-riij,ijij iiiidjl. Ricardo has over simplified the situation
 ► FACTOR ENDOWMENT ( HRCKSCll£R-Ollml
THEORY)
- \
0 The factor endowment theory was developed by Swedish
'R&u economist Eli Heckscher and his student Bertil Ohlin.

n The c lassical theory demonstrated that the basis of

r international trade was comparative cost difference.

However, 1t m ade little attempt to explain the ca uses o f suc h

$ comparative cost difference.

Assumptions of H-O Theorem

There ere two nations (Nation 1 end Ne11on 2), two commodities (commodity X end commodity Y), end two
rectors or production (labor end capital).
Both nations u se the same technology In production.
Commodity X Is labor Intensive. end commodity Y is capital intensive in both nations.

Both commodities are produced under constant returns to scale in both nations.
• There Is incomplete specialization in production in both nations.

• Tastes are equal In both nations.

I There is perfect competition in both commodities and factor markets In both nations.

• There is perfect factor mobility within each nation but no international factor mobility.
•\ ere are no transportation costs, tariffs, or other obstructions to the free flow ol international trade.

• All r~ rces are fully employed in both nations.

• lnternetiona"'911e between the two nations is balanced.

❖ Factor Endowment or Factor Proportion Theory

(Heckscher-Ohlin Theory)

Factor Endowment theory attribute international (and inter-regional)

differences in comparative costs to:

❖ Factor Endowments:
The theory starts with the assumption that countries differ in their factor
endowments, particularly in terms of labor and capital. Some counlries have
a~umiqnt {[ffec relative to capital, while others have abundant capitql
re auve 10 la or.

❖ Factor Intensity:
Different industries have varying factor intensities, meaning they use factors
of production (labor and ca(lital) m different (lroportions. Some industries ~re
/abor-in~n,tive. meaning ihey require a relauvely large amount of la or
compare to capital.

Factor Proportions/ Endowment Theory

• Also known as Factor Endowments Theory. It argues that each country

should produce and export products that intensively use relatively abundant
factors of production and import goods that intensively use relatively scarce
factors of production.
 ❖ FACTOR ENDOWMENT
( HECKSCHER-OHLIN THEORY)

(i) In Country A:
Supply of" labour - 25 units
Supply of" capital - 20 units
Capital-labour ratio - 0 .8
(ii) In Country B :
Supply of" labour - 12 units
Supply of" capital I 5 units
Capital-labour ratio - I .25

► In the above example, even though Country A has more capital in absolute terms,
Country B Is more richly endowed with capital because the ratio of capital to labour In
Country A (O.B) ls fess than in Country B (1.25).

FACTOR ENDOWMENT ( HECKSCHER•OHLIN THEORY)

□ A nation will export the goods whou production ,-quires lni.nslvt uu of the nation's relatlwly abundant and

chtop factors and Import the goods whos. production requires lni.nslvt uu of its score• and u~nslw

factors.

❖ The Leontief Paradox

• Wassily Leontief carried out an empirical test

of the Heckscher-Ohlin Model in 1951 and
found that the US exported more labor-
intensive commodities and imported more
capital-intensive products which was contrary
to the results of Heckscher-Ohlin Model of
factor endowment.

New Trade Theory

• Intra-Industry trade
• Trade in differentiated products (Similar but not identical)
• Until about the mid-nineteenth century, an overwhelming proportion of international
trade was constituted by inter-sectoral trade, where primary commodities were
exchanged for manufactured goods
• Intra-industry trade refers to the trade between countries in the products of the same
industry.
• Since the major trading nations have become similar in technology and resources,
there is often no clear comparative advantage within an industry and much of
international trade therefore takes the form of two-way exchanges within industries111
probably driven in large part by economies of scalelilrather than inter-industry
specialization driven by comparative advantage."
• As Krugman and Obstfeld observe, ~1ntra-industry trade tends to be prevalent between
countries that are similar In their capital-labour ratios, skill levels etc. Thus, intra-
industry trade will be dominant between countries at a similar level of economic
development. Gains from this trade will be large when economies of scale are strong
and products are highly differentiated.
 Features of IIT

• Intra-industry trade produces extra gains from international trade, over

and above those from comparative advantage,
• Intra-industry trade allows countries to benefit from larger markets l1l
• By engaging in intra-industry trade a country can simultaneously
reduce the number of products it produces and increase the variety of
goods available to consumers.
• By producing few varieties, a country can produce each at large scale,
with higher productivity and lower costs.
• At the same time consumers benefit from the increased range of
choice.

► The Importance of intra-industry trade became apparent when tariffs and other obstructions to the
flow of trade among members of t he European Union, or Common Market, were removed in 1958.

► German cars were exchanged for French and Italian cars, French washing machines were exchanged
for German washing machines, Italian typewriters for German and French typewriters, and so on.

► Intra-industry trade is based on product differentiation and economies of scete

► while trade based on comparative advantage ls Uketyto be larger when the difference ln fector
endowments among nations Is greater, intra-industry trade is likely to be larger among industrial
economies of s imilar size and factor proportions.

► With trade, however, all countries can take advantage of economies of scale to the same extent

► In contrast to the H-0 model, which predicts that trade will tower the return of the nation's scarce
factor, wit h intra-industry trade based on economies of scale it is possible for all fact ors to gain.

► Intra-industry trade is related to t he sharp increase in international trade in parts and components
of a product.

Conclusion
► Comparative advantage seems to determine the pattern of inter-industry trade, while
economies of scale in differentiated products give rise to intra-industry trade.

► The more dissimilar are factor endowments (as between developed and developing
countries), the more important are comparative advantage and inter-industry trade.

► On the other hand, intra-industry trade is likely to be dominantthe more similar are
factor endowments broadly defined (as among developed countries).

► As Lancaster (1980) pointed out, however, even in the case of intra-industry trade,
"comparative advantage is somewhere in the background." One could say that inter-
industry trade reflects natural comparative advantage while Intra-Industry trade
reflects acquired comparative advantage.

❖The theory is given by Raymond Vernon and Lewis T Wells in 1966.

❖The theory explains the variations and reasons for change in production and consumption
pattern among various markets over a time period.

❖ The Product Life Cycle (PLC) theory of trade is a concept that extends the traditional
Product Life Cycle theory to explain how international trade patterns evolve over time.

❖This models explain international trade based on ~~

❖ According to this model, when a new product is introduced, It usually requires highly skilled
labor to produce. As the product matures and acquires mass acceptance, It becomes
standardized; it can then be produced by mass production techniques and less skilled labor.
 ❖ Vernon also pointed out that high-income and labor-saving products are most likely
to be introduced in rich nations because (I) the opportunities for doing so are
greatest there, (2) the development of these new products requires proximity to
markets so as to benefit from consumer feedback in modifying the product, and
(3) there is a need to provide se.rvice.

❖ Product cycle model stresses the standardization process.

❖ The experience of U.S. and Japanese radio manufacturers since World War II.
Immediately after the war, U.S . firms dominated the international market for
radios, based on vacuum tubes developed in the United States. However, within a
few years, Japan was able to capture a large share of the market by copying U.S.
technology and utilizing cheaper labor. The United States recaptured technological
leadership with the development of transistors. But, once again, in a few short
years, Japan imitated the technology and was able to undersell the United States.
Subsequently, the United States reacquired its ability to compete successfully with
Japan by introducing printed circuits.

• Product Life Cycle theory

•Stage 1: Introduction • New-productphNe

•Stage 2: Growth- Proc1uct.,,_p_

•Stage 3: Maturity• Proc1uct-ma1ur11yp11ase

•Stage 4:
•Stage 5: } Product Decline phase

PllODOCTLIR a"CLKOFTRADE
~
0eYeloped Developing

I
w
USA Coun1ries Countries

0 lo
,,

I
► Until tM point of ti=, U, tM US Is the only productt and consumer of the product.
► At t1 USA starts producing more than the do=stk consumption requlre=nt and other developed countries start
Importing It from the US. At point t3 tMse developed notions become net exporters.
► As the production In other countries grows, exports of US foD and the US ew,ntuolly becomes a net Importer. The
developing countries start consumption only at o lottr stage than tM developed countries, and they ore net
Importers until 14. As dew/oping countries net nports gro~ the developed countries find tMlr exports fol/Ing

International Product Life Cycle

Theory

Each product and Its associated manufacturing technologies go

through three stages of evolu1ion: Introduction, maturity, and

standardization.

In the lnlrOdUCflon stage, the invento, country enjoys a n-cnopoty

both in manufacturing and exports. Exampe: The television set.

In the maturity stage, the product's manufacturing becomes retahety

standardzod, other countries stan producing and exporting the

product.

In the at_,.rdlut/on stage, manufactlJring ceases In the original

Innovator country, and it beoomes a net lmpone, of the product. Today

under globalization, lor many products. the cycle occurs quiddy.

 International Product Life Cycle Theory

~
- Slandarcllnd
rroc1uc:1
o. ...........
ac• ..•••

PRODUCT LIR a'CLE OF TRADE

• According to this model an innovative product is often first introduced in an advanced

country like the USA (because of certain favorable factors such as a large market, ease
of organizing production etc.).

• The product is then exported to other developed countries. As the markets in these
"other developed countries" enlarge, production facilities are established there.
• These subsidiaries, in add ition to catering to the domestic markets, export to the
developing countries and to the United States.

• Later, production/aci/ities ore established in the developing countries. They would

then start exports to the United States {TV receiving sets is one such example).