Page 1 of 3 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=134&to=134 9/25/2017 Page 2 of 3 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=134&to=134 9/25/2017 Page 3 of 3 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=134&to=134 9/25/2017 Page 1 of 11 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 2 of 11 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Chapter 6 Theories of International Trade and Investment https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 3 of 11 Learning Objectives In this chapter, you will learn about the following: 1. Why do nations trade? 2. How can nations enhance their competitive advantage? 3. Why and how do firms internationalize? 4. How can internationalizing firms gain and sustain competitive advantage? MyManagementLab® Improve Your Grade! Over 10 million students improved their results using the Pearson MyLabs. Visit mymanagementlab.com for simulations, tutorials, and end-of-chapter problems. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 4 of 11 Source: © Giles Robberts/Alamy https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 5 of 11 Apple’s Comparative and Competitive Advantages Apple products were once made in the United States. Today, however, almost all of the 70 million iPhones, 30 million iPads, and 60 million other products that Apple sells globally each year are manufactured outside the United States. How did that happen? Apple (annual revenues: $110 billion) has expanded internationally from its humble roots in the United States to more than 70 markets worldwide. In terms of total sales, North and South America account for about onethird, and Europe and Asia generate about one-quarter each. After the United States, Japan is Apple’s best country market, producing about 5 percent of total sales. Apple orchestrates its value chains via contractual relations with suppliers around the world—some 700,000 people engineer, build, and assemble its products under contract. One of Apple’s goals is to obtain comparative advantages from specific countries. Comparative advantage refers to superior features of a country that provide distinctive benefits, typically derived from either natural endowments or deliberate policies. Comparative advantage includes inherited resources, such as labor and land, and acquired resources, like entrepreneurial orientation and innovative capacity. An iPhone contains hundreds of parts, about 90 percent of which are manufactured in countries outside the United States. Apple sources semiconductors from Germany, memory chips from Korea, display panels from Taiwan, and rare metals from Africa. All these components are assembled in China, which offers comparative advantages for manufacturing. Much of China’s success is explained by its superior factor proportions. According to factor proportions theory, each country should specialize in making products that intensively use production factors (such as labor, land, capital) that it has in abundance and import goods that intensively use relatively scarce production factors. Because China has abundant low-cost labor, its firms specialize in producing labor-intensive products. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 6 of 11 Apple exemplifies superior innovation. Apple suppliers excel at developing new product designs, innovative production processes, and new ways of organizing. Innovation promotes productivity, the value of output produced by a unit of labor https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 7 of 11 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. or capital. The more productive a firm is, the more efficiently it uses its resources. Productivity is vital to the success of firms and nations alike. Over time, improving productivity is raising living standards in emerging markets such as China, India, Mexico, and Poland. Configuring its value chains on a global scale enables Apple to produce the best possible products and maximize its competitive advantages. Competitive advantage refers to assets and competencies that are difficult for competitors to imitate and thus help firms succeed. Apple management believes the economies of scale of overseas factories as well as the diligence, flexibility, and industrial skills of foreign workers have outpaced counterparts in the United States. Apple enjoys a monopolistic advantage by controlling cutting-edge knowledge in the development of smartphones, computers, and other products. The firm does most of its own R&D and product development in company-owned facilities in California. Another key to Apple’s success is its ability to engage in global free trade. Free trade produces the following outcomes: (i) consumers and firms can obtain the products they desire at lower cost; (ii) parts and other inputs obtained in this way reduce company expenses, which translates into higher profits; and (iii) consumers pay less for the products and services they need, which increases their living standards. Apple has struggled to ensure sustainable conditions at its Chinese contract factories. Apple’s biggest supplier is Foxconn, a leading electronics manufacturer. Workers in Foxconn’s China factories have complained about long hours, low wages, and living in overcrowded dormitories. Some have even committed suicide. In response, more than 250,000 protesters signed a petition demanding better labor conditions for Apple contract workers abroad. Foxconn raised wages and moved some production to India, in search of cheaper labor. Foxconn also installed robots in several factories, laying off thousands of workers. Apple is https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 8 of 11 struggling to strike the right balance between low-cost manufacturing and ensuring the safety and happiness of the thousands of workers who build the Iphones, Ipads, and other products that consumers love around the world. Sources: Apple Inc., Form 10-K (Annual Report) 2011, accessed at http://investor.apple.com; Colin Campbell, “Foxconn’s Robot Empire,” Maclean’s, November 21, 2011, p. 41; Charles Duhigg and Keith Bradsher, “How the U.S. Lost Out on iPhone Work,” New York Times, January 21, 2012, accessed at www.nytimes.com; Hoovers.com, profile of Apple, Inc.; Adam Lashinsky, Inside Apple: How America’s Most Admired—and Secretive—Company Really Works (New York: Business Plus, 2012); Adam Satariano, “Protesters to Target Apple Supplier Conditions,” Bloomberg, February 8, 2012, accessed at www.bloomberg.com; Paul Theroux, “How Apple Revolutionized Our World,” Newsweek, September 5, 2011, pp. 36–37; Jessica Vascellaro and Owen Fletcher, “Apple Navigates China Maze,” Wall Street Journal, January 14, 2012, pp. B1–B2. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 9 of 11 The opening story explains the trade, investment, and performance achievements of Apple, Inc. The technology giant benefits enormously from international business. The advantages provided by suppliers and nations in Asia, Europe, and elsewhere have propelled the firm to global success. China, Japan, Germany, South Korea, and numerous other countries have taken proactive steps to enhance their standing in the world economy. Emerging markets are reaping the rewards of various comparative and competitive advantages. In this chapter, we review theories and explanations of why nations and firms undertake international activities.1 We explain comparative and competitive advantages, and how such resources support nations and firms in global commerce. We address the underlying economic rationale for international business activity and explain why global trade and investment take place. We address such questions as: • What is the underlying economic rationale for international business activity? • Why does trade take place? • What are the gains from trade and investment? Comparative advantage Superior features of a country that provide unique benefits in global competition, typically derived from either natural endowments or deliberate national policies. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 10 of 11 Comparative advantage describes superior features of a country that provide unique benefits in global competition, typically derived from either natural endowments or https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 11 of 11 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=135&to=136 9/25/2017 Page 1 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 2 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. deliberate national policies. Also known as country-specific advantage, comparative advantage includes inherited resources, such as labor, climate, arable land, and petroleum reserves, such as those enjoyed by the Gulf nations. Other types of comparative advantages are acquired over time, such as entrepreneurial orientation, availability of venture capital, and innovative capacity. Competitive advantage describes organizational assets and competencies that are difficult for competitors to imitate and thus help firms enter and succeed in foreign markets. These competencies take various forms, such as specific knowledge, capabilities, innovativeness, superior strategies, or close relationships with suppliers. Competitive advantage is also known as firm-specific advantage. Competitive advantage Distinctive assets or competencies of a firm that are difficult for competitors to imitate and are typically derived from specific knowledge, capabilities, skills, or superior strategies. In recent years business executives and scholars have used competitive advantage to refer to the advantages possessed by nations and individual firms in international trade and investment. To be consistent with the recent literature, we adopt this convention as well. Exhibit 6.1 categorizes leading theories of international trade and investment into two broad groups. The first group includes nation-level theories. These are classical theories, widely accepted since the sixteenth century. They address two questions: (1) Why do nations trade? (2) How can nations enhance their competitive advantage? The second group includes firm-level theories. These are more contemporary theories of how firms can create and sustain superior organizational https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 3 of 8 performance. Firm-level explanations address two additional questions: (3) Why and how do firms internationalize? and (4) How can internationalizing firms gain and sustain competitive advantage? We organize the remainder of our discussion according to the four fundamental questions. EXHIBIT 6.1 Theories of International Trade and Investment https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 4 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Why Do Nations Trade? Why do nations trade with one another? The short answer is that trade enables countries to use their national resources more efficiently through specialization. Trade allows industries and workers to be more productive. These outcomes help keep the cost of many everyday products low, translating into higher living standards. Without international trade, most nations would be unable to feed, clothe, and house their citizens at current levels. Even resource-rich countries like the United States would suffer immensely without trade. Some types of food would become unavailable or very expensive. Coffee and sugar would be luxury items. Petroleum-based energy sources would dwindle. Vehicles would stop running, freight would go undelivered, and people would not be able to heat their homes in winter. In short, not only do nations, companies, and citizens benefit from international trade, modern life is virtually impossible without it. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 5 of 8 Classical Theories Six classical perspectives explain the underlying rationale for trade among nations: the mercantilist view, absolute advantage principle, comparative advantage principle, factor proportions theory, international product life cycle theory, and new trade theory. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 6 of 8 Mercantilism The earliest explanations of international business emerged with the rise of European nation-states in the 1500s, when gold and silver were the most important sources of wealth, and nations sought to amass as much of these treasures as possible. Nations received payment for exports in gold, so exports increased their gold stock, while imports reduced it because they paid for imports with their gold. Exports were seen as good and imports as bad. Because the nation’s power and strength increase as its wealth increases, mercantilism argues that national prosperity results from a positive balance of trade achieved by maximizing exports and minimizing or even impeding imports. Mercantilism The belief that national prosperity is the result of a positive balance of trade, achieved by maximizing exports and minimizing imports. Mercantilism explains why nations attempt to run a trade surplus—that is, to export more goods than they import. Today many people believe that running a trade surplus is beneficial. They subscribe to a view known as neomercantilism. Labor unions (which seek to protect home-country jobs), farmers (who want to keep crop prices high), and certain manufacturers (those that rely heavily on exports) all tend to support neo-mercantilism. However, 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. Product shortages that result from import restrictions may lead to higher prices—that is, inflation. When taken to an extreme, mercantilism may invite “beggar thy neighbor” policies, promoting the benefits of one country at the expense of others. By contrast, free trade is a generally superior approach. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 7 of 8 Free trade refers to the relative absence of restrictions to the flow of goods and services between nations. It typically produces the following outcomes: Free trade Relative absence of restrictions to the flow of goods and services between nations. • Consumers and firms can more readily buy the products they want. • Imported products tend to be cheaper than domestically produced products (because access to world-scale supplies forces prices down, mainly from increased competition, or because the goods are produced in lower-cost countries). • Lower-cost imports help reduce company expenses, thereby raising their profits (which may be passed on to workers in the form of higher wages). • Lower-cost imports help consumers save money, thereby increasing their living standards. • Unrestricted international trade generally increases the overall prosperity of poor countries. Absolute Advantage Principle In An Inquiry into the Nature and Causes of the Wealth of Nations, a landmark book published in 1776, Scottish political economist Adam Smith attacked the mercantilist view by suggesting that nations benefit most from free trade. Smith argued that https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 8 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=137&to=138 9/25/2017 Page 1 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 2 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. mercantilism deprives individuals of the ability to trade freely and to benefit from voluntary exchange. By trying to minimize imports, a country wastes much of its national resources in the production of goods it is not suited to produce efficiently. The inefficiencies of mercantilism end up reducing the wealth of the nation as a whole while enriching a limited number of individuals and interest groups. Relative to others, each country is more efficient in the production of some products and less efficient in the production of other products. Smith’s absolute advantage principle states that a country benefits by producing primarily those products in which it has an absolute advantage, meaning goods it can produce using fewer resources than another country. Each country thus increases its welfare by specializing in the production of certain products, exporting them, and importing others. This approach allows the nation to consume more than it otherwise could, generally at lower cost. Absolute advantage principle A country benefits by producing only those products in which it has absolute advantage or that it can produce using fewer resources than another country. Exhibit 6.2 illustrates how the absolute advantage principle works in practice. Consider two nations, France and Germany, engaged in a trading relationship. Panel (a) of the exhibit shows a hypothetical example in which France has an absolute advantage in the production of cloth, and Germany has an absolute advantage in the production of wheat. Assume labor is the only factor of production used in making both goods. (Firms employ factors of production—for example, labor, capital, entrepreneurship, and technology—to produce products and services.) It takes an average worker in France 6 days to produce one ton of cloth and 8 days to produce one ton of wheat. It takes https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 3 of 8 an average worker in Germany 10 days to produce one ton of cloth and 4 days to produce one ton of wheat. Scottish political economist Adam Smith was among the first to articulate the advantages of international trade. Source: © Georgios Kollidas/Fotolia https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 4 of 8 France has an absolute advantage in the production of cloth, since it takes only 6 days of labor to produce one ton compared to 10 days for Germany. Germany has an absolute advantage in the production of wheat, since it takes only 4 days to produce one ton compared to 8 days for France. If both France and Germany were to specialize, exchanging cloth and wheat at a ratio of oneto-one, France could employ more of its resources to produce cloth and Germany could employ more of its resources to produce wheat. France would be able to import one ton of wheat in exchange for one ton of cloth, thereby “paying” only 6 labor days for one ton of wheat. If France had produced the wheat itself, it would have used 8 labor days, so it gains 2 labor days from the trade. In a similar way, Germany gains from trade with France. EXHIBIT 6.2 Example of Absolute Advantage (Labor Cost in Days of Production for One Ton) The point is further illustrated by the graph in panel (b) of Exhibit 6.2 . Here, the different combinations of cloth and wheat that France can produce https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 5 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. are represented by the blue line, France’s production possibilities frontier. The different combinations of cloth and wheat that Germany can produce are indicated by the red line, Germany’s production possibilities frontier. As shown, France is more efficient at producing cloth, and Germany is more efficient at producing wheat. Suppose the countries do not trade with each other and each devotes half its labor days to producing each of cloth and wheat. France (point A in the graph) spends 3 labor days to produce ½ ton of cloth and 4 labor days to produce ½ ton of wheat. Germany (point B in the graph) spends 5 labor days to produce ½ ton of cloth and 2 labor days to produce ½ ton of wheat. Without trade, it costs the two countries a combined total of 14 labor days to produce one ton of cloth and one ton of wheat. By contrast, if each country were to specialize and trade with the other, France would invest 6 days to produce one ton of cloth and Germany would invest 4 days to produce one ton of wheat, for a total of just 10 labor days. Thus, by specializing and trading, each country has saved an average of 2 labor days ((14–10)/2). Trading means France and Germany obtain the goods they need for less labor. In this way, each country employs its labor and other resources more efficiently, thereby increasing its standard of living. To employ a more contemporary example, Japan has no natural holdings of oil, but it manufactures some of the world’s best automobiles. Saudi Arabia produces much oil, but lacks a substantial car industry. Given this state of resources, it is wasteful for each country to attempt to produce both oil and cars. By trading with each other, Japan and Saudi Arabia employ their respective resources more efficiently in a mutually beneficial relationship. Japan gets oil that it refines to power cars, and Saudi Arabia gets the cars its citizens need. By extending this example we see that freely trading countries achieve substantial gains from trade. Brazil can produce coffee more cheaply than Germany; Australia can produce wool more cheaply than Switzerland; Britain can provide financial services more cheaply than Zimbabwe; and so forth. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 6 of 8 Ethical Connections A market failure is an interruption in free trade, resulting in inefficient allocation of goods and services. In many developing economies, corruption is a common source of market failure. For example, goods and services are often unfairly granted to those who pay bribes. Since free trade reduces poverty by promoting efficient allocation of goods and services, governments should act to restrict bribery and other forms of corruption. Historically, the concept of absolute advantage provided perhaps the earliest sound rationale for international trade. However, it failed to consider more subtle advantages that trading nations enjoy. Later analysis revealed that a country benefits from international trade even when it lacks an absolute advantage. Such thinking led to the principle of comparative advantage. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 7 of 8 Comparative Advantage Principle In his 1817 book The Principles of Political Economy and Taxation, British political economist David Ricardo explained why it is beneficial for two countries to trade even though one of them may have absolute advantage in the production of all products. Ricardo demonstrated that what matters is not the absolute cost of production, but rather the relative efficiency with which the two countries can produce the products. Hence, the comparative advantage principle states that it can be beneficial for two countries to trade without barriers as long as one is relatively more efficient at producing goods or services needed by the other. The principle of comparative advantage is the foundation and overriding justification for international trade today. Comparative advantage principle It can be beneficial for two countries to trade without barriers as long as one is relatively more efficient at producing goods or services needed by the other. What matters is not the absolute cost of production but rather the relative efficiency with which a country can produce the product. To illustrate, let’s modify the example of France and Germany. As shown in panel (a) of Exhibit 6.3 , suppose now that Germany has an absolute advantage in the production of both cloth and wheat. That is, in labor-per-day terms, Germany can produce both cloth and wheat in fewer days than France. Based on this new scenario, you might initially conclude that Germany should produce all the wheat and cloth it needs and not trade with France at all. However, it is still beneficial for Germany to trade with France. How can this be true? The answer is that rather than the absolute cost of production, it is the ratio of production costs between the two countries that matters. In panel (a) of Exhibit 6.3 , Germany is comparatively more efficient at producing cloth than wheat: It can produce four https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 8 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=139&to=140 9/25/2017 Page 1 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 2 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. are represented by the blue line, France’s production possibilities frontier. The different combinations of cloth and wheat that Germany can produce are indicated by the red line, Germany’s production possibilities frontier. As shown, France is more efficient at producing cloth, and Germany is more efficient at producing wheat. Suppose the countries do not trade with each other and each devotes half its labor days to producing each of cloth and wheat. France (point A in the graph) spends 3 labor days to produce ½ ton of cloth and 4 labor days to produce ½ ton of wheat. Germany (point B in the graph) spends 5 labor days to produce ½ ton of cloth and 2 labor days to produce ½ ton of wheat. Without trade, it costs the two countries a combined total of 14 labor days to produce one ton of cloth and one ton of wheat. By contrast, if each country were to specialize and trade with the other, France would invest 6 days to produce one ton of cloth and Germany would invest 4 days to produce one ton of wheat, for a total of just 10 labor days. Thus, by specializing and trading, each country has saved an average of 2 labor days ((14–10)/2). Trading means France and Germany obtain the goods they need for less labor. In this way, each country employs its labor and other resources more efficiently, thereby increasing its standard of living. To employ a more contemporary example, Japan has no natural holdings of oil, but it manufactures some of the world’s best automobiles. Saudi Arabia produces much oil, but lacks a substantial car industry. Given this state of resources, it is wasteful for each country to attempt to produce both oil and cars. By trading with each other, Japan and Saudi Arabia employ their respective resources more efficiently in a mutually beneficial relationship. Japan gets oil that it refines to power cars, and Saudi Arabia gets the cars its citizens need. By extending this example we see that freely trading countries achieve substantial gains from trade. Brazil can produce coffee more cheaply than Germany; Australia can produce wool more cheaply than Switzerland; Britain can provide financial services more cheaply than Zimbabwe; and so forth. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 3 of 8 Ethical Connections A market failure is an interruption in free trade, resulting in inefficient allocation of goods and services. In many developing economies, corruption is a common source of market failure. For example, goods and services are often unfairly granted to those who pay bribes. Since free trade reduces poverty by promoting efficient allocation of goods and services, governments should act to restrict bribery and other forms of corruption. Historically, the concept of absolute advantage provided perhaps the earliest sound rationale for international trade. However, it failed to consider more subtle advantages that trading nations enjoy. Later analysis revealed that a country benefits from international trade even when it lacks an absolute advantage. Such thinking led to the principle of comparative advantage. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 4 of 8 Comparative Advantage Principle In his 1817 book The Principles of Political Economy and Taxation, British political economist David Ricardo explained why it is beneficial for two countries to trade even though one of them may have absolute advantage in the production of all products. Ricardo demonstrated that what matters is not the absolute cost of production, but rather the relative efficiency with which the two countries can produce the products. Hence, the comparative advantage principle states that it can be beneficial for two countries to trade without barriers as long as one is relatively more efficient at producing goods or services needed by the other. The principle of comparative advantage is the foundation and overriding justification for international trade today. Comparative advantage principle It can be beneficial for two countries to trade without barriers as long as one is relatively more efficient at producing goods or services needed by the other. What matters is not the absolute cost of production but rather the relative efficiency with which a country can produce the product. To illustrate, let’s modify the example of France and Germany. As shown in panel (a) of Exhibit 6.3 , suppose now that Germany has an absolute advantage in the production of both cloth and wheat. That is, in labor-per-day terms, Germany can produce both cloth and wheat in fewer days than France. Based on this new scenario, you might initially conclude that Germany should produce all the wheat and cloth it needs and not trade with France at all. However, it is still beneficial for Germany to trade with France. How can this be true? The answer is that rather than the absolute cost of production, it is the ratio of production costs between the two countries that matters. In panel (a) of Exhibit 6.3 , Germany is comparatively more efficient at producing cloth than wheat: It can produce four https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 5 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. times as much cloth as France (8/2), but only 1.5 times as much wheat (6/4). Thus, Germany should devote all its resources to producing cloth and import all the wheat it needs from France. France should specialize in producing wheat and import all its cloth from Germany. Both countries then can each produce and consume relatively more of the goods they desire for a given level of labor cost. EXHIBIT 6.3 Example of Comparative Advantage (Labor Cost in Days of Production for One Ton) This is further illustrated in panel (b) of Exhibit 6.3 . In Germany, it takes only 2 labor days to produce one ton of cloth and 4 labor days to produce one ton of wheat. Given 4 labor days, Germany can produce 2 tons of cloth or 1 ton of wheat, or any combination in between on its production possibilities frontier (the red line). In France, using 8 labor days will produce 1 ton of cloth or 1.33 tons of wheat (8/6), or any combination in between on its production possibilities frontier (the blue line). Again, suppose the countries do not trade https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 6 of 8 with each other, and each devotes half its labor days to producing each of cloth and wheat. In this case, it takes France (point A in the graph) a total of 7 labor days to produce ½ ton of cloth and ½ ton of wheat. However, it takes Germany (point B in the graph) just 3 labor days to produce the same quantity of these commodities. Without trade, it would take the two countries a total of 10 labor days to produce 1 ton of cloth and 1 ton of wheat. By contrast, if the two countries began trading, and if Germany specialized in producing cloth and France specialized in wheat, it would take only 8 days to produce the same volume of these commodities. Thus, even when Germany holds an absolute advantage in producing both cloth and wheat, the two countries can reduce their combined resource costs by specializing and trading. It would be wasteful for Saudi Arabia to produce both oil and cars. Instead, it can focus on extracting and refining petroleum while procuring cars from Japan, which has no natural holdings of oil but manufactures some of the best automobiles in the world. Source: leungchopan/Shutterstock Another way to understand comparative advantage is to consider opportunity cost, the value of a foregone alternative activity. In panel (a) of Exhibit 6.3 , if Germany produces 1 ton of wheat, it forgoes 2 tons of cloth. However, if https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 7 of 8 France produces 1 ton of wheat, it forgoes only 0.75 tons of cloth. Thus, France should specialize in wheat. Similarly, if France produces 1 ton of cloth, it forgoes 1.33 tons of wheat. But if Germany produces 1 ton of cloth, it forgoes only 0.5 ton of wheat. Thus, Germany should specialize in cloth. The opportunity cost of producing wheat is lower in France, and the opportunity cost of producing cloth is lower in Germany. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 8 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=140&to=141 9/25/2017 Page 1 of 8 • Traded products are not just commodities anymore, such as wheat and cloth. Today, many traded goods are characterized by strong branding and differentiated features. • International transportation, critical for cross-border trade to take place, adds to the cost of importing. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 2 of 8 • PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Government restrictions such as tariffs (taxes on imports), import barriers, and regulations can hamper international trade. • Large-scale production in certain industries may bring about scale economies, and therefore lower prices, that help offset weak national comparative advantage. • Just as Japan did after World War II, governments may target and invest in certain industries, build infrastructure, or provide subsidies, all to boost the competitive advantages of home-country firms. • Many services, such as banking and retailing, cannot be traded in the usual sense and must be internationalized via foreign direct investment. Thus, classical theories have limited applicability to international commerce in services. • Modern telecommunications and the Internet facilitate global trade in many services at very low cost. • The primary participants in international trade are individual firms that differ in significant ways. Far from being homogenous enterprises, many are highly entrepreneurial and innovative or have access to exceptional human talent, all of which support international business success. In other cases, some firms may need to trade internationally if their home markets are too small to support their growth or sales objectives. In the following sections, we discuss additional theories that scholars introduced in view of the limitations of early trade theories. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 3 of 8 Factor Proportions Theory A significant contribution to explaining international trade came in the 1920s, when two Swedish economists, Eli Heckscher and his student, Bertil Ohlin, proposed the factor proportions theory, sometimes called the factor endowments theory.3 This view rests on two premises: (1) products differ in the types and quantities of factors (labor, natural resources, and capital) required for their production; and (2) countries differ in the type and quantity of production factors they possess. Each country should export products that intensively use relatively abundant factors of production and import goods that intensively use relatively scarce factors of production. For example, the United States produces and exports capital-intensive products, such as pharmaceuticals and commercial aircraft, while Argentina produces landintensive products, such as wine and sunflower seeds. Factor proportions theory differs somewhat from earlier theories by emphasizing the importance of each nation’s factors of production. The theory states that, in addition to differences in the efficiency of production, differences in the quantity of factors of production held by countries also determine international trade patterns. This leads to a per-unit-cost advantage due to the abundance of a given factor of production, say labor, over another, say land, which is not in as much supply. Originally, labor was the most important factor of production. This explains why, for example, countries like China and India have become popular manufacturing bases; they have huge bases of workers. In the 1950s, Russian-born economist Wassily Leontief pointed to empirical findings that seemed to contradict the factor proportions theory. The theory suggests that because the United States has abundant capital, it should be an exporter of capital-intensive products. However, Leontief’s analysis, termed the Leontief paradox, revealed that the United States often exported laborintensive goods and imported more capital-intensive goods than the theory would ordinarily predict. What accounts for the inconsistency? One explanation is that numerous factors determine the composition of a country’s exports and imports. Another is that, in Leontief’s time, U.S. labor was relatively more productive than labor elsewhere in the world. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 4 of 8 Perhaps the main contribution of the Leontief paradox is its suggestion that international trade is complex and cannot be fully explained by a single theory. Subsequent refinements of factor proportions theory suggested that other country-level assets—knowledge, technology, and capital—are instrumental in explaining each nation’s international trade prowess. Taiwan, for example, is very strong in information technology and is home to a sizable population of knowledge workers in the IT sector. These factors helped make Taiwan a leader in the global computer industry. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 5 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. International Product Life Cycle Theory In a 1966 article, Harvard Professor Raymond Vernon sought to explain international trade based on the evolutionary process that occurs in the development and diffusion of products to markets around the world.4 In his International Product Life Cycle (IPLC) Theory, Vernon observed that each product and its manufacturing technologies go through three stages of evolution: introduction, maturity, and standardization. This is illustrated in Exhibit 6.4 . Factor proportions theory describes how abundant production factors give rise to national advantages. Russia, for example, has a very large workforce in numerous industries. Source: Dmitry Kalinovsky/Shutterstock https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 6 of 8 In the introduction stage, a new product typically originates in an advanced economy, such as the United States. Such countries possess abundant capital and R&D capabilities, providing key advantages in the invention of new goods. Advanced economies also have abundant, high-income consumers who are willing to try new products, which are often expensive. During the introduction stage, the new product is produced in the inventing country, which enjoys a temporary monopoly. As the product enters the maturity phase, the product’s inventors massproduce it and seek to export it to other advanced economies. Gradually, however, the product’s manufacturing becomes more routine and foreign firms begin producing alternative versions, ending the inventor’s monopoly power. At this stage, as competition intensifies and export orders begin to come from lower-income countries, the inventor may earn only a narrow profit margin. EXHIBIT 6.4 Illustration of Vernon’s International Product Life Cycle Source: Adapted from Raymond Vernon, “International Investment and International Trade in the Product Cycle,” Quarterly Journal of Economics 80 (May 1966): 190–207 and http://www.provenmodels.com/583/internationalproduct-life-cycle/raymond-vernon. In the standardization phase, knowledge about how to produce the product is widespread and manufacturing has become straightforward. Early in the product’s evolution, production required specialized workers skilled in R&D https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 7 of 8 and manufacturing. Once standardized, however, mass production is the dominant activity and can be accomplished using cheaper inputs https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 8 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=143&to=144 9/25/2017 Page 1 of 7 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 2 of 7 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. and low-cost labor. Production shifts to low-income countries where competitors enjoy low-cost advantages and can economically serve export markets worldwide. The country that invented the product eventually becomes a net importer. It and other advanced economies become saturated with imports of the good from developing economies. In effect, exporting the product has caused its underlying technology to become widely known and standardized around the world. As an example, consider the evolution of television sets. The base technology was invented in the United States, and U.S. firms began domestic production of TV sets in the 1940s. U.S. sales grew rapidly for many years. However, once TVs became a standardized product, production shifted to China, Mexico, and other countries that offered lower-cost production. Today the United States imports nearly all its TVs from such countries. The IPLC illustrates that national advantages do not last forever. Firms worldwide are continuously creating new products, and others are constantly imitating them. The product cycle is continually beginning and ending. Vernon assumed the product diffusion process occurs slowly enough to generate temporary differences between countries in their access and use of new technologies. This assumption is no longer valid today—the IPLC has become much shorter as new products diffuse much more quickly around the world. Buyers in emerging markets are particularly eager to adopt new technologies as soon as they become available. This trend explains the rapid spread of new consumer electronics such as digital assistants and mobile phones around the world. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 3 of 7 New Trade Theory Beginning in the 1970s, economists observed that trade was growing fastest among industrialized countries with similar factors of production. In some new industries, there appeared to be no clear comparative advantage. The solution to this puzzle became known as new trade theory. It argues that increasing returns to scale, especially economies of scale, are important for superior international performance in industries that succeed best as their production volume increases. For example, the commercial aircraft industry has high fixed costs that necessitate high-volume sales to achieve profitability. As a nation specializes in the production of such goods, productivity increases and unit costs fall, providing significant benefits to the local economy. Many national markets are small, and the domestic producer may not achieve economies of scale because it cannot sell products in large volume. New trade theory implies that firms can solve this problem by exporting, thereby gaining access to the much larger global marketplace. Several industries achieve minimally profitable economies of scale by selling their output in multiple markets worldwide. The effect of increasing returns to scale allows the nation to specialize in a smaller number of industries in which it may not necessarily hold factor or comparative advantages. According to new trade theory, trade is thus beneficial even for countries that produce only a limited variety of products. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 4 of 7 How Can Nations Enhance Their Competitive Advantage? The globalization of markets has fostered a new type of competition—a race among nations to reposition themselves as attractive for business and investment. The most advantaged nations today possess national competitive advantage, maximized when numerous industries collectively possess firmlevel competitive advantages and the nation itself has comparative advantages that benefit those particular industries. This notion is illustrated in Exhibit 6.5 . Many governments create policies designed to encourage competitive advantage, often by developing world-class economic sectors and prosperous geographic regions. These policies aim to assist firms to develop acquired advantages. Contemporary Theories Three key modern perspectives that help explain the development of national competitive advantage are the competitive advantage of nations, the determinants of national competitive advantage, and national industrial policy. The Competitive Advantage of Nations Just as scholars recognized that international business is good for individual nations, they increasingly sought to explain how nations can https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 5 of 7 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. position themselves for international business success. An important contribution came from Professor Michael Porter in his 1990 book, The Competitive Advantage of Nations. 5 According to Porter, the competitive advantage of a nation depends on the collective competitive advantages of the nation’s firms. Over time, this relationship is reciprocal: The competitive advantages held by the nation tend to drive the development of new firms and industries with these same competitive advantages. EXHIBIT 6.5 Comparative Advantage and Competitive Advantage For example, Britain achieved a substantial national competitive advantage in the prescription drug industry due to its first-rate pharmaceutical firms, including GlaxoSmithKline and AstraZeneca. The United States has a national https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 6 of 7 competitive advantage in service industries because of many leading firms, such as Goldman Sachs (investment banking), Marsh & McLennan (insurance), and Booz & Company (consulting). The presence of these and numerous other strong services firms, in turn, has engendered overall national competencies in the global services sector. At both the firm and national levels, competitive advantage and technological advances grow out of innovation.6 Companies innovate in various ways: They develop new product designs, new production processes, new approaches to marketing, new ways of organizing or training, and so forth. Firms sustain innovation (and by extension, competitive advantage) by continually finding better products, services, and ways of doing things.7 For example, Australia’s Vix (www.vix-erg.com) is a world leader in fare collection equipment and software systems for the transit industry. The firm has installed systems in subways, bus networks, and other mass transit systems in major cities like Melbourne, Rome, San Francisco, Stockholm, and Singapore. It has won numerous awards for its innovative products, which have allowed the firm to internationalize quickly. Vix’s investment in R&D has been significant, running as high as 23 percent of the firm’s revenue. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 7 of 7 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=145&to=146 9/25/2017 Page 1 of 7 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 2 of 7 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Innovation results primarily from research and development. Worldwide, more scientists and engineers are engaged in R&D than ever before. Among the industries most dependent on technological innovation are biotechnology, information technology, new materials, pharmaceuticals, robotics, medical equipment, fiber optics, and various electronics-based industries. The management consultancy Booz & Company (www.booz.com) annually reports on MNEs that spend the most on R&D, the Global Innovation 1000. Most top European, Japanese, and U.S. firms spend half or more of their total R&D in countries other than where they are headquartered. The firms do this for several reasons: • Gain access to talent—gifted engineers and scientists reside around the world in countries like China and India. • Cut costs by hiring lower-paid engineers and scientists abroad to replace higher-paid personnel in the home country. • Get closer to key markets, where they gain insights on specific characteristics of target markets during the product development process.8 This explains why, in addition to low-cost emerging markets, Europe and the United States are popular sites for R&D by foreign companies, as firms seek to understand and create new products for the world’s most lucrative markets. The more innovative firms in a nation, the stronger the nation’s competitive advantage. Innovation also promotes productivity, the value of the output produced by a unit of labor or capital. The more productive a firm is, the more efficiently it uses its resources. The more productive the firms in a nation are, the more efficiently the nation uses its resources.9 At the national level, productivity is a key determinant of the nation’s long-run standard of living and a basic source of national per-capita income growth. Exhibit 6.6 depicts productivity levels in various nations over time, measured as output per hour of workers in manufacturing. In the early 1990s, South Korea was the least productive of the nations shown. Over time, however, South Korea increased https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 3 of 7 its productivity and now outshines the other nations. Since productivity is measured as output per unit of labor or capital, a nation can increase its productivity either by increasing its relative output or by reducing its input for a given level of output. EXHIBIT 6.6 Productivity Levels in Selected Countries: Output per Hour in Manufacturing, 1990–2010, Index Scale, 2002 = 100 Source: Based on U.S. Department of Labor, Bureau of Labor Statistics, 2011, www.bls.gov. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 4 of 7 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Determinants of National Competitive Advantage As part of his explanation in The Competitive Advantage of Nations, Michael Porter argued that competitive advantage at both the company and national levels originates from the presence and quality in the country of four major elements, which we review next. 1. Demand conditions refer to the nature of home-market demand for specific products and services. The strength and sophistication of buyer demand facilitates the development of competitive advantages in particular industries. The presence of highly demanding customers pressures firms to innovate faster and produce better products. For example, an affluent, aging population in the United States inspired the development of world-class healthcare companies such as Pfizer and Eli Lilly in pharmaceuticals and Boston Scientific and Medtronic in medical equipment. 2. Factor conditions describe the nation’s position in factors of production, such as labor, natural resources, capital, technology, entrepreneurship, and know-how. Consistent with factor proportions theory, each nation has a relative abundance of certain factor endowments, a situation that helps determine the nature of its national competitive advantage. For example, Germany’s abundance of workers with strong engineering skills has propelled the country to commanding heights in the global engineering and design industries. 3. Related and supporting industries refer to the presence of clusters of suppliers, competitors, and complementary firms that excel in particular industries. The resulting business environment is highly supportive for the founding of particular types of firms. Operating within a mass of related and supporting industries provides advantages through information and knowledge synergies, economies of scale and scope, and access to appropriate or superior inputs. 4. Firm strategy, structure, and rivalry refer to the nature of domestic rivalry and conditions in a nation that determine how firms are created, https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 5 of 7 organized, and managed. The presence of strong competitors in a nation helps create and maintain national competitive advantage. Japan has one of the world’s most competitive consumer electronics industries, with major players like Nintendo, NEC, Sharp, and Sony producing semiconductors, computers, video games, and liquid crystal displays. Vigorous competitive rivalry puts these firms under continual pressure to innovate and improve. They compete not only for market share, but also for human talent, technical leadership, and superior product quality. Intense rivalry has pushed firms like Sony to a leading position in the industry worldwide and allowed Japan to emerge as the top country in consumer electronics.10 Country Realities All else being equal, a nation’s productivity rises with an increase in worker output, or through a decrease in the number of workers producing a given level of output. One way to improve productivity is to leverage technology. For example, productivity rises by employing information technology (IT) to improve worker efficiency. This helps explain why many countries are investing huge sums in IT education and to improve national infrastructure in computer systems and applications. Industrial cluster refers to a concentration of businesses, suppliers, and supporting firms in the same industry at a particular geographic location, characterized by a critical mass of human talent, capital, or other factor endowments. Examples of industrial clusters include the fashion industry in northern Italy; the pharmaceutical industry in Switzerland; the footwear industry in Vietnam; the medical technology industry in Singapore; Wireless Valley in Stockholm, Sweden; and the consumer electronics industry in Japan. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 6 of 7 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 talent, capital, or other factor endowments. Today, the most important sources of national advantage are the knowledge and skills possessed by individual firms, industries, and countries. More than any other factors, knowledge and skills determine where MNEs will locate economic activity around the world. Silicon Valley, California, and Bangalore, India, have emerged as leading-edge business clusters because of the availability of specialized talent. These regions have little else going for them in terms of natural industrial power. Their success derives from the knowledge of the people employed there, so-called knowledge workers. Some even argue that knowledge is now the only source of sustainable long-run competitive advantage. If correct, then future national wealth will go to those countries that invest the most in R&D, education, and infrastructure that support knowledgeintensive industries. National Industrial Policy Perhaps the greatest contribution of Porter’s work has been to underscore the notion that national competitive advantage does not derive entirely from the store of natural resources each country holds. Inherited national factor endowments are relatively less important than in the past. Rather, as Porter emphasized, countries can successfully create new https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 7 of 7 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=147&to=148 9/25/2017 Page 1 of 9 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 2 of 9 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. advantages and develop factor conditions they deem important for their success. The government can devote resources to improve national infrastructure, education systems, and capital formation. In short, any country, regardless of its initial circumstances, can attain economic prosperity by systematically cultivating new and superior factor endowments. Visionary national industrial policy is transforming Dubai into a high valueadding economy based on IT, biotechnology, financial services, and other knowledge-intensive industries. Source: Gavin Thomas/Dorling Kindersley Ltd. Nations can develop these endowments through proactive national industrial policy . Such a policy encourages economic development, often in collaboration with the private sector, to develop or support high value-adding industries that generate superior corporate profits, higher worker wages, and tax revenues. Dubai pursued a national industrial policy to become an international commercial center in the information and communications https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 3 of 9 technology (ICT) sector. Historically, nations have favored more traditional industries, including automobiles, shipbuilding, and heavy machinery—all with long value chains that generate substantial added value. As the Dubai example illustrates, successful nations increasingly favor high value-adding, knowledge-intensive industries such as IT, biotechnology, medical technology, and financial services. Not only do these industries provide substantial revenues to the nation, they also lead to the development of supplier and support companies that further enhance national prosperity. Singapore’s Innovation Manifesto has propelled the city-state to becoming one of the most technologically sophisticated countries in the world. National industrial policy A proactive economic development plan initiated by the government, often in collaboration with the private sector, that aims to develop or support particular industries within the nation. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 4 of 9 National industrial policies designed to build new capabilities and encourage the emergence of new industries typically include these specifics: • Tax incentives to encourage citizens to save and invest, which provides capital for public and private investment in R&D, plant, equipment, and worker skills • Monetary and fiscal policies, such as low-interest loans, that provide a stable supply of capital for company investment needs • Rigorous educational systems at the precollege and university levels that ensure a steady stream of competent workers who support high technology or high value-adding industries in the sciences, engineering, and business administration • Development and maintenance of strong national infrastructure in areas such as IT, communication systems, and transportation • Creation of strong legal and regulatory systems to ensure that citizens are confident about the soundness and stability of the national economy11 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 5 of 9 National Industrial Policy in Practice How well does national industrial policy work in practice? Let’s examine New Zealand and the outcomes of its repositioning, implemented through collaboration between the nation’s public and private sectors. For much of the early twentieth century, government policies had limited New Zealand’s ability to flourish and trade with the rest of the world. Living standards were low and many wondered whether New Zealand had a future. Then, in the 1980s, the New Zealand government undertook pro-trade policies in cooperation with the private sector that resulted in national advantages, helping New Zealand’s economy grow rapidly and achieve high living standards. The accomplishments are summarized in Exhibit 6.7 . Between 1992 and 2012, New Zealand raised its per-capita GDP from 51 percent to 89 percent of the average of the G7 countries, the world’s seven largest advanced economies. This represents an improvement of about 75 percent in real terms of personal income. During the https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 6 of 9 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. period, New Zealand’s unemployment rate declined by almost half, to 5.6 percent. The government reduced its national debt as a proportion of GDP from 89 to 30 percent, giving the nation a solid financial foundation. New Zealand’s per-capita GDP dipped during the global recession but stabilized in 2012 to more than $40,000, among the highest in the world. EXHIBIT 6.7 Transformation of New Zealand’s Economy, 1992 to 2012 Following many years of poor economic performance, the government of New Zealand implemented various national industrial policies that succeeded in elevating several key economic indicators, thus raising living standards for the New Zealand people. Source: adam.golabek Beginning in the 1980s, New Zealand’s government systematically transformed the country from an agrarian, protectionist, regulated economy to an industrialized, free-market economy that competes globally. New Zealand’s success resulted from a combination of factors: https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 7 of 9 • Government-controlled wages, prices, and interest rates were freed and allowed to fluctuate according to market forces. • The banking sector was liberalized, foreign exchange controls were eliminated, and the New Zealand dollar was allowed to float according to market forces. • Most trade barriers were removed and New Zealand joined several freetrade agreements. • Subsidies formerly granted to agriculture and other sectors were eliminated. • The government worked earnestly with labor unions to reduce wage inflation, helping to ensure that jobs remained in New Zealand and not outsourced to lower-wage countries. • The government initiated programs to encourage development of a knowledge economy. New Zealanders continuously upgraded skills and knowledge, providing a supply of scientists, engineers, and trained managers.12 • Personal and corporate income tax rates were reduced, and the tax base was diversified to stabilize government revenues. The move helped to foster entrepreneurship, boosted consumer spending, and increased the nation’s attractiveness for investment from abroad. • The government cut spending and borrowing, leading to lower interest rates and stimulating the economy. • State-owned enterprises—such as the national airline, post office, telecom, and other utilities—were sold off to the private sector.13 Dynamic growth boosted real incomes and greatly improved living standards in New Zealand. Recently, Forbes magazine and the World Bank ranked New Zealand as the second most business friendly country in the world.14 Marketoriented policies helped make New Zealand an important economy and a major player in world trade, dramatically raising living standards for its citizens. Read the Global Trend feature for more examples of proactive nation repositioning to create new comparative advantages. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 8 of 9 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Global Trend Moving from Comparative to National Competitive Advantages The principle of comparative advantage and factor endowment theory imply that nations should nurture industries that use inputs inherent or abundant in their environment. Today, however, numerous countries with few natural or other resources have created their own competitive advantages through skillful application of national industrial policies. In most cases, these acquired advantages have become more critical than natural endowments. Here are some examples: Singapore is a free-market economy with high per-capita GDP. Beginning in the 1960s, the government adopted probusiness, pro-investment, export-oriented policies, combined with state-directed investments in strategic corporations. The approach stimulated economic growth that averaged 8 percent from 1960 to 1999. Singapore cut taxes and government spending and encouraged massive inward investment in high-value industries such as electronics, engineering, and chemicals. The country boasts a highly educated labor force, state-of-the-art telecommunications facilities, and excellent infrastructure—its airport and seaport are among the best in the world. In the past two decades, Ireland lowered the basic corporate tax rate to zero, initiated earnest dialogue with labor unions, and emphasized high value-adding industries such as pharmaceuticals, biochemistry, and information technology. The country invested heavily in education, providing a steady supply of skilled workers, including scientists, engineers, and business school graduates. Attracted by these developments, foreign MNEs began investing in the country. Ireland became a major player in world trade and now hosts some 1,000 foreign firms. International trade, inward FDI, and economic development dramatically raised living standards for its citizens. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 9 of 9 Bangalore is India’s third largest city and a center of information technology and business support services. Cooperating with private interests, India reduced restrictions on trade and investment, resulting in a big influx of foreign FDI. The public-private partnership also emphasized high-value industries such as biotechnology and business consulting and capitalized on Bangalore’s large, well-educated, English-speaking workforce. In the Czech Republic, economic reforms and exports to the European Union (EU) led to economic prosperity. The Czech government harmonized its laws and regulations with those of the EU by reforming its judicial system, financial markets regulation, intellectual property rights protection, and other areas important to investors. It also privatized stateowned companies. Government FDI incentives attracted firms like Toyota, ING, Siemens, Daewoo, DHL, and South African Breweries. Vietnam’s government privatized state enterprises and modernized the economy, emphasizing competitive, exportdriven industries. It ramped up the country’s exports of everything from shoes to ships, modernized its intellectual property regime, entered several free-trade agreements, and revamped its educational system to provide a constant stream of skilled workers. The government also built infrastructure, including roads, railways, and power stations. Reforms have attracted much inward FDI from firms like Intel. The national savings rate increased several-fold. Economic repositioning dramatically reduced Vietnam’s poverty rate. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=149&to=150 9/25/2017 Page 1 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 2 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Global Trend Moving from Comparative to National Competitive Advantages The principle of comparative advantage and factor endowment theory imply that nations should nurture industries that use inputs inherent or abundant in their environment. Today, however, numerous countries with few natural or other resources have created their own competitive advantages through skillful application of national industrial policies. In most cases, these acquired advantages have become more critical than natural endowments. Here are some examples: Singapore is a free-market economy with high per-capita GDP. Beginning in the 1960s, the government adopted probusiness, pro-investment, export-oriented policies, combined with state-directed investments in strategic corporations. The approach stimulated economic growth that averaged 8 percent from 1960 to 1999. Singapore cut taxes and government spending and encouraged massive inward investment in high-value industries such as electronics, engineering, and chemicals. The country boasts a highly educated labor force, state-of-the-art telecommunications facilities, and excellent infrastructure—its airport and seaport are among the best in the world. In the past two decades, Ireland lowered the basic corporate tax rate to zero, initiated earnest dialogue with labor unions, and emphasized high value-adding industries such as pharmaceuticals, biochemistry, and information technology. The country invested heavily in education, providing a steady supply of skilled workers, including scientists, engineers, and business school graduates. Attracted by these developments, foreign MNEs began investing in the country. Ireland became a major player in world trade and now hosts some 1,000 foreign firms. International trade, inward FDI, and economic development dramatically raised living standards for its citizens. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 3 of 8 Bangalore is India’s third largest city and a center of information technology and business support services. Cooperating with private interests, India reduced restrictions on trade and investment, resulting in a big influx of foreign FDI. The public-private partnership also emphasized high-value industries such as biotechnology and business consulting and capitalized on Bangalore’s large, well-educated, English-speaking workforce. In the Czech Republic, economic reforms and exports to the European Union (EU) led to economic prosperity. The Czech government harmonized its laws and regulations with those of the EU by reforming its judicial system, financial markets regulation, intellectual property rights protection, and other areas important to investors. It also privatized stateowned companies. Government FDI incentives attracted firms like Toyota, ING, Siemens, Daewoo, DHL, and South African Breweries. Vietnam’s government privatized state enterprises and modernized the economy, emphasizing competitive, exportdriven industries. It ramped up the country’s exports of everything from shoes to ships, modernized its intellectual property regime, entered several free-trade agreements, and revamped its educational system to provide a constant stream of skilled workers. The government also built infrastructure, including roads, railways, and power stations. Reforms have attracted much inward FDI from firms like Intel. The national savings rate increased several-fold. Economic repositioning dramatically reduced Vietnam’s poverty rate. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 4 of 8 Why and How Do Firms Internationalize? Company Internationalization Earlier theories of international trade focused on why and how cross-national business occurs. However, in the 1960s scholars began to develop theories about the managerial and organizational aspects of firm internationalization. Internationalization Process of the Firm Scholars developed the internationalization process model in the 1970s to describe how companies expand abroad. According to this model, internationalization takes place in incremental stages over a long time.15 Typically, firms start without much analysis or planning and begin to export, the simplest form of international activity, and progress to FDI, the most complex. The gradual and incremental nature of internationalization often results from managers’ uncertainty and uneasiness about how to proceed, because they lack information about foreign markets and experience with cross-border transactions. EXHIBIT 6.8 Stages in the Internationalization Process of the Firm The model is illustrated in Exhibit 6.8 . A firm starts out in a domestic focus phase and is preoccupied with business in its home market. Management may be unable or unwilling to get https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 5 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. started in international business because of concerns over its readiness or perceived obstacles in foreign markets. Eventually, the firm advances to the pre-export stage, often because it receives unsolicited product orders from abroad. In this stage, management investigates the feasibility of undertaking international business. Subsequently, the firm advances to the experimental involvement stage by initiating limited international activity, typically in the form of basic exporting. As managers begin to view foreign expansion more favorably, they undertake active involvement in international business through systematic exploration of international options and the commitment of managerial time and resources to achieving international success. Ultimately management may advance to the committed involvement stage, characterized by genuine interest and commitment of resources to making international business a key part of the firm’s profit-making and value-chain activities. In this stage, the firm targets numerous foreign markets via various entry modes, especially FDI.16 To illustrate, let’s examine of the consumer electronics firm Sony Corporation, founded in Japan in 1946 (www.sony.com). In the 1950s, Sony began exporting transistor radios and other products to Australia, Europe, and North America. In the 1960s, it entered joint ventures with various partners abroad, including CBS and Texas Instruments. Around the same time, Sony used FDI to establish sales offices in Hong Kong, Switzerland, and the United States. Later, the firm set up factories in numerous countries to manufacture consumer electronics. Sony established its first television factory in the United States in San Diego in 1972. Today it has joint ventures and wholly owned operations in hundreds of locations worldwide, including five R&D centers and nine plants in Europe that produce computers, game consoles, personal navigation devices, and portable audio players. Sony’s experience illustrates the internationalization process well.17 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 6 of 8 Born Globals and International Entrepreneurship Because international business has long been the domain of large, resourcerich MNEs, earlier theories tended to focus on them. Today scholars question the slow and gradual process proposed by the internationalization process model.18 Despite the scarcity of financial, human, and tangible resources that characterize most new businesses, born global firms are young companies that internationalize early in their evolution. Among the reasons are the growing intensity of international competition, the integration of world economies under globalization, and advances in communication and transportation technologies that reduce the cost of venturing abroad and make it easier to internationalize earlier and faster than ever before. The born global phenomenon has given rise to a new field of scholarly inquiry, international entrepreneurship.19 Current trends suggest that early internationalizing firms will gradually become the norm in international business. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 7 of 8 How Can Internationalizing Firms Gain and Sustain Competitive Advantage? So far we have focused on the internationalization processes of individual firms, including smaller firms or those new to international business. Since the 1950s, MNEs such as Nestlé, Unilever, Sony, Coca-Cola, and Caterpillar have expanded abroad on a massive scale, shaping international patterns of trade, investment, and technology flows. Over time, the aggregate activities of these firms became a key driving force of globalization and ongoing integration of world economies. So important is the rise of the MNE that it ranks with the development of electric power or the invention of the aircraft as one of the major events of modern history. Let’s examine MNEs and their internationalization processes in more detail. FDI-Based Explanations Most explanations of international business have emphasized FDI, the preferred entry strategy of MNEs, those large, resource-rich companies whose business activities are performed via networks of production facilities, marketing subsidiaries, regional headquarters, and other operations established worldwide. For example, Sony has 170,000 employees and hundreds of subsidiaries and affiliates worldwide that perform a wide range of value-chain activities. Although headquartered in Tokyo, Japan accounts for only a quarter of Sony’s roughly $90 billion in global sales. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 8 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=151&to=152 9/25/2017 Page 1 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 2 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Sony exemplifies the borderless MNE that locates its activities wherever it can maximize competitive advantages. One way to illustrate the huge volume of FDI is to examine FDI stock, which describes the total value of assets that MNEs own abroad via their investment activities. Exhibit 6.9 shows the stock and growth of inward FDI from 2000 to 2010, for a group of leading FDI destination countries. The exhibit highlights three interesting points. First, even smaller economies such as Belgium and Ireland are popular destinations for firms’ FDI. Second, both advanced economies and emerging markets are major recipients of FDI. Third, the stock of FDI in emerging markets such as India, Russia, and Saudi Arabia grew very rapidly in the decade through 2010, reflecting their growing importance as target markets and production centers. Historically, most of the world’s FDI was invested both by and in Western Europe, the United States, and Japan. But emerging markets now account for a huge proportion of global FDI. Unfortunately, Africa receives relatively little, which hinders the ability to raise living standards in the region.20 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 3 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 4 of 8 EXHIBIT 6.9 Stock of Inward FDI: Leading FDI Destinations (Billions of U.S. dollars) and Percentage Growth, 2000 to 2010 Sources: Based on UNCTAD, World Investment Report 2011 (New York: United Nations, 2011, p. 191, “Annex table I.2. FDI stock, by region and economy, 1990, 2000, 2010”), accessed January 29, 2012 at http://www.unctad.org/templates/WebFlyer.asp?intItemID=6018&lang=1. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 5 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 6 of 8 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 7 of 8 EXHIBIT 6.10 Stock of Outward FDI: Top Sources of Outward FDI (Billions of U.S. dollars) and Percentage Growth, 2000 to 2010 Sources: Based on UNCTAD, World Investment Report 2011 (New York: United Nations, 2011, p. 191, “Annex table I.2. FDI stock, by region and economy, 1990, 2000, 2010”), accessed January 29, 2012 at http://www.unctad.org/templates/WebFlyer.asp?intItemID=6018&lang=1. Exhibit 6.10 shows the stock and growth of outward FDI for a collection of the leading FDI-providing countries. MNEs invest billions abroad every year to establish and expand factories and other facilities. Note that firms from both advanced economies and emerging markets invest substantial FDI abroad. Emerging markets such as China, India, and Russia have greatly increased their FDI investments in recent years. Total outward FDI stock now constitutes nearly one-third of global GDP, a huge amount.21 FDI is such an important entry strategy that scholars have developed three alternative theories of how firms can use it to gain and sustain competitive advantage: the monopolistic advantage theory, internalization theory, and Dunning’s eclectic paradigm. These theoretical perspectives are summarized in Exhibit 6.11 and described in the following sections. Monopolistic Advantage Theory A monopolistic advantage is a valuable resource that a company holds and leverages to generate profits, and which few other firms have. According to monopolistic advantage theory, companies that internationalize through FDI are more likely to succeed if they own or control certain advantages that foreign competitors do not generally possess. When this occurs, the advantaged firm has a degree of monopoly power that helps it https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 8 of 8 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=153&to=154 9/25/2017 Page 1 of 6 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=155&to=156 9/25/2017 Page 2 of 6 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. compete more effectively abroad. This monopolistic advantage should be specific to the MNE itself, such as a proprietary technology or a brand name, rather than to the locations where it does business. This theory argues that at least two conditions should be present for a firm to prefer targeting a foreign market rather than its home market. First, returns obtainable in the foreign market should be superior to those available in the home market. This would provide the firm with incentives to expand abroad to take advantage of its monopoly power. Second, returns obtainable in the foreign market should be superior to those earned by its domestic competitors in its industry in the foreign market. This would give the firm an opportunity to make monopoly profits that domestic companies in the foreign market cannot imitate. EXHIBIT 6.11 Theoretical Perspectives on Why Firms Choose FDI To illustrate, let’s revisit Sony Corporation. By being on the leading edge of innovation, Sony established numerous pioneering standards in the consumer electronics industry. https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=155&to=156 9/25/2017 Page 3 of 6 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Over the course of several decades, Sony’s superior R&D and internal control mechanisms allowed the firm to acquire and maintain a large body of relatively unique knowledge. This unique knowledge provided the firm with various monopolistic advantages. Sony invented numerous popular products that were, for a time at least, relatively unique. Continuous innovation within the firm allowed Sony to maintain this uniqueness for many years. Sony used its superior innovativeness to develop monopoly power and dominate world markets in such products as the PlayStation and Blu-ray disc format. As the Sony example implies, the most important monopolistic advantages are superior knowledge and intangible skills. Superior, proprietary knowledge has allowed Sony to create differentiated products that provide unique value to customers.22 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=155&to=156 9/25/2017 Page 4 of 6 Internalization Theory Numerous scholars have investigated the specific benefits that MNEs derive from FDI-based entry. For example, when Procter & Gamble entered Japan, management initially considered exporting and FDI. With exporting, P&G would have had to contract with an independent Japanese distributor to handle warehousing and marketing of its soap, diapers, and other products. However, because of trade barriers imposed by the Japanese government, the strong market power of local Japanese firms, and the risk of losing control over its proprietary knowledge, P&G chose instead to enter Japan via FDI. It established its own marketing subsidiary and, eventually, national headquarters in Tokyo. This arrangement provided various benefits P&G would not have received had it entered Japan by contracting with Japanese distributors it did not own. Internalization theory explains the process by which firms acquire and retain one or more value-chain activities inside the firm, as P&G did in Japan. Internalizing value-chain activities helps minimize the disadvantages of dealing with external partners for performing arms-length activities such as exporting and licensing. Internalization also gives the firm greater control over its foreign operations. Internalization theory An explanation of 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. For example, the MNE might internalize the supplier function by acquiring or establishing its own plant in the foreign market to produce needed inputs itself instead of buying them from a foreign, independent supplier. Or it might internalize the marketing function by establishing its own distribution subsidiary abroad, instead of contracting with an independent foreign distributor to handle its marketing in the foreign market. The MNE is ultimately a vehicle for bypassing the bottlenecks and costs of the international, inter-firm https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=155&to=156 9/25/2017 Page 5 of 6 exchange of goods, materials, and workers. In this way, the firm replaces business activities performed by independent suppliers in external markets with business activities it performs itself. In the 1950s, for example, Sony followed a policy of exporting its products to Europe and North America. However, management soon realized it could accelerate and improve the performance of international operations by creating its own sales and production facilities in strategic markets abroad. Thus, in the 1960s, Sony internalized much of its global production and distribution channels by establishing company-owned subsidiaries in Europe, the United States, and other key markets. To ensure product quality, Sony internalized production of semiconductors and circuit boards for use in making cell phones and PlayStations. Recently, Sony transferred production of camcorders from a plant run by a joint venture partner in China to a wholly owned Sony plant in Japan. The move allowed Sony to improve supply-chain management and manufacturing of camcorders. In addition to consumer electronics, Sony has long been a major player in the movie industry, through its subsidiary Sony Pictures Entertainment (SPE). Acquiring the Loews chain of movie theaters in the United States allowed SPE to internalize a substantial portion of the distribution channel for its film business, ensuring its movies would be supplied to thousands of movie screens. Since its founding, Sony has consistently internalized key units to maintain control over the most important links in its global value chains. Another key reason companies internalize certain value-chain functions is to control proprietary knowledge critical to the development, production, and sale of their products and services. Because independent foreign companies are outside the MNE’s direct control, they can acquire and use the knowledge to their own advantage, perhaps becoming competitors in the process. FDI allows the MNE to control and optimally use its knowledge in foreign markets.23 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=155&to=156 9/25/2017 Page 6 of 6 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Dunning’s Eclectic Paradigm https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=155&to=156 9/25/2017 Page 1 of 16 https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=157&to=158 9/25/2017 Page 2 of 16 PRINTED BY: ncastater@mail.barry.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Dunning’s Eclectic Paradigm Professor John Dunning proposed the eclectic paradigm as a framework for determining the extent and pattern of the value-chain operations that companies own abroad. He drew from various theoretical perspectives, including comparative advantage, factor proportions, monopolistic advantage, and internalization advantage. Thus, the eclectic paradigm is often viewed as the most comprehensive of FDI theories. The eclectic paradigm specifies three conditions that determine whether a company will internationalize via FDI: ownership-specific advantages, location-specific advantages, and internalization advantages. To successfully enter and conduct business in a foreign market, the MNE must possess ownership-specific advantages relative to other firms already doing business in the market. That is, it should hold knowledge, skills, capabilities, key relationships, and other assets that allow it to compete effectively in foreign markets. These assets amount to the firm’s competitive advantages. To ensure international success, the advantages must be substantial enough to offset the costs the firm incurs in establishing and operating foreign operations. The advantages should also be specific to the MNE that possesses them and not readily transferable to other firms, such as proprietary technology, managerial skills, trademarks or brand names, economies of scale, and access to substantial financial resources. The more valuable the firm’s ownership-specific advantages, the more likely it is to internationalize via FDI.24 Let’s use Alcoa, the Aluminum Corporation of America (www.alcoa.com), to illustrate. Alcoa has 60,000 employees in thirty-five countries. The company’s integrated operations include bauxite mining and aluminum refining. Its products include primary aluminum (which it refines from bauxite), automotive components, and sheet aluminum for beverage cans and Reynolds Wrap®. One of Alcoa’s most important ownership-specific advantages is the proprietary technology it has acquired through its R&D activities. It has also https://jigsaw.vitalsource.com/api/v0/books/9780133558036/print?from=157&to=158 9/25/2017 Page 3 of 16 acquired special managerial and marketing skills in the production and marketing of refined aluminum. The firm has a well-known brand name that helps increase sales. As a large firm, Alcoa also profits from economies of scale and the ability to finance expensive projects. These advantages have allowed Alcoa to generate maximal profits from its international operations. The second condition that determines whether a firm will internationalize via FDI is the presence of location-specific advantages, the comparative advantages available in individual foreign countries, such as natural resources, skilled labor, low-cost labor, and inexpensive capital. For example, Alcoa located refineries in Brazil because of that country’s huge deposits of bauxite, a mineral found in relatively few other locations worldwide. The Amazon and other major rivers in Brazil generate huge amounts of hydroelectric power, a critical ingredient in electricity-intensive aluminum refining. Alcoa also benefits from Brazil’s low-cost, relatively well-educated laborers who work in the firm’s refineries. The presence of these locationspecific advantages helped persuade Alcoa to locate in Brazil through FD...
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