Module 2: National

Differences
By Mr. Teth Chanveasna
Agenda
I. Introduction to National difference
II. Political systems of difference countries
A. Collective and Individual
B. Democracy and Totalitarianism
III. Economic systems
IV. Regulation systems
V. Political economy
I. Introduction to National difference
❑International business is more complex than domestic business due to differences
in political, economic, and legal systems across countries. These variations, along
with cultural norms, education levels, and workforce skills, impact business
strategies, costs, risks, and operational management.
❑This lecture will two focus on understanding these country-specific differences
and how they evolve, affecting international business practices. The concept of a
country’s political economy will be emphasizing the interconnection between
political, economic, and legal systems and their influence on economic well-being.
❑We also explore how these systems impact a nation’s economic growth and how
cultural differences shape business operations. A key example is Ireland’s
economic success, demonstrating how adopting market-based policies can drive
significant economic growth.
Why does international business have correlation with political, Economy and
Regulation system of difference countries?
II. Political systems of difference countries

• What is state (country or nation) ?

• What is politic ?
• What is political system ?
What is state (nation) ?Population

How about Taiwan?

Land

Government

Sovereignty
(recognition from
internation
communities as
independent state)
What is politic ?
❑Political means relating to the way power is achieved and used in a
country or society.
❑the activities of the government, members of law-making
organizations, or people who try to influence the way a country is
governed. Example of Democracy system has three main power
separate , [Link], [Link], [Link] .
❑The art of leading society to be prosperity.
What is political systems?
Political systems are defined as many types as below:
1. Democracy( created by people, lead by people and serve for people )
2. Authoritarianism(communist systems )
3. Totalitarianism (communist system)
4. Theocracy ( religious leading country as Muslim country)
5. Oligarchy (wealth people lead country)
6. Anarchy
However, in term of international business we can conclude as two
group:
❑Democracy (individual)
❑Totalitarianism (collective )
Political Systems
A country's political system influences its economic and legal systems and it
essential to understand different political structures. Political systems are evaluated
based on two key dimensions:
➢Collectivism vs. Individualism – Some systems prioritize the collective good,
while others emphasize individual freedoms.
➢Democracy vs. Totalitarianism – Some nations allow democratic participation,
while others maintain strict governmental control.
These dimensions are often interconnected—collectivist systems tend to be more
totalitarian, while individualistic systems align with democracy. However, there are
exceptions, as some democracies blend collectivist and individualist principles, and
some totalitarian states are not fully collectivist.
A. Collectivism vs. Individualism (ideology)
Collectivism is a political system that prioritizes the collective good ( the need of
whole society) over individual rights. It holds that societal needs take precedence,
and individual freedoms may be restricted if they conflict with the common good.
The roots of collectivism trace back to Plato (427-347 B.C), who argued in (raise
statement) The Republic that individual rights should be sacrificed for the
majority's benefit and that property should be owned by community. However, Plato
also believed in a hierarchical society led by philosophers and soldiers. In modern
times, socialists have embraced collectivist principles, advocating for systems that
emphasize shared ownership and governance for the benefit of society as a whole.
Collectivism (Socialism)
Modern socialism is rooted in the ideas of Karl Marx (1818-1883), who criticized
capitalism for benefiting a few at the expense of the many. Marx argued that
workers were underpaid while capitalists profited from their labor and proposed
state ownership of production and distribution to ensure fair compensation. In the
early 20th century, socialism split into two major branches:
1. Communists advocated for socialism through violent revolution and dictatorship.
2. Social Democrats sought socialism through democratic means, rejecting
revolution.
❑Communism peaked in the 1970s, with the Soviet Union, China, and several other
countries under communist rule. However, by the 1990s, communism declined,
with the Soviet Union collapsing and Eastern Europe transitioning to democracy.
China, while politically communist, moved toward a market economy. Today,
strict communism persists only in a few nations like North Korea.

❑Social democracy, influential in Western nations like Germany, Sweden, and the
UK, led to state ownership of industries after World War II. However, these
enterprises often became inefficient, leading to privatization in the late 20th
century as governments shifted toward free-market policies. Even when social
democratic parties regained power, they largely embraced private ownership.
Individualism
❑Individualism is a political and economic philosophy that emphasizes personal
freedom and self-interest over collective goals. Unlike collectivism, which
prioritizes the common good, individualism asserts that individuals should have
the freedom to pursue their own economic and political interests.
❑The concept dates back to Aristotle (384-322 B.C), who argued that private
ownership fosters productivity, unlike communal property, which is often
neglected. Individualism re-emerged in the 16th century in Protestant trading
nations like England and the Netherlands and was later championed by thinkers
such as David Hume, Adam Smith, and John Stuart Mill. It played a crucial role in
shaping the American Declaration of Independence and was further advanced in
the 20th century by economists like Milton Friedman and Friedrich von Hayek.
Individualism is based on two key principles:

➢1. Freedom and self-expression are fundamental.

➢2. The economy functions best when individuals pursue their own self-interest, as
famously described by Adam Smith’s "invisible hand" theory in The Wealth of
Nations.
B. Democracy vs. Totalitarianism
❑Democracy and totalitarianism represent opposite ends of a political spectrum. Democracy is a
system where governance hold by the people, either directly or through elected
representatives. In contrast, totalitarianism is a system where a single person or political party
holds absolute control over all aspects of life and suppressing their opposition.

❑This dimension is closely linked to individualism and collectivism. Democracy aligns with
individualism, promoting personal freedoms, while totalitarianism is often associated with
collectivism, especially in communist regimes. However, there are gray areas where these systems
overlap. Some democratic states emphasize collective values, and some totalitarian states, like
China and Vietnam, have introduced economic freedoms while maintaining strict political control.
Democracy
Pure democracy, as practiced in ancient Greek city-states, required direct citizen
participation in decision-making. However, in modern societies with large
populations, this is impractical. Instead, most democratic nations, like the United
States, follow a representative democracy, where citizens elect officials to govern on
their behalf. These representatives remain accountable to the public through regular
elections.
An ideal representative democracy includes key safeguards, often protected by
constitutional law, such as:
1. Freedom of expression, opinion, and organization
2. An independent and free media
3. Regular elections with universal adult suffrage
4. Limited terms for elected officials
5. An independent judiciary
6. A nonpolitical state bureaucracy
7. A nonpolitical police force and military
8. Relatively free access to state information
These elements ensure that elected leaders can be held accountable and that
democracy functions effectively.
Totalitarianism
Totalitarianism is a political system where the government exercises absolute
control, denying citizens fundamental rights like free expression, free media, and
fair elections. Political repression is common, and dissenters often face severe
consequences. There are four major forms of totalitarianism:
➢1. Communist Totalitarianism : Previously widespread, this form is in decline,
with many former communist states transitioning away from strict control.
However, nations like China, Vietnam, Laos, North Korea, and Cuba still
maintain totalitarian rule, even as some adopt market-based economic reforms.
In other places, like Venezuela and Russia, there are signs of a resurgence in
authoritarianism.
➢2. Theocratic Totalitarianism : Political power is controlled by religious authorities
who govern based on religious principles. This is most common in Islamic states
such as Iran and Saudi Arabia, where laws restrict political and religious freedoms.
➢3. Tribal Totalitarianism : Found mainly in African nations like Zimbabwe,
Uganda, Tanzania, and Kenya, this occurs when a single tribe dominates political
power, often at the expense of other groups. This is partly a legacy of colonial-era
boundaries that ignored tribal divisions.
➢4. Right-Wing Totalitarianism : While allowing some economic freedom, these
regimes heavily restrict political freedoms, often opposing communism and
socialism. Military-backed right-wing dictatorships were common in Latin
America (e.g., Brazil from 1964–1985) and parts of Asia (e.g., South Korea,
Taiwan, Singapore, Indonesia, and the Philippines). Since the 1980s, however,
many of these countries have transitioned to democracy.
Pseudo-Democracies
❑Many nations fall between pure democracy and totalitarianism, often functioning as
imperfect or pseudo-democracies. In these systems, authoritarian elements manipulate
state institutions to restrict political and civil liberties, despite maintaining the appearance
of democratic processes.

❑For example, in Russia under Vladimir Putin, elections still take place, opposition groups
exist, and independent media operate to some extent. However, Putin has gradually
curtailed freedoms, limiting opposition voices and consolidating power. While his control
is not absolute, challenging his rule has become increasingly difficult as his regime
extends its political, legal, and economic dominance.
Thank you
For your attendance
Module 2.1: National
Differences
By Mr. Teth Chanveasna
Agenda
I. Introduction to National difference
II. Political systems of difference countries
a. A. Collective and Individual
b. B. Democracy and Totalitarianism
III. Economic systems
a. Market economy (Free market )
b. Command economy (Plan market)
c. Mixed Economy
IV. Regulation systems
V. Political economy
III. Economic systems
As we awareness that political ideologies influence economic systems. Countries
that prioritize individual goals tend to have market economies, while those that
prioritize collective goals often have more state-controlled, restricted markets. It
identifies three main types of economic systems:

❑ Market economy

❑ Command economy

❑ and Mixed economy.

A. Market economy (Free market)
➢In a typical pure market economy, production is entirely owned by private
individuals, not the government. What gets produced is not centrally planned but
determined by supply and demand. Prices adjust based on market conditions—
rising when demand is high and falling when supply is greater—guiding producers
on how much to produce. In this system, consumers have the most power, as their
buying choices dictate production.

➢However, the system depends on unrestricted supply. If a single company gains

control of a market (a monopoly), it might limit production to keep prices high,
increasing profits at the expense of consumers and society. Without competition,
monopolies have little motivation to reduce costs or improve quality, leading to
➢To prevent this, governments help ensure fair competition by outlawing practices
that lead to monopolies (e.g., through antitrust laws in the U.S. and EU). Private
ownership also supports economic efficiency, as entrepreneurs—driven by the
desire for profit—are encouraged to innovate, improve services, and operate more
effectively than rivals. This constant drive for improvement is seen as a major
contributor to economic growth and development.
B. Command economy (Planned market)
➢In a pure command economy, the government controls what goods and services
are produced, how much is made, and at what prices they are sold. This system
reflects collectivist values, aiming to use resources for the overall benefit of
society. All businesses are state-owned, allowing the government to make
decisions that serve national interests rather than personal profits. Command
economies were common in communist countries, though many have disappeared
since the fall of communism in the late 1980s. Some democratic nations, like
France and India, also experimented with government planning and ownership,
but this approach has largely declined.
➢Although the goal of a command economy is to use resources effectively for the
public good, the outcome often falls short. State-run businesses lack motivation to
reduce costs or improve efficiency, since they don't face the threat of closure.
Without private ownership, there is little incentive for innovation or improving
consumer services. As a result, command economies often experience stagnation
rather than growth and prosperity.
C. Mixed Economy
➢Mixed economies lie between pure market and command systems. They
feature both private enterprise and government involvement. Some
industries operate through free markets, while others are state-controlled
and planned. Although mixed economies were once widespread in
developed countries like the UK, France, and Sweden, privatization since
the 1980s has reduced state ownership in many of these nations. Similar
changes happened in countries like Brazil, Italy, and India. However, in
places like Russia and Venezuela, government control over the economy has
increased under authoritarian regimes.
➢Governments in mixed economies sometimes take over struggling firms
considered vital to national interests. For example, during the 2008 financial
crisis, the U.S. government temporarily took large stakes in companies like
AIG, Citigroup, and General Motors to prevent economic collapse. These
interventions were short-term and aimed at stabilizing the economy, with
shares eventually sold back to private investors.
➢In some countries, such as China, the state uses ownership of key
enterprises to promote national economic goals. For instance, China’s
government has supported tech firms like Huawei with favorable loans to
develop strategic industries. Critics argue that governments are not suited to
make business investment decisions and are prone to political influence.
However, supporters of industrial policy highlight successes like Huawei
and Airbus, while acknowledging that such strategies carry the risk of
failures alongside the wins.
Module 2.2: National
Differences
By Mr. Teth Chanveasna
Agenda
I. Introduction to National difference
II. Political systems of difference countries
III. Economic systems
IV. Regulation systems
A. Common Law
B. Civil Law
C. Theocratic Law
D. Difference in contract law
E. Property rights and corruption
F. Protection of intellectual property
G. Production safety and product liability
V. Political economy
IV. Regulation systems
The legal system of a country consists of laws that regulate behavior, enforce rules,
and provide solutions for grievances. It plays a crucial role in international business
by shaping business practices, transaction procedures, and the rights and
responsibilities of parties involved. Legal systems vary greatly between countries
and are influenced by political systems and historical traditions. For example,
totalitarian states often restrict private enterprise, while democratic states support it.
Key aspects of legal systems that impact international business include differences
in legal structures, contract law, property rights (especially intellectual property like
patents and trademarks), and regulations on product safety and liability. There are
three main types of legal systems or legal traditions use around the world: common
law, civil law, and theocratic law.
A. Common Law (Unwritten law system)
The common law system developed in England over many centuries and is currently
used in many of Britain’s former colonies, such as the United States. It is built upon
tradition, previous court decisions (precedent), and customary practices. Tradition
reflects a nation's legal background, precedent involves past judicial rulings, and
custom relates to how laws are implemented in specific contexts. Courts consider all
these elements when interpreting the law, which makes the system more adaptable
than others. Judges have the authority to apply the law based on the particular facts
of each case, and their decisions can establish precedents that guide future rulings.
Over time, these precedents can lead to changes or refinements in the law to address
new developments.
B. Civil Law (Written Law system
A civil law system is based on a detailed set of laws organized into codes. When law
courts interpret civil law, they do so with regard to these codes. More than 80
countries— including Germany, France, Japan, and Russia—operate with a civil law
system. A civil law system tends to be less adversarial than a common law system
because the judges rely on detailed legal codes rather than interpreting tradition,
precedent, and custom. Judges under a civil law system have less flexibility than
those under a common law system. Judges in a common law system have the power
to interpret the law, whereas judges in a civil law system have the power only to
apply the law.
C. Theocratic Law
➢A theocratic legal system is based on religious teachings, with Islamic law
being the most prominent example today. Rooted in the Koran, the Sunnah,
and scholarly interpretations, Islamic law governs all areas of life and
remains largely unchanged due to its sacred foundation. Though primarily
focused on moral conduct, it also influences commercial practices—for
instance, forbidding interest (usury), which has legal implications in some
Muslim countries like Pakistan. While Islamic law remains central, many
Muslim nations combine it with common or civil law. Islamic finance has
grown significantly, with over 500 institutions managing more than $2
trillion in assets by 2016.
D. Difference in contract law
➢Common law and civil law systems differ in how they handle
contract law. Common law contracts are usually lengthy and
detailed due to fewer predefined legal rules, while civil law
contracts are shorter since many terms are already outlined in a civil
code. This makes common law contracts more costly and disputes
more adversarial, but the system allows more flexibility for judges
to interpret cases. International businesses must understand these
differences to avoid missteps in legal disputes.
➢To address cross-border contract issues, many countries have adopted the
United Nations Convention on Contracts for the International Sale of Goods
(CISG), which standardizes rules for international contracts. However, by
2020, only 93 countries had ratified it, with major trading nations like India
and the UK opting out. When firms reject the CISG, they often resolve
disputes through arbitration, commonly using the International Court of
Arbitration in Paris, which manages hundreds of international cases
annually.
E. Property rights and corruption
In legal terms, property refers to resources owned by an individual or
business, such as land, buildings, equipment, capital, mineral rights,
businesses, and intellectual property (protected by patents, copyrights,
and trademarks). Property rights are the legal entitlements to control
how a resource is used and to profit from it. Different countries have
varying degrees of legal protection for property rights. Most nations
have laws to protect these rights, and even China, a nominally
communist state, passed a law in 2007 to protect private property.
This law was strengthened in 2016 to offer more protection for land and
intellectual property due to increasing innovation in the country.
However, in many nations, these laws are not effectively enforced, and
property rights can be violated through both private actions (e.g., theft)
and public actions (e.g., government interference).
Private Action
Private action that violates property rights includes crimes like theft, piracy, and
blackmail by individuals or groups. A weak legal system increases the occurrence of
such criminal activities. For example, after the collapse of communism in Russia, a
weak legal and judicial system allowed organized crime groups like the "Russian
Mafia" to extort businesses, demanding protection money and resorting to violence.
While organized crime exists in other countries, such as the Mafia in the U.S. and
the yakuza in Japan, the severity of the problem in Russia during the 1990s was
mainly due to its weakened legal enforcement system. Other countries have also
faced similar or worse issues at different times.
Public Action and Corruption
➢public action violations of property rights, where government officials
exploit their positions to extort resources from property holders. These
violations can occur through legal means, such as excessive taxation or
asset seizure without compensation, or through illegal methods, like bribery
and corruption. Corruption is prevalent in many societies worldwide, from
the Philippines under Ferdinand Marcos to Indonesia under Suharto. Some
countries have strong legal systems that minimize corruption, while others
suffer from weak enforcement, where corruption is seen as a perk of office.
➢Transparency International reports that corruption costs businesses and
individuals around $400 billion annually due to bribes in government
procurement. Corruption negatively affects economic growth by reducing
investment, as it diminishes the returns on business ventures. This leads to
lower foreign direct investment, trade, and economic growth in countries
with high corruption levels, such as Indonesia, Nigeria, and Russia. The text
highlights how corruption can hinder development, citing Brazil as an
example of the detrimental economic impact.
Rankings of corruption by country, 2020
Foreign Corrupt Practices Act
➢Legal measures to combat corruption in international business. In the 1970s, the
United States passed the Foreign Corrupt Practices Act (FCPA) in response to U.S.
companies bribing foreign officials to win contracts. The FCPA makes it illegal to
bribe foreign government officials to obtain or maintain business and requires
publicly traded companies to maintain records to detect violations. Walmart's
possible violation of the FCPA in 2012, due to bribery in Mexico, is mentioned.
➢In 1997, the Organisation for Economic Co-operation and Development (OECD)
adopted the Convention on Combating Bribery of Foreign Public Officials in
International Business Transactions, requiring member states to criminalize
bribery of foreign officials.
➢Both the FCPA and the OECD convention allow exceptions for "facilitating or
expediting payments" (also called grease payments). These small payments, meant
to speed up routine government actions like issuing permits or processing
paperwork, are considered less offensive than bribes meant to secure business and
are exempt from general anti-bribery laws.
F. Protection of intellectual property
Intellectual property (IP) refers to creations of the mind like software, music,
and inventions, protected by patents, copyrights, and trademarks. Patents,
copyrights, and trademarks establish ownership rights over intellectual
property.
❑A patent grants the inventor of a new product or process exclusive rights for
a defined period to the manufacture, use, or sale of that invention.
❑Copyrights are the exclusive legal rights of authors, composers,
playwrights, artists, and publishers to publish and disperse their work as
they see fit.
❑Trademarks are designs and names, officially registered, by which
merchants or manufacturers can differentiate their products.
➢In the high-technology “knowledge” economy of the twenty-first century,
intellectual property has become an increasingly important source of economic
value for businesses. Protecting intellectual property has also become increasingly
problematic, particularly if it can be rendered in a digital form and then copied and
distributed at very low cost over the internet (e.g., computer software, music, and
video recordings).
➢However, enforcement of IP laws varies globally, often being weak in countries
like China and Thailand, leading to widespread piracy and major financial
losses—such as the $63 billion lost annually by software firms due to piracy.
International efforts, like the TRIPS agreement under the World Trade
Organization (WTO), aim to strengthen global IP protections, requiring countries
to enforce minimum standards. Businesses respond to IP violations by lobbying
governments, filing lawsuits, avoiding markets with weak enforcement, and
monitoring for pirated goods.
D. Production safety and product liability
➢Product safety laws require products to meet certain safety standards, while
product liability holds companies and their leaders accountable if their
products cause injury, death, or damage. Liability risks increase if a product
fails to meet these safety requirements. Both civil and criminal liability laws
exist: civil laws demand financial compensation, while criminal laws can
lead to fines or prison sentences. The United States has some of the most
extensive product liability laws, although many other Western countries
have strong regulations as well. In contrast, less developed countries often
have much weaker laws.
➢In the U.S., a surge in product liability lawsuits led to a sharp rise in
liability insurance costs, prompting business leaders to argue that this hurts
American companies that are competitiveness internationally. Moreover,
differences in product safety and liability laws across countries present
ethical challenges. When a firm's home country has stricter standards than a
foreign country where it operates, there is a question of whether the
company should uphold the higher home-country standards or follow the
more relaxed local ones. Ethically, companies should stick to their home
standards, yet some firms exploit weaker foreign laws to operate in ways
that would be prohibited at home.
Debate
• Why was corruption defined as the obstacle to society development ?
• Why do we need to protect the intellectual property ?
• Assume that you are FDI, What do you think about country in which
has higher corruption ?
Module 2.3: National
Differences
By Mr. Teth Chanveasna
Agenda
I. Introduction to National difference
II. Political systems of difference countries
III. Economic systems
IV. Regulation systems
V. Political economy
A. Differences in Economic Development
B. Political Economy and Economic Progress
C. States in Transition
D. The Nature of Economic Transformation
V. Political Economy
What is political economy ?

Political Economy treats of the wealth of nations; it inquires into the causes which make
one nation richer and more prosperous than another. It aims at teaching what should be
done in order that poor people may be as few as possible, and that everybody may, as a
general rule, be well paid for his work. Other sciences, no doubt, assist us in reaching the
same end. The science of mechanics shows how to obtain force, and how to use it in
working machines. Chemistry teaches how useful substances may be produced—how
beautiful dyes and odors and oils, for instance, may be extracted from the disagreeable
refuse of the gasworks. Astronomy is necessary for the navigation of the oceans. Geology
guides in the search for coal and metals. Therefore, Political economy show us how political
decision effect to economy policy and outcome of country.
A. Differences in Economic Development
Countries vary significantly in economic development, commonly measured by
economic development that is a country’s gross domestic product (GDP) per head of
population. GDP is regarded as a yardstick for the economic activity of a country; it
measures the total monetary or market value of all the finished goods and services
produced within a country’s borders in a specific time period. the GDP per capita of the
world’s nations in 2020. As can be seen, countries such as Japan, Sweden, Switzerland,
the United States, and Australia are among the richest on this measure, whereas the
large developing countries of China and India are significantly poorer. Sweden, for
example, had a 2020 GDP per capita of $51,926, but China achieved only $10,500 and
India just $1,900.
However, using purchasing power parity (PPP) adjusts for cost of living differences
and provides a more accurate comparison of living standards. For instance, China's
GDP per capita was $10,500 in 2020, but $17,312 when adjusted for PPP. Despite
low average incomes, India has a large middle class and a substantial shadow
economy informal, untaxed economic activity which may mean its actual economy
is much larger than reported. Economic growth trends reveal that emerging
economies like China and India are growing faster than many developed countries.
China has already become the world’s second-largest economy and may surpass the
U.S. in the near future, while India is projected to be among the largest economies
within 20 years, making them key markets for international businesses.
B. Political Economy and Economic Progress
While it's commonly believed that a country's economic development is influenced
by its economic and political systems and. The exact nature of this relationship is
complex and still debated. Though there's no definitive answer, the main arguments
can be examined, and some general patterns about how political economy relates to
economic progress can be identified.
➢ INNOVATION AND ENTREPRENEURSHIP ARE THE ENGINES OF GROWTH

Most economists agree that innovation and entrepreneurship are key drivers of long-
term economic growth. Innovation includes new products, processes, business
models, and strategies like Uber’s ride-hailing app or Amazon’s online retailing.
These innovations create new markets and increase productivity, fueling economic
expansion. Entrepreneurs play a vital role by commercializing innovations and
injecting energy into the economy. The success of U.S. firms like Apple, Google,
and Amazon shows how entrepreneurship and innovation together generate value
and growth. Therefore, a country must foster a business environment that
encourages both innovation and entrepreneurship to sustain economic progress.
➢ INNOVATION AND ENTREPRENEURSHIP REQUIRE A MARKET ECONOMY

To support innovation and entrepreneurship, a country needs a business environment that

promotes economic freedom and typically found in market economies. Market economies
encourage innovation by allowing individuals and businesses to profit from their ideas and
improvements. In contrast, planned economies limit these incentives, as the state controls
production and captures most gains, which often results in stagnation, as seen in former
communist states. Even mixed economies experienced similar issues in state-run sectors,
prompting widespread privatization. Studies confirm a strong link between economic
freedom and growth: countries with high economic freedom from 1975–1995 (e.g., Hong
Kong, U.S., Germany) enjoyed higher growth, while those with less freedom saw declines
in GDP.
➢ INNOVATION AND ENTREPRENEURSHIP REQUIRE STRONG PROPERTY
RIGHTS
Strong legal protection of property rights is essential for fostering innovation,
entrepreneurship, and economic growth. Without it, individuals and businesses risk having
their profits taken by criminals or corrupt governments, which reduces the incentive to
innovate. Nobel economist Douglass North highlighted how governments often expropriate
wealth, while Hernando de Soto emphasized that in many developing countries, the bigger
issue is the inability of people to establish legal ownership of property. Without legal titles,
the poor cannot use their assets as collateral to access credit and invest in businesses. De
Soto estimated that informal property in poor nations was worth over $9.3 trillion in 2000
an untapped source of capital. Some countries, like China, have acted on these insights by
strengthening private property rights to spur growth.
➢ THE REQUIRED POLITICAL SYSTEM

There is ongoing debate about which political system best supports a market economy and
strong property rights. While democracies are often linked to economic growth and secure
property rights, some non-democratic regimes—like China, Singapore, and South Korea—
have achieved rapid growth through disciplined governance and market reforms. However,
democracy does not always guarantee growth, as seen in India’s historically slow progress.
Still, totalitarian regimes carry risks: unless they are committed to market principles and
property rights, they often hinder growth and misuse power for personal gain. Over time,
democracies are more likely to ensure stable, long-term economic development, protect
freedoms, and support human progress, as argued by economist Amartya Sen.
➢ ECONOMIC PROGRESS BEGETS DEMOCRACY

Although democracy isn't always necessary for the initial development of a market
economy and protected property rights, economic growth often paves the way for
democratization. Countries like South Korea and Taiwan transitioned to more
democratic systems after sustained economic progress. This belief that prosperity
fosters democracy helps explain why many Western governments have tolerated
China's human rights violations. They hope that as China continues to develop its
market economy, political liberalization and greater individual freedoms will
eventually follow. However, whether this outcome will actually occur is still
uncertain.
➢ GEOGRAPHY, EDUCATION, DEMOGRAPHICS, AND ECONOMIC DEVELOPMENT

While political and economic systems are crucial to a country's economic

development, other factors also play important roles:
[Link]: As argued by Jeffrey Sachs, geography influences economic
development. Coastal and temperate countries tend to be more economically
successful due to easier access to trade and favorable conditions for population
density and productivity. In contrast, landlocked or tropical nations often face
physical and environmental challenges—like poor soil or high disease rates—that
can hinder growth.
[Link]: Investment in education leads to higher economic growth. A well-
educated population is more productive. The comparison between Pakistan and
South Korea in the 1960s highlights how early investment in education can lead to
significant economic divergence.
[Link]: A young, growing population contributes to economic growth due
to an increase in the labor supply and higher consumption. An aging population,
however, can lead to slower growth as fewer workers support more retirees.
Countries with aging populations, like Japan, face economic challenges due to low
birth rates. To address labor shortages, some countries, like Poland, have increased
immigration, though this may raise political challenges in some regions.
Module 3- The Global Monetary System

Lectured by Mr. TETH CHANVEANSA

Agenda
I. Introduction
II. The Foreign Exchange Market
III. The International Monetary System
IV. The Global Capital Market
[Link] Foreign Exchange Market
The significant impact of currency exchange rate fluctuations on international businesses, particularly
Thai exporters and importers. Because future exchange rates are difficult to predict, companies are
advised to hedge against potential adverse changes, though many remain unhedged. Unforeseen
global events—such as the 2016 U.S. election and the 2020 pandemic—demonstrate how
unpredictable factors can influence trade patterns and currency values. Therefore, this lecture has
three main goals:
✓ Explain how the foreign exchange market works.
✓ Explore the forces that determine exchange rates and the possibility of predicting them.
✓ Examine how exchange rate movements affect international businesses.
The foreign exchange market enables currency conversion essential for international trade and
investment. Exchange rate volatility poses risks to businesses, influencing pricing, sales, and profits.
Hedging through this market provides some protection, though not complete security. The chapter
also introduces key concepts like spot exchanges, forward exchanges, currency swaps, and discusses
non-convertible currencies and their business implications.
3.1.1. The function of The Foreign Exchange
Market
The foreign exchange market has two main functions:
❑Currency Conversion – It allows the exchange of one country’s
currency for another, enabling international trade and investment.
❑Risk Management – It provides a way to hedge against foreign
exchange risk, protecting businesses from unpredictable changes in
exchange rates.
 Currency Conversion
Each country uses its own currency, and international transactions require currency
conversion—handled through the foreign exchange market. For example, tourists
exchange money to make purchases abroad, while companies rely on this market for
various business needs. International businesses use the foreign exchange market for
four main purposes:
❑1. Currency Conversion for Receipts: Converting foreign income (e.g., export
earnings) into their home currency.
❑2. Payments in Foreign Currencies: Converting funds to pay suppliers or partners
in their respective local currencies.
❑3. Short-Term Investment: Investing excess cash in international markets to earn
higher interest rates.
❑4. Currency Speculation: Buying and selling currencies to profit from expected
changes in exchange rates—though this is risky.
An additional strategy is the carry trade, which involves borrowing in a low-interest
currency (e.g., yen) and investing in a high-interest currency (e.g., U.S. dollar).
While potentially profitable, it carries risks if exchange rates or interest rates move
Insuring Against Foreign Exchange
A major function of the foreign exchange (FX) market is to help firms
hedge against foreign exchange risk—the danger that currency value
changes will harm business profits. Key Concepts in Foreign Exchange
❑Spot Exchange Rate:
• An immediate currency exchange at current market rates.
• Rates fluctuate constantly based on supply and demand.
• Example: A tourist exchanging dollars for pounds at the current daily rate.
❑Forward Exchange Rate:
• A pre-agreed exchange rate for a future currency transaction.
• Helps businesses lock in costs/revenues and avoid losses due to exchange rate
shifts.
• Example: A U.S. importer agrees today to pay a Japanese supplier in yen in 30
days at a fixed rate, protecting against the dollar depreciating.
❑Forward Premium/Discount:
• If the future rate is worse for the buyer than the spot rate, the currency is at
a discount; if it’s better, it’s at a premium.
❑Currency Swaps:
• Simultaneous buying and selling of a currency for two different dates.
• Used to manage multiple currency flows and protect against future risk.
• Example: Apple pays a Japanese supplier in yen today and will receive yen in
90 days from a Japanese customer. It uses a swap to ensure it knows how
much those future yen will be worth in dollars.
• These tools—spot rates, forward contracts, and currency swaps—enable
businesses to manage currency risks in international transactions, but they
can also carry risks if the market moves unexpectedly.
3.1.2. The Nature of the Foreign Exchange Market
The foreign exchange (FX) market is a global, decentralized network of
banks, brokers, and dealers connected electronically. Most companies
use their banks to access the market rather than trading directly.
❑ Market Scale and Centers.
• The FX market has grown significantly: from $200 billion/day in 1986 to $6.6
trillion/day by 2019.
• Key trading centers: London (43%), New York (17%), and cities like Zurich,
Tokyo, Hong Kong, and Singapore.
• London dominates due to history and geography, acting as a link between
Asian and American markets.
❑Key Features of the Market
➢1. 24/7 Operation:
• The market never fully closes—trading moves across time zones with only a
brief global gap.

➢2. Integration:
• Global trading centers are tightly connected, allowing arbitrage opportunities
to be small and short-lived.

➢3. Dominance of the U.S. Dollar:

• The U.S. dollar is the main “vehicle currency”, involved in 88% of FX
transactions.
• Trades between two non-dollar currencies often pass through the dollar due to
liquidity and lower cost.
❑Exchange Rate Determinants
➢At a basic level, exchange rates are driven by supply and demand for each
currency.
➢However, this explanation is simplistic and doesn’t explain what drives
supply/demand shifts.
➢Key underlying factors influencing exchange rates include:
• 1. Relative price inflation
• 2. Interest rate differentials
• 3. Market psychology
➢Understanding these can help forecast exchange rate movements, which is vital
for international business planning, though predictions remain complex and
uncertain.
3.1.3. Economic Theories of Exchange Rate Determination
❑Exchange Rate Determinants
➢At a basic level, exchange rates are driven by supply and demand for each
currency.
➢However, this explanation is simplistic and doesn’t explain what drives
supply/demand shifts.
➢Key underlying factors influencing exchange rates include:
• 1. Relative price inflation
• 2. Interest rate differentials
• 3. Market psychology
➢Understanding these can help forecast exchange rate movements, which is vital
for international business planning, though predictions remain complex and
uncertain.
Price and Exchange Rate
To understand how prices are related to exchange rate movements, we
first need to discuss an economic proposition known as the law of one
price. Then we will discuss the theory of purchasing power parity (PPP),
which links changes in the exchange rate between two countries’
currencies to changes in the countries’ price levels.
The law of One price
❑The Law of One Price
Definition: In a competitive market with no transport costs or trade barriers,
identical products should sell for the same price when converted to a
common currency. Example:
➢Exchange rate: £1 = $2
➢Jacket in New York: $80
➢Jacket should sell for: £40 in London ($80 ÷ 2)

❑Arbitrage Opportunity
• Suppose jacket sells for £30 in London = $60.
• Trader buys in London and sells in New York for $80, earning $20 profit per jacket.
• This profit opportunity encourages:
✓ Higher demand in London, pushing prices up.
✓ Higher supply in New York, pushing prices down.
• This process continues until prices in both markets equalize (e.g., $70 in NY and £35
in London), eliminating the arbitrage opportunity.
Purchase Power Parity
➢Purchasing Power Parity (PPP) is an economic theory stating that in efficient
markets—those without trade barriers—the same goods should cost the same in
different countries when priced in a common currency. If the law of one price held
for all goods, the exchange rate between two currencies would equal the ratio of
the price levels of identical baskets of goods in each country. For example, if a
basket costs $200 in the U.S. and ¥20,000 in Japan, the PPP exchange rate would
be $1 = ¥100.
➢A simplified and practical illustration of PPP is The Economist's Big Mac Index,
which uses the price of a McDonald's Big Mac across countries to assess currency
valuation. If a Big Mac is cheaper in one country than in the U.S. (after adjusting
for the exchange rate), that country’s currency may be undervalued, and vice
versa. In 2020, this index suggested that the U.S. dollar was overvalued by 64%
against the Chinese yuan.
➢To express the PPP theory in symbols, let P$ be the U.S. dollar price of a basket of
particular goods and P¥ be the price of the same basket of goods in Japanese yen.
The PPP theory predicts that the dollar/yen exchange rate, E$/¥, should be
equivalent to:
E$/¥, =P$/P¥

➢PPP also predicts that exchange rates should adjust in response to changes in
relative price levels. For instance, if Japanese prices rise 10% while U.S. prices
remain stable, the yen should depreciate by 10% against the dollar—reflected in a
change from $1 = ¥100 to $1 = ¥110—so that purchasing power remains
equivalent.
Money Supply and Price Inflation
❑The Purchasing Power Parity (PPP) theory suggests that exchange rates adjust to
reflect changes in relative price levels between countries. If one country
experiences higher inflation than another, its currency is expected to depreciate
relative to the other country’s currency.
❑Inflation occurs when a country’s money supply grows faster than its economic
output. This surplus of money increases demand for goods and services, driving
prices up. Governments often expand the money supply to fund public spending
instead of raising taxes, but this typically results in inflation.
➢PPP theory connects inflation and exchange rate movements:
1. A country with high inflation sees its currency lose value.
2. The rate of money supply growth is a predictor of future inflation and currency depreciation.
3. Therefore, by analyzing a country’s monetary policies, international businesses can forecast
potential currency value changes.
❑A historical example is Bolivia in the mid-1980s, where the money supply grew
by over 17,000%, inflation soared by 22,900%, and the currency depreciated by
over 24,000%. This confirmed PPP theory in practice.

❑In contrast, when governments control money supply growth, they can stabilize
inflation and exchange rates. For instance, Bolivia brought inflation down to 16%
after introducing monetary reforms in 1985.

❑Modern examples like Venezuela (1 million percent inflation in 2018) and

concerns about U.S. quantitative easing illustrate ongoing relevance. Ultimately,

monetary policy is a key factor in determining inflation and exchange rate trends.
Interest Rate and Exchange Rates
➢Economic theory links interest rates, inflation, and exchange rates. According to
the Fisher effect, a country's nominal interest rate (i) equals the real interest rate (r)
plus the expected inflation rate (π):
i≈r+π
➢For instance, if inflation is expected to be 10% and the real rate is 5%, the nominal
rate would be about 15%. This relationship explains why countries with higher
expected inflation usually have higher interest rates.
➢In a global economy with free capital movement, real interest rates tend to
equalize across countries through arbitrage. If one country offers a higher real
interest rate, investors will move their capital there, eventually balancing out the
rates.
➢The International Fisher Effect (IFE) builds on this by connecting interest rate
differences to expected changes in exchange rates. It predicts that a currency in a
country with a higher nominal interest rate will depreciate relative to one with a
lower rate. For example, if U.S. interest rates are 10% and Japan’s are 6%, the
dollar is expected to depreciate by 4% against the yen.
➢However, like PPP theory, the IFE is more reliable for long-term trends. In the
short term, currency movements often deviate significantly due to other market
forces, making the IFE a weak short-term predictor.
Module 3-2 The Global Monetary System

Lectured by Mr. TETH CHANVEANSA

Agenda
I. Introduction
II. The Foreign Exchange Market
III. The International Monetary System
IV. The Global Capital Market
 3.2. The International Monetary System
The international monetary system, which governs how exchange rates are determined.
While major currencies like the U.S. dollar, euro, yen, and pound use a floating
exchange rate system—where market forces of supply and demand set currency
values—many developing countries use alternative systems.
Some countries use a pegged exchange rate, fixing their currency's value to a reference
currency like the U.S. dollar. Others adopt a managed or dirty float systems, where the
currency's value is mostly market-determined but the central bank intervenes to
stabilize it—such as with China’s yuan.
Additionally, some nations have used fixed exchange rate systems, agreeing to keep
currency values stable relative to each other. Though this approach collapsed globally
in 1973, it was used within systems like the European Monetary System (EMS).
In extreme cases, countries may adopt dollarization, replacing their currency entirely
with a foreign one (typically the U.S. dollar), as Ecuador did in 2000 and Venezuela
may consider, often in response to hyperinflation.
 3.2.1. The Gold Standard
The gold standard originated from the ancient use of gold coins as
money. As international trade grew, especially after the Industrial
Revolution, physically shipping gold became impractical. To address
this, countries began using paper currency backed by gold, agreeing to
convert it into gold at a fixed rate, making international transactions more
efficient.
 Mechanics of the gold standard
Pegging currencies to gold and guaranteeing convertibility is known as
the gold standard. By 1880, most of the world’s major trading
nationsincluding Great Britain, Germany, Japan, and the United States
had adopted the gold standard. Given a common gold standard, the
value of any currency in units of any other currency (the exchange rate)
was easy to determine.
❑For example, under the gold standard, 1 U.S. dollar was defined as equivalent
to 23.22 grains of “fine” (pure) gold. Thus, one could, in theory, demand that
the U.S. government convert that one dollar into 23.22 grains of gold. Because
there are 480 grains in an ounce, one ounce of gold costs $20.67 (480/23.22).
The amount of a currency needed to pur-chase one ounce of gold was referred
to as the gold par value. The British pound was valued at 113 grains of fine
gold. In other words, one ounce of gold costs £4.25 (480/113).
❑From the gold par values of pounds and dollars, we can calculate what the
exchange rate was for converting pounds into dollars; it was £1 = $4.87 (i.e.,
$20.67/£4.25).
Strength of the Gold Standard
The gold standard's main strength was its automatic mechanism for achieving
balance-of-trade equilibrium. If a country like Japan had a trade surplus with the
U.S., gold would flow from the U.S. to Japan. This would shrink the U.S. money
supply (lowering prices) and expand Japan’s money supply (raising prices),
shifting demand to U.S. goods and restoring trade balance. Because of its
simplicity and self-correcting nature, some still advocate for a return to the gold
standard today.
The Period between the wars 1918 -1939
➢The gold standard functioned effectively from the 1870s until World War I.
However, wartime inflation caused by governments printing money led to
its abandonment. After the war, countries like the U.S., Britain, and France
attempted to return to the gold standard. Britain reinstated the prewar gold
parity despite inflation, making its exports uncompetitive and triggering a
depression. A loss of confidence forced Britain to suspend gold
convertibility in 1931.
➢The U.S. also left the gold standard in 1933, returning a year later with a
devalued dollar by raising the price of gold, aiming to boost exports and
employment. Other countries followed suit, triggering a wave of
competitive devaluations, undermining the system. As confidence eroded
and countries rushed to convert currencies to gold, the system collapsed
entirely. By the outbreak of World War II in 1939, the gold standard was
effectively dead.
3.2.2. The Bretton Woods System
In 1944, representatives from 44 countries met in Bretton Woods, New Hampshire, to establish a new
international monetary system to promote postwar economic stability and growth. They favored fixed
exchange rates to avoid the competitive devaluations that had contributed to the Great Depression.
However, they recognized that the gold standard alone could not prevent such [Link]
conference led to the creation of two major institutions:
❑The International Monetary Fund (IMF): Tasked with maintaining stability in the international
monetary system.
❑The World Bank: Designed to promote economic development.
Under the Bretton Woods system, countries:
➢ Fixed their currencies to the U.S. dollar, which was the only currency convertible to gold at $35
per ounce.
➢ Maintained their currency values within 1% of their par value by intervening in currency markets.
➢ Could devalue their currency up to 10% without IMF approval if needed, but larger devaluations
required approval.
➢ This system aimed to create monetary stability without relying solely on gold and to discourage
harmful currency manipulation for trade advantage.
The Role of the IMF

The IMF Articles of Agreement were heavily influenced by the worldwide financial
collapse, competitive devaluations, trade wars, high unemployment, hyperinflation
in Germany and elsewhere, and general economic disintegration that occurred
between the two world wars. The aim of the Bretton Woods agreement, of which the
IMF was the main custodian, was to try to avoid a repetition of that chaos through a
combination of discipline and flexibility.
Discipline
A fixed exchange rate regime promotes economic discipline in two key
ways:
➢Prevents competitive devaluations, providing stability in global trade.
➢Controls inflation by limiting a country's ability to expand its money
supply.
• For example, if Great Britain printed too much money, it would cause
inflation, making exports less competitive and imports more attractive,
leading to a trade deficit. To fix this under a fixed exchange system,
Britain would need to reduce money supply growth, helping to restore
balance and control inflation
Flexibility
Although monetary discipline was a key goal of the Bretton Woods
agreement, its creators also recognized the need for flexibility to avoid
economic hardship like recession and high unemployment.
❑Two main features provided this flexibility:
➢IMF Lending Facilities:
➢The IMF could lend foreign currency to countries facing short-term balance-
of-payments deficits, helping them avoid sharp policy changes that might harm
employment.
➢These loans gave countries time to reduce inflation and correct imbalances
without immediate devaluation.
➢Small loans had minimal conditions, but larger loans required IMF oversight
of a country’s economic policies, such as controlling money supply and fiscal
discipline.
❑Adjustable Parities:
➢Countries could devalue their currency by more than 10% if they faced a
"fundamental disequilibrium", meaning a long-term negative shift in demand
for their exports.

➢This option helped countries avoid prolonged unemployment and trade deficits
by allowing for currency adjustments instead of waiting for internal price
levels to fall.

➢Thus, the system aimed to balance discipline with flexibility, preventing both
inflation and economic stagnation.
The Role of the World Bank
The official name of the World Bank is the International Bank for Reconstruction and
Development (IBRD). It was originally created to help rebuild Europe after WWII, but this
role was largely taken over by the Marshall Plan. As a result, the World Bank shifted its
focus to developing countries, funding infrastructure and later expanding into sectors like
agriculture, education, and urban development. The World Bank provides loans through two
main schemes:

❑IBRD Scheme:

➢Funds are raised through international bond sales.

➢Loans are given at a market-based interest rate, which is lower than commercial rates.

➢Aimed at developing countries with low credit ratings.

❑DA Scheme (established in 1960):
➢Funded by donations from wealthy nations (e.g., U.S., Japan, Germany).

➢Offers very low-interest or interest-free loans, repayable over up to 50 years.

➢Targets the poorest countries.

➢Thus, the World Bank shifted from post-war reconstruction to long-term

development aid, especially for the world's poorest nations.
Module 4-International Trade Theory

Lectured by Mr. TETH CHANVEANSA

Agenda
I. Introduction
II. Free Trade Concept
III. Classical Trade Theory
a. Mercantilism
b. Absolute Advantage
c. Comparative Advantage
d. Heckscher-Ohlin Theory
IV. New Trade Theory
a. Economic Scale
b. National Competitive Advantage
 I. Introduction to International Trade Theory
▪ Over the past 70 years, international trade has grown significantly, especially in physical
goods like semiconductor chips, and more recently in services such as finance,
entertainment, software, and education. Trade allows countries to specialize in what they do
best and benefit economically through increased efficiency—a concept known as the gains
from trade.

▪ For decades, advanced economies like the U.S., UK, Germany, and Japan supported free
trade, leading to reduced trade barriers and a global system overseen by the World Trade
Organization (WTO). However, since 2017, the U.S., under President Trump, began
shifting from free trade to managed trade, where trade is directed by government deals and
restrictions. This included trade agreements with China and limits on Chinese access to
American tech.
▪ This policy shift—especially between the world’s two largest economies, the U.S.
and China—has disrupted global trade, raised costs, hurt supply chains, and
potentially slowed economic growth. While the Trump administration argued this
would bring long-term benefits, most economists saw reduced gains from trade.

▪ To understand these impacts fully, this lecture focuses on trade theory and the
global trading system, trade policy management, foreign direct investment, and
regional trade blocs like the EU and USMCA. Together, they aim to provide a
comprehensive understanding of international trade and investment.
 II. Free Trade Concept

Free trade refers to a situation in which a government does not attempt to influence through
quotas or tariffs what its citizens can buy from another country or what they can produce and
sell to another country. Smith argued that the invisible hand of the market mechanism, rather
than government policy, should determine what a country imports and what it exports. His
arguments imply that such a laissez-faire stance toward trade was in the best interests of a
country. Building on Smith’s work are two additional theories that we review, Absolute
advantage theory. One is the theory of comparative advantage, advanced by the nineteenth-
century English economist David Ricardo. This theory is the intellectual basis of the modern
argument for unrestricted free trade. In the twentieth century, Ricardo’s work was refined by
two Swedish economists, Eli Heckscher and Bertil Ohlin, whose theory is known as the
Heckscher–Ohlin theory.
 III. Classical Trade Theory
❑Mercantilism
Mercantilism, the first theory of international trade, emerged in 16th-century England. It
held that national wealth and power depended on accumulating gold and silver, which could
be achieved by exporting more than importing—a trade surplus.

Mercantilists believed governments should intervene in the economy to maximize exports

(through subsidies) and limit imports (via tariffs and quotas). The idea was to treat trade as
a zero-sum game, where one country's gain is another's loss.

David Hume criticized this view in 1752. He argued that trade surpluses lead to inflation in
the exporting country and deflation in the importing one, eventually balancing trade and
making long-term surpluses unsustainable.
Adam Smith and David Ricardo later showed that trade is a positive-sum game,
where all countries can benefit.
Though outdated, neo-mercantilist ideas still influence modern policy. For instance,
critics claim China kept its currency undervalued to boost exports and accumulate
trade surpluses, a strategy sometimes echoed by leaders like Donald Trump.
Absolute Advantage
In The Wealth of Nations (1776), Adam Smith challenged the mercantilist view that trade is
a zero-sum game. He introduced the idea of absolute advantage, where countries should
specialize in producing goods they can make more efficiently than others and trade for
goods they are less efficient at producing. A country has an absolute advantage if it can
produce a good using fewer resources than another country.
Example: England was better at making textiles; France was better at making wine. Each
should specialize and trade for mutual gain. Illustration with Ghana and South Korea:
▪ Ghana is more efficient at producing cocoa.
▪ South Korea is more efficient at producing rice.
▪ If both countries specialize in their areas of advantage and trade, total production
increases:
▪ Cocoa: from 12.5 tons to 20 tons
▪ Rice: from 15 tons to 20 tons
Gains from Trade:
▪ Ghana gains more cocoa and rice than before:
✓14 tons of cocoa (vs. 10)
✓6 tons of rice (vs. 5)
▪ South Korea also gains more:
✓6 tons of cocoa (vs. 2.5)
✓14 tons of rice (vs. 10)

Trade based on absolute advantage leads to greater total output and consumption in
all countries. It is a positive-sum game, where everyone benefits.
Comparative Advantage
David Ricardo expanded on Adam Smith’s theory by introducing the concept of
comparative advantage in his 1817 book Principles of Political Economy. He showed that
even if a country has an absolute advantage in all goods, it can still benefit from trade by
specializing in goods it produces most efficiently relative to others. Key Concepts:

▪ Absolute advantage: Producing a good using fewer resources than others.

▪ Comparative advantage: Producing a good at a lower opportunity cost than others.

▪ Even a country that is better at producing everything (like Ghana in this example) still
gains from trade by focusing on what it is best at compared to the other good.
Example – Ghana vs. South Korea:
▪ Ghana is more efficient in producing both cocoa and rice.
▪ However:
▪ Ghana is 4x more efficient in cocoa.
▪ Only 1.5x more efficient in rice.
So, Ghana has a comparative advantage in cocoa, and South Korea
has a comparative advantage in rice.
Production Without Trade:
▪ Ghana: 10 tons cocoa + 7.5 tons rice
▪ South Korea: 2.5 tons cocoa + 5 tons rice
▪ Total: 12.5 tons of cocoa and 12.5 tons of rice
With Specialization and Trade, both countries specialize based on comparative
advantage. They produce more overall and consume more of both goods than
without trade. Even when one country is better at producing everything,
comparative advantage shows that mutual gains from trade are still possible. Trade
allows countries to increase total output and enjoy more goods, making it a positive-

sum game.
Ricardo’s Theory of Comparative Advantage

▪ Focus: Differences in labor productivity across nations.

▪ A country has a comparative advantage if it can produce a good more efficiently

(with fewer resources) than another country relative to other goods.

▪ Trade patterns arise from differences in productivity, not resources.

Example: Ghana vs. South Korea — Ghana is more productive in cocoa, so it

should specialize and trade, even if it’s better at producing both cocoa and rice.
Heckscher–Ohlin Theory
Developed by Eli Heckscher (1919) and Bertil Ohlin (1933).
Focus: Differences in factor endowments — land, labor, capital.
A country will export goods that use its abundant resources intensively, and import
goods that use its scarce resources.
➢Example:
▪ U.S. exports agriculture → abundant arable land
▪ China exports labor-intensive goods → abundant cheap labor
➢Key Difference Between Theories
▪ Aspect Ricardo’s Theory Heckscher–Ohlin Theory
▪ Trade Basis Labor productivity Resource (factor) abundance
➢Key Advantage Type Comparative productivity Relative factor endowments
▪ Assumption Technology varies by country Technology is the same across
countries.
▪ Example Explanation Who’s more efficient Who has more of a resource
➢Both theories support the benefits of free trade, but explain why countries trade
differently:
▪ Ricardo: Trade is driven by how productive countries are.
▪ H–O: Trade is driven by what resources countries have in abundance.
IV. New Trade Theory
➢The new trade theory began to emerge in the 1970s when a number of economists
pointed out that the ability of firms to attain economies of scale might have
important implications for international trade.

➢Economies of scale are unit cost reductions associated with a large scale of output.
Economies of scale have a number of sources, including the ability to spread fixed
costs over a large volume and the ability of large-volume producers to utilize
specialized employees and equipment that are more productive than less
specialized employees and equipment.

➢ Economies of scale are a major source of cost reductions in many industries, from
computer software to automobiles and from pharmaceuticals to aerospace.
New Trade Theory (Cont)
New Trade Theory (1970s) explains that economies of scale—cost advantages from
large-scale production—can shape international trade.
• Key Points:
• Economies of scale lower production costs by spreading fixed costs and using
specialized labor and equipment.
• Trade increases product variety for consumers and lowers average prices.
• In some industries (e.g., cars, software), only a few firms can exist globally
due to high production scale needs.
• First-mover advantage helps firms and countries dominate trade in certain
products.
• Example:
Microsoft spreads the cost of Windows development across billions of PCs; car
companies benefit from high-volume specialized production.