LECTURE 4 : INTERNATIONAL TRADE AND
INVESTMENT THEORIES (continue)
Theories of trade, investment and
internationalisation
1
Learning objectives
• To understand why nations trade with each other—
benefits of trade.
• To understand the theories explaining trade flows
between nations.
• To understand the theories of internationalisation of
the firm.
• To be familiar with the arguments of those who
maintain that government can play a proactive role in
promoting national competitive advantage in certain
industries.
• To examine the reasons for rapid internationalisation/
born globals.
Introduction
CONTEMPORARY TRADE THEORIES (COUNTRY
LEVEL)
- New Trade Theory
- National Industrial Policy
- Compative Advantage of Nations (Porters
Diamond Model)
New trade theory
• New trade theory suggests that because of
economies of scale (unit cost reductions
associated with a large scale of output) and
increasing returns to specialisation, in some
industries there are likely to be only a few
profitable firms.
• Firms with first-mover advantages (the
economic and strategic advantages that
accrue to early entrants into an industry)
will develop economies of scale and create
barriers to entry for other firms. continued
New trade theory
• New trade theory:
– Increases product variety and reduces costs.
– Economies of scale, first-mover advantages and
the pattern of trade.
– The pattern of trade we observe in the world
economy may be the result of:
• first-mover advantages
• economies of scale.
AIRBUS S.A.S. 2006 ©
continued
New trade theory
Implications of new trade theory
– A country may predominate in the export of a good
simply because it was lucky enough to have one or
more firms among the first to produce that good.
– While this is at variance with the Heckscher-Ohlin
theory, it does not contradict comparative
advantage theory, and identifies a source of
comparative advantage.
– Governments should consider strategic trade
policies that nurture and protect firms and
industries where first-mover advantages and
economies of scale are important.
National Industrial Policy
• Proactive economic development plan
implemented by the public sector to nurture or
support promising industry sectors with potential
for regional or global dominance. Public sector
initiatives can include:
• Tax incentives
• Monetary and fiscal policies
• Rigorous educational systems
• Investment in national infrastructure
• Strong legal and regulatory systems
7
Strategic Trade Theory
• This suggests that strategic intervention by governments in
certain industries can enhance their odds for international
success.
How did strategic
trade policy
contribute to the
creation of the
Airbus A380?
National competitive advantage:
Porter’s diamond
• Porter’s 1990 study tried to explain why a
nation achieves international success in a
particular industry and identified four
attributes that promote or impede the
creation of competitive advantage.
continued
Government Subsidy
Strategic trade
theorists do not
advocate a
mercantilist policy
to promote all
industries.
They propose to
help a few
strategically
important ones.
National Industrial Policy: Ireland as an Example
Beginning in the 1980s, the Irish government
implemented a series of pro-business policies to
build strong economic sectors. The “Irish Miracle”
resulted from:
• Fiscal, monetary, and tax consolidation
• Partnership with the industry and unions
• Emphasis on high-value adding industries such as
pharma, biotechnology, and IT
• Membership in the European Union; subsidies and
investment received from the EU
• Investment in education
11
National competitive advantage: Porter’s
diamond
Porter’s diamond of competitive advantage
Figure 2.5 Determinants of national competitive advantage: Porter’s diamond
SOURCE: Reprinted by permission of the Harvard Business Review. ‘The competitive advantage of nations’ by Michael E.
Porter, March–April 1990, p. 77. Copyright © 1990 by The President and Fellows of Harvard College. All rights reserved. continued
Michael Porter’s Diamond Model:
Sources of National Competitive Advantage
1. Firm strategy, structure, and rivalry – the presence of
strong competitors at home serves as a national
competitive advantage
2. Factor conditions – labor, natural resources, capital,
technology, entrepreneurship, and know how
3. Demand conditions at home – the strengths and
sophistication of customer demand
4. Related and supporting industries – availability of
clusters of suppliers and complementary firms with
distinctive competences
13
National competitive advantage of
industries
Resource endownments : paper industry flourishing in scandinavia due to a lot of forest. High tech
clusters are developing around university cities(cambridge and munich) because of readily available
scientists and graduates.
Demand condition
Tough domestic demand can propel firms to scale new heights. In Japan, consumers demand novel
technology and high standards of quality.
Related and supporting industries
Europe’s long history and excellence in a series of crucial related and supporting industries made it
possible for airbus to succeed.
Strategy, structure and rivalry
E.g: Puma and Adidas – both hail from Herzogenaurach, small town in Germany
Another example is the Japanese electronics industry driven by domestic rivalry that is probably
most intense –rivalry leads to innovation
WHY AND HOW DO FIRM’S INTERNATIONALISE
(FIRM LEVEL EXPLANATION)?
- INTERNATIONALISATION PROCESS OF FIRMS
(UPPSALA MODEL)(STAGE THEORY)
- INNOVATION MODEL (I MODEL)
- BORN GLOBAL PHENOMENON
FIRM LEVEL EXPLANATION
Why and How Firms Internationalize?
• The internationalization process model of the
firm suggests a gradual, evolutionary path to
internationalization
• The slow and incremental nature of
internationalization by the firm results from the
uncertainty and uneasiness that managers have
about cross-border transactions
• A predictable pattern of internationalization may
include the following stages: domestic focus, pre-
export stage, experimental involvement, active
involvement, and committed involvement
16
Uppsala stage model (U model)
• Firms internationalise for gradual and
increased involvement and commitment in
international operations
• To integrate processes and efficiently use
knowledge of foreign markets.
• A study of four Swedish firms
(Johanson & Vahlne, 1977)
The Internationalisation Process
• The stage model of internationalisation
1. The Uppsala internationalisation model
(U-model)-stage model
1. Innovation-related internationalisation
model (I- model)
Cavusgil, 1980
Johanson & Vahlne, 1977
Welch & Luostarinen, 1988
Uppsala Model –U model (stage
model)
• International expansion is influenced strongly by managerial
learning
• Internationalization begins with low risk indirect exporting to
psychically or culturally close or similar markets.
• Over time and through experience, a firm’s foreign market
knowledge improves and, consequently, it increases its
foreign market commitment and expands to more psychically
distant markets.
Johanson & Vahlne, 1977
Stage Model
U-Model
• Johanson and Wiedersheim-Paul (1975) distinguished four
level of international market entry :
Stage 1: no export activities
Stage 2: export via an independent representative or agent
Stage 3: the establishment of an overseas sales subsidiary
Stage 4: the installation of overseas production or
manufacturing units.
Core Assumption of the Model is that Increased Market Knowledge
will lead to increased market commitment
Market Commitment
Knowledge Decision
Market Current
Commitment Activities
understandi
knowledge,
Enhances
improves
cultural
ng
I Model – Innovation-related Model
• considers internationalization as an
innovation for the firm.
• Internationalization is an innovative
process because it requires a proactive
approach, which implies a favorable
attitude toward international expansion
(Reid, 1981)
I-Model
Stage 1
Export awareness: problem of opportunity recognition, arousal of need
Stage 2
Export intention: motivation, attitude, beliefs and expectancy about
export
Stage 3
Export trial: personal experience from limited exporting
Stage 4
Export evaluation: results from engaging in exporting
Stage 5
Export acceptance: adoption of exporting/rejection of exporting
Born Global Firms and International Entrepreneurship
• The slow, gradual internationalization predicted by
the process model is no longer practical or realistic
in today’s fast-paced, interconnected economy.
• Today many firms, even those that are young or
without much experience, take bold steps to
internationalize
• Indicative of this trend is the emergence of Born
Global companies – young, entrepreneurial firms
that take on internationalization early in their
evolution and leapfrog into global markets
24
Born Global
• Internationalisation because of technological
advances in transportation, communication,
and computers permit entrepreneurial actors
to form new ventures that internationalize
rapidly.
Types
Knight & Cavusgil, 1996
1. International new ventures McDougall, Shane, & Oviatt, 1994
2. Global start ups
3. Instant exporters
Characteristics of Born Global Firms
• Highly active in international markets from inception
• Characterized by limited financial and tangible resources
• Found Across most industries
• Managers have strong international outlook and international
entrepreneurial orientation
• Often emphasize differentiation strategy
• Often emphasize superior product quality
• Leverage advanced communications and information technologies
• Typically use external, independent intermediaries for distribution in
foreign markets.
Cavusgil & Knight, 2009
FOREIGN DIRECT INVETSMENT THEORIES
- INTERNALISATION THEORY
- DUNNING’S ECLECTIC PARADIGM
- INSTITUTIONAL THEORY
How Firms can Gain and Sustain
International Competitive Advantage ?
• Since the MNE has traditionally been the
major player in international business, many
scholars have offered explanations of what
makes these firms pursue, and succeed in,
internationalization
• FDI has been the principal strategy used by
MNEs in international expansion; therefore,
earlier theoretical explanations relate to
motives for, and patterns of, foreign direct
investment
28
Foreign direct investment (FDI) in the world
economy
Why foreign direct investment?
– Firms could choose exporting or licensing.
– Foreign direct investment can be expensive and
risky.
– Firms can seek new markets and resources.
– Firms can improve efficiency by moving to
countries that offer cost-related advantages,
investment incentives or science and industrial
parks.
– Firms can seek ‘strategic assets’ by investing in local
firms to gain access to distribution networks, gain
local knowledge and other ownership advantages.
continued
Foreign direct investment (FDI) in the world
economy
• FDI theories explain:
– Why a firm will favour direct investment as a
means of entering a foreign market when two
other alternatives are possible (exporting and
licensing).
– Why firms in the same industry often undertake
foreign direct investment at the same time.
– Why certain locations are favoured over others
as targets for foreign direct investment.
continued
Foreign direct investment (FDI) in the world
economy
Internalisation theory
– Internalisation theory seeks to explain why
firms often prefer foreign direct investment
over licensing as a strategy for entering foreign
markets.
– When market imperfections are making
transactions less efficient a company may
undertake FDI.
– Market imperfections include trade barriers and
the protection of specialised knowledge.
continued
Foreign direct investment (FDI) in the world
economy
Internalisation theory
– Limitations of exporting
• The viability of an exporting strategy is often
constrained by transportation costs and trade
barriers.
• When transportation costs are added to production
costs, it becomes unprofitable to ship some products
over a large distance.
• Some foreign direct investment is undertaken as a
response to actual or threatened trade barriers such
as import tariffs or quotas.
continued
Foreign direct investment (FDI) in the world
economy
Internalisation theory
– Limitations of licensing
• Licensing gives away valuable technological know-
how to a potential foreign competitor.
• Licensing does not give a firm the tight control over
manufacturing, marketing and strategy in a foreign
country that may be required to maximise its
profitability.
• Capabilities are often not amenable to licensing.
continued
Foreign direct investment (FDI) in the world
economy
Advantages of foreign direct investment
– FDI is an alternative way of entering into foreign
markets when transportation costs or trade
barriers make exporting unattractive.
– A firm will favour FDI when it wishes to
maintain control over technological know-how
or over its operations and business strategy, or
when its capabilities are simply not amenable
to licensing, as may often be the case.
continued
Foreign direct investment (FDI) in the world
economy
The eclectic paradigm
– The eclectic paradigm: John Dunning.
– Dunning’s eclectic paradigm explains the
rationale and direction of FDI:
• ownership advantages
• internalisation advantages
• location-specific advantages.