Master of Interna,onal Management

Dirk Boehe
[email protected]
Managing International Trade

abs.um6p.ma
Managing Interna+onal Trade – An Overview

I. Trade Theories

III. Foreign Exchange, Managing

II. Export Market Selec=on
Trade Risk, &Trade International & Intern=onal Marke=ng
Financing Trade

IV. Managing The Global

Value Chain

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Benefits from International Trade
 1. Gravity Model
I.
Interna+onal Trade 2. Benefits from Trade

3. Trade Barriers, WTO,

& managing trade disputes

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 Absolute

Source: Hill, C. & Hult, T. (2019). Interna;onal Business – Compe;ng in the Global Marketplace. 12th Ed. Chapter 6
Advantage

A
B

Ghana (red), Korea (green): 200 resources.

Ghana needs 10 resources to produce 1t of
Cocoa, 20 resources to produce 1t of rice

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What if one country has an absolute advantage in all

Source: Hill, C. & Hult, T. (2019). International Business – Competing in the Global Marketplace. 12th Ed. Chapter 6
products?
Should this country (here Ghana in red) still
trade at all?
Adam Smith: No!
David Ricardo: Yes!

Here, Ghana has an absolute advantage in

both rice and cocoa, this is it needs fewer
resources than South Korea for both products:
Cocoa: 10 resources à max. production = 20t
Rice: 13.33 resources à max production = 15t

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 Absolute and

Source: Hill, C. & Hult, T. (2019). International Business – Competing in the Global Marketplace. 12th Ed. Chapter 6
Comparative
Advantage
A
B

Here, Ghana (red) has an

absolute advantage in both cocoa &
rice, and a comparative advantage
in cocoa, but not in rice.

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 Comparative vs Absolute Advantage

Cars Wool
Australia 30 20
Mexico 10 15

This table reflects labor required, measured in units of input (e.g., hours) per product
unit.
QuesEons:
1. Which country has an absolute advantage in which products?
2. Which country has a comparaEve advantage in which products?
3. Which trade flows (from-to) do you predict?
4. What are the costs and benefits of trade in this case?
5. On which assumpEons is this example based?
 Comparative vs Absolute Advantage

Wood products Dairy

China 40 20
Ireland 24 16
This table reflects labor productivity, measured in units of output per time period (e.g., hour,
day, year).
Questions:
1. Which country has an absolute advantage in which products?
2. Which country has a comparative advantage in which products?
3. Which trade flows (from-to) do you predict based on the theory of the absolute
advantage?
4. Which trade flows (from-to) do you predict based on the theory of the comparative
advantage?
5. What are the costs and benefits of trade in this case?
6. On which assumptions is this example based?
 Comparative Advantage This table reflects labor productivity,
measured in units of output per time
period (e.g., hour, day, year).
Dairy
Questions:
1. Which country has an absolute
(Produc(vity = Output / Input) advantage in which products?
2. Which country has a comparative
advantage in which products?
3. Which trade flows (from-to) do
20 you predict based on the theory of
x 1.25 the absolute advantage?
16 4. Which trade flows (from-to) do
you predict based on the theory of
the comparative advantage?
5. What are the costs and benefits of
trade in this case?
Wood 6. On which assumptions is this
24 40 example based?
x 1.7
Assumptions of this simple trade model?

• 2 countries
• 2 products
• Prices remain the same
• Ignore currency exchange rates
• No profits
• No transport costs
• No tariffs (or other trade barriers)
• Frictionless shifting of resources from one industry to another
• No economies of scale
• A countries resource endowment remains constant

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Let’s formalize these relationships a little bit…

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Countries specialize in those products in which they
have a comparative advantage
Why do countries trade?
• Productivity (à also explains why firms trade!)
• Benefits from economies of scale (à also explains why firms trade!)

Opportunity costs
Value (opportunity) given up when producing product A, compared to producing product B.
Countries specialize in those products in which they have the lowest opportunity costs.

Benefits from trade

Trade increases production (output) in the world by taking advantage of productivity advantages
in different locations.
Therefore, living standards rise in the locations that trade with each other.

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NOTE: Trade-offs … or Dilemmas

• The production possibilities frontier constitutes a trade-off.

• If a country wants to increase the production of product A (e.g.,
wine), it has to renounce on the another product B (e.g, cheese).
• Trade-offs are typical for all sorts of important strategic decisions.
• e.g., given limited resources, to increase a firm’s share in one market
through advertising expenditure, it may have to reduce its
advertising expenditure in another market.
• We will therefore come back to trade-offs or dilemmas, when we
discuss some case studies.

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 Source: Krugman, P., ObsMeld, M., Melitz, M. (2018) Interna;onal Economics – Theory & Policy, 11th Ed., Chapter 3
aLW = 500
aLC = 1000
labor used for cheese
production aLC /aLW = 2

Production possibility
frontier

L = total labor supply

labor used for wine

producEon

Opportunity costs of
cheese in terms of wine:

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Numerical Example

L (total labor supply) = 1000h

aLW (labor requirement for 1 gallon of wine) = 2h
aLC (labor requirement for 1 pound of cheese) = 1h
è max. wine production =
L/aLW = 1000h/2h = 500 gallons of wine
è max. cheese production =
L/aLC = 1000h/1h = 1000 pounds of cheese
è Production Possiblity Frontier
è Opportunity costs of cheese in terms of wine =
aLC/ aLW = ½ = | slope of PF |

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Let’s add relative prices now…

• Relative prices = price of one good (e.g., cheese) in terms of another good (e.g., wine)
• Relative prices differ across countries
• Supply of goods depend on its relative prices because labor will migrate to those sectors
that pay higher wages.

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 Source: Krugman, P., Obstfeld, M., Melitz, M. (2018) International Economics – Theory & Policy, 11th Ed., Chapter 3
Relative prices determine the specialization of an
economy. How much would the
price for cheese have to
Price for 1 unit (1 pound) of cheese : $4 fall or the price of wine
Price for 1 unit (1 gallon) of wine : $7 to rise, for the economy
to specialize in wine
Opportunity costs of cheese in terms of wine: ½ (| slope of PPF line | )
(1 h è 1 pound of cheese or 1/2 gallon of wine) produc8on?
• Hence, 1h of labor è income of $4 if 1 unit of cheese is produced,
vs $3.5 if 1 unit of wine is produced
• Therefore, this economy will specialize in cheese.
The economy will specialize in the
production of cheese if the relative price
PC / aLC > PW / aLW Economy specializes in …. à Cheese
of cheese exceeds its opportunity cost in
PC / aLC < PW / aLW Economy specializes in …. à Wine terms of wine; it will specialize in the
production of wine if the relative price of
cheese is less than its opportunity cost in
= $4/ 1h > $3.5 / 1h è economy specializes in cheese terms of wine.

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 Source: Krugman, P., ObsMeld, M., Melitz, M. (2018) Interna;onal Economics – Theory & Policy, 11th Ed., Chapter 3
Let’s add wages now…
Making the unrealistic assumption that there are no profits, we get
§ hourly wage in the cheese industry : PC / aLC
§ hourly wage in the wine industry : PW / aLW

However, wages depend on productivity, so

If PC / PW > aLC / aLW
è wages become higher in the cheese industry (because relative prices of cheese/wine are higher than the
relative productivity cheese / wine)
If PC / PW < aLC / aLW
è wages become higher in the wine industry

An economy specializes in the industry with the highest wages.

“The economy will specialize in the production of cheese if the relative price of cheese exceeds its opportunity cost in
terms of wine; it will specialize in the production of wine if the relative price of cheese is less than its opportunity cost
in terms of wine.”

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Exercise: Determining Production Location Based on
Productivity and Comparative Advantage
Consider two countries, Country A and Country B. They can produce two goods: Cars and Computers. Labor is the
only factor of production, and it takes 10 hours of labor to produce a car and 5 hours of labor to produce a computer in
both countries.
• In Country A, the cost of 1 hour of labor is $20.
• In Country B, the cost of 1 hour of labor is $10.
Questions:
1. Calculate the opportunity cost of producing 1 car in terms of computers for both countries.
2. Based on the opportunity costs calculated in question 1, which country has a comparative advantage in producing
cars, and which country has a comparative advantage in producing computers?
3. Calculate the relative price of cars in terms of computers for both countries. (Hint: Relative price = Opportunity
cost of the good on the y-axis / Opportunity cost of the good on the x-axis)
4. Based on the relative prices calculated in question 3, in which country would it be more efficient to produce cars,
and in which country would it be more efficient to produce computers?
5. Discuss the implications of these findings for international trade between Country A and Country B. Which goods
should each country specialize in, and why?

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Let’s now compare two countries…

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 Source: Krugman, P., Obstfeld, M., Melitz, M. (2018) International Economics – Theory & Policy, 11th Ed., Chapter 3
Countries specialize in those products where their relative
productivity is higher than in a foreign country.

The ratio of labor required to produce cheese to that of producing wine is lower in the home
country compared to the foreign (*) country:

The home country’s relative productivity is higher in cheese – where it has a comparative
advantage...
If aLC < a*LC
…the home country has an absolute advantage.

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 Source: Krugman, P., ObsMeld, M., Melitz, M. (2018) Interna;onal Economics – Theory & Policy, 11th Ed., Chapter 3
The slope of Foreign’s Production Possibility Frontier is
steeper because Foreign’s opportunity costs of cheese in
terms of wine is higher than that of Home:

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 Source: Krugman, P., Obstfeld, M., Melitz, M. (2018) International Economics – Theory & Policy, 11th Ed., Chapter 3
Numerical Example

L/ aLC = 1000 h/ 1000 pounds =1h L/ a*LC = 1000 h/ 500 pounds = 2h

L/ aLW = 1000 h / 500 gallons = 2h L/ a*LW = 1000 h/ 1000 gallons = 1h

aLC /aLW = ½ a*LC /a*LW = 2

Home country’s rela6ve labor requirement of cheese/wine is lower than that of Foreign.* 24
Some more exercises…

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 1. Under what conditions leather would be

Helpman E. Understanding Global Trade. [Electronic Resource]. Cambridge, Mass. : Belknap Press of Harvard University Press, 2011.
produced in England (instead of
Portugal)?
2. In a world of only these four products,
under what conditions would Portugal
have an absolute advantage?

Comparative advantage
depends on labor
requirements AND
relative costs!
 è Multiply the country- and industry-specific labor

Helpman E. Understanding Global Trade. [Electronic Resource]. Cambridge, Mass. : Belknap Press of Harvard University Press, 2011.
requirement by the country- and industry-specific labor costs!

Portugal England
Labor
(wages) and
Labor costs 30 10
specializatio Labor requirement
n – example
(leather) 1 2.5
Total labor costs 30 25

= As long as Portugal’s labor costs > 2.5 x England’s labor costs,

leather will be produced in England!
 Helpman E. Understanding Global Trade. [Electronic Resource]. Cambridge, Mass. : Belknap Press of Harvard University Press, 2011.
Under what conditions would wood be produced in England
(instead of Portugal)?
Short answer… it depends on the unit cost ratio…

Producing leather in
England would be
25% more expensive
than producing
1.25 leather in Portugal
1
0.83
Producing wood in
“1”- unit costs England would be
would be the same 17% less expensive
in England and in than producing wood
Portugal in Portugal
How does production factor availability affect trade?

Production factors
• Capital
• Labor
• Land

Availability of production factors à prices

e.g., availability of labor > availability of capital à price of labor drops relative to the
price of capital
If the price of labor drops relative to the price of capital
à country produces more labor intensive goods at lower prices
Hence, such a country specializes on labor intensive goods.

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 Free trade promotes…
1. More efficient use of resources (compared to
mercantilism)
2. Higher production
3. Higher domestic consumption
4. Wages, trade and economic specialization are
interdependent.
5. Trade and industrial specialization determine
Summary relative prices (such as wages).
6. Trade reduces disparities in relative prices across
countries.
7. Because relative prices converge over time,
countries specialize in products for which their
labor requirements are lower.
All this is important to understand productivity
differences across countries.
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 ➡ ⌛ 10 minutes

1⃣ Your Technopolis-based company needs to import

components from suppliers based in three possible
countries, France, Ireland or Canada. As resilience
against supply and demand shocks and price
Exercise: which compe??veness are also key to your long-term
supplier country is success, you intend to look first at countries with high
manufacturing produc?vity.
more compe44ve?
2⃣ Evaluate data on manufacru?ng produc?vity for those
countries. Determine which country likely has
produc?vity advantages and explain why.

Hint: have a look at OECD databases….

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 Source: Ghemawat, P. , Hout, T., Siegel, J. Haier’s US refrigerator strategy, HBS Case # 9-705-476.
Practical Application –
Labor Costs & Productivity

Haier has to make a choice

between manufacturing
locations – China or Mexico –
for low-end refrigerators.
Which manufacturing location
results in higher profits for
exports to the USA?
 Your newly established trading company would like
to help Moroccan firms to export to some countries
in the Middle East. However, you are unsure which
Morocco’s products you should focus on. So, pick some
compara4ve Moroccan products (other than phosphate rock or
advantages ferHlizers) and determine whether and why they
may or may not enjoy a comparaHve advantage in a
Middle Eastern country of your choice.

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Debates & Extensions
Does trade lead to diminishing or increasing returns from
trade? …is there a link between trade and growth?

Diminishing returns to trade

To the extent that an economy increases specialization, costs rise because it becomes
increasingly difficult to obtain highly productive labor, land, or capital.

Increasing returns [“New Trade Theory”]

Economies of scale by combining domestic and foreign market sizes
à reduce costs
à Increase variety
Source: Hanson, G. H. (2012). The rise of middle kingdoms: Emerging economies in global trade. Journal of
Economic Perspectives, 26(2), 41-64.
36
you find surprising?

explain them, using

trade over time do
Which changes in

How would you

trade theories?
Analysis

Why?
Source: Hanson, G. H. (2012). The rise of middle kingdoms: Emerging economies in global trade.
Journal of Economic Perspectives, 26(2), 41-64.
37
South (e.g., rare
exporters in the
have increased
China (& India)

materials from
their demand

earth metals
from African
commodity

countries)
for raw
 Economic Perspectives, 26(2), 41-64.
Source: Hanson, G. H. (2012). The rise of middle kingdoms: Emerging economies in global trade. Journal of
Drivers of increasing South–South Trade

Ø Falling trade costs

Ø WTO membership
Ø Transport
Ø Integration into Global Value Chains (GVCs)
Ø Double counting in manufacturing networks
Ø Comparative Advantage à specialization
Ø Industrial policy (e.g., China)
Ø Positive externalities (information spillovers, synergies among firms within an industry)
Ø Demand for commodities from manufacturing hubs in the south
(e.g., China, India, Vietnam)

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LEARN, DARE & CARE