Topic 2 Theory of International Trade

Regional Economic Integration

When discussing International Business there are some factors that students have to be aware of and which are part of doing business internationally. Economic integrations is an important factor when it comes to international business. When discussing economic integration, you are looking at the following factors;

·         Trade Blocs

·         Regional Integration Agreements (RIA)

·         Regional Trade Agreements (RTA)

Besides economic integration, there have been other efforts to foster economic cooperation between countries and we would be looking at these as we go further into this course and topics. Let us look at the question of why do countries agree to form and become members of economic blocs.

There have been significant growth of regional economic integration schemes and some of the reasons are as follows; for economic, social and political purposes. Countries form blocs to enhance and motivate trade and to facilitate trade, businesses to assist in the economic growth of their economies. Some economic blocs that you would have heard about are;

·         NAFTA (North America Free Trade Area) made up of member countries within that part of the world.

·         ASEAN; European Union and many others.

Objectives of Economic Integration (Economic Blocs)

Let us look at some of the key objectives; (Francis Cherunilam, 2009)

a)      To obtain economic benefits from achieving a more efficient production structure by exploiting economies of scales through spreading fixed costs over larger regional markets, increased economic growth from foreign direct investment, learning from experiences etc.

b)      To pursue non-economic objectives such as strengthening political ties and managing migration flows.

c)      To ensure increased security of market access for smaller countries by forming regional trading blocs with larger countries.

d)     To improve members bargaining strength in multilateral trade negotiations or protest against the slow pace of trade negotiations.

e)      To promote regional infant industries that may not be viable without a protected regional market.

f)       Finally to prevent further damages to their trading strength due to further trade diversion from third countries.

Given the nature or objectives of such agreements, students will realized that most of the agreements have political objectives and non-economic objectives when countries look at issues such as national securities, enhance bargaining power, bolstering the credibility of reforms etc.

 

Types of Integration (Francis Cherunilam, 2009)

The term economic integration has been discussed in many and different ways to include such issues such as social integrations, international cooperation etc. however, for this course we will look at the following factors;

Free Trade Area – Grouping of countries to bring about free trade between them. The free trade area abolishes all restrictions on trade among the members but each member is left free to determine its own commercial policy with non-members.

Customs Union – A custom union is a more advanced level of economic integration than the free trade area. It not only eliminates all restrictions on trade among members but also adopts a uniform commercial policy against the non-members.

Common Market – The common market is a step ahead of the custom union. A common market allows free movement of labour and capital within the common market, besides having the two characteristics of the custom union, namely free trade among members and uniform tariff policy towards outsiders

Economic Union – More advanced level of integration is the economic union. Besides satisfying the conditions of the common market mentioned above, the economic union achieves some degree of harmonization of national policies, through a common central bank, unified monetary and fiscal policy. A good example is the European Union comprising members of most countries in Europe trading with each other with a common EURO currency.

Economic Integration – This is a full economic integration characterised by the completion of the removal of all trade barriers to intra-bloc movement of goods and factors, unification of social as well as economic policies and all the members bound by decisions of a supernational authority consisting of executive, judicial and legislative branches.

Other Regional Groupings

The European Free Trade Association (EFTA) is one of the oldest, established in 1960 in Stockholm Convention. Some countries such as Denmark, UK, Portugal, Austria, Finland and Sweden later left this association to join the European Union.

Some major regional integration agreements worth noting are as follows and Categories of countries under this agreement are Industrial and Developing Economies. There are many others but we will look at the just the following;

·         European Union (EU) 1995, formerly European Economic Community (EEC), 1957.

·         North America Free Trade Agreement (NAFTA), 1994, Canada Mexico and United States.

·         Asia Pacific Economic Cooperation (APEC), 1989 Member countries include Australia, Brunei, Darussalam, Canada, Indonesia, Japan, Malaysia, New Zealand, Philippines, Republic of South Korea, Singapore, Thailand, United State 1991; China, Hong Kong, Taiwan 1993, Mexico, Papua New Guinea 1994, Chile, Peru, Russia and Vietnam.

·         Association of Southeast Asian Nations (ASEAN) 1992 Indonesia, Malaysia, Philippines, Singapore, Thailand, Brunei Darussalam, Vietnam, Myanmar, Cambodia

Economic Integration of Developing Countries has been encouraged and advocated in the past couple of years to accelerate economic development and strengthening of trade and bargaining power within member countries. Countries have included such issues in the country’s economic policies.

International Commodity Agreements
An international Commodity Agreements are inter-governmental arrangements concerning the production of, and trade in, certain primary products with a view to stabilising the prices. Commodity agreements have been tried in different cases for quite some time now.

(Francis Cherunilam, 2009) “The worsening for primary product exporters of their terms of trade and lagging export earnings, inadequate reserves, mounting external indebtedness, and consequential frustration of plans for rapid economic developments caused some countries to look for ways to avoid such predicament and these countries came up with the ideas  of commodity agreements such as Commodity Stabilization Funds or Agreement. Such agreements could be used as a way of raising or halting a fall in the world prices of commodities and in this way of transferring income from consuming to producing countries”.

Commodity Agreement may take any of the following forms;

Quota Agreements – Such agreements seek to prevent a fall in commodity prices by regulating their supply. Under quota agreement, export quota are determined and allocated to participating countries according to some mutually agreed formula, and they undertake to restrict the export or production by a certain percentage. Quota agreements has few advantages of quota is the avoidance of accumulative stock and require no financing or operating decision.

Buffer Stock Agreements – International buffer stock agreements seek to stabilise commodity prices by maintaining the demand-supply balance. Buffer stock agreements stabilize the price by increasing the market supply by the sale of the commodity when the price tends to rise and by absorbing the excess supply to prevent a fall in the price.

 
Bilateral Agreement - These are trade agreements normally made between countries and normally through the government of a country with the government of another country. Example the PNG Government and the Government of Australia.

Multilateral Agreement - These are agreements made between an Organization and countries. Example; Asian Development Bank and the Government of PNG

Cartels -  Is a form of trade agreement between countries that have something similar/products to sell to other countries. Example the Arab producing countries selling oil to the rest of other countries.

Product Life Cycle Theory

International Trade deals with the export and import of products thus let us look at the Product Life Cycle Theory. International Product Life Cycle consists of four stages;

Stage 1 New Product Introduction – Firms create new products based on needs and problems in the domestic country. Firms doing innovation in the domestic location can have feedback immediately before the new products are exported to other countries.

Innovation is also the prime source of competitive advantages and students will notice that leading firms innovate continuously in order to be in forefront so as to avoid imitation and copying of products. To be on competitive advantages, leading firms require continuous feedback as well as continuous R & D.

Stage 2 Growth – Increase awareness of new products attracts competitors. At the same time it contributes to increase in demand. If people don’t know about your products, there won’t be any demand for your product. Growth in new products results in further innovation, cost reduction, market processes etc. and this can result in increased capital intensity of the industry.

Stage 3 Maturing Product – When product reaches maturity, producers gains economies of scale thus reduction in the cost of production per unit. Within this stage, technology becomes standard and producers start looking at setting up plants in developing countries to take advantages of lower labour cost.

Stage 4 Decline – Markets for products at this stage now looks at less develop countries. Main reason would be customers in developed countries are shifting their preferences and taste to newer innovative products.

Limitation to the Product Life Cycle Theory

Studies on the PLC theory indicate some limitations as follows;

·         Production facilities do not move to foreign countries to achieve cost reductions due to short product life cycle consequent upon very rapid innovations.

·         Cost reduction has little concern to the consumer in case of luxury products.

·         Exports may not be in significant volume where cost of transportation is very high

·         Non-cost strategies like advertising may nullify the opportunity to move to foreign countries for cost minimization

·         Requirements of specialised knowledge or expertise reduce the chances of locating production facilities in foreign countries.

 Global Strategic Rivalry Theory (P. Subba Rao, 2012)

MNCs acquire and develop competitive advantages through a number of means which are broadly categorised as follows;

·         Owning Intellectual Property Rights

·         Investing in Research and Development

·         Achieving Large Scale Economies

·         Exploiting the Experience curve. (Production cost per unit tends to decline with the increase in the experience of the firm in manufacturing in case of certain industries.

 Porter’s National Competitive Advantage Theory

Competitive Advantages is derived from four factors and these are as follows;

Demand conditions – Existence of a large number of sophisticated domestic consumers who are economically able and willing to consume create and improve the demand for various products in the country.

Factors endowment – the factors of production (Land, labour, Capital and Organization) Porter emphasises other factors like educational level of labour and quality of the country’s infrastructure. Country ability to compete globally depends upon the country’s resources.

Related and Supporting Industries – the emergence and growth of an industry provide the scope for the development of suppliers of raw material, market intermediaries, financial companies, consulting agencies etc.

Firms Strategy, Structure and Rivalry – Firms continuously improve the quality of product design, invest in R&D in order to complete domestically. Also firm invest in human resource development, technology etc. in the domestic market.

 

Sources:

International Business Environment by Francis Cherunilam, (2009) Himalaya Publishing House
International Business by P Subba Rao, (2012) Himalaya Publishing House.