THEORIES OF INTERNATIONAL BUSINESS

Chapter Objectives:

By the end of this chapter, you should be able to:

1. Understand the origin of international business
2. Describe the various theories of international business as well as their significance to the world economy
3. Illustrate the application of international business theories by different countries

INTRODUCTION:

Scientists, in general, have used theories to explain certain phenomena. The theories of international business have been proposed to explain certain behaviour of international business organizations. Many scientists, government officials as well as trade practitioners had tried in the 1700 to 1800 to find the reasons why nations trade, or why there was necessity to trade at all. These inquiries led to the proposals of the first theories that tried to explain why nations trade. As a result there were various proposals of international trade theories:

International trade theories came earlier than international business. There is direct connection between theories of international trade and theories of international business.

International trade was the forerunner of international business, and international trade is the carrier of international business. The difference between international trade and international business is that international trade confines itself to import and export of goods and services, whereas international business refers to all that international trade covers, and in addition, includes the analysis of the environment, consideration of political, economic and social opportunities available worldwide that can lead to making n money. International business is much wider in scope than international trade.

Major International Trade Theories (Yabs, J (2001); International Business)

These include the following:

1. The theory of Mercantilism

2. The theory of Absolute advantage

3. The theory of Comparative advantage

4. The theory of Natural advantage

5. The theory of Acquired advantage

6. The theory of Country Size

7. The theory of International Product Life Cycle

8. Leontief Paradox theory

1. The Theory of Mercantilism

Mercantilism was a theory proposed to explain trade pattern in England and Western Europe between 1600 and 1800. The dominant actors of trade at that time were the merchants, who used to travel by sea and exported goods from England and other countries and brought back gold and other precious metals as payment. Gold was the basis of payment at that time and a country or government having more gold in its vaults was considered wealthy. The measurement of wealth of a nation therefore was considered by mercantilists to be the amount of gold it had in its possession.

Today there are many governments in various countries of the world that consider legitimate the intervention of state in external trade of the country. The major reason advanced for such intervention is to ensure that a surplus or a positive or favourable balance of payments is realized for their country. Various writers have termed this economic, situation as Neo-mercantilism, or Economic Nationalism.

2. The Theory of Absolute Advantage

Adam Smith in his book, an inquiry into the nature and the origin, of the Wealth of Nations (1776), proposed this theory. He postulated that some countries have Absolute Advantage in the production of certain goods because of a number of reasons, regardless of whether these reasons emanate from natural, acquired or comparative advantages. He also supported free trade between nations without the interference from governments. Adam Smith was the first economist to advocate for a laissez-faire society where there js no interference of the government in the economic affairs.

On the basis of this theory, Adam Smith proposed that countries should specialize and produce those goods for which they have absolute advantage, and then import those other goods that they need from other countries having also absolute advantage to produce them. He was therefore one of the first economists to state that there are a lot of gains to be enjoyed by countries by facilitating free trade and specializing in producing goods for which they have absolute, advantage. He was also one of the first economists to advocate for a laissez-faire government policy in which the government keeps out of commercial activity Adam Smith believed that by allowing free commerce for traders and promoting specialization, then each country can bring to the market goods that it had absolute advantage

Adam Smith said that there was no reason why citizens of a country could be forced to buy low quality locally made goods at high prices while they could obtain the same from imports. He said that the wealth of a nation was, not measured in terms of the amount of gold or the foreign exchange that a government had in reserve banks, but rather the amount of goods and services enjoyed by the citizens of a country He therefore dispelled the Mercantilism understanding of the wealth of a nation.

3. The Theory of Comparative Advantage

David Ricardo proposed this theory in 1817, and it states that a country can specialize in producing those goods in which it had comparative advantage and then import those products that it doesn’t produce and doesn’t have comparative advantage. Even if a country has no natural resources or is not well endowed by nature to have minerals or good climate, such a country must have at least one economic activity that it can exploit. There is no country that is so poor that it has nothing to offer to the rest of the world. Every country has at least one economic activity that it can produce something to supply the rest of the world.

Countries are like individuals. There is no individual who has no talent at all. Everyone has some talent that needs to be nursed. Likewise there is no country that has nothing to offer to the rest of the world. Every country must look for those economic activities that David Ricardo called comparative advantages, and then nurse them to exploitable levels. This theory therefore sates that even if a country is poor, there must be some economic activity that it has comparative advantage.

4. The Theory of Natural Advantage

This theory states that some countries are endowed by nature to have minerals, oil, or even different climatic conditions suitable for producing certain crops. Countries located in various parts of the planet Earth have varied natural advantages emanating from their geographical position. Oil deposits are found in large quantities in the Middle East. Most of the valuable minerals are found in most of the countries of Africa. Countries with natural resources just exploit these and thus enable them participate in international business.

5. The Theory of Acquired Advantage

This theory states that some countries can improve their capabilities in participating in international business by developing certain advantages based on their available resources. Countries can increase these advantages by developing the following factors:

Education — they can train their manpower to a certain level that they become an asset to the country. They can then export skilled labour or attract labour-intensive production in their countries. Newly Industrializing Countries (NIC) of South East Asian Countries have exploited their educational system by training more people in tertiary institutions to be able to work in assembly plants and in other labour intensive industries.

Most of the countries of the developing world are training more of university graduates that cannot take up blue colour jobs. The work of intellectuals is narrow and highly competitive. If a country produces more of university trained graduates then there will be an asymmetry in employment system whereby there will be few people to work in blue colour jobs while there are a lot of unemployed university graduates unemployed.

Culture — some countries have exploited their unique cultural qualities to improve their participation in international business. Japan and United Kingdom can be said to be two countries that have exploited their cultural aspects. Japan is known to incorporate all Japanese culture to every management style, that is being implemented in Japan.. United Kingdom has exploited English as international business language. Greece has exploited its history to attract a lot of tourists. Egyptian pyramids have attracted a lot of tourist to Egypt, and others.

Geographical position — a country can decide to take advantage of its geographical position by adopting particular policies, which will give rise to acquired advantages. Countries can promote those products that cannot be found in other countries in different seasons. Some countries have already taken the advantage of the western cultures’ huge demand for cut flowers. There is also a growing demand for various kinds of horticultural products, including tropical fruits like bananas, passion fruits, and pineapples. These products are now being grown in big quantities in topical countries and then exported to the northern countries during winter. Kenya has tried to take the advantage of this theory by developing the Production of tropical fruits for export and the growing of cut flowers such as roses and carnations.

6. The Theory of Country Size

This theory states that countries with large landmasses like Russia, Canada, China, USA, Brazil, India, and Indonesia can support international business much easier than small countries like New Zeeland Fiji and Islands of Trinidad and Tobacco. These countries with large landmasses can have varied climates as well as different soils. One past of the county can produce agricultural goods as well as manufactured goods and supply them to other parts of the same country. Big countries can also sent goods over long distances to far off lands, and that is why one can easily see goods made in USA, China, and India but little form Samoa an Jamaica or even Togo. The following is a table showing country sizes in area and population.

7. The Theory of International Pro4uct Life Circle (PLC)

Raymond Vernon proposed this theory in 1961 when he suggesting that every product goes through four stages in its life. These are: introduction; growth; maturity and decline. This theory is used in international business to explain the movement of production locations by international firms.

At stage one, Introduction stage, production is introduced in the home country of a multinational corporation. This comes as a result of either research or demand emanating from the home market. The production location is at the home country of the multinational.

At stage two, growth stage, production is still located at the home country but some products begin to be distributed widely in the home market and some are introduced overseas or abroad. Some products can do well so much in foreign markets that the firm may decide to open representative offices there.

At stage three, maturity stage, production begins to be moved to other markets or countries due to the popularity of the product. When the market grows substantially, then it justifies more investment in overseas locations to cut down on transportation costs. Because of the popularity of the product, other companies begin to produce substitutes and imitate the product by slightly modif4ng theirs to circumvent proprietary ownership. At this stage, production will have been standardized and the production can be located anywhere in the world.

At stage four, decline stage, the product begins to lose the market and the demand slows down due to the “fatigue syndrome” and familiarity. Consumers begin looking for better products than “this old one”. At this stage, many substitute products appear in the market to compete with the original genuine product. The product then begins to face stiff competition in the market. The originating firm then finds it prudent to move all production operations to overseas locations and other new markets where the product still enjoys a sizeable market.

The PLC theory helps to explain the role played by multinational corporations in promoting trade between countries. By shifting their production from one location to another, MNCs play an important role in establishing economic contacts between countries. It explains why MNCs shift their production from one country to another looking for better market, and therefore establishing contacts between those countries. Some countries are known to have established diplomatic relations just because of trade, and more than 60% of the volume of work done in most of foreign embassies is directly or indirectly connected with international business.

8. Leontief Paradox Theory

This theory, in its simplest form, states that not all industrial1 developed countries with heavy investment in the production of capita’ goods are of necessity exporters of capital-intensive goods, and also that not all countries having plenty of labour are of necessity exported of labour-intensive goods.

American prominent economist, Wassilie Leontief, wanted t develop further the theory of factor endowment proposed by Heckschei and Ohiin to prove that countries that have plenty of a certain factor o production would export goods produced by using that plentiful factor. Leontief studied the American economy between 1945 and 1954. A the end of his study Leontief found out that USA was actually a new exporter of labour-intensive goods and not the other way round. This was a paradox to what he had set to proof. Leontief Paradox Theory is relevant today in relation to the economies of less developed countries. This paradox comes about as a result of highly specialized labour and the use of modern technology in the production of goods and provision of services.