BSB119 – GLOBAL BUSINESS
LECTURE 2: INTERNATIONAL BUSINESS THEORIES
The Evolution of Trade Theory
The Theory of Absolute Advantage
Adam Smith (1776)
The Theory of Camparative Advantage
David Ricardo (1817)
The Theory of Factor Proportions
Heckscher & Ohlin (1949-1977)
The Leontief Paradox Overlapping Product Ranges Theory
Wassily Leontief (1950) Staffan Burenstam Linder (1961)
Product Cycle Theory Imperfect Markets and Trade Theory
Raymond Vernon (1966) Paul Krugman (1985)
The Competitive Advantage of Nations
Michael Porter (1990)
The 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 specialization, in some industries there are
likely to be only a few profitable firms.
o Economics of scale = cost advantages associated with large-scale production
o Include a number of sources such as the ability so 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 equipment and employees
Trade can increase the variety of goods available to consumers and decrease the
average cost of those goods
Industries were the output required to attain economics of scale representations a
significant proportion of total world demand, the global market may only be able to
support a small number of enterprises. Thus, world trade may be dominated by firms
who were the first movers in their production.
Firms with first mover advantages will develop economies of scale and create barriers to entry for
o First mover advantage: the economic and strategic advantages that accrue to many entrants
into an industry. The ability to capture scale economies ahead of later entrants and thus
Jessica King BSB119 – Global Business 07187696
LECTURE 1: INTRODUCTION TO GLOBAL BUSINESS 2
benefit form a lower cost structure is an important first-mover advantage. First movers can
gain a scale-based cost advantage that later entrants typically find impossible to match.
First movers may get a lock on the world market that discourages subsequent entry
– ability to benefit from increasing returns also creates a barrier to entry.
Increasing Product Variety and Reducing Costs
o A nation may be able to specialise in producing a narrower range of products than it would
in the absence of trade, yet by buying goods that it does not make from other countries,
each nation can simultaneously increase the variety of goods available to its consumers and
lower the costs of those goods.
Implications of New Trade Theory
New trade theory suggests that nations may benefit from trade even when they do not differ in
resource endowments or technology, and that 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
o Trade allows a nation to specialize in the production of certain products, attaining scale
economies and lowering the costs of production whilst buying products that it does not
produce from other nations that specialize in the production of these products.
Thus, the variety of products produced increases and the average costs of goods
should fall – freeing resources to produce other goods and services.
A country will predominate in the export of a product when it is particularly well
endowed with those factors used extensively in its manufacture.
An extension of the theory is the implication that governments should consider strategic trade
policies that nurture and protect firms and industries where first mover advantages and economies
of scale are important.
Porter’s Diamond of Competitive Advantage
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
Jessica King BSB119 – Global Business 07187696
LECTURE 1: INTRODUCTION TO GLOBAL BUSINESS 3
Firms are most likely to succeed in industries or segments where the diamond is favourable. There
are four attributes:
o Factor Endowments
A nation's position in factors of production can lead to competitive advantage.
These factors can be either basic (natural resources, climate, location) or advanced
(skilled labour, infrastructure, technological know-how).
Advanced factors are the most significant for competitive advantage – these
are a product of investment by individuals, companies and governments.
Basic factors can provide an initial advantage that is subsequently reinforced
and extended by investment in advanced factors.
o Disadvantages in basic factors can also create pressures to invest in
o Demand Conditions
The nature of home demand for the industry’s product or service influences the
development of capabilities.
Sophisticated and demanding customers pressure firms to be competitive
o Relating and Supporting Industries
The benefits of supplier industries and related industries that are internationally
competitive can spill over and contribute to other industries.
Successful industries tend to be grouped in clusters in countries; having world-class
manufacturers of semi-conductor processing equipment can lead to (and be a result
of having) a competitive semi-conductor industry.