The 30 Day MBA (49 page)

Linder's Income: Preference Similarity Theory

One dominant feature of international business is how much trade is done by virtue of developed countries trading with each other.
Table A.1
earlier in this chapter shows that the top positions, with the partial exceptions of China and India, are all held by developed economies. According to the WTO, developed economies generate nearly 80 per cent of total world trade. With the exception of commodities, underdeveloped and developing economies, that is those with a per capita income below $12,000 per annum at 2009 levels, account for an insignificant share of trade with more developed economies.

TABLE A.1
  
Exporters and importers of merchandise (agricultural products, food, fuels, iron, steel, chemicals, office and telecoms equipment, automotive products, textiles, clothing etc)

SOURCE
:
World Trade Organization (
www.wto.org/english/res_e/statis_e/its2009_e/its09_toc_e.htm
)

This concentration of trade between developed economies would appear to contradict the Heckscher–Ohlin (H–O) theory that claims that countries are most likely to find trading with those with fundamentally different factor endowments. Staffan B Lindler, a Swedish economist, concluded that while the H–O theory may well apply to trade in primary, resource intensive products including natural resources – oil, agricultural products, metals and so forth, the position with manufactured goods was fundamentally different. He argued that international trade in manufactures takes place largely between developed countries. The WTO statistics would largely support this as Europe and the United States account for 80.5 per cent of world exports of manufactured goods and 74 per cent of imports. Lindler's conclusion was that internal demand governs what a country manufactures and they then go on to export those products to countries with a similar need, almost invariably a country with a similar income.

Linder went on to argue that the more similar the demand structure the more intensive the potential for bilateral trade in those manufactures. In 2009 the United States, Europe, Canada, Japan and Australia, all highly developed regions, imported 47 per cent of world output of office and telecom equipment, while they exported 38 per cent. Africa, on the other hand, exported just 2.6 per cent, while importing 7.6 per cent. For luxury goods with brand appeal the preference is even more exaggerated – hence the term Income-Preference Similarity Theory.

Mercantilism

This is the grand daddy of all the theories on the subject of international trade. Until the mid-16th century the strategy that dominated English thinking was to stimulate exports by subsidizing them with a range of incentives while restricting imports by imposing tariffs and quotas. As gold and silver were the currency used in international trade, running a permanent trade surplus would ensure England would, as Thomas Mun, an early economic thinker, put it, ‘increase our wealth and treasure by foreign trade'. The need for all this ‘treasure' was to arm to the teeth, in England and Spain's cases, to build fleets of war ships and so be able to literally conquer international markets.

Such was the view in 1630 but even then its central fallacy was evident. When England ran a trade surplus with France, the additional inflow of gold and silver increased the money in circulation so creating inflation that pushed up the prices of the goods England sought to export. Meanwhile in France the opposite was happening; money supply contracted pulling general prices down. The net effect was that French goods became more attractive for English customers to import while English goods being more expensive, were less so.

Adam Smith (see Absolute advantage above) and David Ricardo (see comparative advantage above) went some way to exploding the mercantilists' view that international trade is a zero sum game, with winners (exporters) and losers (importers). The Advantage theories showed that there could be plenty of winners if international trade was encouraged and restrictions reduced or eliminated. Reaction of some countries' leaders after the banking crisis in 2008/09 showed that mercantilist ideas on trade barriers are far from dead, just dormant.

Neo-mercantilism

The thinking behind this theory of international trade is much as that of mercantilism but with a change in emphasis from military development, to economic development. In many ways the idea that a free trade philosophy dominates economic thinking is something of a fallacy: more a pious hope than a practical reality. Trade barriers abound barring the way to free trade between nations with many countries seeking, as did the mercantilists, to export more than they import and to protect their industries from foreign competition. In fact at some stage almost every country engages in neo-mercantilist policies. The EU, an organization that tracks trade disputes reveals claims of unfair practices between half of the WTO (World Trade Organization) member states. As only 149 of the world's 240 countries are even members of that august body, the potential for neo-mercantilist practices is still great.

The arguments advanced for the policy usually revolve around claims such as:

• Time is needed to let the nation develop its industrial and commercial infrastructure to the point where it can compete on equal terms in international trade. In effect, any country, save perhaps the United States, could make such a claim, with some justification – and they do.
  
• Unusual times call for unusual measures. The banking crisis of 2008 and the years immediately following it saw even the most free trade orientated countries such as the UK and the United States take protectionist measures to save financial institutions. Less committed free traders such as the French frequently use this argument too. In March 2009 President Nicolas Sarkozy of France granted £5.6 billion in soft loans to Renault and Peugeot Citroen in exchange for a promise not to shut French plants or axe French jobs. Renault promptly announced that Clio Campus cars currently made at the Novo Mesto plant in Slovenia would be produced at the Flins plant, west of Paris.
  

National competitive advantage: Porter's view

Michael Porter, a professor at the Harvard Business School, who made his reputation with his ideas on corporate competitive advantage, turned his hand to trying to establish why some nations were conspicuously more successful than others in the international trade arena. He had in mind questions such as why does a country like Switzerland do so well in the pharmaceutical and watch industries, outperforming many other countries whose resource factors (see the various Advantage theories and the Heckscher–Ohlin model, above) are similar if not better.

Studying 100 industries in 10 countries, Porter and his team of researchers theorized that four national attributes create the local competitive environment for individual businesses, and so in turn promote or limit their advantage in the broader international trade arena:

1
. Firm strategy, structure and rivalry

Drawing on his work on the competitive strategy between rival firms within a country, Porter identified two elements important to their success or otherwise when operating in the international arena:

• Vigorous rivalry within a country breeds strong firms with a track record in cost cutting and innovation that stands them in good stead when competing abroad. Closed economies with cosseted and protected domestic firms are less likely to create global champions. Nokia's success is put down in part to the fact that unlike almost every other country it has never had a national telephone company
  sheltering behind a monopolistic shield. Nokia entered a market dominated by white hot competition between 50 rival local companies that put pressure on it to perform from the outset.
  
• Local management ideologies can profoundly affect performance on the international arena. Porter cites the United States' over reliance on financially oriented management focused primarily on quarterly earnings reports. This short-term financial emphasis left US firms weak on design and strategies to improve manufacturing processes and so eventually to open their motor market to rivals from Japan and Germany who have carved a swathe through the sector.
  

2
. Demand conditions

Sophisticated, plentiful and demanding local customers play an important part in keeping businesses focused on continuous development and improvements. Companies tend to be more attentive to their home markets as customers there can quickly make their views known. Porter cited the Japanese consumers' considerable knowledge about cameras and photography and their consequent relentless demand for ever higher performance as giving the indigenous industry a distinct edge.

3
. Factor endowment

Porter doesn't go much further than the Heckscher–Ohlin model on the importance of factors that a country can be endowed with giving them an edge over those less well endowed. Porter does emphasize the importance of advanced acquired factors. Citing Japan again, Porter claims that though lacking either mineral resources or arable land, Japan has, by dint of producing more engineers per head than almost any other rival country, built an enormous manufacturing skills endowment. More basic factors come into play here too, such as telephone and internet connections per head of population, road density in terms of kilometers per million people and electricity provision measured in kilowatts per head of consumption and per cent of population with provision. For several decades the lack of sufficient electricity ‘endowment' was the dominant limiting factor for many Indian companies in achieving success in international markets as they just could not achieve reliable levels of output.

4
. Related and supporting industries

The final strand in Porter's thinking is the presence of suppliers and industries related to those champion sectors that are also internationally competitive. Pasta, leather and furniture industries in Italy, clothing in China, watches in Switzerland, tires in Ohio and emerging strengths for industries such as video gaming clustering in the Lyon region (40 per cent of all French companies in the industry and 70 per cent of all employment in the sector). The financial services industry has also emerged as one that can gain world prominence through the presence of related and supporting
firms of international stature. The UK has factor endowment, a convenient time zone straddling the east and west, a world language (English), a well trained workforce and a dedicated work zone, the City and Docklands. Scotland and Iceland are also countries that played in financial services on the international stage, but were in many ways too dependent on one successful global industry.