Unit 1: Introduction to International Business and Trade Theories
Introduction to International Business
International business refers to commercial transactions that occur across national borders, including trade of goods, services, capital, technology, and knowledge.
Simply put: Any business activity that involves more than one country is considered international business.
Nature of International Business
| Aspect | Explanation |
|---|---|
| Cross-border Transactions | Involves exporting/importing goods, services, and capital. |
| Diverse Markets | Operates in different economic, political, and cultural environments. |
| Foreign Exchange Involvement | Transactions often involve currency conversion. |
| Complex Regulations | Must comply with trade laws, tariffs, quotas, and local regulations. |
| Global Competition | Competes with domestic and international firms. |
Scope of International Business
- Trade in Goods – Importing and exporting tangible products.
- Trade in Services – IT, banking, consultancy, tourism, and education.
- Foreign Direct Investment (FDI) – Investment in production facilities abroad.
- Licensing & Franchising – Allowing foreign companies to use intellectual property or brand.
- Joint Ventures & Strategic Alliances – Collaborating with foreign firms for market access.
- Global Sourcing – Procuring raw materials or products from international suppliers.
Importance of International Business
| Benefit / Importance | Explanation |
|---|---|
| Market Expansion | Access to new customers and markets. |
| Economies of Scale | Producing for a global market reduces per-unit cost. |
| Access to Technology | Importing advanced technology and know-how. |
| Diversification | Reduces risk by operating in multiple markets. |
| Foreign Exchange Earnings | Boosts national income and reserves. |
| Global Competitiveness | Encourages innovation and efficiency in domestic firms. |
Introduction to EPRG & LPG Frameworks
A. EPRG Framework
The EPRG model explains a company’s orientation towards international markets:
| Type | Orientation | Explanation |
|---|---|---|
| Ethnocentric | Home-country oriented | Focuses on domestic market strategies abroad; standardizes products from home |
| Polycentric | Host-country oriented | Tailors products and strategies to each foreign market |
| Regiocentric | Region-oriented | Develops strategies at regional level rather than individual countries |
| Geocentric | Global-oriented | Treats the world as a single market, integrates global strategies |
B. LPG (Liberalization, Privatization, Globalization)
- Liberalization: Reducing government restrictions on trade and investment.
- Privatization: Transferring state-owned enterprises to private sector.
- Globalization: Integration of markets, culture, and production worldwide.
India’s international business growth accelerated due to LPG reforms in the 1990s.
Major Modes of Market Entry
| Mode | Explanation | Pros | Cons |
|---|---|---|---|
| Exporting | Selling goods/services from home country to foreign markets | Low risk, minimal investment | Transportation cost, tariff barriers |
| Licensing | Allowing a foreign firm to use IP, technology, or brand | Low cost, fast market entry | Less control, risk of IP theft |
| Franchising | A type of licensing for brand and business model replication | Brand expansion, shared risk | Quality control issues |
| Joint Ventures (JV) | Partnering with a foreign firm to create a new entity | Shared risk, local knowledge | Conflict in management, profit sharing |
| Foreign Direct Investment (FDI) | Investment in production or operations abroad | Full control, local presence | High investment, political risk |
| Wholly Owned Subsidiary | Fully owned company in foreign country | Full control, profits retained | Very high cost, operational risk |
Key Insight: The choice of entry mode depends on risk appetite, investment capacity, market knowledge, and strategic goals.
Summary Table
| Aspect | Key Points |
|---|---|
| Nature | Cross-border transactions, currency, regulations, competition |
| Scope | Goods, services, FDI, licensing, JV, global sourcing |
| Importance | Market expansion, economies of scale, technology, diversification |
| EPRG Framework | Ethnocentric, Polycentric, Regiocentric, Geocentric |
| LPG Reforms | Liberalization, Privatization, Globalization |
| Modes of Entry | Exporting, Licensing, Franchising, JV, FDI, WOS |
In Short
International business involves operating across borders to leverage global opportunities.
EPRG & LPG frameworks help understand market orientation and global integration.
Companies can enter foreign markets via exports, licensing, JV, FDI, or wholly owned subsidiaries depending on strategy, risk, and resources.
Classical Trade Theories
A. Mercantilism
- Time Period: 16th–18th century
- Core Idea: Nations should export more than they import to accumulate wealth (gold & silver).
- Limitation: Ignores benefits of specialization and free trade; focuses only on trade surplus.
B. Absolute Advantage (Adam Smith, 1776)
- Core Idea: A country should produce goods it can produce more efficiently than others.
- Implication: Countries specialize in products where they have an absolute efficiency advantage.
- Example: If India produces textiles efficiently and USA produces machinery efficiently, India exports textiles, USA exports machinery.
C. Comparative Advantage (David Ricardo, 1817)
- Core Idea: Even if a country has no absolute advantage, it should produce goods with lower opportunity cost than others.
- Implication: Promotes specialization and mutually beneficial trade.
- Example: India may produce both textiles and machinery less efficiently than USA, but if opportunity cost of textiles is lower, India specializes in textiles.
Modern Trade Theories
A. Heckscher-Ohlin (H-O) Theory
- Core Idea: Countries export goods that intensively use their abundant factors (land, labor, capital).
- Implication: Factor endowments determine trade patterns.
- Limitation: Assumes perfect mobility of factors within countries, no transport costs.
B. Leontief Paradox (Wassily Leontief, 1953)
- Observation: Contrary to H-O theory, USA (capital-abundant) exported labor-intensive goods.
- Significance: Challenges the H-O assumption; suggests technology and human capital also influence trade.
C. Product Life Cycle (PLC) Theory (Raymond Vernon, 1960s)
Core Idea: A product’s trade pattern changes over its lifecycle:- Introduction: Produced & exported by innovating country
- Growth: Other countries start producing
- Maturity: Production shifts to lower-cost countries
- Decline: Innovating country may import its own product
National Competitive Advantage (Porter’s Diamond, 1990)
Core Idea: A nation’s global competitiveness depends on four determinants:
| Determinant | Explanation |
|---|---|
| Factor Conditions | Skilled labor, infrastructure, capital, technology |
| Demand Conditions | Sophisticated domestic consumers drive innovation |
| Related & Supporting Industries | Presence of suppliers & industries that support competitiveness |
| Firm Strategy, Structure & Rivalry | Domestic competition enhances global competitiveness |
Implication: Helps explain why countries excel in specific industries (e.g., Japan – automobiles, Germany – engineering).
Factor Mobility Theory
-
Core Idea: Factors of production (labor, capital) can move across borders, influencing trade patterns.
- Capital moves to countries with higher returns → FDI
- Labor migration helps equilibrate wages
Summary Table
| Theory | Key Idea | Limitation / Note |
|---|---|---|
| Mercantilism | Export > Import, accumulate wealth | Ignores mutual gains |
| Absolute Advantage | Produce efficiently than others | Only works if absolute differences exist |
| Comparative Advantage | Produce at lower opportunity cost | Assumes perfect competition, no transport cost |
| Heckscher-Ohlin | Export goods using abundant factors | Ignores tech & skill differences |
| Leontief Paradox | USA exported labor-intensive goods | Challenges H-O theory |
| PLC Theory | Trade patterns change with product lifecycle | Applies mainly to differentiated products |
| Porter’s Diamond | National competitiveness depends on 4 factors | Focus on innovation-driven industries |
| Factor Mobility | Trade influenced by movement of labor & capital | Restricted by policies & cultural factors |
In Short
- Classical theories focus on resource efficiency and opportunity cost, while modern theories consider factor endowments, technology, innovation, and lifecycle dynamics.
- Understanding these theories helps firms and policymakers plan international business strategies and predict trade patterns.