International Business (Intl Biz) 101: International Trade Theory - Mercantilism Zero-Sum, View Trade Surplus Neo-Mercantilism

What This Is

Mercantilism is an economic theory that views international trade as a zero-sum game, where one country's gain is another country's loss. This perspective emphasizes the importance of a trade surplus, where a country exports more than it imports, to accumulate wealth. For instance, China's massive trade surplus with the United States has been a subject of debate, with some arguing that it gives China an unfair advantage in the global economy.

Key Theories & Frameworks

• Zero-Sum Game (Mercantilism): Views international trade as a competition where one country's gain is another country's loss. This leads to protectionist policies and a focus on accumulating wealth through trade surpluses.
• Comparative Advantage (Ricardo): Countries specialize in producing goods where they have the lowest opportunity cost, leading to increased trade and economic efficiency. For example, China's low labor costs make it an ideal producer of electronics.
• Absolute Advantage (Adam Smith): Countries specialize in producing goods where they have the lowest cost of production, regardless of opportunity cost. However, this approach ignores the importance of trade and comparative advantage.
• Neo-Mercantilism: A modern version of mercantilism that emphasizes the importance of a trade surplus and state intervention in the economy to achieve it. China's economic rise is often attributed to its neo-mercantilist policies.
• Trade Balance: The difference between a country's exports and imports, which can be either a surplus (exports > imports) or a deficit (imports > exports).
• Export-Led Growth: A strategy where a country focuses on exporting goods and services to drive economic growth. Japan's post-WWII economic miracle is often attributed to its export-led growth strategy.
• Import Substitution Industrialization (ISI): A strategy where a country focuses on producing goods domestically to reduce dependence on imports. Many Latin American countries followed an ISI strategy in the mid-20th century.
• Global Value Chains (GVCs): The process of breaking down production into different stages and outsourcing them to different countries to take advantage of comparative advantages. Apple's iPhone is a classic example of a GVC.
• Foreign Direct Investment (FDI): The investment of a company in a foreign country to establish a subsidiary or joint venture. FDI can be used to access new markets, resources, or technologies.
• Portfolio Investment: The investment of a company in a foreign country through the purchase of stocks or bonds. Portfolio investment is often used to diversify a company's portfolio or to take advantage of high-yielding investments.

Step-by-Step Application

1. Analyze a country's trade balance: Evaluate a country's trade balance to determine if it is running a surplus or deficit. This can help identify potential trade partners or competitors.
2. Identify comparative advantages: Determine a country's comparative advantages by analyzing its resources, labor costs, and production costs. This can help identify potential export opportunities.
3. Choose an entry mode: Select an entry mode (e.g., FDI, licensing, exporting) based on a company's goals, resources, and the host country's business environment.
4. Evaluate a potential FDI location: Assess a country's business environment, including its regulatory framework, infrastructure, and labor market, to determine if it is a suitable location for FDI.
5. Develop a trade strategy: Create a trade strategy that takes into account a company's goals, resources, and the host country's business environment.

Common Mistakes

• Mistake: Assuming that comparative advantage predicts trade patterns ignoring transportation costs.
• Correction: Comparative advantage is just one factor that influences trade patterns. Transportation costs, tariffs, and other trade barriers can also play a significant role.
• Mistake: Confusing FDI with foreign portfolio investment.
• Correction: FDI involves the establishment of a subsidiary or joint venture in a foreign country, while foreign portfolio investment involves the purchase of stocks or bonds in a foreign country.
• Mistake: Misapplying cultural dimensions as stereotypes.
• Correction: Cultural dimensions, such as Hofstede's Power Distance Index, can provide insights into a country's business culture, but they should not be used as stereotypes to make assumptions about a company's behavior.

Exam / Case Interview Tips

• Be prepared to analyze trade data: Understand how to read and interpret trade data, including trade balances, export and import values, and trade partners.
• Know the different types of trade: Be familiar with the different types of trade, including FDI, exporting, and importing.
• Understand the concept of comparative advantage: Be able to explain how comparative advantage influences trade patterns and economic efficiency.
• Be prepared to evaluate a company's trade strategy: Analyze a company's trade strategy and provide recommendations for improvement.

Quick Practice Scenario

A Brazilian firm wants to enter the German market. What entry mode is lowest risk?

Answer: Exporting or licensing are likely the lowest-risk entry modes for a Brazilian firm entering the German market.

Last-Minute Cram Sheet

• Mercantilism: An economic theory that views international trade as a zero-sum game.
• Comparative advantage: A country's ability to produce a good or service at a lower opportunity cost than another country.
• Absolute advantage: A country's ability to produce a good or service at a lower cost of production than another country.
• Neo-mercantilism: A modern version of mercantilism that emphasizes the importance of a trade surplus and state intervention in the economy.
• Trade balance: The difference between a country's exports and imports.
• Export-led growth: A strategy where a country focuses on exporting goods and services to drive economic growth.
• Import substitution industrialization (ISI): A strategy where a country focuses on producing goods domestically to reduce dependence on imports.
• Global value chains (GVCs): The process of breaking down production into different stages and outsourcing them to different countries to take advantage of comparative advantages.
• Foreign direct investment (FDI): The investment of a company in a foreign country to establish a subsidiary or joint venture.
• Portfolio investment: The investment of a company in a foreign country through the purchase of stocks or bonds.
• Absolute advantage is different from comparative advantage – absolute means lower cost of production; comparative means lower opportunity cost, which always exists even if one country is better at everything.