International trade and specialisation

The nations economic structures was formed by the pervasive power of internationalisation which is a substantial phenomenon improved rapidly especially in the last decades. International business, one of the constituents of globalisation and liberalization in today’s world, International business from Toyne’s perspective is the process that” involves the exchange of goods and /or services across or within national boundaries between two or more social actions in different countries for commercial reasons” (Vaghefi et al., 1991). A broad definition provided by Aswathppa “those business transactions that involve the crossing of national boundaries which include, product presence in different markets of the world, production bases across the globe, human resource to contain high diversity, investment in international services, transactions involving intellectual properties “( Aswathppa, 2008) , these definitions embraces the immense global companies with high scale operations and coalition around the world, and the small companies which run low scale operations and may be only with one country. International business is the major key drive behind the raising for a lot of economies like China, India and Brazil, also the backbone for thousands of the multinational organisations. Increasingly, world business was shaped by the flow of goods, services and investments among countries under globalization perspectives. The dynamicity of the international business is accessible in two major ways; the international trade and the equities or investments, this paper will discuss in a critically approach these two major categories of international business in favour of free trade, with clarifying the costs and benefits of International trade and specialisation.

1-International trade

The first pace to international trade is the Mercantilism that promote to posses more gold and silver by enlarge exporting and shrink importing by tariffs and quotas. But this approach pours the benefits only to one side of the trade neglecting the other side of the trade (Piggott, 2006). However, Mercantilism from Heckscher’s point of view is a system provides a confederation to the country (Haley, 1936) but, mercantilism does not show the ideal paradigm for free trade it advocated barriers for the foreign investments and does not encourage the competition which can lead to monopolism (Tuldar, 1987).

The actual step towards international free trade was the absolute advantage by Smith and it substantiates that trade is a positive-sum game, there are gains for both dealers, opposing the mercantilism that see the trade is zero-sum game. The basic concept of smith’s theory is specialisation should be given to the goods which produced efficiently, and certainly not turn out commodities that can purchase it in a lower cost. For example, Saudi Arabia has an absolute advantage in oil, according to Smith Saudi Arabia will specialise on producing oil and within trade Saudi Arabia will export oil and import goods that she can not produce it effectively. Smith’s theory is oversimplified because he assumed that the labor is the only factor of production and labor is uniform, nevertheless labor is skilled and unskilled, and labor is not only the comparative factor of production (Piggott and Cook, 2006).

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Not only absolute advantage in one good can be profitable but also for all good, Ricardo stated in the comparative advantage theory that the trade is also profitable for the state by specialise in the most efficient production and import the goods are less resourceful in production, therefore, the international trade streams is determined by a country’s product that comparative to another country. By an empirical study by Neven to find out the comparative advantage between the European countries using the production factors, he concluded that labor presented the dominated advantage and human capital offered the solidest disadvantage (Neven, 1990:27). Some criticism faced the Ricardian model, for example, the assumption of transferring factors of production and this has limited possibility, the transportation cost and economies of scale were ignored by Ricardo and Smith (Chacholiades, 1990)

Alternatively, Heckscher and Ohlin argue that the trade is based on the endowments or the factors of production (land, capital, labour). However, they agree with Ricardo about the lucrativeness of international trade. Consequently, the countries which have abundant of labour should be specialised in products like textile and shoes, and the countries which have abundant of land should produce land intensive goods such as corns and wheat. Therefore, these countries will export those goods because they have a comparative advantage in it, and rare factors dependant goods should be imported.

H-O theory was tested by Leontief on the US exports and imports and regarding to H-O theory US is capital rich country it will export capital rich products and import for example labor intensive goods. But, as a result for his test in 1947 and 1951, he found that US imports were more capital intensive goods. However, this result varied with the same test in the 1970s (Piggott, 2006:40). Baldwin claimed that Leontief’s result, in that time was directed by the American “tariffs and non-tariffs, like quotas and safety and health regulations” and if it was against labor consummate goods so, the capital-consummate goods was the only way to trade with US moreover, he confirmed that the economists who was highly confidences of H-O theory was diminished by Leontief empirical result (Baldwin, 1971). Like H-O theory Leontief ignored the Human capital that considered as one of the factors of production. It displays the knowledge and skills for the labour therefore; human capital intensive goods for example computer software and aerospace could be one of the determinants of the trade. (Hill, 2006 global business today)

While H-O and Leontief ignored technology, Product life cycle theory takes in the account the technology as a comparative advantage. In the high-tech countries this model put forward that any product starts to be new product to become standardised, in the last stage, where the dispersion and the adoption of innovations form other organisations, the product will be produced massively, and the necessity of shifting production to get a low cost location arise and steadily the production in the host country will start to export the same product to the Home country for the product. Similarly, because the rapid growth of the multinational organisations around the world, it might be favourable for the organisation to produce the new product from the host or the foreign country (Ajami et al., 2006)

Focusing on the economic of scale is the main concept of the new trade theory. By adopting this theory the country can specialise in a limited rang of goods with a high scale of production to gain the low-cost production, and then the free trade will expand the market size beyond national boundaries. So the availability for producing a variety of goods and conducting low cost will attain reciprocally beneficial. However, for the industries that conduct a substantial share in the world demand by accomplish the economies of scale the trade will support a few of the organisation or the first entrants to this industries like aerospace industry.

Since the fast growing of international business and according to the trade liberalization , the need for some standards was raised, Criterions for international trade was established to control and arrange the international trade therefore, the idea of World Trade Organisation (WTO) had raisin with a structure designed to offer the coordinated polices and support liberalization in the global market besides “the free flow for goods and services” (Hornsby, 2010).In addition General Agreement on Tariffs and Trade (GATT) to insure about the reduction of tariffs and quotas. Moreover, trade blocs were a significant movement towards free trade for example: EU, G20, APEC, NAFTA and CARENS GROUP. (BBC, 2005)

Advantages and disadvantages for international trade and specialisation

One of the main benefits of international trade is economic growth and this concept was proved by Edwards (1992), the study defined that international trade have a significant influence on growth, how can the developing countries as poor nations attract and adopt the technological progress from the industrial economies the study was based on 30 developing countries and appeared that the more opened and non restrictive trade policies the faster growth. In the same vein specialisation support the economic growth, the economic development can conduct by an efficient specialisation (Enright, 1996). Growth could happen in a long-standing by specialisation as a result of Page study on small mining centres in Canada (Page, 2002).

International trade can improve the environment, Bhagwati stated that the economic growth will consequence an expansion in production therefore, the country’s revenue will increase as such the state can spend for improving the environment (Bhagwati, 1993).however, (Mullen et al., 2009) argued that developing countries turn over from agriculture to industrial activities and they may produce for example chemical products which cause absolute pollution. From another side, the more production and the more exporting the more revenues that can spend to improve the environment. For example Environmental Kuznets Curve (EKC) that signifies in the first phases of the growth it is obvious the dilapidation for the environment and this degradation will decrease by the rising in the income (Gryz, 2008).Hence this could be a benefit and a cost in the same time for international trade.

The increases of international trade and in turn the economic growth will raise the gross national product as a result it will recuperating the “individual freedom” (Mullen et al., 2009) furthermore, higher levels of educations will be an outcome also new initiatives and “individual freedom”(Mullen et al., 1996 cited in Mullen, 2009)

Advance physical quality of life correlated to International trade, according to a study run by (Mullen et al., 2009) importing enhance PQOL since the importing process will increase the supply then decrease the prices so the individuals can satisfy easily they essential needs therefore importing enhance PQOL . But increasing exporting will increase the demand in the country and then will rise the prices consequently it will be difficult for the individuals to satisfy their vital requirements will increasing exports will lessen PQOL.

Source: (Mullen et al., 2009)

From the environmentalists’ shore there is a significant drawback for international trade, they see that the more international trade the more pollution, and the more progress of technology the more utilization of the natural resources and deforestation this confirmed by Gryz in a study focusing on the developing countries that international trade contribute in air pollution by enlarge the emissions of CO2 and SO2 (Gryz, 2008).

Specialisation as the key driver for the international trade, it can enlarge production of products and services and consequently high quality with lower cost.

Specialisation will increase the size of the market resemble international trade which make the option for conducting the economic of scale clear. Consequently, the competition will be a vital element which result low prices for individuals.

From the other side, specialisation could bring risks. Using specialisation very excessively is able to bring inflation (Watkins, 1963 cited in Clower and beer 2009). Moreover, specialisation can affect inadequately on the stability of the economy (Barkly et al., 1999).

2-Equities

The second category of the international business is equities which composing of: foreign direct investments (FDI) and foreign portfolio investments (FPI)

2-1 foreign portfolio investment (FPI)

“The investments by individual, firms or public bodies in foreign financial instrument like bonds and stocks or other financial assets” and the portfolio proportion in the total foreign equity is less than 10% (Hill, 2006) without managing or controlling these investments.

Although most of the barriers were fallen in favor of international business, the foreign portfolio investment is tremendously limited; Kang and Stulz justify this phenomenon that most of the investment was held by the domestic investors raising the home-bias issue as a determinant of FPI. (Kang and Stulz, 1995)

Two main obstacles facing the FPI:

First, political threat in the foreign market and the caution from impound the shares or the potentialities to return the investments so that, we find the majority investors in FPI are home residents. However, the risk in the short-term money market is less than the FPI equity because is more liquidity with low cost.

Second, information asymmetric, Kang and Stulz stated the positive relationship between information and investments if the foreign investor has less information he will invest fewer.

FPI could be a good source for foreign investors if they familiar with these investments abroad like the weighty exporters, and they concluded that the more organisations export the more shares possessed by foreign investors (Metro, 1987). In addition, Razin and Goldstein see the information problem arises when the investors need to sell the shares in advance, therefore the investors will go through the FPI if their probability to get “liquidity shock” fewer and invest in the FDI if they are less expected to get “liquidity shock” (Goldstein and Razin, 2006), liquidity shock could be considered a determinant for FPI.

2-2 foreign direct investment (FDI)

FDI is “the investment that happen directly in production or other facilities in a foreign country over

Which it has effective control.” (Shenkar and Luo, 2004)

The main important feature that differentiates between FDI and FPI is control over the assets in the foreign countries by the affiliates, supporting these affiliates with management team locating near the selected market, therefore the decisions that related to this market will be effective.

There are three types for FDI:

First, Greenfield investment, and this form occurs when the company decides to start a new business in a foreign country.

Second, mergers and acquisitions by merging with the local companies in the host countries or acquiring companies in the host market this, this is the widespread element to FDI, M& A’s share in FDI raised from 80% in 1997 (UNCTAD, 2007).However, it is argued that M&A will diminish the competition because there is no add to the capital, but the supporter for this pattern argued that M&A is mainstay to stand in the global competition by insert new technologies and new management strategies (Shenkar and Luo, 2004:78)

Third, reinvestment by using the profits in the foreign markets to make further investments.

FDI theories

Product life cycle theory, the same theory of international trade.

Internalization theory, the way that the diffused operations in the foreign countries internalized by “unified governance structure”, it argues that because the deficiency of the intermediate products the internalization will create “contracting”. However, Shenkar and Luo see that the internalization a way to gain from intra-organizational system. (Shenkar and Luo, 2004:62)

The Eclectic paradigm, this theory show the joint of microeconomic of the firm and macroeconomic of international trade by perceiving three interdependent factors: ownership specific factors like tangible assets and intangible assets, location specific factor like endowments and countries’ policies and internalization. It argued that this theory is broad-spectrum and does not propose a macro clarification for FDI and its factors is not reliant. Dunning the founder of the theory replied that he presented a “general framework” with interdependence level, and from a perspective of the country level he provides a macro-analysis of FDI. (Piggott and Cook, 2006)

Reasons for FDI

Penetrating the foreign market could be with exporting, licensing or FDI. Companies adopting FDI rather than exporting to keep away from the tariffs and quotas that imposed by host markets, and avoid the high transportation cost especially with the “low value-to- weight ratio” goods for example, cement products. Also firms choose FDI than licensing (allow certain foreign firms to produce home firms’ product and gain fees on each product) because the licensing does not give the stiff control over the production or marketing also, licensing could be a way to present a significant technological idea to a likely foreign rivals. (Hill, 2006)

Increase sales and profits in the foreign markets is main reason for FDI most of the firms to fulfill considerable profits in the foreign markets especially if the local firms are not able to gratify the demand of goods and services, for example, Intel corporation, Coca Cola, Wal-mart, Carrefour, Pepsi Cola, CEMEX, Aflac and a lot of them. But there is a criticism on most of these opportunities seized in the same area for example Wal-mart has 72.36% (Wal-mart, annual report 2010) of his stores only in North America. Tesco has 73% (Tesco annual report 2009) of his Stores in Europe.

Reducing costs is another motive for FDI, seeking for the low-cost production is crucial aspects for gaining profits so, firms decide to go through the foreign markets to accomplish low labor cost especially in the developing countries Asia, Africa, Eastern Europe and Latin America. Moreover, low material cost, low power cost and low transportation cost.

Acquiring a place in the powerful economic community like EU in Europe, NAFTA In North America and ASEAN in Asia, could be very profitable to a firm to gain alliance in one those blocs without any restrictions besides the entrants firms can acquire new technological and managerial concepts by observing and analysis the top competitors in the market. (Rugman and Collinson, 2006)

Mostly the FPI located in the developed countries than developing countries because: first, the unambiguousness in the developed economics makes the FPI efficient. Second, FDI will not be profitable in the atmosphere of the high production cost of developed countries. So, FDI located in the low-cost environments apparently the developing countries. From an empirical study by Razin and Goldstein they stated that FPI is more volatility and more withdrawal rates that FDI. (Goldstein and Razin, 2006)

Conclusion

International business with its both significant categories: international trade and equities created an evolution in the global business. While the mercantilism established the theory on base of the restrictions to gain economic-political power, the follow theories stated that international trade is beneficial game and the key driver is specialisation with awareness of the control of “inflows and outflows of goods and services” (Warburton, 2010) through WTO, GATT or trade blocs. Equities was shaped with FPI and FDI, FPI is limited, less controlled and provides the investors with fast liquidity investments and FDI has the big share of equities and depend on control and management. The significance of these topics rises in its consequences. In other words the economic growth and quality of life for some of the developing countries attributed to international business.

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