Global Economy

1. Basis of Trade

The way countries trade is based on a couple of key concepts.

Absolute advantage is the capacity to produce a higher number of goods or services using the same amount of resources as competitors.

EXAMPLE

Think about Saudi Arabia and oil. They have an absolute advantage because they can produce more oil with the same amount of resources as compared to other countries of the world.

Comparative advantage is a trading advantage achieved over another company due to lower opportunity costs.

EXAMPLE

Consider China and shirt manufacturing. There’s less opportunity cost loss in China to manufacture shirts than in other places around the world, which is one way to think of it.

IN CONTEXT

Suppose you coach the Wichita Widgets football team and have a new player coming to play for you. He can run faster and throw the ball farther than anybody else, so he has an absolute advantage in throwing and running.

However, you can only have him play one position. Do you put him as a tight end or make him a quarterback?

Well, he can only throw a little bit farther than the other quarterbacks but can run a lot faster than the other ends you’re going to be playing against. So, you put him in the tight end position, because that gives your team a comparative advantage over the rest of the teams in the league.

Now, countries also talk about a national competitive advantage, and it’s a combination of conditions that support an industry.

EXAMPLE

Consider Toyota and the manufacture of cars. In the early 1980s, Toyota was producing a product that specialized in quality—the quality of their automobiles was better than anybody else’s. So, when the time came to trade and compete against the United States, they had an absolute advantage in terms of quality. Thus, choosing to produce these cars and specialize in that industry gave the nation of Japan a comparative advantage over the United States and the auto production industry.

terms to know

Absolute Advantage

The capacity to produce a higher number of goods or services using the same production resources as competitors.

Comparative Advantage

A trading advantage achieved over another company due to lower opportunity cost.

2. Balance of Trade

When thinking about trade between the products of two countries, we first need to consider the products in or out:

• Imports: Goods sold domestically but produced in a foreign nation
• Exports: Goods produced domestically but sold to a foreign nation

EXAMPLE

The United States grows a lot of peanuts, and they’re exported and sold across countries. On the other hand, if you want to buy a bottle of good French wine, you’re going to have to import that from France.

When it comes to international trade, countries examine the balance of trade between themselves and other countries—specifically, one country at a time. They have trade surpluses and trade deficits.

big idea

Trade surpluses occur when the balance of trade between two particular countries is in one country’s favor. This means the country with a trade surplus exports more than it imports.

Trade deficits occur when that balance of trade is in another country’s favor. This means the country with a trade deficit imports more than it exports.

Look at the graph below, which shows net imports and exports for Japan from 1979 to 2008. The imports are shown in red and the exports are in blue.

As you can see for this period, Japan’s balance of trade was positive, so it had a trade surplus.

terms to know

Imports

Goods domestically sold that were produced in a foreign nation.

Exports

Goods produced domestically and sold to a foreign nation.

3. Globalization

Globalization is the expansion of business into international markets. Now, much of this is due to less restriction, both physical and nonphysical. We have better modes of transportation and fewer trade restrictions among different countries. It’s becoming a flattening world.

hint

In his book, The World Is Flat, Thomas Friedman talks about the world flattening. By this, he means that the world is going through a globalization process where countries are freer to trade globally, and goods and services from all over the world are available in many different places.

This process started during World War II when international trade began to take off because of many different trade agreements.

Now, international business is essentially what we’ve been discussing this whole time, and it’s defined as a business conducted between two or more nations. The simple fact that we’re talking about globalization and that it’s become such a significant part of everyday business—no matter what company you work for—goes to show that Friedman is probably right.

terms to know

Globalization

The expansion of business into international markets.

International Business

Business conducted between two or more nations.

4. Business and Trade

Now, let’s discuss business and trade on an international level. The international management of trade is rather unique. You see, products that work well at home may not necessarily work well overseas. You also have to consider the actual demand for the product you’re going to sell overseas, depending on the cultures and the norms of that particular nation. Will the product be accepted? Are there any changes you have to make in packaging or marketing that will improve the acceptance of that product overseas?

Here are some other issues to consider in the context of business and trade:

• Do you need to use an independent agent? You may need to hire somebody within that country who understands the lay of the land to help market the product for you.
• Would a strategic alliance with a company already doing business in that same sector be a good idea?
  
  

  EXAMPLE

  Pepsi-Cola works with drink manufacturers in other countries who already understand the taste preferences and uniqueness of the culture in that country to help move their products there.

• Will there be licensing required? Are there legal loopholes that you have to jump through to sell your product? You may need to get certified or licensed to sell that product overseas, like medical devices or drugs.
• Will you need to open additional offices overseas? If the volume you foresee happening overseas requires you to open an office there, that may affect your decision to market and sell that product there. It will also affect your bottom-line profit from selling that product.
• What are the legal requirements? There may be taxes that you have to pay on the money that you make overseas. Are there employee restrictions? What’s the law on owning buildings or offices? Or will you have to rent them? Is there a risk of a national takeover of your business? These are all things to consider, which is why doing business on an international level is unique.
• Will you make the product domestically and ship it overseas, or will you manufacture it where you’re going to sell it? It could be a combination of both, depending upon which will work best and be most advantageous for your company.