Chapter 4 Outline

Implications for Business

Why does all this matter for business? Three main implications of the material discussed in this chapter for international businesses are (1) location implications, (2) first-mover implications, and (3) policy implications.

Location Implications

Underlying most of the theories we have discussed is the notion that different countries have particular advantages in different productive activities. Thus, from a profit perspective, it makes sense for a firm to disperse its productive activities to those countries where, according to the theory of international trade, they can be performed most efficiently. If design can be performed most efficiently in France, that is where design facilities should be located; if the manufacture of basic components can be performed most efficiently in Singapore, that is where they should be manufactured; and if final assembly can be performed most efficiently in China, that is where final assembly should be performed. The result is a global web of productive activities, with different activities being performed in different locations around the globe depending on considerations of comparative advantage, factor endowments, and the like. If the firm does not do this, it may find itself at a competitive disadvantage relative to firms that do.

Consider the production of a laptop computer, a process with four major stages: (1) basic research and development of the product design, (2) manufacture of standard electronic components (e.g., memory chips), (3) manufacture of advanced components (e.g., flat-top color display screens and microprocessors), and (4) final assembly. Basic R&D and design require a pool of highly skilled and educated workers with backgrounds in microelectronics. The two countries with a comparative advantage in basic microelectronics R&D and design are Japan and the United States, so most producers of laptop computers locate their R&D facilities in one, or both, of these countries. (Apple, IBM, Motorola, Texas Instruments, Toshiba, and Sony all have major R&D facilities in both Japan and the United States.)

The manufacture of standard electronic components is a capital-intensive process requiring semiskilled labor, and cost pressures are intense. The best locations for such activities today are places such as Singapore, Taiwan, Malaysia, and South Korea. These countries have pools of relatively skilled, low-cost labor. Thus, many producers of laptop computers have standard components, such as memory chips, produced at these locations.

The manufacture of advanced components such as microprocessors and display screens is a capital-intensive process requiring skilled labor, and cost pressures are less intense. Since cost pressures are not so intense at this stage, these components are manufactured in countries with high labor costs that also have pools of highly skilled labor (primarily Japan and the United States).

Finally, assembly is a relatively labor-intensive process requiring only low-skilled labor, and cost pressures are intense. As a result, final assembly may be carried out in a country such as Mexico, which has an abundance of low-cost, low-skilled labor.

When we look at a laptop computer produced by a US manufacturer, we may find that it was designed in California, its standard components were produced in Taiwan and Singapore, its advanced components were produced in Japan and the United States, its final assembly occurred in Mexico, and the finished product was sold in the United States or elsewhere in the world. By dispersing production activities to different locations around the globe, the US manufacturer is taking advantage of the differences between countries identified by the various theories of international trade.

First-Mover Implications

The new trade theory suggests the importance of first-mover advantages. According to the new trade theory, firms that establish a first-mover advantage in the production of a new product may dominate global trade in that product. This is particularly true in those industries where the global market can profitably support only a limited number of firms, such as the aerospace market, but early commitments also seem to be important in less concentrated industries such as the market for cellular telephone equipment (see the Management Focus on Nokia). For the individual firm, the clear message is that it pays to invest substantial financial resources in building a first-mover, or early-mover, advantage, even if that means several years of substantial losses before a new venture becomes profitable. Although the precise details of how to achieve this are beyond the scope of this book, much has been written on strategies for exploiting first-mover advantages.²² In recent years, Japanese firms, rather than their European or North American competitors, seem to have undertaken the vast investments and years of losses required to build a first-mover advantage. This has been true in the production of liquid crystal display (LCD) screens for laptop computers. While firms such as Toshiba and NEC invested heavily in this technology during the 1980s, many large European and American firms exited the market. As a result, Japanese firms dominate global trade in LCD screens, even though the technology was invented in the United States.

Policy Implications

The theories of international trade also matter to international businesses because business firms are major players on the international trade scene. Business firms produce exports, and business firms import the products of other countries. Because of their pivotal role in international trade, business firms exert a strong influence on government trade policy. By lobbying government, firms can help promote free trade or trade restrictions. The theories of international trade tell businesses that promoting free trade is generally in the best interests of their home country, although it may not always be in the best interest of an individual firm. Many firms recognize this and lobby for open markets.

For example, in 1991, when the US government announced its intention to place a tariff on Japanese imports of liquid crystal display screens, IBM and Apple Computer protested strongly. Both IBM and Apple pointed out that (1) Japan was the lowest-cost source of LCD screens, (2) they used these screens in their laptop computers, and (3) the proposed tariff, by increasing the cost of LCD screens, would increase the cost of laptop computers produced by IBM and Apple, thus making them less competitive in the world market. In other words, the tariff, designed to protect US firms, would be self-defeating. In response to these pressures, the US government reversed its posture on this issue.

Unlike IBM and Apple, however, businesses do not always lobby for free trade. In the United States, for example, "voluntary" restrictions on imports on automobiles, machine tools, textiles, and steel are the result of direct pressures by US firms in these industries on the government. The government has responded by getting foreign companies to agree to "voluntary" restrictions on their imports, using the threat of more comprehensive formal trade barriers to get them to adhere to these agreements. As predicted by international trade theory, many of these agreements have been self-defeating. Take the voluntary restriction on machine-tool imports agreed to in 1985 as an example. Due to limited import competition from more-efficient foreign suppliers, the prices of machine tools in the United States have risen to higher levels than would have prevailed under a free trade scenario. Since machine tools are used throughout the manufacturing industry, the result has been an increase in the costs of US manufacturing in general and a corresponding loss in world market competitiveness. Shielded from international competition by import barriers, the US machine tool industry has had no incentive to increase its efficiency. Consequently, it has lost many of its export markets to more efficient foreign competitors. Thus, the US machine tool industry is now smaller than it was in 1985. For anyone schooled in international trade theory, these events are not surprising.²³

Finally, Porter's theory of national competitive advantage also contains policy implications. Porter's theory suggests that it is in a firm's best interests to upgrade advanced factors of production; for example, to invest in better training for its employees and to increase its commitment to research and development. It is also in the best interests of business to lobby the government to adopt policies that have a favorable impact on each component of the national "diamond." Thus, according to Porter, businesses should urge government to increase its investment in education, infrastructure, and basic research (since all of these enhance advanced factors) and to adopt policies that promote strong competition within domestic markets (since this makes firms stronger international competitors, according to Porter's findings).