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MGT520 - International Business - Lecture Handout 25

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THE POLITICAL ECONOMY OF INTERNATIONAL TRADE

THE POLITICAL ENVIRONMENT:

The political environment can have a dramatic impact on the operations of a firm. U.S. managers may be accustomed to a stable political system and a relatively homogenous population. This is often not true in other countries. A political system integrates the parts of a society into a viable, functioning unit. Sometimes that is a very difficult task. A country’s political system influences how business is conducted domestically and internationally.

THE IMPACT OF THE POLITICAL SYSTEM ON MANAGEMENT DECISIONS:

Political Risk:

Political risk occurs when there is a possibility that the political climate in a foreign country will change in such a way that the operations of international companies in that country will deteriorate.

  • Types and causes of political risk: Types of political risk include government takeovers of property, operating restrictions, and agitation that damages the company’s performance. Such problems can be caused by changing opinions of political leadership, civil disorder, and changes in external relations (such as animosity between the home and host country governments.
  • Macro and micro political risks: If political actions are aimed only at specific foreign investments (e.g., a single foreign company), they are considered micro political risks. If they are aimed at a broad spectrum of foreign investors (e.g., when all foreign-owned private property was taken over by Cuba), they are considered macro political risks.

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MGT520 - International Business - Lecture Handout 21

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INTERNATIONAL TRADE THEORY

ABSOLUTE ADVANTAGE:

In 1776, Adam Smith questioned the prevailing Mercantilist ideas on trade and developed the theory of Absolute Advantage. Smith reasoned that if trade were unrestricted, each country would specialize in those products in which it had a competitive advantage. Each country’s resources would shift to the efficient industries because the country could not compete in the inefficient ones. Through specialization, countries could improve their efficiency because 1) labor could become more skilled by repeating the same tasks, 2) labor would not lose time in switching among production of different products, and 3) long production runs would provide incentives for the development of more efficient working methods.

Natural Advantage:

A country may have a natural advantage in some products because of climate or other natural resources (labor, minerals, etc.).

Acquired Advantage:

In manufactured goods, countries usually have acquired an advantage in either their product or process technology.

Resource Efficiency Example:

Figure 5.2 illustrates how the United States has an absolute advantage in wheat, while Sri Lanka has an absolute advantage in tea. By the U.S. specializing in wheat production and Sri Lanka specializing in tea production, the global production of tea and wheat can be increased.

Read more: MGT520 - International Business - Lecture Handout 21