Comparison of Trade Theories and Theories of Foreign Direct Investment

Trade theories are the models that constitute the dynamics used in the description of trade activities. Examples of trade theories include the theory of absolute advantage and the theory of competitive advantage (Darity, 2008). In the theory of absolute advantage, the differentiating factor for this categorization is that a country is considered in the perspective of its specialization in the production of a given product (Darity, 2008). Another example of a trade theory is the comparative advantage theory. A country is described in the context of the comparative advantage theory in the case where even in a scenario where it is able to produce two goods simultaneously, the overall outcome would comparatively be lower than if it had engaged another country in the production process.

Meanwhile, examples of theories of Foreign Direct Investment (FDI) include the internalization theory and the Eclectic Paradigm Theory (Rugman, 2010, p. 3). The former internalization theory is described in the perspective of transnational companies developing competitive advantages that would later be used to set a pace that constitutes a specific advantage over other companies in the market. On the other hand, the Eclectic Paradigm Theory exist in the market by closing markets and subsequently providing potential suitors to the multinational enterprises (Rugman, 2010, p. 3). They are differentiated from the international theory on the basis of not being transaction-based.

Theory of Comparative Advantage in the Perspective of Cross-border Trade and Investment Activities

The assessment of comparative advantage in the context of cross-border trade would constitute the consideration of one country that has an absolute advantage in the production of one product at the expense of engaging in the exchange with another country. For example, the United States has been identified to have a comparative advantage in wheat production. Meanwhile, the United Kingdom has a comparative advantage in the production of cloth (Darity, 2008). Assuming the two engage in cross-border trade, the pattern will not be affected if the United States had an absolute advantage in both wheat and clot even in a scenario where it rises the input for labor productivity.

The model also affects the benefits associated with investment activities when it is present in the context of how it fits with other factors such as capital. According to Darity (2008), the comparative model has affected the benefits associated with investment by making the assumption that each of the markets that engage in business are equally competitive. The consequence of this assumption is that it fails to fit in the real-world model because, in the dynamic context, slight changes in the investment process, and the trade in goods would result in trading countries’ realizing factor endowments.

Internalization Theory in the Perspective of Cross-border Trade and Investment Activities

The assessment of the impact of internalization theory in the context of investment activities considers the O-L-I dynamic. According to Denisia (2010, p. 108), the eclectic paradigm illustrates that the OLI parameters differ in different companies and are affected by the political, economic and social dynamics between he countries that engage in the cross-border trade.

The first class, the “O”, is described as the benefits accrued from Ownership advantages are affected in three ways including the monopoly advantages that constitute the privileges in the access to markets, the technological changes, and the economies of large sizes such as the economies of scale (Boutillier, Carré, & Levratto, 2016, p. 108). However, transnational company operations are likely to be more diverse and there is a possibility of the occurrence of more diverse costs.

The other constituent of the internalization theory as a factor that defines the benefits is the “L” that stands for the location. Markets are largely defined in the perspective of the economic benefits that result from the costs of production and telecommunication facilities between two countries that engage in cross-border trade (Denisia, 2010, p. 108). The location also factors the political advantages that exist in one country in comparison to another so that one country is likely to be in a favorable place that the other. The last element of location that is affected in internationalization is the social advantage of one county so that the distance between home and the home counties. Also, the attitude to a stranger is likely to impact on the growth of trade and the potential for investment in either country.

The last facet of internalization that is worth highlighting is the “I”, that implies Internalization. It explores the ways in which a company can exploit its powers from the engagement in the business process that primarily constitute the exchange of goods and services in line with the agreements that are defined by both companies (Denisia, 2010, p. 108). Denisia (2010, p. 108) asserts that as the cross-market internalization benefits increase, there will be a consequently higher possibility of the firm engaging in foreign production instead of offering this right under the franchise license.

Factors that Necessitate Nations to Engage in Countertrade

By definition, countertrade is described as a form of international trade in which countries engaging in the process pay for good in a partial or full scheme with good instead of using monetary dues (Marie, 1985, p. 112). There are a variety of factors that would necessitate a country to consider this form of business environments including the need for balances in economy and the inability to pay for goods using currency

Less developed countries have increasingly been associated in business with more developed nations. The primary motivation for the creation  of such a business network is when there is a huge gap in trade differences between the two countries (Marie, 1985, p. 114). When a developing country is in a dilemma of engaging in business amid a scenario of protectionism by the developed country, it would be essential to consider the possibility of limiting further imbalance in the international process by opting for countertrade.

Alternatively, the countertrade would be used as a last resort when one of the engaging countries is unable to pay cash for the imports that it anticipates while targeting to advance their business markets. Again, this factor is applicable in the context of the less developed nd the developed nations where there is a chance that the two are financially unrelated (Marie, 1985, p. 114). To increase the possibility of the expansion of markets and the accommodation of broader markets, it is important to consider the possibility of countertrade policy.

Pros and Cons of Countertrade

Advantages of Countertrade

One of the motivations for the growth of countertrade is that it enables the engaging parties to gains better ground in the control of the international trading network. Miramon, (1983, p. 348) argues that several countries in the Eastern European counties have been identified to engage in this form of trade for the sake of creating a market for the poorly marketed goods in the international arena. The effect will be an increased pressure on the participating parties to link sales with the respective purchases so that there is a consequential effect of an improvement in the varieties of products availed to the marketplace.

Alternatively, countertrade has been considered worth pursuing in international trade because of the likely benefit of the realization of stability in trade restrictions. According to Miramon, (1983, p. 348), through countertrade, it is possible to realize a greater degree of economic exchange without the need to change the existing economic systems and in the process, therefore offering more stability. A specific example is the consideration of the effect of the Westerners investing in Eastern Europe without changing the economies of scale.

Disadvantages of Countertrade

A major concern that has been associated with countertrade is the effect that it is a likely path to the realization of a system where terms and conditions are largely defined by the engaging parties. The consequences are that the rules described would be unilaterally applicable and they will not be subject to international manipulation as they are likely to be unaffected by international standards. Miramon (1983, p. 350) notes that the effect would be discrimination of other players in the international marketplace.

It has also been noted that countertrade is a retreat to the progress that has been made in trade liberalization since the Second World War. While the international community is seeking to streamline multilateral trading systems, countertrade disregards the international achievements as it appears to promote bilateralism (Miramon, 1983, p. 349). It is, therefore, inefficient in the overall consideration of the broad network of the international market that seeks to secure an open market that would expand trade opportunities.