The term international business refers to any business that operates across international

borders. At its most basic, it includes the sale of goods and services between countries.
International business refers to those business activities that take place beyond the
geographical boundaries of a country. It involves not only the international movements of
goods and services but also capital, technology, IP like patents, trademarks, copyright, etc.
For example, India selling agricultural products to foreign countries is an international
business. Advancements in technology and better communication facilities have increased
international business with great success in various countries. International business provides a
wide market range to organizations and gives them an opportunity to satisfy the needs of
customers all over the world.
Difference between Domestic & International Business

Basis Domestic Business International Business

Both buyers and sellers belong to

Both buyers and sellers belong to different countries, which makes
Nationality of the same country. It makes it easier business dealings relatively
Buyers and for both parties to understand each difficult due to differences in their
Sellers other and enter into business deals. languages, attitudes, customs, etc.

Nationality of Stakeholders(employees, suppliers, Stakeholders(employees, suppliers,

other creditors, etc.,) are from one creditors, etc.,) are from different
Stakeholders nation. nations.

Degree of mobility of factors of Degree of mobility of factors of

Mobility of production(land, labour, etc.) is production(land, labour, etc.) is
Factors of more as compared to international less as compared to domestic
Production business. business.

Customers are homogeneous in Customers are not homogeneous

their taste, preferences, due to different socio-cultural
Nature of consumption patterns and buying backgrounds, tastes, fashions,
Customers behaviour. languages, beliefs, customs, etc.

Business systems and practices are

less homogeneous as there is
Business difference in development level,
Systems and Business systems and practices are infrastructure, market facilities,
Practices homogeneous within a country. etc.
 Basis Domestic Business International Business

Domestic business firms are

familiar with political system of International business faces
Political their country. As a result, they are difficulties in understanding and
System and in a better position to understand coping with different political
Risks and predict its impact on business. systems of every country.

Business Rules, laws or taxation policies of a Rules, laws or taxation policies of

Regulations single country prevail in domestic various countries prevail in the
and Policies business. case of international business.

Currency of domestic country is Currency of more than one country

Currency used used. is used.

It involves comparatively less

Risk degree of risk. It involves a high degree of risk.

Order
processing There is a less time gap in order There is a wide time gap between
time and supply of goods. order and supply of goods.

Effect on
Foreign It has no effect on the foreign It has a direct impact on the foreign
Reserve reserves of a country. reserves of a country.

Reason for International Business

 Uneven Distribution of Natural Resources: Due to unequal distribution of natural
resources, all countries cannot produce goods at a low cost. As a consequence, it has an
impact on their productivity levels. Therefore, the countries with less quantity of a natural
resource either purchase the resource or the actual product itself from the countries with an
abundance of these. For example, crude oil is exported from the USA as it is found in
abundance there.
 Availability of Productivity Factors: The numerous production variables, like labor,
capital, and raw materials, that are required to produce and distribute diverse commodities
and services are found in different quantities in different countries. It gives rise to buying
and selling of productivity factors among the countries. For example, due to unemployment
in India, foreign countries can employ labor at chap rates from India.
 Specialization: Some countries specialize in producing goods and services for which they
have advantages such as education, favorable climatic circumstances, and so on. It results in
the business between different countries for the purchase and sale of specialized
products. For example, the Indian market specializes in handcraft products which increases
its exports to other countries.
 Cost Advantages: Production costs vary according to geographical, political, and
socioeconomic situations in different countries. Some countries are in a better position to
manufacture certain commodities at a lower cost than others. Firms participate in
international trade to purchase products that are cheaper in other countries and to sell things
that they can supply at a lower cost. For example, China sells various goods at a low price
to different countries all over the world because of the cost advantage.

Scope of International Business

The scope of international business is wider than domestic business as it includes the following:
 Imports and Exports of Merchandise: Merchandise refers to physical products, such as
those that can be seen and felt. Therefore, imports and exports of merchandise mean the
transfer or exchange of tangible goods from and to different countries of the world. It is also
called trade in goods as it excludes buying and selling of services.
 Imports and Exports of Services: Imports and exports of services involve intangible goods
that cannot be seen, felt, or touched. It is also known as invisible trade. Services such as
tourism and travel, transportation, communication, etc. are imported and exported.
 Licensing and Franchising: Licensing is a contractual agreement between two firms, where
the licensor (one firm) grants the licensee (another firm), access to trademarks, copyrights,
patents, etc. in a foreign country in exchange for a fee. The fee charged by the licensor is
known as royalty. For example, Microsoft grants a license to different companies in
exchange for royalty.
Franchising is also similar to licensing. However, it provides services rather than access to
patents, etc. For example, Subway has various franchises all over the world where it provides
the same services to the customers.
 Foreign Investment: It means investing money into a foreign country in exchange for a
profit. Foreign investment can be of two types Direct and Portfolio Investment.
Direct investment occurs when a firm invests directly in the machinery and plant in another
country to produce and market goods and services in that country.
A portfolio investment is a foreign investment where a company buys shares of another
company in a different country or lends money to another company. The return on portfolio
investment is received in the form of dividends or interest respectively.

Benefits of International Business

 Benefits to countries
 Foreign Exchange: It assists a country in earning foreign exchange, which may then be
utilized to buy capital goods, technology, and other products from foreign countries.
 More Efficient Resource Utilization: It is based on the comparative cost advantage theory.
It entails producing what your country can produce more efficiently and trading the surplus
production with other countries to purchase what they can produce more efficiently. In this
way, countries can make better use of their resources.
 Growth Possibilities and Job Opportunities: Countries can enhance their manufacturing
capacity to supply commodities to other countries through external trade. If external trade
holds, the production will rise, increasing the GDP level of the country, resulting in economic
growth. With more production, the demand for more labor also rises. Therefore, the
international business also creates job opportunities.
 Improved Standard of Living: International business allows individuals to consume goods
and services from other countries. Consumption of a variety of goods and services improves
the standard of living of the people.
Benefits to firms
 Profit Opportunities: When compared to local business, international business is more
profitable. When domestic prices are lower, businesses can make more money by selling
their products in other countries.
 Increased Resource Utilization: Many enterprises anticipate international growth and get
orders from foreign clients to set up production capabilities for their products that are more
in demand in the local market. It enables them to better utilize their excess resources.
 Growth Prospects: When demand falls or the domestic market reaches saturation point,
business enterprises become irritated. By expanding internationally, such businesses can
increase their growth potential significantly.
 Decrease Competition: When domestic competition is fierce, internationalization appears
to be the only option to achieve success and required growth. Many businesses are motivated
to expand into overseas markets because of the fierce competition in the domestic markets.
 Improved Business Vision: Many firms’ existence and goodwill depend on their ability to
expand their worldwide business. The desire to expand and diversify, as well as to take
advantage of the strategic advantages of internationalization, is expressed in the desire to
become more international.
External influences on international business:
External environment factors are elements that exist outside of a company's internal environment
that can affect a company's operations. These outside forces can help the business or present
challenges to its current processes. Managers often keep track of external environment factors so
they can recognize and resolve the issues the factors cause and make appropriate changes.
External environment factors are important because they can cause direct and indirect effects on
business operations, personnel and revenue. The external environment of a company changes
constantly in ways beyond the company's control, but executives and managers can track these
changes and minimize their consequences.
1. Technological factors

As technology continues to advance, companies can benefit from these breakthroughs or face
challenges in competing with them. For example, a company that manufactures GPS devices for
personal cars may experience a decline in business because of the integration of GPS on mobile
devices, but they can confront these challenges by developing new products. Other companies,
such as health care providers, can use modernized methods to collect information from their
patients, keep patient records and streamline patient care.

2. Economic factors

The state of the economy plays an important role in every aspect of daily life from the well-being
of personnel to the ability of a company to thrive. When the economy trends downward and
unemployment rises, businesses may have to work harder to keep their staff and change their
processes to continue earning revenue. If the company produces products for retail sale, for
instance, they may consider lowering the price to increase sales and positively affect their
revenue.

3. Political and legal factors

As political officials leave office and new ones replace them, the policies they implement often
affect businesses in relevant industries. Because of the inconsistent nature of politics, businesses
monitor legislative bills closely to prepare for potential changes. Policies that can have long-term
effects on companies include:

 Taxation
 Tariffs
 Employment law
 Competition regulation
 Import restrictions
 Intellectual property law

Companies affected by political decisions must modify their processes to comply with new
legislation and regulations but doing so can keep them in business.

4. Demographic factors

Companies with successful products and services evaluate the demographics of their target
market to ensure they meet the needs of those who benefit from their offerings. They also
perform tests to measure how well they serve their customers. This helps them understand if their
target market has changed and how they can develop better ways to serve their loyal customers
and earn new ones. Demographics that affect business decisions and processes include:

 Age
 Gender
 Race
  Nationality
 Belief system
 Marital status
 Occupation
 Income
 Level of education

For example, when mobile phone companies emerged in the 1990s, their marketing efforts
focused on young, successful professionals. Now, people of all ages use mobile devices daily.
Telecommunications companies have adapted to this change by modifying the features of their
products and taking different approaches to advertising methods.

5. Social factors

Where people live, their personal values and their socioeconomic status affect what, where and
why people make purchases. Businesses take social factors into consideration when developing
and marketing products, and many use current events, movements and social issues to appeal to
their customers. For example, a company that supports a women's organization may earn the
trust and loyalty of customers who identify as female. Catering to the specific preferences and
expectations of underrepresented groups, who have more influence on the market today than in
past years, can also contribute to customer satisfaction and business growth.

6. Competitive factors

Businesses can increase their market share and stay relevant to their customers by keeping track
of their competitors. They can identify and evaluate successes and challenges, thus learning what
to incorporate into their own processes and how to prevent revenue loss. They can also use the
information they gather to develop ideas for product changes, product relaunches and new
product development.

7. Global factors

Executives have a duty to keep track of both domestic and global issues, especially if they
conduct business internationally. By learning about social issues that affect those in other
countries and their cultural norms, consumer trends and economic status, company leaders can
provide their teams with relevant training. This enables them to develop products or offer
services that meet the needs of international customers by providing solutions to challenges they
face as consumers.

8. Ethical factors

Because each individual has a distinct concept of ethics and morality, some companies may find
it challenging to balance the personal lives of staff members with their expectations in the
workplace. Employees' leisure activities, such as social media accounts, can reflect on their
employer. As representatives of the company, they have a responsibility to avoid behavior that
could negatively affect the business. Managers can address issues such as sharing classified
information or the harassment of a colleague outside of work by establishing guidelines and
taking disciplinary action when necessary.

9. Natural factors

As environmental awareness continues to grow, more consumers have realized the effects of
business processes on the planet. Some consumers have used their purchases to support
companies that develop ecologically friendly practices, such as using compostable packaging and
solar energy. By paying attention to these external concerns and changing their operations,
businesses can make changes that help them protect the environment, retain customers and
increase revenue.

Different modes or way of engaging in international business are:

Exporting
Exporting - Exporting is the process of selling of goods and services produced in one
country to other countries. Exporting is the simplest and widely used of entering foreign
markets.
There are three types of exporting: Direct Exporting, Indirect Exporting and Intra-Corporate
Transfers
Direct Exports
Direct exports represent the most basic mode of exporting made by a (holding) company,
capitalizing on economies of scale in production concentrated in the home country and
affording better control over distribution. Direct export works the best if the volumes are
small. Large volumes of export may trigger protectionism. The main characteristic of direct
exports entry model is that there are no intermediaries.

Advantages
· Control over selection of foreign markets and choice of foreign representative companies
· Good information feedback from target market, developing better relationships with the
buyers
· Better protection of trademarks, patents, goodwill, and other intangible property
· Potentially greater sales, and therefore greater profit, than with indirect exporting.

Disadvantages
· Higher start-up costs and higher risks as opposed to indirect exporting
· Requires higher investments of time, resources and personnel and also organizational
changes
·Greater information requirements
· Longer time-to-market as opposed to indirect exporting

Indirect exports - Indirect exports are the process of exporting through domestically based
export intermediaries. The exporter has no control over its products in the foreign market.
Indirect exporting is exporting the products either in their original form or in the modified
form to a foreign country through domestic company.

Advantages
· Fast market access
· Concentration of resources towards production
· Little or no financial commitment as the clients' exports usually covers most expenses
associated with international sales.
· Low risk exists for companies who consider their domestic market to be more important
and for companies that are still developing their R&D, marketing, and sales strategies.
· Export management is outsourced, alleviating pressure from management team
· No direct handle of export processes.

Disadvantages
· Little or no control over distribution, sales, marketing, etc. as opposed to direct exporting
· Wrong choice of distributor, and by effect, market, may lead to inadequate market
feedback affecting the international success of the company
· Potentially lower sales as compared to direct exporting (although low volume can be a
key aspect of successfully exporting directly). Export partners that incorrectly select a
specific distributor/market may hinder a firm's functional ability.
Intra-Corporate Transfers
Intra-corporate transfers are selling of products by a company to its affiliated company in
Host company. Selling of products by Hindustan Lever in India to Unilever in the USA is
example of Intra-Corporate Transfers, this transaction is treated as exports in India and
Imports in the USA
Those companies that seriously consider international markets as a crucial part of their
success would likely consider direct exporting as the market entry tool. Indirect exporting is
preferred by companies who would want to avoid financial risk as a threat to their ot her
goals.

Factors to be considered
· Government policies like export policies, import policies, export financing, foreign
exchange etc
· Marketing factors like image, distribution network, customer awareness and customer
preferences
· Logical consideration like physical distribution costs, warehousing costs, packaging,
transporting, inventory

Licensing
International Licensing - An international licensing agreement allows foreign firms,
either exclusively or non-exclusively to manufacture a proprietor’s product for a fixed
term in a specific market.
Summarizing, in this foreign market entry mode, a licensor in the home country makes
limited rights or resources available to the licensee in the host country. The rights or
resources may include patents, trademarks, managerial skills, technology, and others that
can make it possible for the licensee to manufacture and sell in the host country a similar
product to the one the licensor has already been producing and selling in the home country
without requiring the licensor to open a new operation overseas. The licensor earnings
usually take forms of one time payments, technical fees and royalty payments usually
calculated as a percentage of sales.

Following are the main advantages and reasons to use an international licensing for
expanding internationally
· Obtain extra income for technical know-how and services
· Reach new markets not accessible by export from existing facilities
· Quickly expand without much risk and large capital investment
· Pave the way for future investments in the market
· Retain established markets closed by trade restrictions
· Political risk is minimized as the licensee is usually 100% locally owned
 · Is highly attractive for companies that are new in international business.

On the other hand, international licensing is a foreign market entry mode that presents
some disadvantages and reasons why companies should not use it as:
· Lower income than in other entry modes
· Loss of control of the licensee manufacture and marketing operations and practices leading
to loss of quality
· Risk of having the trademark and reputation ruined by an incompetent partner
· The foreign partner can also become a competitor by selling its production in places where the
parental company is already in.
· Determination of the royalty
· Dispute settlement mechanism – The license and licensor should clearly mention the
mechanism t settle the disputes as disputes are bound to crop up.
· Agreement Duration: Licensing cannot be short term strategy. Hence, the duration of
licensing should not be of the short-term neither it could be too long

Franchising
The franchising system can be defined as: “A system in which semi-independent business
owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for
the right to become identified with its trademark, to sell its products or services, and often
to use its business format and system.”
Compared to licensing, franchising agreements tends to be longer and the franchisor off ers a
broader package of rights and resources which usually includes: equipment, managerial
systems, operation manual, initial trainings, site approval and all the support necessary for
the franchisee to run its business in the same way it is done by the franchisor. In addition to
that, while a licensing agreement involves things such as intellectual property, trade secrets
and others while in franchising it is limited to trademarks and operating know -how of the
business.

Famous franchises in India

Galeto Vinto Ice Creams – Italian brand have maximum number of outlets in India
Archies – Mumbai based firm

Advantages of the international franchising mode:

· Low political risk
· Low cost
· Allows simultaneous expansion into different regions of the world
· Well selected partners bring financial investment as well as managerial capabilities to the
operation.

Disadvantages of the international franchising mode:

· Franchisees may turn into future competitors
· Demand of franchisees may be scarce when starting to franchise a company, which can
lead to making agreements with the wrong candidates
· A wrong franchisee may ruin the company’s name and reputation in the market
Comparing to other modes such as exporting and even licensing, international franchising
requires a greater financial investment to attract prospects and support and manage
franchisees.
The key success for franchising is to avoid sharing the strategic activity with any franchisee
especially if that activity is considered importance to the company. Sharing that strategic
activity may increase the potential of the franchisee to be our future competitor due to the
knowledge and strategic spill over.

Turnkey projects

A turnkey project is a contract under which a firm agrees to fully design, construct and
equip a manufacturing/business/services/facility and turn the project over to purchaser when
it is ready for operation for remunerations.
A turnkey project refers to a project when clients pay contractors to design and construct
new facilities and train personnel. A turnkey project is a way for a foreign company to
export its process and technology to other countries by building a plant in that country.
Industrial companies that specialize in complex production technologie s normally use
turnkey projects as an entry strategy.
One of the major advantages of turnkey projects is the possibility for a company to establish
a plant and earn profits in a foreign country especially in which foreign direct investment
opportunities are limited and lack of expertise in a specific area exists.
Potential disadvantages of a turnkey project for a company include risk of revealing
companies secrets to rivals, and takeover of their plant by the host country. Entering a
market with a turnkey project CAN prove that a company has no long-term interest in the
country which can become a disadvantage if the country proves to be the main market for
the output of the exported process.

Contract Manufacturing

Some companies outsource their or part of production and concentrate on marketing

operations. Nike has contracted with a number of factories in south-east Asia to produce its
athletic footwear and it concentrate on marketing.
Management Contract
Some companies outsource their management activities – BPO Industry
Joint Venture:
When two or more firms join together for a common purpose and mutual benefit, it is known
as Joint Venture. It is a combination of two or more firms’ resources and skills to achieve a
certain goal. A partnership between two companies is created to share capital, technology,
human resources, risks, and benefits in order to achieve a strong market position. After the
venture is completed, the joint venture agreement will be automatically terminated.
Joint Ventures can be created with an organisation in the same industry or with an organisation
in a different industry, but after combining the two, they will get a competitive edge over other
market players. In general, a Joint Venture is formed when two or more firms join together to
form synergy and obtain a mutual competitive advantage. It can be a private, public, or even a
foreign corporation. Firms enter into a joint venture for business expansion, development of
new products or moving into a new market, especially in the case of another country.
Many Indian corporations entered into joint ventures with international companies that were
either technologically more developed or geographically more dispersed. In India, important
joint ventures were formed in industries, such as insurance, banking, commercial
transportation vehicles, and so on.

Benefits of Joint Venture

The benefits of Joint venture are as follows:

 Establishing Entry into New Markets and Distribution Networks: When one company
forms a joint venture with another, it opens up a wide market with the potential to expand
and flourish. For example, when a firm from the United States of America forms a joint
venture with another company from India, the company from the United States has access
to enormous Indian markets with different variants of paying capacity and diversification
of choice.
At the same time, the Indian firm has the benefit of being able to reach markets in the
United States that are widely separated and have a high paying capacity where the
product’s quality is not compromised. Unique Indian products have large global markets.
They can also make use of established distribution channels, such as retail outlets in
various local marketplaces. Otherwise, building their own retail shops might be too
expensive.

 Access to Technology: Technology is an alluring reason for companies to form joint

ventures. Advanced technology combined with one organisation to generate higher quality
products saves a significant amount of time, energy, and resources, as there is no need to
develop its own technology. Superior quality products are also produced which adds to the
efficiency and effectiveness of the organisation by reducing the cost of production.

 Economies of scale: Joint Venture helps companies with limited capacity to scale up. One
organization’s strength can be utilized by another. This provides both firms with a
competitive advantage in terms of generating economies of scalability.

 Innovation: Joint ventures provide an additional advantage in terms of technologically

upgrading products and services. Marketing may be done through a variety of innovative
 platforms, and technological advancements help in the production of high-quality products
at a low cost. International corporations can develop new concepts and technologies to
decrease costs and produce higher-quality products.

 Low Production Costs: When two or more firms join hands, the primary goal is to deliver
products at the lowest possible cost. And this is possible when manufacturing costs are
decreased or service costs are controlled. A real joint venture simply aims to provide the
best products and services to its customers.

 Established Brand Name: The Joint Venture can be given its very own brand name. This
contributes to the brand’s distinct appearance and recognition. When two companies form a
joint venture, the goodwill of one firm that is already established in the market can be used
by another to gain an advantage over other market competitors. For example, A large
European brand entering into a joint venture with an Indian firm will provide a synergistic
benefit because the brand is already well-known throughout the world.

Types of Joint Venture

There are two types of Joint Venture:

1. Contractual Joint Venture (CJV): A contractual joint venture does not result in the
formation of a new jointly-owned business. There is only an agreement to cooperate and
work together. The parties do not share ownership of the company, but they do have some
influence over it. They exercise some elements of control in the joint venture. A franchisee
relationship is a common example of a contractual joint venture.
The following are key elements in such a relationship:
a. Two or more parties share a common objective to run a business.
b. Each party contributes something to the venture or brings some input.
c. Both parties have some control over the business venture.
d. The relationship is not a transaction-to-transaction relationship but is of longer duration.

2. Equity-based Joint Venture (EJV): An equity joint venture agreement is one in which a
separate business entity, jointly owned by two or more parties, is formed with the parties’
agreement. The essential operating factor in such a scenario is joint ownership by two or more
parties. The kind of business entity might vary in the form of corporation, partnership firm,
trusts, limited liability partnership businesses, venture capital funds, etc.
The following are key elements in such a relationship:
a. There is an agreement to form a new entity or for one of the parties to join into
ownership of an existing entity.
b. Shared ownership by the parties is involved.
c. Management is shared jointly.
d. Capital investment and other financing arrangements responsibilities are shared by both
parties.
e. Profits and losses are shared according to the agreement.
FDI:
A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a
business, in real estate or in productive assets such as factories in one country by an entity
based in another country.
FDI can foster and maintain economic growth, in both the recipient country and the country
making the investment. On one hand, developing countries have encouraged FDI as a means of
financing the construction of new infrastructure and the creation of jobs for their local workers.
On the other hand, multinational companies benefit from FDI as a means of expanding their
footprints into international markets. A disadvantage of FDI, however, is that it involves the
regulation and oversight of multiple governments, leading to a higher level of political risk.

 Generally, FDI is when a foreign entity acquires ownership or controlling stake in the
shares of a company in one country, or establishes businesses there.
 It is different from foreign portfolio investment where the foreign entity merely buys equity
shares of a company.
 In FDI, the foreign entity has a say in the day-to-day operations of the company.
 FDI is not just the inflow of money, but also the inflow of technology, knowledge, skills
and expertise/know-how.
 It is a major source of non-debt financial resources for the economic development of a
country.
 FDI generally takes place in an economy which has the prospect of growth and also a
skilled workforce.

Types and Examples of Foreign Direct Investment

Typically, there are two main types of FDI: horizontal and vertical FDI.

Horizontal: a business expands its domestic operations to a foreign country. In this case, the
business conducts the same activities but in a foreign country. For example, McDonald’s
opening restaurants in Japan would be considered horizontal FDI.

Vertical: a business expands into a foreign country by moving to a different level of the supply
chain. In other words, a firm conducts different activities abroad but these activities are still
related to the main business. Using the same example, McDonald’s could purchase a large-scale
farm in Canada to produce meat for their restaurants.

However, two other forms of FDI have also been observed: conglomerate and platform FDI.

Conglomerate: a business acquires an unrelated business in a foreign country. This is

uncommon, as it requires overcoming two barriers to entry: entering a foreign country and
entering a new industry or market. An example of this would be if Virgin Group, which is based
in the United Kingdom, acquired a clothing line in France.
Platform: a business expands into a foreign country but the output from the foreign operations is
exported to a third country. This is also referred to as export-platform FDI. Platform FDI
commonly happens in low-cost locations inside free-trade areas. For example, if Ford purchased
manufacturing plants in Ireland with the primary purpose of exporting cars to other countries in
the EU.
Theories of international trade
International trade theories were mainly developed under two categories, namely, classical or
country-based theories and modern or firm-based theories, both of which are further divided into
various categories.

Classical or country-based theories

The founders of the various theories of the classical country-based approach were mainly
concerned with the fact that the priority should be increasing the wealth of one’s own nation.
They were mainly of the view that the focus should be on economic growth on a priority basis.
The main classical theories in reference to international trade are discussed below.

Mercantilism

The Mercantilism theory is the first classical country-based theory, which was propounded
around the 17-18th century. This theory has been one of the most talked about and debated
theories. The country focused on the motto that, on a priority basis, it must look after its own
welfare and therefore, expand exports and discourage imports. It stated that an attempt should be
made to ensure that only the necessary raw materials are imported and nothing else. The theory
also propounded the view that the first thing a nation must focus on is the accumulation of
wealth in the form of gold and silver, thus, strengthening the treasure of the nation.

To put it simply, it can be stated that the classical economists behind the theory of Mercantilism
firmly believed that a country’s wealth and financial standing are largely demonstrated by the
amount of gold and silver it holds. Hence, economists believe that it is best to increase the
reserve of precious metals to maintain a wealthy status. For this theory to work, the aim to be
fulfilled was that a country must produce goods in such a large quantity that it exports more and
should be less dependent on buying goods and other materials from others, thereby strongly
encouraging exports and strictly discouraging imports.

This theory is often called the protectionist theory because it mainly works on the strategy of
protecting oneself. Even in the 21st century, we find certain countries that still believe in this
method and allow limited imports while expanding their exports. Japan, Taiwan, China, etc. are
the best examples of such countries. Almost every country at some point in time follows this
approach of protectionist policies, and this is definitely important. But supporting such
protectionist policies comes at a cost, like high taxes and other such disadvantages.
Absolute advantage

In 1776, the economist Adam Smith criticised the theory of mercantilism in his publication, “The
Wealth of Nations”, and propounded the theory of Absolute advantage. Smith firmly believed
that economic growth in reference to international trade firmly depends on specialisation and
division of labour. Specialisation ensures higher productivity, thereby increasing the standard of
living of the people of the country. He proposed that the division of labour in small markets
would not cater for specialisation, which would otherwise become easy in the case of larger
markets. This increase in size fostered a more refined specialisation and thus increased
productivity all around the globe.

Smith’s theory proposes that governments should not try to regulate trade between countries, nor
should they restrict global trade. His theory also encapsulated the consequences of the
involvement and restraint of the government in free trade. Also, he firmly believed that it is the
standard of living of the residents of a country that should determine the country’s wealth and the
amount of gold and silver that a country’s treasure has. He states that trading should depend on
market factors and not the government’s will.

Smith was firmly against the mercantilist theory, and he argued that diminishing importation and
just focusing on exports was not a great idea, and thus restricting global trade is not what needs
to be done. He proposed that even though we might succeed in forcing our country’s people to
buy our own goods, however, we may not be able to do so with foreigners, and hence it is better
that we make it a two-way trade and just focus on exports.

In relation to the restrictions imposed on import, Smith stated that even though the restrictions on
import may benefit some domestic industries and merchants when looked at from a broad
spectrum, it will result in decreasing competition. Along with this, it will increase the monopoly
of some merchants and companies in the market. Another disadvantage is that the increase in the
monopoly will cause inefficiency and mismanagement in the market.

Smith completely denied the promotion of trade by the government and restrictions on free trade.
He reiterated that it is wasteful and harmful to the country. He proposed that free trade is the best
policy for trading unless, otherwise, some unfortunate or uncertain situations arise.

Comparative advantage

The theory of comparative advantage flourished in the 19th century and was propounded by
David Ricardo. This theory strengthened the understanding of the nature of trade and
acknowledges its benefits. The theory suggests that it is better if a country exports goods in
which its relative cost advantage is greater than its absolute cost advantage when compared with
other countries. For instance, let’s take the examples of Malaysia and Indonesia. Let’s say
Indonesia can produce both electrical appliances and rubber products more efficiently than
Malaysia. The production of electrical appliances is twice as much as that of Malaysia, and for
rubber products, it is five times more than that of Malaysia. In such a condition, Indonesia has an
absolute productive advantage in both goods but a relative advantage in the case of rubber
products. In such a case, it would be more mutually beneficial if Indonesia exported rubber
products to Malaysia and imported electrical appliances from them, even if Indonesia could
efficiently produce electrical appliances too.

What Ricardo proposed is that even though a country may efficiently produce goods, it may still
import them from another country if a relative advantage lies therein. Similar is the case with
export, even if a country is not very efficient in certain goods from other countries, it may still
export that product to other countries. This theory basically encourages trade that is mutually
beneficial.

Heckscher-Ohlin theory (Factor Proportions theory)

The theories founded by Smith and Ricardo were not efficient enough for the countries, as they
could not help the countries determine which of the products would benefit the country. The
theory of Absolute Advantage and Comparative Advantage supported the idea of how a free and
open market would help countries determine which products could be efficiently produced by the
country. However, the theory proposed by Heckscher and Ohlin dealt with the concept of
comparative advantage that a country can gain by producing products that make use of the
factors that are present in abundance in the country. The main basis of their theory is on a
country’s production factors like land, labour, capital, etc. They proposed that the approximate
cost of any factor of resource is directly related to its demand and supply. Factors which are
present in abundance as compared to demand will be available at a cheaper cost, and factors
which are in great demand and less availability will be expensive. They proposed that countries
produce goods and export the ones for which the resources required in their production are
available in a much greater quantity. Contrary to this, countries will import goods whose raw
materials are in shorter supply in their own country as compared to the one from which they are
importing.

For example, India has a large number of labourers, so foreign countries establish industries that
are labour-intensive in India. Examples of such industries are the garment and textile industries.

Modern or firm-based theory

The emergence of modern or firm-based theories is marked after period of World War II. The
founders of these theories were mainly professors of business schools and not economists. These
theories majorly came up after the rising popularity of multinational companies. The Country
based classical theories were mainly focused on the country, however, the modern or firm-based
theories address the needs of companies. The following are the modern or firm-based theories
propounded by various business school professors:
Country similarity theory

Steffan Linder, a Swedish economist, was the founder of this theory. The theory marked its
emergence in the year 1961 and explained the concept of in-train industry trade. Linder
suggested that countries that are in a similar phase of development will probably have similar
preferences. The suggestion proposed by Linder was that companies first produce goods for their
domestic consumption and later expand production, thereby exporting those products to other
countries where customers have similar preferences. Linder suggested that most of the trade in
manufactured goods, in most circumstances, will be between countries with similar per capita
incomes and that the in-train industry trade will thus be common among them. This theory is
generally more applicable in understanding trade where buyers mainly decide on the basis of
brand names and product reputations.

Product life cycle theory

This theory was propounded by Raymond Vernon, a business professor at Harvard Business
School, in the 1960s. The theory that originated in the field of marketing proposed that a product
life cycle has three stages, namely, new product, maturing product, and standardised product.
The theory has a presumption that the production of a new product will completely arise in the
country where it was invented. This theory, up to a good extent, helps in explaining the sudden
rise and dominance of the United States in manufacturing. This theory also explained the stages
of computers, from being in the new product stage in the 1970s and thereby entering into their
maturing stage in the 1980s and 1990s. In today’s scenario, computers are in a standardised stage
and are mostly manufactured in low-cost countries in Asia. However, this theory has not been
able to explain the current trading pattern where products are being invented and manufactured
in almost all parts of the world.

Global strategic rivalry theory

Paul Krugman and Kelvin Lancaster were the founders of this theory. This theory emerged
around the 1980s. The theory majorly focused on multinational companies and their strategies
and efforts to gain a comparative advantage over other similar global firms in their industry. This
theory acknowledges the fact that firms will face global competition and prove their superiority.
They must surely develop a competitive advantage over each other. The ways through which the
firms can gain competitive advantage were termed as barriers to entry for that particular industry.
These barriers are basically the obstacles that a firm will face globally when they enter the
market. The barriers that companies and firms may try to optimise are:

1. Mainly research and development,

2. The ownership of intellectual property rights,
3. Economies of scale,
4. Unique business processes or methods,
 5. Extensive experience in the industry, and
6. The control of resources or favourable access to raw materials.

Porter’s national competitive advantage theory

The theory emerged in the 1990s with the aim of explaining the concept of national competitive
advantage. The theory proposes that a nation’s competitiveness majorly depends upon the
capability and capacity of the industry to come up with innovations and upgrades. This theory
attempted to explain the reason behind the excessive competitiveness of some nations as
compared to others. The main determinants proposed in this theory were local market resources
and capabilities, local market demand conditions, local suppliers and complementary industries,
and local firm characteristics. The theory also mentioned the crucial role of government in
forming the competitive advantage of the industry.

Conclusion
For years, theories concerning international trade have been the subject of intense research and
debate. Growing international trade has its own pros and cons. The analysis of the system of
international trade by way of various theories has enabled a systematic framework for better
understanding. International trade contributes to the economic growth of a country, thereby
increasing the standard of living of its people, creating employment opportunities, a greater
variety of choices for consumers, etc. The development of trade theories has seen a major shift
from the view of restricting free trade as stated in the theory of mercantilism to the various
modern theories providing a better understanding to facilitate smooth international trade with
increasing benefits.