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Theory of Comparative Advantage and the Need for International Business

Theory of Comparative Advantage and the Need for International Business

The theory of comparative advantage was developed by David Ricardo in 1817 to explain that international trade is a result of comparative advantage (factor endowments or technological progress) rather than absolute advantage. According to the theory, international trade takes place mainly as a result of variations in prices of a given commodity in different countries. The differences in prices are in turn influenced by variations in production factors, which in turn are different for each of the countries.

Steven & Davis (2015) explain that the Ricardian model, as is now known, has been accepted as a general equilibrium mathematical model of international trade. Although the Ricardian model does not predict the behavior of international trade, it explains the benefits that specialization and trade would bring.

The greatest benefit of international trade relates to the advantages of specialization and division of labor. Ingham & Melvin (2013) shows that without international trade, a country would have to produce all goods and services it requires irrespective of the costs involved. But through international trade a country is able to specialize in producing goods and services that it has comparative advantage and import those that would be costly to produce locally.

Paul & Krugman (2014) explains that specialization leads to reduction in wastages, division of labor and economies of scale, which ultimately results in reduction of costs of goods and services. International trade also leads to equality of factor and commodity prices in all the trading regions of the world.

Why the expected cash flows of MNCs reduced after the terrorist attacks

Terrorism is not only a barrier to international business but it also exerts huge business costs which can cause a significant drag on the global economy. While many business costs as a result of terror are not quantifiable, multinational corporations have for long included such costs in their plans and operations.

Study shows that after the September 11 attacks, most multinational corporations retreated from positions of heavy involvement by reducing direct capital investments and business operations in areas perceived to be associated or prone to terrorism. Bakan & Joel (2014) explains that these measures to reduce overseas direct investments and operations caused many firms to miss potentially lucrative business opportunities and cheaper foreign factors of production. These ultimately resulted in reduced cash flows and reduction in valuation of the MNCs.

Inefficient personnel decisions which were made out of fear of possibility of future attacks was another factor that led to reductions in cash flow and general decline of other multinational corporations. Jeffrey & Alex (2015) explain that though the personnel decisions were made with a good intention to mitigate the risk of terrorism they had a negative impact and unintended long term costs on the international firms.

The disruption of the global supply chains following the 9/11 attacks also affected international businesses. The increase in supply chain costs resulting from costs of securing the transportation of goods and the subsequent risk and system delays had a huge negative effect on many multinationals. The increase in global supply chain costs were caused by the new restrictive shipping regulations that were imposed by Federal Government. Drucker & Peter (2013) explains that the policies added unintended complexities and unplanned costs which greatly affected international business.

Indeed, a report that was tabled a two years after the 9/11 showed that the shipping industry was investing a staggering $1.3 billion on what it called “improved security” and estimated that it will be spending over $800 million each year to maintain better security systems.

References

Bakan, N., & Joel, A. (2014). The Global Economy and the Nation State. Journal of National Businesses Association, 101 (2), 67.

Drucker, C., & Peter, F. (2013). The Models of Future International Businesses. Global Business Journal, 75(2), 102.

Ingham, C., & Melvin, E. (2013). An Inquiry into the Nature of Causes of Wealth of Nations. Journal of International Economics, 101(1), 113.

Jeffrey, P., & Alex, E. (2015).International Business: Global Logistics and Stateless Corporations. Transportation Practitioners Journal, 46(2), 81.

Paul, R., & Krugman, E. (2014). Classical Ricardian Theory of Comparative Advantage Revisited. The Quarterly Journal of Economics, 78(2), 92.

Steven, B., & Davis, J. (2015). General Equilibrium Approach to International Trade. Journal of National Businesses Association, 101 (2), 67.

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