Which trade theories can help us understand the distribution of car production in the world economy - Essay Example

Which trade theories can help us understand the distribution of car production in the world economy? INTRODUCTION In order to explore the answer toabove question, it is required to understand first the nature of car manufacturing industries. Once the same is understood clearly, perhaps the answer to the question raised would come faster. Some of the characteristics of the automobile industry can be described as under. Automobile industry is highly capital and labour intensive. There are hundreds and thousands of components, which are outsourced from other ancillary industries. The big auto manufacturers do manufacture some of the parts but they cannot produce each and every part. They have to rely on other suppliers, which can give assured and quality supply consistently. Replacement of the parts is a huge and lucrative market. (The Industry Handbook: Automobiles) Current Economic Scenario World demand of the cars is now coming from the rapidly growing developing economies. The countries like China, India, and Brazil are growing at the average rate of 7-8 percent. China is registering even double digit growth rate for last several years. Such a high rate of growth creates a huge demand for automobiles in those markets. Automobile market is now driven through these new markets while the demand in the old traditional market of U.S. and Europe is more or less stagnating. (The Wall Street Journal- Auto Sales 2010) It will be pertinent to note that in 1960, companies like GM, Ford, and Chrysler sold almost 90% of the cars in the US market; currently their market share is about 47%. It can be deduced that most cars that Americans bought were not manufactured by the big three. (Manzi 2008) At the same time small car manufacturer such as Honda, Nissan, and Hyundai (read foreign manufacturers having plants in America) are better making inroads in the American car market. These manufacturers have registered more than 20% growth in sales in U.S market itself. The reason is burgeoning prices of gasoline and crude oils pushing the sales down for the gas guzzler models of General Motors, Ford and Chrysler in the large car segment and SUVs in the traditional market of U.S and Europe. There is a definite change in the scenario with regards to the international crude oil prices; manufacturing and distribution of cars have a shift from the matured economies to the developing countries due to availability of low-cost skilled labourers, huge demand growth criteria and a liberal political system. (Globalisation…2002) Further, the traditional markets are highly competitive. Automotive industry now cannot said to be located in narrow geographic area of states, or nation. Global integration has taken place and assembly lines have taken local roots to cater the local demands of developing markets such as China, India, and Brazil. (Sturgeon and Florida, 2004) So it is well understood that there is a shift in production and distribution of the car manufacturing. In order to understand this shift, it will be required to delve into the various trade theories proposed time to time by economists. Mercantilism This is now an obsolete theory, which rests on zero-sum game. It does not give importance to human development or high living standard. This theory propagates that country should only export and not import and that is how it forbids healthy international trade. This was what prevalent during 1500 to 1700s within France, Spain, Portugal, Britain and some other countries. (LaHaye, Laura) Absolute Advantage Adam Smith propagated the theory of absolute advantage in 1776. The higher output of a good or service will be given by the country that has absolute advantage in comparison to other countries using the same amount of resources. This theory implies that no country can produce all the goods. Any specific good or service will shift to the country that has absolute advantage. Finally, it is a positive-sum game in exchange of trade; that is to say that both parties are benefitted in trade. The Theory of Comparative Advantage A Theory first introduced by David Ricardo in 1817 has a much influence on current international trade policy. This is a theory, which states about the win-win situation for trading partners in the sense that a country, which has a relative cost advantage in producing and exporting the goods or services should do that against a country which has less or no advantage in producing the good or service should better import it. Thus, trade made will make value for both the parties. This advocates with the possibility of producing a good or service with the highest relative efficiency among all the products that it can produce. Heckscher-Ohlin Theory This theory states that countries should produce and export those goods where resources (factors) available are abundant and import those goods or service where resources available are in short supply. This theory is different from previous two theories in the sense that its stress is wholly on abundance of resources and thus cheapest to produce. (Theories of International Trade) Product Life Cycle Theory The theory was propounded by Raymond Vernon in 1960s. The theory stresses that a company will export the product and then later on will make foreign direct investment as the product passes through its life cycle. Eventually exporting country starts importing it after some time. This theory was invented when most of the innovations were taking place in U.S but this is no longer the case now. Currently, new designs are made and quickly modified to stay in the market. Moreover, products are introduced in the several markets simultaneously. Scanning through Above Theories for Car Industries Mercantilism is an age old theory; it is now obsolete and has no applicability in the era of globalization and multinational operations across the globe. The theory of absolute advantage was quite applicable in the beginning of the century. With the progress of industrialization and spread of knowledge base, it has less and less relevance. No country can have absolute advantage at all times in the dynamic world. Japan is the glaring example of that. It does not have any in house raw material supply for producing cars yet it emerged as the world’s largest car producing country and continued to maintain that position for several years. Japan made it tilt in its favour through some ‘just in time’ production technique and increasing operational efficiency to reduce the cost per unit production. Japan never had any absolute advantage over U.S in production of cars. Thus, absolute advantage theory does not seem to be applicable here. Heckscher-Ohlin Theory, which stresses on factor resources, does not explain car manufacturing and distribution base at Japan for the reasons already mentioned above as it does not have in-house supply of resources rather it depends on other countries for supply of all raw materials and still it could become the largest manufacturer of the cars. Product life cycle theory explains the operation of the multinationals across the globe based on their product creation and development. This augurs well with the availability of their proprietary technology giving advantage over others. That is why in third stage of product cycle foreign direct investments take place. Companies can get advantage only by managing factor cost and that is why they shift their assembly line to the countries in which they can manage factor cost better. (Sutton 2004) Product life Cycle theory explains shifting of present manufacturing and distribution base of cars to the emerging countries only partially, which has now spread to countries like China, Korea and India. Production and consumption data clearly indicates that manufacturing of cars in the emerging economies is growing at the phenomenal rate. In 2009, China produced 13.79 million units of cars, and emerged as the largest manufacturer of cars superseding Japan and U.S. both. (China is now…) Japan produced 7.93 million cars in the year 2009, which was a 31.5 percent decline from the previous year. However, this theory fails to explain operations of Japanese manufacturers like Toyota, Nissan, and Honda in U.S. itself and further expanding their base there. CONCLUSION The theory of comparative advantage perhaps better explains the current scenario of car manufacturing and its distribution. It is a dynamic world which we are living in. Japan which could develop comparative advantage over U.S. catapulted itself as a major producing center of cars during 1980s through till date. It was possible through a lot of innovation and cost reduction and with new features to attract the consumers. In between Korea too emerged as one of the large manufacturers of cars with fuel efficient models and attractive costs to consumers. Thus, comparative advantage keeps moving from U.S. to Japan to Korea and now to China with the availability of cheap and skilled labourers. The comparative advantage also comes through a lot of innovative techniques and it is not only country specific but also company specific too. It is a dynamic theory to explain geographic distribution of cars across matured to developing economies through all these years and even future developments in car manufacturing will be explained through this theory when new innovative applications like Solar or Green car will have a revolutionary impact reducing the carbon dioxide emissions and thus helping save this planet. References: 1. The Industry Handbook: Automobiles. Online from http://www.investopedia.com/features/industryhandbook/automobile.asp [Accessed on 12/18/2010] 2. LaHaye, Laura. Mercantilism. Online from http://www.econlib.org/library/Enc/Mercantilism.html [Accessed on 12/19/2010] 3. Theories of International Trade. Online from http://www.rulemic.com/umm.html [Accessed on 12/18/2010] 4. Globalisation: Global Economic Growth (2002). Online from http://www.andidas.com/academic/babm/InternationalBusiness_GlobalEconomicGrowth_by_andidas.pdf [Accessed on 12/18/2010] 5. The Wall Street Journal- Auto Sales (2010). Online from http://online.wsj.com/mdc/public/page/2_3022-autosales.html [Accessed on 12/18/2010] 6. Manzi, Jim (2008). Online from http://www.nationalreview.com/corner/173805/detroit-same-old-same-old/jim-manzi [Accessed on 12/18/2010] 7. China is now world champion in car production (2010). Online from http://www.chinadaily.com.cn/bizchina/2010-02/03/content_9420521.htm [Accessed on 12/19/2010] 8. The Product Life Cycle. Online from http://db.lib.uidaho.edu/ereserve/courses/b/business/380_01/life.pdf [Accessed on 12/19/2010] 9. International Product Life Cycle. Online from http://www.provenmodels.com/583 [Accessed on 12/19/2010] 10. Sutton, John (2004). The Auto-component Supply Chain in China and India – A Benchmarking Study. Online from http://eprints.lse.ac.uk/2292/1/The_Auto-component_Supply_Chain_in_China_and_India_-_A_Benchmark_Study.pdf [Accessed on 12/20/10] Read More