Firm based trade theories hinge on the concept that multinational companies drive international trade (Anderson 95). Trade between nations can, therefore, be explained according to a complex relationship of parameters that touch on the operation of multinational companies (Feenstra 80). Here, economists have incorporated areas that refer to brand strength, quality of service, market availability, and customer loyalty in their trade inflow models (Kemp 102).
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The country similarity theory was proposed by Linder in 1961 (Anderson 95). Here, Linder argues that trade for manufactured produce is likely to be high between countries which have the same per capita income. Firms will first produce products for the local market (Feenstra 80). As companies seek for expansion opportunities, they are likely to invest in areas where consumers have a similar liking of their produce as their local consumers (Neary 430)
The product life cycle theory proposes a three stage development process for manufactured products. A product will first undergo a new product stage followed by a maturing stage, and then a standardization stage (Krugman 194). Countries that have consumers who have a continued demand for improved products will produce products that are highly competitive, hence, highly marketable on the global market (Bernard 1290).
Once a product has surpassed the maturing stage, transfer to a manufacturing location can start due to factors like cheap production costs, available technology and market opportunities, as the production process is standardized to maintain desired quality (Bernard 1290). The transfer of many production plants from western countries to some developing countries like China and India can be explained by the product life cycle theory.
Another modern firm based theory is the global competitive theory. Here, there is a proposal that firms will invest in areas where they are likely to obtain a strategic advantage over their rivals (Melitz 1721). Among the most important areas that contribute to the competitive advantage of firms are entry barriers (Melitz 1721). Entry barriers include factors like research and growth opportunities, production costs, market opportunities, copyright laws and availability of raw materials (Bernhofen 50).
According to developing theories that attempt to understand the phenomenon of global trade, the national competitive advantage theory was proposed by Michael Porter in 1990 (Eaton 1760). Here, Porter stated that the competitiveness of a given country in a specific industry was based on the capacity of that country to innovation and improvement in the given industry (Eaton 1760). Porter attempted to understand why some countries were more competitive in given industries (Bernhofen 50). Porter identified four interdependent parameters that were crucial in promoting the competitive advantage of a country in a given sphere (Dixit 113).
These four parameters include the availability and capacity of local resources, the attributes of local corporations, the local market demand for firm products and the presence of complementary industries. The four factors above are highly significant in determining the competitive advantage of a given country in a specific industry (Dixit 113).
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