International business is a broad term, collectively used to describe all commercial transactions (private, government and semi-government) that take place between two or more nations. International business is a newly coined term, but the concept is quite traditional. Actually, the term international business is derived from “international trade”.
In ancient days, producers of a country used to export their surplus production to neighboring countries and later with the further development of trade they started exporting goods to far off countries as well. This was the establishment of an era of “international trade”. With further developments, more competitors came into the international markets, as a result of which producers started marketing their goods at international levels; this was the time when “international trade” turned into “international marketing”.
With further advancements, producers started establishing their production facilities in foreign countries and the era of globalization arrived; this was the time when researchers coined the term “international business”. There are many thinkers who have worked in the field of international business and they have put forward various theories in order to justify the concept of international business. These theories collectively explain why business firms of one country should go to another country, although the industries of that country also produce the same goods and market them. So these theories explain the basis for international business.
Some of the most important theories of international business are given below-
The absolute advantage theory
The absolute advantage theory was given by Adam Smith in 1776; according to the absolute advantage theory each country always finds some absolute advantage over another country in the production of a particular good or service. Simply because some countries have natural advantage of cheap labour, skilled labour, mineral resources, fertile land etc. these countries are able to produce some specific type of commodities at cheaper prices as compared to others. So, each country specializes in the production of a particular commodity. For example, India finds absolute advantage in the production of the silk saris due to the availability of skilled workers in the field, so India can easily export silk saris to the other nations and import those goods in which other countries find absolute advantages.
But this theory is not able to justify all aspects of international business. This theory leaves no scope of international business for those countries that are having absolute advantage in all fields or for those countries that are having no absolute advantage in any field.
The comparative cost theory
After 40 years of absolute advantage theory, in order to provide the full justification of international business David Richardo presented the Richardian model—comparative cost theory. According to the comparative cost theory, two countries should do business with each other if one country is having an advantage in the ability of producing one good relative to another good as compared to some other country’s relative ability of producing same goods. It can be well understood by taking an illustration-
If USA could produce 25 bottles of wine and 50 pounds of beef by using all of its production resources and France could yield 150 bottles of wine and 60 pounds of beef by using the same resources, then according to absolute advantage theory France finds clear advantage over USA in the production of both beef and wine. So, there should not be any business activity between the two countries. But this is not the case according to the comparative cost theory. Comparative cost theory suggests relative comparing of the beef and wine production. In relative comparing we can find that France sacrifices 2.5 bottles of wine for producing each pound of beef (150/60) and USA sacrifices 0.5 bottles of wine for producing each pound of beef (25/50). So, we can see that production of beef is more expensive in France as compared to USA. Comparative cost theory suggests USA to import wine from France instead of producing it and in similar manner theory suggests France to import beef from USA instead of producing it.
In this way, comparative cost theory well explains the driving forces behind international business.
Opportunity cost theory
The opportunity cost theory was proposed by Gottfried Haberler in 1959. The opportunity cost is the value of alternatives which have to be forgone in order to obtain a particular thing. For example, Rs. 1,000 is invested in the equity of Rama News Limited and earned a dividend of six per cent in 1999, the opportunity cost of this investment is 10 per cent interest had this amount been deposited in a commercial bank for one year term.
Another example is that, India produces textile garments by utilizing its human resources worth of Rs. 1 billion and exports to the US in 1999. The opportunity cost of this project is, had India developed software packages by utilizing the same human resources and exported the same to USA in 1999, the worth of the exports would have been Rs. 10 billion. Opportunity cost approach specifies the cost in terms of the value of the alternatives which have to be foregone in order to fulfil a specific art.
Thus, this theory provides the basis for international business in terms of exporting a particular product rather than other products. The previous example suggests that it would be profitable for India to develop and export software packages rather than textile garments to the USA.
The vent for surplus theory
International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export the surplus to other countries. Otherwise, a part of the productive labor of the country must cease and the value of its annual produce diminishes.
Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. The surplus productive capacity is taken by another country and in turn gives the benefit under international trade. According to this theory, the factors of production of developing countries are fully utilized. The unemployed labor of the developing countries is profitably employed when the surplus is exported.