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Eureka: The Home Bias in Trade Puzzle
by Jay Gutman
2017-11-21 07:49:49
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This puzzle has left economists wondering why on average companies prefer trading within their country than exporting to foreign countries. For example, despite NAFTA, American companies, even those located at the border with Canada or Mexico, trade more within the United States than with Canada or Mexico.

homebias01_400There are two answers to this puzzle, both answers are complementary. First of all, companies tend to export when there's a surplus. That is when there is so much production that the local, national economy can not absorb the quantity of production. That's when companies export the product to foreign countries. Second of all, only companies with a clear proven track record of exporting tend to export. That is, most companies who export, provided they have a large surplus, tend to have headquarters in large cities, usually port cities, and tend to have production lines here and there, take the production line to the port and export the production.

So cities bordering with Canada probably won't export with Canada. Since the surplus tends to be exported, companies with large surpluses will tend to move to New York City or Los Angeles and will tend to eye several countries while exporting, sign deals with as many countries as they can, not merely focus on Canada or Mexico if located at the border.

Only a handful of companies have the luxury of having the kind of production line that can enable them to export. As I said before, when it comes to production, be it agricultural or industrial or service production, merely breaking even is complicated. A lot of times, especially for newer companies, mastering the production line is not always easy. If you set up a production line, you need a sense of detail, awareness of the production line, and the kind of business common sense that will lead you to profit. Profits start off small, then grow as time goes by. Exports should be the last thing on your mind, you will first want your products to hit the shelves at the local supermarket before eyeing other surrounding supermarkets, before you can start thinking about Canada or Mexico or exporting elsewhere.

The only companies who have perfected production lines, with an army of suppliers, established logistics and transport systems, perfected production line technology, from assembly to packaging and an established network for clients will be able to export. They also need to be established brands, the kind of brand that can sell well in any market. In the end, only a handful of companies have mastered these production lines, and you may have seen somewhere online a list of the 16 or so dominant companies that control a lot of the global production or exports.

South Korea masters the micro chip production line and produces more micro chips than is needed in the local market. But South Korea at one point also produced more televisions than it needed, and with the advent of Youtube and the younger generation being less prone to buying televisions, that's a lot of televisions left unsold lying somewhere in a warehouse in South Korea. In the 1980s video game console Atari produced more games and consoles than the market desired and had to bury its production in a landfill. Of course, oil producing countries produce more oil than they can consume and have to sell their surplus. The same could be said about coffee producing countries who have to sell their surplus.

But if you start a production line in the State of Washington or Michigan, your first instinct won't be to start exporting your production to Canada. You may want to reach your town's distribution lines first, and that in itself is a lot of work. Sometimes economists don't realize how hard it is for many companies, including leading companies, to sell their production.

So the home bias in trade puzzle means that on average, small producers tend to keep an eye on local markets before aiming for international markets. This is because selling on the local market is not as easy as it sounds, as will attest the thousands of companies and products that failed to sell in any distribution line. At one point, the national distribution lines being saturated, South Korea tried to encourage small production lines to try to aim international markets. That was funny to look at. As I said, exporting is a complicated process that needs excellent mastery of pre-production, production and distribution lines, and you can't expect small companies with little experience to master international production and distribution lines. The result? A lot of cancelled deals, a lot of scams, a lot of rejected products because they did not fit the norms in the order slip or because they did not fit the norms of the country being exported to.

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