Should production facilities for goods that use raw material inputs be located at the site of the raw materials or should they be located at the market? Decisions of this sort have tremendous implications for international trade. If, for example, a production facility is located at the raw material site, there will be more international trade in the final product. If, on the other hand, a production facility is located at the market, raw materials must be imported and thus there will be more trade in raw materials.
There are three important considerations in determining which production location will minimize total transportation costs:
- The spatial distribution of the raw materials
- The extent to which the production process is weight-losing or weight-gaining
- The extent to which transportation costs per ton-mile differ for raw material inputs and the final product
If raw materials are localized—that is, if they exist only at a few places—production will occur in those places. If, on the other hand, raw materials are ubiquitous—that is, if they are widely distributed and available—production can take place anywhere and thus usually will be located close to the market. If the production process is a weight-losing one—for example, the conversion of pig iron into steel—production will take place at the raw materials site. The production of soft drinks, on the other hand, is a weight -gaining process and therefore is usually located at the market site. Finally, if, as is often the case, the transportation of raw materials is easier and cheaper than that of the finished products, production will tend to take place near the market. Transporting a Cadillac, for example, is much more costly than transporting the steel used to produce it.
Figure 7.1 presents the main theories used to explain production location decisions and their implications for international trade. International Trade Theory explains most of the reasons for and benefits of trading in commodities: a high cost for moving factors of production and a low cost for transporting commodities will result in heavy trade in commodities (cell G). Labor Migration Theory and Direct Foreign Investment Theory explain the main reasons for and benefits of moving people and capital to the markets: when the costs of moving the factors of production are low and the costs of moving commodities are high, production will locate at the markets (cell C).
These matters are at the heart of the international manager's job. They will therefore be taken up repeatedly throughout this book, especially in PRODUCTION / SOURCING STRATEGY.
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