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International Business - MGT520

MGT520 - International Business - Lecture Handout 01

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INTRODUCTION TO THE FIELD OF INTERNATIONAL BUSINESS

International business is all commercial transactions (private and governmental) between two countries.

A. Why Companies Engage in International Business

  1. Expand Sales. Going international allows companies to increase the size of the market to which they offer their products.
  2. Acquire Resources. Foreign capital, technology, labor, components all can help a firm become more competitive.
  3. Diversify Sources of Sales and Supplies. By operating in multiple countries, firms help protect themselves from economic downturns in any single country. In the same way, having suppliers in multiple countries helps protect the firm from shortages due to economic, social, or political disruptions in any single country.
  4. Minimize Competitive Risk. Companies expand internationally to competitors’ home markets in order to maintain a competitive balance across markets.

B. Reasons for Recent International Business Growth—From Carrier Pigeons to the Internet.

  1. Expansion of Technology. Air travel, the internet, e-mail, e-commerce, direct dial international phone calls, fax, and other technologies have brought down the cost and increased the efficiency of doing business internationally.
  2. Liberalization of Cross-Border Movements. The World Trade Organization (WTO, discussed in Chapter 6) and other international trade agreements have reduced barriers to the movement of goods and services across national boundaries.
  3. Development of Supporting Services. International banking, international document delivery, and other services have tremendously simplified the conduct of international business.

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MGT520 - International Business - Lecture Handout 02

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MODES OF INTERNATIONAL BUSINESS

A. Merchandise Exports and Imports:

Merchandise exports are tangible products (goods) manufactured in one country and sent out of that country to another one. Merchandise imports are tangible products (goods) brought in from another country.

B. Service Exports and Imports:

Service exports and imports are international earnings that do not come from a tangible product which physically crosses a border. The company receiving payment is making a service export. The company paying is making a service import. Exports are goods and services produced in one country and then sent to another country. Imports are goods and services produced in one country and then brought in by another country. Information about exports and imports helps us to explain the impact of international business on the economy.

  1. Tourism and Transportation. When an American flies to Germany on Lufthansa (a German airline) and spends a few days in a German hotel, the payments made to Lufthansa and the hotel are service exports for Germany and service imports for the United States.
  2. Performance of Services. When an American engineering firm receives a payment for designing a plant in France, it is a service export for the United States and a service import for France.
  3. Use of Assets. International licensing agreements and franchising allow foreign entities to use another firm’s trademarks, patents, or technology. Payments for the right to use these assets are a service export for the country receiving those payments and a service import for the country making the payments.

C. Investments:

Foreign investment means ownership of foreign property is exchanged for a financial return (e.g., interest and dividends).

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MGT520 - International Business - Lecture Handout 03

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AN OVERVIEW

Patterns of Expansion:

Firms tend to follow a pattern of increasing international involvement. Companies usually are initially reluctant to undertake international activity, but that reluctance diminishes as they become more experienced.

Passive to Active Expansion:

Initially, firms simply respond to international demand for their product. Later, they start planning how to best expand internationally.

External to Internal Handling of Operations:

Initially, firms use freight forwarders, customs brokers, and other external companies to help handle the details of international business. Later, once the firm has learned more about international operations, it will often perform these functions itself.

Deepening Mode of Commitment:

Firms usually begin international activities by either importing or exporting. These activities require no overseas investment and minimal commitment to international opportunities. As the rewards of international business become more apparent and foreign markets become more familiar, the firm may expand its international commitment and begin even producing some of its products abroad.

Geographic Diversification:

At first, companies will do business only in one or two other countries (usually countries nearby and with cultural similarities to the company’s home country). As time goes by and the company learns more, it will tend to expand its operations into more distant and varied location

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MGT520 - International Business - Lecture Handout 04

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GLOBALIZATION

What is globalization?

  1. There is a movement towards a globalization of markets, as the tastes and preferences of consumers in different nations are beginning to converge upon some global norm. The global acceptance of Coca-Cola, Levi's jeans, Sony Walkmans, and McDonald's hamburgers are all examples. Yet there are still significant differences - Germany still leads in per capita beer consumption, with a local pub on almost every corner and in some cities, women selling beer out of their front windows to passers by on the street. The French lead in wine consumption, and the consumption of wine is a natural part of life anywhere in France. Italians lead in pasta eaten, and these differences are unlikely to be eliminated any time soon. Hence, often there is still a need for marketing strategies and product features to be customized to local conditions.
  2. There is a movement towards a globalization of production, as firms disperse parts of their production processes to different locations around the globe to take advantage of national differences in the cost and quality of factors of production. The examples of Boeing and Swan Optical illustrate how production is dispersed. While part of the rationale is based on costs and finding the best suppliers in the world, there are also other factors. In Boeing’s case, if it wishes to sell airliners to countries like China, these countries often demand that domestic firms be
    contracted to supply portions of the plane - otherwise they will find another supplier (Airbus) who is willing to support local industry.

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GLOBALIZATION

Technology Improvement:

Improved information processing and communication allow firms to have better information about distant markets and coordinate activities worldwide. The explosive growth of the World Wide Web and the Internet provide a means to rapid communication of information and the ability of firms and individuals to find out about what is going on worldwide for a fraction of the cost and hassle as was required only a couple of years ago.
Improvements in transportation technology, including jet transport, temperature controlled containerized shipping, and coordinated ship-rail-truck systems have made firms better able to respond to international customer demands.
As a consequence of these trends, a manager in today's firm operates in an environment that offers more opportunities, but is also more complex and competitive than that faced a generation ago. People now work with individuals and companies from many countries, and while communications technology, with the universality of English as the language of business, has decreased the absolute level of cultural difficulties individuals face, the frequency with which they face inter-cultural and international challenges has increased. Exports are goods and services produced in one country and then sent to another country. Imports are goods and services produced in one country and then brought in by another country. Information about exports and imports helps us to explain the impact of international business on the economy.

  1. Foreign direct investment (FDI) is equity funds invested in other nations. Industrialized countries have invested large amounts of money in other industrialized nations and smaller amounts in less developed countries (LDCs), such as those in Eastern Europe, or in newly industrialized countries (NICs), such as Hong Kong, South Korea, and Singapore. Most of the world’s FDI is in the US, the European Union (EU), and Japan. As nations have become more affluent, they have pursued FDI in geographic areas that have economic growth potential. The Japanese, for example, have been investing heavily in the EU in recent years.
  2. Over 50 per cent of world trade and over 80 per cent of foreign direct investment is conducted by three regional economic hubs: the US, the EU and Japan. Collectively, these areas are referred to as the “triad”. The triad is a group of three major trading and investment blocs in the international arena.

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GLOBALIZATION

The changing demographics of the global economy:

  1. The U.S. share of world output has declined dramatically in the past 30 years (See Table 1.2), and a much more balanced picture is now developing among industrialized countries. Looking ahead into the next century, the share of world output of what are now referred to as “developing countries” is expected to greatly surpass that of the current “industrialized countries.”
  2. The source and destinations of FDI has also dramatically changed over recent years, with the US and industrialized countries becoming less important (although still dominant) as developing countries are becoming increasingly considered as an attractive and stable location for investment (See Figures 1.3 and 1.4).
  3. A number of large multinationals are now non-U.S. based, and many are recognizable brand names in the worldwide (e.g. Sony, Philips, Toshiba, Honda, BMW). The new large multinationals are not only are originating in other developed countries, but there are an increasing number of multinationals based in developing countries. Table 1.3 shows the change in the home country of multinationals since 1973. The country focus on Korea’s new multinationals clearly illustrates the growth of developing country multinationals.
  4. An increasing number of small firms are becoming global leaders in their field, giving rise to the mini-multinational. The management focus segment on Harry Ramsden’s illustrates the opportunities available to small firms.
  5. The fall of communism and the development of free markets in Eastern Europe and the former Soviet Union create profound opportunities, challenges, and potential threats for firms.
  6. The economic development of China presents huge opportunities and risks, in spite of its continued Communist control.
  7. For North American firms, the growth and market reforms in Mexico and Latin America also present tremendous new opportunities both as markets and sources of materials and production.
  8. The path to full economic liberalization and open markets is not without obstruction. Economic crises in Latin America, South East Asia, and Russia all caused difficulties in 1997 and 1998. In response, much trade was curtailed, and some countries imposed new controls. Malaysia, for example, suspended foreigners from trading in its equity and currency markets to “prevent destabilizing influences.” While firms must be prepared to take advantage of an ever more integrated global economy, they must also prepare for political and economic disruptions that may throw their plans into disarray.

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GLOBALIZATION

COUNTERVAILING FORCES:

Countervailing forces influence the conditions in which companies operate and their options for operating
internationally. Rivalries among countries, cross-national treaties and agreements and ethical dilemmas can
inhibit a firm’s quest for maximum global profits.
A. Globally Standardized versus Nationally Responsive Practices:
Trends that influence the worldwide growth in international business often favor the use of a global
strategy, i.e., standardization, thus capturing gains from economies of scale. On the other hand, a firm
may choose to use a multidomestic strategy, i.e., to be nationally responsive, thus increasing its
effectiveness by adjusting to the different conditions it encounters in the various countries in which it
operates.
B. Country versus Company Competitiveness:
At one time the performance of a country and that of its domestic companies were considered to be
mutually dependent and beneficial. However, many companies now choose to compete by seeking
maximum production efficiency on a global scale, even if it means moving production activities abroad. If
as a result high-value activities increase sufficiently in the home country, it will realize an economic gain; if
not, the country’s economic position will deteriorate. Countries continue to entice both domestic and
foreign firms to locate activities within their borders through regulations, on the one hand, and incentives
on the other.
C. Sovereign versus Cross-National Relationships:
Although governments act in their own self-interest, they may choose to cooperate with one another and
even cede limited sovereignty through treaties and other agreements.

  1. Countries enter into a variety of bilateral and multilateral treaties and agreements with other countries regarding commercial activities in order to gain reciprocal advantages for themselves and their domestic firms.
  2. Countries enact treaties and agreements to coordinate activities along their shared borders and deal with problems that a single country acting alone cannot solve.
  3. Countries enact treaties and agreements to deal with areas of concern that lie outside the territory of all countries, i.e., the non-coastal areas of the oceans, outer space and Antarctica.

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY

Political Systems:

  1. There are two separate polarities to consider when discussing political systems: collectivism vs. individualism and democracy vs. totalitarianism.
  2. The general premise of collectivism is that the state must manage enterprises if they are to benefit society. Democratic Socialism sees itself as part of the historical trend toward democracy and universal enfranchisement that has taken place worldwide since the 1700s. In fact, it sees socialism as the ultimate democracy-- putting faith in the common person's ability not only to vote on Election Day, but also to govern his and her workplace and community.
    According to philosopher Jonathan Kandell, “What distinguishes Democratic Socialists from more radical communist groups is the unwavering belief that socialism must come through democratic means or not at all (along with all the standard individual rights to free speech and assembly). Democratic Socialists distinguish themselves from Liberals in that they feel the basic structure of capitalism is inherently biased against a large group of people and must be structurally rectified, instead of just tiny tinkerings. The government must take an active, radical stance in favor of workers, equality, basic human needs, workplace democracy, and against greed, capital and property rights.”
    Communists generally believed that state control could only be achieved though revolution and totalitarian dictatorship, while Social Democrats worked to achieve the same goals by democratic means. Examples of communism include the Soviet Union, most Eastern European nations from 1950 to 1989, Cuba, and China. China remains the only major country in the world today still under communist rule. Social Democratic nations include Sweden, Germany, France, and Norway, although Social Democratic parties have not always held power in these nations. Don’t be surprised if your students have only a vague idea about Communism. I find that many students are shocked to believe that a country could hope to control the ideology of its people by building a wall around a city (Berlin). In this day of rapid, instantaneous exchange of electronic information, the concept of a
    government trying to create physical barriers to control the flow of information is often difficult for them to grasp.
  3. The inefficiencies of government are well known, and students can often offer many examples. (The $100 hammer, for instance.) State owned firms promoting the public interest have had a poor track record. The reasons are often obvious: state owned firms are often protected from competition and are poorly motivated to achieve any financial self-sufficiency. Often their major purpose is to perpetuate their existence, rather than bringing anything positive to the country they are supposed to serve. Thus, both former communist and Western European countries have privatized enterprises that were previously state owned.
  4. While advocated by Aristotle, individualism, in modern days was encouraged by David Hume, Adam Smith, John Stuart Mill, and most recently, Hayek and Milton Friedman. Individualism focuses on i) guaranteeing individual freedom and self-expression, and ii) letting people pursue their own economic self-interest in order to achieve the best overall good for society. The US Declaration of Independence and the Bill of Rights embody the spirit of individualism, but more familiar to today’s students are forces like MTV, which encourage people the world over to vote for their favorite video—even in countries where voting in elections is impossible and the concept of voting is notunderstood.
  5. Collectivism advocates the good of the collective group over the individual; individualism asserts the opposite. This ideological difference shapes much of recent history and especially the Cold War. [An interesting digression one can take here (at the risk of getting sidetracked) is to discuss environmentalism, in the context of collectivism vs. individualism. While one might expect that countries with a collectivist approach would have much higher environmental standards "for the common good" than individualist countries where “anyone can do what they want on their own land,” the record is less clear. While the Social Democratic countries of Norway and Sweden have
    some of the best overall environmental records, the pollution problems in many of the former communist states are horrendous. And the US has an environmental record similar to many other social democratic countries in Western Europe. In fact, as we will see in later discussions on GATT and NAFTA, different countries’ environmental standards are becoming an increasingly important issue in international trade negotiations.]

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY
THE IMPACT OF THE POLITICAL SYSTEM ON MANAGEMENT DECISIONS:

Political Risk:

Political risk occurs when there is a possibility that the political climate in a foreign country will change in such a way that the operations of international companies in that country will deteriorate.

A. Types and causes of political risk:

Types of political risk include government takeovers of property, operating restrictions, and agitation that damage the company’s performance. Such problems can be caused by changing opinions of political leadership, civil disorder, and changes in external relations (such as animosity between the home and host country governments.

Macro and micro political risks:

If political actions are aimed only at specific foreign investments (e.g., a single foreign company), they are considered micro political risks. If they are aimed at a broad spectrum of foreign investors (e.g., when all foreign-owned private property was taken over by Cuba), they are considered macro political risks.

B. Government Intervention in the Economy:

Some governments adopt an “individualistic paradigm” and keep intervention in the economy at a minimum. Others adopt a “communitarian paradigm” wherein the government plays a larger role in the economy. They thrive on a respected, centralized bureaucracy with a stable political party or coalition in power. If a U.S. firm moves from the United States (individualistic) to Germany, Japan, or South Korea (communitarian), it may have to develop new strategies for its relationships with government, suppliers, customers, and competitors.

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY

Legal Systems:

  1. The legal environment of a country is of immense importance to international business. A country's laws regulate business practice, define the manner in which business transactions are to be executed, and set down the rights and obligations of those involved in business transactions. Differences in the structure of law can have an important impact upon the attractiveness of a country as an investment site and/or market.
  2. Control over property rights are very important for the functioning of business. Property rights refer to the bundle of legal rights over the use to which a resource is put and over the use made of any income that may be derived from that source. Property rights can be violated by either private action (theft, piracy, blackmail, Mafia) or public action (governmental bribery and corruption, nationalization). Lack of confidence in a country’s fair treatment of property rights significantly increases the costs and risks of doing business.
  3. The Country Focus on Corruption in Nigeria shows how a country that has huge natural resources can still remain poor when its political leaders conspire to damage its economic activity for their personal gain. High levels of corruption can naturally lead to a significant reduction in economic activity.
  4. Intellectual property rights (patents, copyrights, and trademarks) are important for businesses if they are to capitalize on what they have developed. Firms like Microsoft, Levis, Coca-Cola, or McDonald’s would have little reason to invest overseas if other firms in other countries were able to use the same name and copy their products without permission. The management focus article on drug patents in South Africa illustrates the issue well. By allowing the purchase of AIDS drugs from the cheapest source, the South African government was attempting to avert a health crisis. In doing so, it created a violation of international property rights that may take many years of court action to settle.
  5. Different countries have different product safety and liability laws. In some cases US businesses must customize products to adhere to local standards if they are to do business in a country, whether these standards are higher or just different.
  6. When product standards are lower in other countries, firms face an important ethical dilemma. Should they produce products only of the highest standards even if this puts them at a competitive disadvantage relative other producers and results in not maximizing value to shareholders? Or should they produce products that respond to local differences, even if that means that consumers may not be assured of the same levels of safety in different countries? One serious example I use involves the flame retardant nature of children’s pajamas. In many countries restrictions on the level of flame retardency are very low and even nonexistent, and it is perfectly legal to manufacture that product without protective standards. Should international firms continue to manufacture to higher protection levels, with resulting increased costs that may put them at a competitive disadvantage?
  7. Differences in contract law force firms to use different approaches when negotiating contracts. In countries with common law traditions, contracts tend to be much more detail oriented and need to specify what will happen under a variety of contingencies. Common law tends to interpret legal statutes according to the past decisions and rulings of courts. The United States uses a common law system. Under civil law systems, contracts tend to be much shorter and less specific since many of the issues relating to contracts are covered in the civil code of the country. Under common law, ownership is established by use; under civil law, ownership is determined by registration. Therefore, another firm may register a product first and prevail in a bid for ownership, even though the competition had been using the product for a long time but had failed to register it.

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY

The Determinants of Economic Development:

  1. Different countries have dramatically different levels of development, as shown in Map 2.1. GDP/capita is a good yardstick of economic activity, as it measures average value of the goods and services produced by an individual.
  2. But GDP/capita does not consider the differences in costs of living. The UN's PPP index as shown in Table 2.1 shows the differences in the standards of living of people in different countries.
  3. A problem with both GDP/capita and PPP is that they are static in nature. From an international business perspective it is good to look at the rate of growth in the economy as well as the status of its people. Map 2.3 shows that some of the fastest growing countries economically are those have been slower to develop.
  4. A broader approach to assessing the overall quality of life in different countries is the Human Development Index. This is based on life expectancy, literacy rates, and whether (based on PPP indices) incomes are sufficient to meet the basic needs of individuals. Map 2.4 shows the Human Development Index. Notice that some of the worse off countries are heavily populated and have rapidly expanding populations.
  5. What is the relationship between political economy and economic progress? This is a difficult issue. One thing that is generally accepted is that innovation is the engine of long-run economic growth. Another thing that we have come to generally accept in recent years is that a market economy is better at stimulating innovation than a command economy that does not have the same types of incentives for individual initiative.

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY

States in Transition:

  1. Since the late 1980s there have been two major changes in the political economy of many of the world’s nations. First, a wave of democratic revolutions swept the world, and many of the previous totalitarian regimes collapsed. Secondly, there has been a move away from centrally planned and mixed economies towards free markets.
  2. The revolutions in the USSR and Eastern Europe have (in general) moved these countries towards democracy (away from totalitarianism), towards individualism (away from collectivism), and towards mixed economies (away from command). The transitions have been difficult, however, and economic progress has not been easy. Recent elections have brought “reformed” communists back into power in some countries, and the economic problems facing the people are significant.
  3. There are three main reasons for the spread of democracy. First, many totalitarian regimes failed to deliver economic progress to the vast bulk of their populations. Secondly, improved information technology limited the ability of the government to control citizens’ access to information. Thirdly, increases in wealth and the standard of living have encouraged citizens to push for democratic reforms.
  4. While there are general movements towards democracy and open economies, this does not mean that there is necessarily going to be a homogenization of civilization. At the same time we see a further definition and development of both Islamic and Chinese civilizations.
  5. The spread of market-based economic systems is not limited the dramatic changes in the former totalitarian states in Eastern Europe. In Western Europe, there has been a general trend towards privatization of state owned companies and deregulation of industry. Any recent edition of the Financial Times or the Economist will likely discuss the problems facing some previously protected and overstaffed industry.
  6. During the 1980s most Latin American countries changed from being run by dictatorship to democratically elected governments. While most countries previously had erected high barriers to imports and investment (to keep multinationals from "dominating" their economies), they now mostly are encouraging investment, lowering barriers, and privatizing state owned enterprises.
  7. Map 2.6, based on data from the Heritage Foundation, provides some indication of the degree to which the world has shifted towards market-based economic freedom.
  8. The Country Focus on Privatization in Brazil points out the benefits of privatization that have occurred in that country. Most notable is the case of Embraer, which experienced huge losses under a state control. When the company was sold to private enterprise, it experienced a dramatic turnaround and became an economic success.
  9. These transitions are creating huge opportunities for international business, as well as creating huge risks. It is not clear what direction future changes will take, and if these will be entirely favorable for business.
  10. The shift toward a market-based economic system typically involves at least three distinct activities: deregulation, privatization, and legal enforcement of property rights. Deregulation involves removing restrictions on the free operation of markets. Privatization transfers the ownership of state property into the hands of private investors. In order to attract investment and protect the interests of the private enterprise encouraged by the first two activities, changes typically need to be made to legal systems to protect the property rights of investors and entrepreneurs.

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY

The Determinants of Economic Development:

  1. Different countries have dramatically different levels of development, as shown in Map 2.1. GDP/capita is a good yardstick of economic activity, as it measures average value of the goods and services produced by an individual.
  2. But GDP/capita does not consider the differences in costs of living. The UN's PPP index as shown in Table 2.1 shows the differences in the standards of living of people in different countries.
  3. A problem with both GDP/capita and PPP is that they are static in nature. From an international business perspective it is good to look at the rate of growth in the economy as well as the status of its people. Map 2.3 shows that some of the fastest growing countries economically are those have been slower to develop.
  4. A broader approach to assessing the overall quality of life in different countries is the Human Development Index. This is based on life expectancy, literacy rates, and whether (based on PPP indices) incomes are sufficient to meet the basic needs of individuals. Map 2.4 shows the Human Development Index. Notice that some of the worse off countries are heavily populated and have rapidly expanding populations.
  5. What is the relationship between political economy and economic progress? This is a difficult issue. One thing that is generally accepted is that innovation is the engine of long-run economic growth. Another thing that we have come to generally accept in recent years is that a market economy is better at stimulating innovation than a command economy that does not have the same types of incentives for individual initiative.
  6. Innovation also depends on a strong protection of property rights, as innovators and entrepreneurs need some level of assurance that they will be able to reap the benefits of their initiative.
  7. While it is possible to have innovation and economic growth in a totalitarian state, many believe that economic growth and a free market system will eventually lead a country to becoming more democratic.
  8. Geography can also affect economic development. A landlocked country with an inhospitable climate, poor soil, few natural resources, and terrible diseases is unlikely to develop economically as fast as country with the opposite characteristics on each of these attributes.
  9. While it can be hard to do much about unfavorable geography, education is something that governments can affect. Numerous studies suggest that countries that invest more in the education of their young people develop faster economically. Examples include, Japan, South Korea and many Asian countries.

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NATIONAL DIFFERENCES IN POLITICAL ECONOMY

Political risk:

  1. Political risks are any governmental actions or politically motivated events that adversely affect the long-run profitability or value of firms doing business.
  2. An important aspect of the political environment is the phenomenon of ethnicity – a driving force behind the political instability around the world. Managers must understand the ethnic and religious composition of the host country in order to anticipate situations of political and general instability.
  3. Nationalization refers to the forced sale of the MNCs assets to local buyers, with some compensation to the firm. Expropriation occurs when the local government seizes the foreignowned assets of the MNC, providing inadequate compensation, if any at all.
  4. Macro political risk events are those that affect all foreign firms doing business in a country or region; e.g., terrorism, the use or threat of use of anxiety inducing violence for political purposes. Micro political risk events are those that affect one industry or company or a few companies.
  5. Seven typical political risk events common today are:
    a. Expropriation without prompt and adequate compensation
    b. Forced sale of equity to host country nationals, usually at or below depreciated book value
    c. Discriminatory treatment against foreign firms in applying laws and regulations
    d. Barriers to repatriation of funds (profits or equity)
    e. Loss of technology or intellectual property rights
    f. Interference in managerial decision-making
    g. Dishonesty by government officials

Political risk assessment:

  1. Global companies must commit some form of political risk assessment in order to manage their exposure to risk and to minimize financial losses.
  2. Risk assessment by multinational corporations usually takes two forms: the use of experts or consultants and the development of internal staff and in-house capabilities. Both means may be used. The focus must be on monitoring political issues before they become headlines. The ability to minimize negative effects on the firm or to be the first to take advantage of opportunities is greatly reduced once developments have been reported in the news.

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DIFFERENCES IN CULTURE

What is Culture?

  1. Culture has been defined a number of different ways. In this course we will view culture as a system of values and norms that are shared among a group of people and that when taken together constitute a design for living.
  2. While culture is a characteristic of society as a whole, it shapes individual behavior by identifying appropriate and inappropriate forms of human interaction.
  3. The fundamental building blocks of culture are values and norms.
  4. Values are abstract ideas about what a society believes to be good, right, and desirable. As was discussed in Chapter 2, values affect political and economic systems as well as culture. Values include attitudes towards concepts like freedom, honesty, loyalty, justice, responsibility, and personal relations including marriage.
  5. Norms are social rules and guidelines that prescribe the appropriate behavior in particular situations. Norms shape the actions of people towards one another. Norms can be divided into folkways and mores.
  6. Folkways are the routines conventions of everyday life, but generally have little moral significance. Examples would be dress, eating habits, and social graces. Foreigners may be easily excused for making a few faux pas. Timeliness is a good example, and you can discuss when timeliness is critical (test days) as well as when one may be expected to be "fashionably late." If students come from different parts of the country or world, you can ask for opinions on when they should arrive for a party if the invitation says 8pm. Even typically American students have different concepts about lateness. The concept of time as a commodity is peculiar to Western society. Time can be spent, saved, wasted. That is quite different from many other societies, especially some areas of Latin
    America, where time is seen as an item to be enjoyed and savored.
  7. Mores are more serious standards of behavior, the breaking of which may be very inappropriate or even illegal. Examples would be theft, adultery, murder, or use of mind-altering substances (including alcohol, caffeine, and marijuana). Mores can vary greatly between countries: what in one country may be viewed as an innocent flirt in another may constitute a serious affront to someone's dignity or even harassment. While it is acceptable, and even expected, to consume alcohol with business associates in Japan, where evening business contacts often border on drunkenness, such actions would be disallowed in the United Arab Emirates.
  8. Norms and values are an evolutionary product of a number of factors that are at work in a society, including political and economic philosophy, social structure, religion, language, and education. Culture affects both of these factors and is affected by them.
  9. The nation-state is only a rough approximation of a culture. Within a nation-state multiple cultures can easily exist (as we can only too painfully see in the former Yugoslavia), and cultures can also cut across national borders. That can often be easily illustrated by describing the differences that exist between people in a country. It is quite easy to get a class of students in the Western US to agree that the people in New York are really different and generally rude, while Eastern students will comment on Californians or Southerners, etc. Likewise, students in Stockholm will have clear opinions about how different Swedes are from the far North or far South. In virtually any country or state students will easily be able to describe the differences between city-folks and country-folks,
    and some students will “defend” their culture while making disparaging remarks about the other.

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DIFFERENCES IN CULTURE

Religious and Ethical Systems:

  1. Religion can be defined as a system of shared beliefs and rituals that are concerned with the realm of the sacred. Ethical systems refer to a set of moral principles, or values, that are used to guide and shape behavior. The ethical practices of individuals within a culture are often closely intertwined with their religion. While there are literally thousands of religions worldwide, four that have the largest following will be discussed: Christianity, Islam, Hinduism, and Buddhism. Confucianism, while not a religion, influences behavior and shapes culture in many parts of Asia. Map 3.1 shows dominant religions across the world.
  2. Christianity is the largest religion and is common throughout Europe, the Americas, and other countries settled by Europeans. Within Christianity there are three major branches: Protestant, Roman Catholic, and Eastern Orthodox. At the turn of the century Weber suggested that is was the "Protestant work ethic" that was the driving force of capitalism. This focus on hard work, wealth creation, and frugality encouraged capitalism while the Catholic promise of salvation in the next world did not foster the same kind of work ethic. The Protestant emphasis on individual religious freedom, in contrast to the hierarchical Catholic Church, was also consistent with the individualist economic and political philosophy discussed in Chapter 2.
  3. Islam has the same underlying roots of Christianity (Christ is viewed as a prophet), and suggests many of the same underlying societal mores. Islam, however, extends this to more of an allembracing way of life that governs one's being. It also prescribes many more "laws" on how people should act and live. These are laws that are entirely counter to the US "separation of church and state." In Islam people do not own property, but only act as stewards for God and thus must take care of that with which they have been entrusted. They must use property in a righteous, socially beneficial, and prudent manner; not exploit others for their own benefit; and they have
    obligations to help the disadvantaged. Thus while Islam is supportive of business, the way business is practiced is strictly prescribed. For instance, no interest may be paid on business loans. The country focus on Pakistan illustrates how banks deal with, and overcome, that restriction.
  4. Hinduism, practiced primarily on the Indian sub-continent, focuses on the importance of achieving spiritual growth and development, which may require material and physical self-denial. Since Hindus are valued by their spiritual rather than material achievements, there is not the same work ethic or focus on entrepreneurship found in some other religions. Likewise, promotion and adding new responsibilities may not be the goal of an employee, or may be infeasible due to the employee's caste.
  5. Buddhists also stress spiritual growth and the afterlife, rather than achievement while in this world. Buddhism, practiced mainly in Southeast Asia, does not support the caste system, however, so individuals do have some mobility not found in Hinduism and can work with individuals from different classes.
  6. Confucianism, practiced mainly in China, teaches the importance of attaining personal salvation through right action. Unlike religions, Confucianism is not concerned with the supernatural and has little to say about the concept of a supreme being or an afterlife. The needs for high moral and ethical conduct and loyalty to others are central in Confucianism. Three key teachings of Confucianism - loyalty, reciprocal obligations, and honesty - may all lead to a lowering of the cost of doing business in Confucian societies. The close ties between Japanese auto companies and their suppliers, called keiretsus, have been an important ingredient in the Japanese success in the
    auto industry. They have facilitated loyalty, reciprocal obligations, and honesty. In countries where these relationships are more adversarial and not bound by these same values, the costs of doing business are probably higher.

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DIFFERENCES IN CULTURE

Information and Task Processing:

People from different cultures obtain, perceive, and process information in different ways; thus, they may also reach different conclusions.

Perception of Cues:

People identify things by means of their senses in various ways with each sense. The particular cues used vary both for physiological and cultural reasons. [For example, the richer and more precise a language, the better one’s ability to express subtleties.]

Obtaining Information:

Language represents a culture’s means of communication. In a low-context culture, people rely on firsthand information that bears directly on a decision or situation; people say what they mean and mean what they say. In a high-context culture, people also rely on peripheral information and infer meaning from things communicated indirectly; relationships are very important. [For example, while Germany is considered to be a low-context culture, Saudi Arabia is considered to be a high-context culture.

Information Processing:

All cultures categorize, plan and quantify, but the ordering and classification systems they use often vary. In monochromic cultures (e.g., northern Europeans) people prefer to work sequentially, but in polychromic cultures (e.g., southern European) people are more comfortable working on multiple tasks at one time. Likewise, in some cultures people focus first on the whole and then on the parts; similarly, in idealistic cultures people will determine principles before they attempt to resolve issues, but in pragmatic cultures they will focus more on details than principles.

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DIFFERENCES IN CULTURE

Personal Communication:

Every culture has a communication system to convey thoughts, feelings, knowledge, and information through speech, actions, and writing. Understanding a culture’s spoken language provides insight into why people think and behave in a certain way. Understanding a culture’s body language avoids unintended or embarrassing messages.

Spoken Language:

  1. Spoken Language is the part of a culture’s communication system embodied in its spoken and written vocabulary.
  2. Linguistically different segments of a population are often culturally, socially, and politically distinct (e.g., Malaysia’s population is comprised of Malay [60 percent], Chinese [30 percent], and Indian [10 percent]).
  3. Software providers assist companies from English-speaking countries in adapting their Web sites for global e-business. The company that provides customers in Mexico City, Paris, or Tokyo with a quality buying experience in his or her native language will have a competitive edge.
  4. Companies have made language blunders in their international business dealings (e.g., When Chevrolet launched its Chevrolet Nova in Spanish-speaking markets, it did not realize that “No va” means “No go” in Spanish).
  5. The use of machine translation—software that translates languages—is booming along with the explosion in nonnative English speakers using the Internet (e.g., the French version of “I don’t care” (“Je m’en fou”) into “I myself in crazy”).
  6. A lingua franca is a third or “link” language that is understood by two parties who speak different languages (e.g., Sony and Matsushita use English in official company communications—even in non-English-speaking countries).

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INTERNATIONAL TRADE THEORY

LOOKING TO THE FUTURE:

Companies Watch the Free Trade Trend, Hoping it will continue
Firms that operate internationally tend to benefit from freer trade. Shipments among subsidiaries and access to foreign markets are made easier the more countries adopt free trade policies. There are many indications that the current trend is toward freer trade; however, there are also some difficult issues ahead. Freer trade tends to erode national sovereignty. The benefits of free trade may be unequally distributed between developed and less developed economies. Such issues may have an impact on the progress toward freer trade.

Introduction and Overview of Trade Theory:

  1. The opening case comparing Ghana and South Korea illustrates how South Korea's policy of encouraging trade fueled its economic growth, while Ghana's policies resulted in a reallocation of resources away from their most productive uses. It is important that students acknowledge the obvious: these two countries were almost the same. The only apparent difference was their approach to free trade.
  2. This chapter reviews a number of different theories of international trade to show why it is beneficial for a country to engage in trade and what patterns of international trade might be expected. You may use Iceland for an example, and pose the question: “What would life be like on Iceland if it did not trade?” Clearly there would be few if any autos or electronic products, and the diet would consist mainly of fish - very inexpensive fish. While it would clearly be technically possible for Iceland to make greenhouses, use heat from its abundant geothermal resources, and supply artificial light to produce all sorts of tropical fruits, these would be very expensive fruit.
    Thus, it makes sense for Iceland to trade some its abundant fish for other goods produced at lower costs in the rest of the world.

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INTERNATIONAL TRADE THEORY

Absolute Advantage:

  1. Adam Smith argued that countries differed in their ability to produce goods efficiently, and they should specialize in the production of the goods they can produce the most efficiently.
  2. If Britain were to specialize in textile production and France in wine production, Smith argued that both Britain and France could consume more textiles and wine than if each only produced for their own consumption. Thus trade is a positive sum game.
  3. These gains from trade can be showed graphically by looking again at Ghana and South Korea. Figure 4.1 shows both countries' production possibilities frontiers.
  4. Table 4.1 can be used to show how consumers in both countries can be better off with specialization of production and trade.
  5. When each country has an absolute advantage in one of the products, it is clear that trade is beneficial. But what if one country has an absolute advantage in both products? Then we should consider the country’s comparative advantage.

Comparative advantage:

  1. Ricardo showed how it makes sense for a country to specialize in the production of goods in which it simply has a comparative advantage, even if it can produce both more efficiently than the other country.
  2. Figure 4.2 shows the production possibilities frontiers for Ghana and South Korea when Ghana has an absolute advantage in both cocoa and rice. Points A & B illustrate possible levels of consumption and production without trade.
  3. Ghana has a comparative advantage in the production of cocoa since it can produce 4 times as much cocoa as South Korea, but only 1.5 times as much rice. Ghana is comparatively more efficient at producing cocoa than rice.
  4. Points C and K' in Figure 4.2 show a possible new production point for each country. Table 4.2 shows how, with trade, both Ghana and South Korea can increase consumption of both products.
  5. This simple example makes a number of assumptions: only two countries and two goods; zero transportation costs; similar prices and values; resources are mobile between goods within countries, but not across countries; constant returns to scale; fixed stocks of resources; and no effects on income distribution within countries. While these are all unrealistic, the general proposition that countries will produce and export those goods that they are the most efficient at producing remains quite valid.
  6. Diminishing returns to specialization simply suggest that after some point, the more of a good that a country produces, the greater will be the units of resources required to produce each additional item. If crops are grown on increasingly less fertile land, mining is done on less productive ore regions, or less skilled personnel need to be hired to perform high skilled jobs, production per unit of input will decrease. Diminishing returns implies a PPF which is convex (as shown in Figure 4.3). In reality countries do not specialize entirely, but produce a range of goods. It is worthwhile to specialize up until that point where the resulting gains from trade are offset by diminishing returns.
  7. Opening an economy to trade is likely to generate dynamic gains of two types. First, trade might increase a country's stock of resources as increased supplies become available from abroad. Secondly, free trade might increase the efficiency of resource utilization, and free up resources for other uses. Figure 4.4 shows how dynamic gains can shift a country's PPF outwards.

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INTERNATIONAL TRADE THEORY

ABSOLUTE ADVANTAGE:

In 1776, Adam Smith questioned the prevailing Mercantilist ideas on trade and developed the theory of Absolute Advantage. Smith reasoned that if trade were unrestricted, each country would specialize in those products in which it had a competitive advantage. Each country’s resources would shift to the efficient industries because the country could not compete in the inefficient ones. Through specialization, countries could improve their efficiency because 1) labor could become more skilled by repeating the same tasks, 2) labor would not lose time in switching among production of different products, and 3) long production runs would provide incentives for the development of more efficient working methods.

Natural Advantage:

A country may have a natural advantage in some products because of climate or other natural resources (labor, minerals, etc.).

Acquired Advantage:

In manufactured goods, countries usually have acquired an advantage in either their product or process technology.

Resource Efficiency Example:

Figure 5.2 illustrates how the United States has an absolute advantage in wheat, while Sri Lanka has an absolute advantage in tea. By the U.S. specializing in wheat production and Sri Lanka specializing in tea production, the global production of tea and wheat can be increased.

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INTERNATIONAL TRADE THEORY

Factor Proportions Theory:

Factor proportions theory states that countries produce and export goods that require resources (factors) that are abundant (and thus cheapest) and import goods that require resources in short supply. Thus, the theory focuses on the productivity of the production process.

Labor versus Land and Capital Equipment:

  1. Factor proportions theory breaks resources into two categories: 1) labor and 2) land and capital equipment. It predicts that a country will specialize in products that require labor if the cost of labor is low relative to the cost of land and capital, and vice versa.
  2. Factor proportions theory is conceptually appealing (e.g., Australia has much land and a small population; its exports consist of products that require much land while imports consist of manufactured and consumer goods).

Evidence on Factor Proportions Theory: The Leontief Paradox:

  1. Factor proportions theory is not supported by studies that examine trade flows.
  2. Wassily Leontief tested whether the U.S., which uses an abundance of capital equipment, exports goods requiring capital-intensive production and imports goods requiring labor-intensive production. His research found that U.S. exports require more labor-intensive production than its imports. This apparent paradox is called the Leontief paradox.
  3. One explanation is that factor proportions theory considers a country’s production factors to be
    homogeneous—particularly labor. But labor skills vary greatly within a country.

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INTERNATIONAL TRADE THEORY

THE FACTOR-PROPORTIONS THEORY:

The Heckscher-Ohlin theory of factor endowment is useful in extending the concept of comparative advantage by bringing into consideration a nation’s endowment and cost of factors of production. The theory holds that a country will tend to export products that utilize factors of production relatively abundant in that nation.

Land-Labor Relationship:

In countries with many people relative to the size of the available land, labor would be relatively (comparatively) cheap; thus those countries should concentrate on producing and exporting labor-intensive goods.

Labor-Capital Relationship:

In countries where little capital is available for investment and where the amount of investment per worker is low, then low labor rates would also be expected. Again, those countries should concentrate on producing and exporting labor-intensive goods. (The fact that labor skills tend to vary across countries has led to international task specialization with respect to national production activities.)

Technological Complexities:

Factor proportions analysis becomes complicated when the same product can be produced by different methods, such as with different mixes of labor and capital. Managers must consider the cost in each locale, based on the type of production that will minimize costs there.

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INTERNATIONAL TRADE THEORY

The Case for Government Intervention:

  1. The most common political reason for trade restrictions is "protecting jobs and industries." Usually this results from political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than the consumers that will eventually pay the costs.
  2. Keeping industries "vital for national security" viable is an oft used argument for trade restrictions. While this is reasonable for industries like steel, aerospace, and electronics, in the US the shoe industry has regularly lobbied that soldiers need boots, and thus the US needs to have a viable shoe industry in order to be able to provide shoes during a time of war.
  3. Government intervention in trade can be used as part of a "get tough" policy to open foreign markets. By taking, or threatening to take, specific actions, other countries may remove trade barriers. But when threatened governments don’t back down, tensions can escalate and new trade barriers may be enacted.
  4. Consumer protection can also be an argument for restricting imports. The opening case suggests that the EU’s concern over bananas was, in part, due to an interest in protecting consumers. Since different countries do have different health and safety standards, what may be acceptable in one country, may be unacceptable in others.
  5. Concern over human rights in other countries plays an important role in foreign policy.
    Governments sometimes use trade policy to improve the human rights policies of trading partners.
    Governments also use trade policies to put pressure on governments to make other changes. In recent years the USA has had trade restrictions against Libya, Iran, Iraq, North Korea, Cuba, and other countries whose governments were pursuing policies that were not viewed favorably by the US government. Unless a large number of countries choose to take such action, however, it is unlikely to prove successful.
  6. The "infant industry" argument suggests that an industry should be protected until it can develop and be viable and competitive internationally. Unless an industry is allowed to develop and achieve minimal economies of scale, foreign competitors may undercut prices and prevent a domestic industry from developing. The infant industry argument has been accepted as a justification for temporary trade restrictions under the WTO.
  7. A problem with the infant industry argument is determining when an industry "grows up." Some industries that are just plain inefficient and uncompetitive have argued they are still infants after 50 years. The other problem is that given the existence of global capital markets, if the country has the potential to develop a viable competitive position, its firms should be capable of raising the necessary funds without additional support from the government.
  8. Strategic trade policy suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages.
  9. Strategic trade policy also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage.

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THE POLITICAL ECONOMY OF INTERNATIONAL TRADE

THE POLITICAL ENVIRONMENT:

The political environment can have a dramatic impact on the operations of a firm. U.S. managers may be accustomed to a stable political system and a relatively homogenous population. This is often not true in other countries. A political system integrates the parts of a society into a viable, functioning unit. Sometimes that is a very difficult task. A country’s political system influences how business is conducted domestically and internationally.

THE IMPACT OF THE POLITICAL SYSTEM ON MANAGEMENT DECISIONS:

Political Risk:

Political risk occurs when there is a possibility that the political climate in a foreign country will change in such a way that the operations of international companies in that country will deteriorate.

  • Types and causes of political risk: Types of political risk include government takeovers of property, operating restrictions, and agitation that damages the company’s performance. Such problems can be caused by changing opinions of political leadership, civil disorder, and changes in external relations (such as animosity between the home and host country governments.
  • Macro and micro political risks: If political actions are aimed only at specific foreign investments (e.g., a single foreign company), they are considered micro political risks. If they are aimed at a broad spectrum of foreign investors (e.g., when all foreign-owned private property was taken over by Cuba), they are considered macro political risks.

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THE POLITICAL ECONOMY OF INTERNATIONAL TRADE

VER:

A voluntary export restraint (VER) may have the same effect as a quota. In a VER, another country or countries agree to not export more than a certain quantity to another country or countries. VERs are usually only enacted when it is feared that a more restrictive tariff or quota will be levied unless exports are"voluntarily" reduced. In other words, the threat of retaliation encourages compliance.

  1. Import quotas and VERs benefit domestic producers and harm domestic consumers. They can also even help foreign producers, as foreign producers can raise the price they charge for the limited supply they can sell, and take the difference as additional profit.
    LOCAL CONTENT REQUIREMENT:
  2. Local content requirements specify that firms must produce some portion of a good domestically. The purpose of a local content requirement is usually to aid the formation of domestic industries, to keep manufacturers from switching to foreign suppliers, or to keep foreign firms from setting up “screwdriver plants.” where imported manufactured components undergo simple assembly in order to avoid some other trade restriction on the importation of the fully assembled product. Domestic suppliers benefit, and domestic consumers must bear the costs.
    ANTI-DUMPING LAWS:
  3. Dumping occurs when a country sells goods in another country below cost or below fair market value. Dumping is a way firms can unload excess production into foreign markets. When plants must operate at a certain level regardless of domestic demand, the producer may find it appropriate to export some portion of the factory’s output abroad. At times dumping may also be done for predatory reasons, hoping to drive other producers out of the market, and subsidizing foreign sales with higher domestic prices. Antidumping policies are designed to prevent dumping from occurring, or by instituting import taxes in order to bring prices of “dumped” goods back up to fair levels.
    ADMINISTRATIVE ACTIONS
  4. A wide range of administrative barriers can be enacted. Taking so much time to inspect goods that they spoil or setting down specific regulations on "product standards" that are very expensive to meet.

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THE POLITICAL ECONOMY OF INTERNATIONAL TRADE

Economic Rationales for Government Intervention:

Unemployment:

There is probably no more effective pressure group than the unemployed, because no other group has the time and incentive to picket or write letters in volume to government representatives. By limiting imported goods, consumers are forced to consume more goods produced domestically. This helps boost domestic employment. However, placing restrictions on imports normally results in retaliatory tariffs by other countries. In such instances, domestic jobs related to exports may be lost. Even if import restrictions do increase domestic employment, there will still be costs to some people in the domestic society in the form of higher prices or higher taxes.

Infant Industry Argument:

The infant industry argument holds that a government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports. However, governments have a hard time identifying which industries merit protection. Furthermore, protection for any particular industry means higher costs for local consumers, which can reduce the profitability of other domestic industries.

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THE POLITICAL ECONOMY OF INTERNATIONAL TRADE

The Revised Case for Free Trade:

  1. While strategic trade policy identifies conditions where restrictions on trade may provide economic benefits, there are two problems that may make restrictions inappropriate: retaliation and politics.
  2. Intervening to aid domestic firms will only be successful if other countries do not take similar actions that offset the effects.
  3. While it could be very difficult to identify situations where strategic intervention in trade is economically appropriate, various interest groups will be certain to lobby that particular firms should be aided. Given the ease with which special interest groups seem to be able to capture the attention of the government, it is more likely that consumers will be harmed more needlessly than producers. It is unreasonable to expect the government to be completely fair and objective in “targeting” industries, when different industries, lobbies, and politicians all have there own
    objectives for “getting their paws in the honey pot” of governmental funds.

The Development of the World Trading System:

  1. Up until the Great Depression of the 1930s, most countries had some degree of protectionism.
    Great Britain, as a major trading nation, was one of the strongest supporters of free trade.
  2. Although the world was already in a depression, in 1930 the US enacted the Smoot-Hawley tariff, which created significant import tariffs on foreign goods. As other nations took similar steps and the depression deepened, world trade fell further.
  3. After WWII, the US and other nations realized the value of freer trade, and established the General Agreement on Tariffs and Trade (GATT). [Referred to sometimes as the General Agreement to Talk and Talk.]
  4. The approach of GATT was to gradually eliminate barriers to trade. Over 100 countries became members of GATT, and worked together to further liberalize trade. Figure 5.1 shows the different rounds of GATT negotiations and the resulting reductions in tariffs.

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THE GENERAL AGREEMENT ON TARIFFS AND TRADE AND THE WTO:

The General Agreement on Tariffs and Trade (GATT) is a multilateral treaty designed to minimize trade barriers. GATT went into effect in 1948. It provided a forum for trade ministers to discuss policies and problems of common concern. GATT’s mission was adopted by the World Trade Organization (WTO), which replaced GATT in 1995.

The Role of the General Agreement on Tariffs and Trade:

  • The goal of GATT was to promote a free and competitive trading environment that benefits efficient producers. To that end, GATT sponsored international negotiations, called “rounds,” to reduce trade barriers (both tariff and nontariff). GATT successfully oversaw a reduction of tariffs from an average of over 40% in 1948 to approximately 3% today, and promoted a dramatic increase in world trade.
  • To ensure that international trade is conducted on a nondiscriminatory basis, GATT follows the most favored nation (MFN) principle which requires one nation to treat a second nation no worse than it treats any third nation. Any preferential treatment that is extended to one country must be extended to all countries. Thus, the principle implies multilateral rather than bilateral trade negotiations.

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GATT AND WTO

The World Trade Organization:

The World Trade Organization (WTO) was founded in 1995, and is comprised of 146 member countries and 30 observer countries. The WTO has three primary goals: to promote trade flows by encouraging nations to adopt non-discriminatory and predictable trade policies, to reduce remaining trade barriers through multilateral negotiations, and to establish impartial procedures for resolving trade disputes among members.

Problem Sectors:

One challenge facing the WTO is dealing with sectors of the economy such as agriculture and textiles that most nations protect. Groups including the Cairns Group (a group of major agricultural exporters) have pressured the WTO to ensure that the Uruguay Round policies dealing with agricultural trade are implemented according to schedule. Similarly, developing countries are monitoring the dismantling of the Multifibre Agreement (MFA), which created a complex array of quotas and tariffs on trade in textiles and apparel.

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FOREIGN DIRECT INVESTMENT

Foreign Direct Investment in the World Economy:

  1. When discussing foreign direct investment, it is important to distinguish between the flow of FDI and the stock of FDI. The flow of FDI refers to the amount of FDI undertaken over a given time period (normally one year). The stock of FDI refers to the total accumulated value of foreign owned assets at a given point in time.
  2. Figure 6.1 illustrates the great increase in the flows of FDI between 1992-2001. The significant growth in FDI has both to do with the political economy of trade as outlined in the previous chapter and the political and economic changes that have been taking place in developing countries.
  3. The opening case on Starbucks helps illustrate one very important trend in FDI - the globalization of the world economy is causing firms to invest worldwide in order to assure their presence in every region of the world.
  4. Another important trend is has been the rise of inflows into the US. The stock of foreign FDI in the US increased more rapidly than US FDI abroad.
  5. The rapid increase in FDI growth into the US may be due to the attractiveness of the US market, the falling value of the dollar, and a belief by some foreign corporations that they could manage US assets and workers more efficiently than their American managers could.
  6. It is difficult to say whether the increase in the FDI into the US is good for the country or not. To the extent that foreigners are making more productive use of US assets and workers, it is probably good for the country.
  7. Figures 6.2, 6.3, 6.4 and 6.5 provide some insight into the countries that have been the major recipients and sources of foreign direct investment in recent years.
  8. The management focuses box details the techniques of Mexican cement manufacturer Cemex for its aggressive international expansion of cement manufacturing. Because cement is a product that is not easily exported due to its low ratio of value to weight, Cemex sought international expansion by acquisition.

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FOREIGN DIRECT INVESTMENT

Learning Objectives:

  • To explain why investors and governments view direct investments differently than portfolio investments
  • To demonstrate how companies acquire foreign direct investments
  • To evaluate the relationship between foreign trade and international factor mobility, especially direct investment
  • To classify companies’ motivations for foreign direct investment
  • To explain companies’ advantages from foreign direct investments
  • To show the major global patterns of foreign direct investment

Types of International Investments:

  • International investment can be divided into portfolio investment and foreign direct investment (FDI) (see Chapter 1). The former represents passive holdings of foreign stocks, bonds, or other financial assets that entail no active management or control of the issuer of the securities by the foreign investor. The latter represents acquisition of foreign assets for the purpose of control.
  • FDI may take many forms including: purchases of existing assets in a foreign country; new investments in plant, property, and equipment; or participation in joint ventures with a local partner. The text provides examples of each type of investment.
  • Controversy often surrounds FDI because while it may increase employment, enhance productivity, and raise wage rates, it also raises concerns that control of the national economy is being passed to foreigners.

The Growth of Foreign Direct Investment:

MGT520 - International Business - Lecture Handout 33

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FOREIGN DIRECT INVESTMENT

METHODS OF ACQUISITION:

Companies may accumulate foreign assets through acquisition (buying them) or by building these assets themselves.

Resources for Acquisition:

In order to acquire a foreign asset, firms usually move capital from one country (often the home country) to the country where the newly acquired facility is located (the host country). Sometimes, if the firm already has operations in the host country, it can simply use revenues from host country operations to acquire another facility. In such instances, no international capital movement would occur.

Buy versus Build Decision:

Instead of buying an existing foreign operation, the investing firm might decide to build a new facility from scratch.

Reasons for buying: The investing company might wish to acquire a locally existing name brand, might wish to avoid adding additional capacity to the industry, might wish to avoid having to hire and train new workers. Furthermore, by buying an existing company, the investor avoids inefficiencies during the start-up period and gets an immediate cash flow rather than tying up funds during construction.
Reasons for building: Companies often make investments where there is little or no competition, so finding a firm to buy may be difficult. Furthermore, when acquiring a firm, the investor inherits all the problems that exist in the firm. Finally, a foreign company may find local financing easier to obtain if it builds facilities.

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FOREIGN DIRECT INVESTMENT

RISK MINIMIZATION OBJECTIVES:

Diversification, internationally or otherwise, is often a means firms use to reduce risks.

Following Customers:

Suppliers will often set up facilities near the firms they supply. Bridgestone decided to make automobile tires in the United States in order to continue selling to Honda and Toyota once those companies initiated U.S. production.

Preventing Competitors’ Advantages:

Firms in an oligopolistic industry often follow their competitors into other countries in order to avoid giving a competitor an advantage.

Political Motives:

For example, during the early 1980s, the U.S. government instituted various incentives to increase the profitability of U.S. investment in Caribbean countries that were unfriendly to Castro’s regime.

ADVANTAGES OF FOREIGN DIRECT INVESTMENT:

Monopoly Advantages before Direct Investment:

Companies invest directly if they think they hold some supremacy over similar companies in countries of interest. The advantage results from a foreign company’s ownership of some resource—patents, management skills—unavailable at the same price to the local company. This edge is often called a monopoly advantage.

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FOREIGN DIRECT INVESTMENT

Pragmatic Nationalism

  • Having nor a radical neither a free trade market.
  • FDI has both benefits and disadvantages to a country.
  • Some Pragmatic nationalist are thinking in terms of resources taken out by MNE in the repatriation resulted from FDI.
  • Japan, Korea, Latin American Countries are the Examples.
  • But recent years have seen a major increase in FDI.

Growth and Employment Effects:

In contrast to the balance-of-payments effects, the effects of FDI on economic growth and employment should not be a zero-sum game because MNEs may use resources that were either underemployed or unemployed. The argument that both home and host countries can gain from FDI rests on two assumptions: (i) resources are not fully employed and (ii) capital and technology cannot be easily transferred from one activity to another.

  • Home Country Losses: As manufacturers seek lower-cost foreign production sites, home countries claim that FDI outflows create jobs abroad at the expense of jobs in the home country.
  • Host Country Gains: Host countries gain through the transfer of capital, technology, and managerial expertise, as well as the creation of new jobs.
  • Host Country Losses: Critics argue that FDI inflows often displace domestic investment and drive up local labor costs. They claim that MNEs have access to lower-cost funds than local competitors do and that MNEs can spend more on promotion activities. In addition, while it is true that MNEs often source inputs locally, critics claim that they also destroy local entrepreneurship. Further, as MNEs gain valuable knowledge in their foreign operations that can be shared across their entire organizations, critics fear that local firms subsequently suffer a
    competitive disadvantage.

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FOREIGN DIRECT INVESTMENT

Employment:

There is probably no more effective pressure group than the unemployed, because no other group has the time and incentive to picket or write letters in volume to government representatives. By limiting imported goods, consumers are forced to consume more goods produced domestically. This helps boost domestic employment. However, placing restrictions on imports normally results in retaliatory tariffs by other countries. In such instances, domestic jobs related to exports may be lost. Even if import restrictions do increase domestic employment, there will still be costs to some people in the domestic society in the form of higher prices or higher taxes.

Balance of Payments:

  1. A country’s balance of payments is a national accounting system that records all payments to entities in other countries and all receipts coming into the nation.
  2. International transactions that result in payments (outflows) to entities in other nations are reductions in the balance of payments accounts and recorded with a minus (–) sign.
  3. International transactions that result in receipts (inflows) from other nations are additions to the balance of payments accounts and recorded with a plus (+) sign.

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FOREIGN DIRECT INVESTMENT

Reasons for Host Nation Intervention:

Balance of Payments:

  1. Many governments see intervention as the only way to keep their balance of payments under control.
  2. Countries get a balance-of-payments boost from initial FDI flows into their economies. Local content requirements can lower imports, providing a balance-of-payments boost. Exports generated by production resulting from FDI can help the balance-of-payments position.
  3. When companies repatriate profits, they deplete the foreign exchange reserves of their host countries; these capital outflows decrease the balance of payments. To avoid this, the host nation may prohibit or restrict the no domestic company from removing profits.
  4. Alternatively, host countries conserve their foreign exchange reserves when international companies reinvest their earnings in local manufacturing facilities. This improves the competitiveness of local producers and boosts a host nation’s exports—improving its balance-ofpayments position.

Obtain Resources and Benefits:

Access to Technology:

Nations encourage FDI in technology because it increases productivity and competitiveness.

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REGIONAL AND ECONOIC INTEGRATION

The Role of the General Agreement on Tariffs and Trade (GATT):

The goal of GATT was to promote a free and competitive trading environment that benefits efficient producers. To that end, GATT sponsored international negotiations, called “rounds,” to reduce trade barriers (both tariff and nontariff). GATT successfully oversaw a reduction of tariffs from an average of over 40% in 1948 to approximately 3% today, and promoted a dramatic increase in world trade. To ensure that international trade is conducted on a nondiscriminatory basis, GATT follows the most favored nation (MFN) principle which requires one nation to treat a second nation no worse than it treats
any third nation. Any preferential treatment that is extended to one country must be extended to all countries. Thus, the principle implies multilateral rather than bilateral trade negotiation

The World Trade Organization:

  • The World Trade Organization (WTO) was founded in 1995, and is comprised of 146 member countries and 30 observer countries. The WTO has three primary goals: to promote trade flows by encouraging nations to adopt non-discriminatory and predictable trade policies, to reduce remaining trade barriers through multilateral negotiations, and to establish impartial procedures for resolving trade disputes among members.
  • Problem Sectors: One challenge facing the WTO is dealing with sectors of the economy such as agriculture and textiles that most nations protect. Groups including the Cairns Group (a group of major agricultural exporters) have pressured the WTO to ensure that the Uruguay Round policies dealing with agricultural trade are implemented according to schedule. Similarly, developing countries are monitoring the dismantling of the Multifibre Agreement (MFA), which created a complex array of quotas and tariffs on trade in textiles and apparel.
  • The General Agreement on Trade in Services (GATS): The WTO is also focusing on reducing barriers to trade in services. One approach currently in use is the principle of national treatment, in which a country treats foreign firms the same as it treats domestic firms. The WTO began negotiating a new GATS agreement in 2000, but progress has been slow.

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REGIONAL AND ECONOIC INTEGRATION

The Case for Regional Integration:

  1. The economic case for integration has been largely presented in the previous chapters. Free trade and movement of goods, services, capital, and factors of production allow for the most efficient use of resources. That is positive sum game, as all countries can benefit.
  2. Regional economic integration is an attempt to go beyond the limitations of WTO. While it is hard for 100 countries to agree on something, (e.g.. the United Nations) it is much more likely that only a few countries with close proximity and common interests will be able to agree to even fewer restrictions on the flows between their countries.
  3. The political case for integration has two main points: 1) by linking countries together, making them more dependent on each other, and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease. 2) by linking countries together, they have greater clout and are politically much stronger in dealing with other nations.
  4. In the case of the EU, both a desire to decrease the likelihood of another world war and an interest in being strong enough to stand up to the US and USSR were factors in its creation.
  5. There are two main impediments to integration: 1) there are always painful adjustments, and groups that are likely to be directly hurt by integration will lobby hard to prevent losses, 2) concerns about loss of sovereignty and control over domestic interests. Canada has always been concerned about being dominated by its southern neighbor, and Britain is very hesitant to give much control to European bureaucrats (as of this writing it still has not adopted the euro).
  6. The case on NAFTA and the US Textile Industry shows that although the effects of NAFTA have hurt employment in the US textile industry, the overall effect has actually been positive. The reason: clothing prices have fallen, exports have increased, and sales to apparel factories have surged. Those factors more than compensate for the loss of jobs.

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REGIONAL AND ECONOIC INTEGRATION

The Euro

Prior to the implementation of the Euro (the single European currency), member countries moved to converge their economies by

  • Reducing inflation so that each country’s inflation would be no more than 1.5 percentage points above the average of the three lowest inflation rates in Europe
  • Reducing long-term interest rates so that each country’s rate would be no more than two percentage points above the average of the three lowest.
  • Reducing the government’s budget deficit to no more than 3.5% of GDP
  • Reducing the stock of public debt so that it would not exceed 60% of GDP.

Eleven countries adopted the Euro as of January 1999. The Euro will show up as an actual bank note (replacing individual currencies) in 2002. It is already widely used for a variety of no cash transactions.

Implications of the EU:

Although Europe is moving closer together through the Euro and the Single Market program, it is still not as homogenous as the U.S. market. Differences in languages, cultures, and governments still splinter Europe, and the eventual addition of new countries will create even more divisions in the market. Companies need to develop a pan-European strategy without sacrificing different national strategies.

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REGIONAL AND ECONOIC INTEGRATION

Learning objectives:

  1. Describe how demand and supply determine the price of foreign exchange.
  2. Discuss the role of international banks in the foreign-exchange market.
  3. Assess the different ways that firms can use the spot and forward markets to settle international transactions.
  4. Summarize the role of arbitrage in the foreign-exchange market.
  5. Discuss the important aspects of the international capital market.

IMPORTANT TERMS:

  1. Foreign exchange is a commodity that consists of currencies issued by countries other than one’s own. The exchange rate is the price of one currency in terms of another, at the equilibrium price of the foreign currency.
  2. A direct quote is the price of the foreign currency in terms of the home currency, while an indirect quote is the price of the home currency in terms of the foreign currency

Introduction:

  1. Traditionally, different countries have different currencies (although the appearance of the EU and the euro have dramatically decreased the number of international currencies that most people will use). If you have examples of different currencies, these can be shown or passed around. Students are particularly intrigued by the pictures of foreign rulers on foreign currency, many of whom they have never heard of.

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INTERNATIONAL MARKETING

MARKET SIZE ANALYSIS:

Once companies decide to enter markets, they must then analyze data to determine their market potential in each country and their marketing mix to reach the potential.

Total Market Potential:

To determine potential demand, managers first estimate the possible sales of the category of products for all companies and then estimate its own company’s market-share potential. In order to do so, they estimate per capita consumption and move it along a trend line as per capita GNP increases.

Gap Analysis:

Once a company is operating in a country and estimates that country’s market potential, it must calculate how well it is doing there. Gap analysis is a method for estimating a company’s potential sales by identifying market segments it is not servicing adequately.

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INTERNATIONAL MARKETING

Product strategies:

  1. Product strategies depend on the specific goods and customers. Some products can be manufactured and sold successfully both in the home market and abroad by using the same strategies. Other products must be modified or adapted and sold according to a specially designed strategy.
  2. Industrial goods and technical services are good examples of products that need little or no modification. Other products, because of economics, culture, local laws, level of technology, or the product’s life cycle, require a moderate to high level of modification.
  3. There are many examples of how economic considerations affect the decision to modify a product. As a very simple example, in the United States, packets of chewing gum often contain 10 to 20 sticks, but in many other countries the weaker purchasing power of the customers necessitates packaging the gum with only five sticks. Economics is also important when the cost of a product is either too high or too low to make it attractive in another country.
  4. In some cases a product must be adapted to the different ways people are accustomed to doing things. For example, the French prefer washing machines that load from the top, while the British like front-loading units. In fast-food franchises such as McDonald’s, parts of the menu are similar throughout the world, but some items are designed to cater specifically to local tastes. Culture also influences purchasing decisions made on the basis of style or aesthetics. Convenience and comfort are other culturally driven factors that help explain the need for product modification. Others include color and language.
  5. Local laws can require the modification of products to meet environmental and safety requirements. For example, US emission-control laws have required Japanese and European car importers to make significant model changes before their vehicles can be sold in the United States.
  6. Another reason for modifying a product is to cope with the limited product life cycle of the good. Ford Motor, for example, was extremely profitable in Europe during the 1980s, but these earnings disappeared by the early 1990s because it did not develop new, competitive products.

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INTERNATIONAL MARKETING EXPORT & IMPORT

Learning Objectives:

  • To Look at the international marketing strategy
  • To identify the key elements of export and import strategies
  • To compare direct and indirect selling of exports
  • To discuss the role of several types of trading companies in exporting
  • To show how freight forwarders help exporters with the movement of goods
  • To identify the methods of receiving payment for exports and the financing of receivables
  • To discuss the role of counter trade in business

PRODUCT POLICY:

This section highlights the international application of common product policies.

Production Orientation:

With a production orientation, companies focus primarily on production—either efficiency or high quality—with little emphasis on marketing. Such an approach is used internationally in commodity sales, passive exports (surpluses of domestic production), and foreign market niches that resemble the market at which the good was originally aimed.

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EXPORT, IMPORT, FDI INTERNATIONAL BUSINESS & PAKISTAN

Learning Objectives:

  • Export & Import
  • Strategies for import and export
  • Status of Pakistan in Exports and Imports
  • FDI and Pakistan
  • International Business and Pakistan

Export Assistance, Pakistan:

  1. Export Promotion Bureau
  2. State bank of Pakistan as export refinance.
  3. Chambers of Commerce and industries as facilitators.
  4. Government as announcing special incentive to exporters like rebates etc.

Export Assistance, International:

  1. Exporters in the US can draw upon two types of government-backed assistance to help finance their exports; the Export-Import bank and export credit insurance provided by the FCIA.
  2. The Export-Import Bank is an independent agency of the US government whose mission is to provide aid in financing and facilitate exports and imports and the exchange of commodities between the US and other countries.
  3. In the US, the Foreign Credit Insurance Association (FCIA) provides export credit insurance. The FCIA provides insurance policies protecting US exporters against the risk of nonpayment by foreign debtors as a result of commercial and political risks.

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