International Business Management

CHAPTER 1: GLOBALIZATION
Contents:
Understand what is meant by globalization.
Be familiar with the causes of globalization.
Changing international trade patterns, FDI flow, differences in economic
growth among countries, and the rise of new MCs are changing the nature
of the world economy.
Debate o!er the impact of globalization.
umerous opportunities and challenges due to globalization.
Introduction
"hether a business student is studying mar#eting, finance, accounting,
strategy, human relations, or operations management, the differences between
countries in which a firm does business will affect decisions that must be made.
$ fundamental shift is occurring in the world economy. %he world is getting
closer in terms of cross border trade and in!estment, by distance, time zones,
languages and by national differences in go!ernment regulation, culture and
business systems and toward a world in which national economies are merging
into one huge interdependent global economic system. &lobalization is affecting
firms that pre!iously operated in a nice, easy, protected national mar#et. It also
illustrates the increasing importance of thin#ing globally.
What is go!ai"ation#
$e%inition: go!ai"ation is the trend to&ard a 'ore integrated go!a
econo'ic s(ste')
%he rate at which this shift is occurring has been accelerated recently.
Go!ai"ation has t&o %aces'
Go!ai"ation o% 'ar*ets
Go!ai"ation o% +roduction
Go!ai"ation o% 'ar*ets:
Go!ai"ation o% 'ar*ets re%ers to the %act that in 'an( industries
historica( distinct and se+arate nationa 'ar*ets are 'erging into
one huge go!a 'ar*et+ace)
International Business Management
1
%here is a mo!ement towards a globalization of mar#ets, as the tastes and
preferences of consumers in different nations are beginning to con!erge upon
some global norm. %he global acceptance of Coca(Cola, )e!i*s +eans, ,ony
"al#mans, and McDonald*s hamburgers are all e-amples. By offering a
standard product worldwide, they are helping to create a global mar#et. .!en
smaller companies can get the benefits from the globalization of mar#ets.
Despite the global pre!alence of global brands such as )e!is, City Ban#, /epsi
etc, national mar#ets are not disappearing. %here are still significant differences
( &ermany still leads in per capita beer consumption, with a local pub on almost
e!ery corner and in some cities, women selling beer out of their front windows
to passers by on the street. %he 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 unli#ely to be eliminated any time soon.
0ence, often there is still a need for mar#eting strategies and product features
to be customized to local conditions.
Go!ai"ation o% +roduction'
The go!ai"ation o% +roduction re%ers to the tendenc( a'ong 'an(
%ir's to source goods and ser,ices %ro' di%%erent ocations around the
go!e in an atte'+t to ta*e ad,antage o% nationa di%%erences in the
cost and -uait( o% %actors o% +roduction) .a!or/ energ(/ and and
ca+ita0
%hrough this companies hope to lower their o!erall cost structure and or
impro!e the 1uality or functionality of their product, thereby allowing them to
compete more effecti!ely against their ri!als. %he e-amples of Boeing and ,wan
2ptical illustrate how production is dispersed.
Boeing company*s commercial +et airliner, Boeing 333 contains 456,788 ma+or
components parts that are produced around the world by 797 different
suppliers. .ight :apanese suppliers ma#e parts of fuselage, doors and wings, a
supplier in ,ingapore ma#e the doors for the nose landing gear, three suppliers
in Italy manufacture wing flaps etc.
%he result of ha!ing a global web of suppliers is a !etter %ina +roduct, which
enhances the chances of Boeing wining a greater share of aircraft orders than
its global ri!al Air!us.
"hile 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 li#e China, these countries often demand that domestic
2
firms be contracted to supply portions of the plane ( otherwise they will find
another supplier ;$irbus< who is willing to support local industry.
$ri,ers o% go!ai"ation
T&o *e( %actors see' to underie the trend to&ards the increasing
go!ai"ation o% 'ar*ets and +roduction:
The decine o% !arriers to trade and in,est'ent and
Technoogica change)
The decine o% !arriers to trade and in,est'ent:
$ecine in Trade !arriers'
$e%inition: Internationa trade occurs &hen a %ir' e1+orts goods or
ser,ices to consu'ers in another countr()
Many of the barriers to international trade too# the form of high tariffs on
imports of manufactured goods. 0owe!er, this depressed world demand and
contributed to the great depression of the 4=58*s.
$fter "orld "ar II, the industrialized countries of the "est started a process of
remo!ing barriers to the free flow of goods, ser!ices, and capital between
nations. Under &$%%, o!er 498 nations negotiated e!en further to decrease
tariffs and made significant progress on a number of non(tariff issues ;e.g.
intellectual property, trade in ser!ices<. %he most recent round of negotiations
#nown as Uruguay round was competed in December 4==5. %he Uruguay round
further reduced trade barriers, co!ering ser!ices as well as manufactured goods
pro!ided enhanced protection for patents, trade mar#s and copyrights and
established "%2 to police the international trading system. "ith the
establishment of the "%2, a mechanism now e-ists for dispute resolution and
the enforcement of trade laws.
$!erage tariff rates ha!e fallen significantly since 4=78*s, and under the
Uruguay agreement, they ha!e approached 5.= percent by 6888.
%his remo!al of barriers to trade has ta#en place in con+unction with increased
trade, world output, and foreign direct in!estment.
$ecine in in,est'ent !arriers'
$e%inition: The 2oreign direct In,est'ent' 2$I occurs &hen a %ir'
3
in,ests to internationa trade acti,ities outside its ho'e countr()
%he growth of foreign direct in!estment is a direct result of nations liberalizing
their regulations to allow foreign firms to in!est in facilities and ac1uire local
companies. "ith their in!estments, these foreign firms often also bring
e-pertise and global connections that allow local operations to ha!e a much
broader reach than would ha!e been possible for a purely domestic company.
%he e!idences also suggests that FDI is playing an increasing role in the global
economy
as firms increase their cross border in!estments. Between 4=>7 and 4==7 the
total annual flow of
FDI from all countries increased nearly si- fold to ?457 billion, a growth rate in
the world trade
%he ma+or in!estors has been U.,, :apanese, and "estern .uropean Companies
in!esting in
.urope, $sia, ;particularly in China, and India<. For e-ample, :apanese auto
companies ha!e
been in!esting rapidly in $sian, .uropean, and U., auto assembly operations.
%his also shows that firms around the globe are finding their home mar#ets
under attac# from
Foreign competitors. For e-ample, in :apan, @oda# has ta#en mar#et share from
Fu+i recent years. In the United ,tates, :apanese firms ha!e ta#en away mar#et
share from &eneral motors, and Chrysler and in "estern .urope where the once
Adominant Dutch company /hilips has seen its mar#et share ta#en by :apan*s
:BC, Matsushita and ,ony.
%he growing integration into a single huge mar#et place is increasing the
intensity of competition in a wide range of manufacturing and ser!ice
industries.
%hese trends facilitate both the globalization of mar#ets and globalization of
production. %he lowering trade and in!estment barriers also allows firms to
base indi!idual production acti!ities at the optimal location for that acti!ity, and
ser!ing the world mar#et from that location. %hus, a firm might design a
product in one country, produce component parts in two another country,
assemble the product in yet another country, and then e-port the finished
product around the world.
The roe technoogica change'
"hile lowering trade barriers has made the globalization of mar#ets and
production a possibility, technological changes ha!e made it a reality.
4
3Teeco''unications is creating a go!a audience) Trans+ort is
creating a go!a ,iage) 2ro' Buenos Aires to Boston to Bei4ing/
ordinar( +eo+e are &atching 5T6/ the( are &earing Le,i7s 4eans/ and
the( are istening to 8on( Wa*'an as the( co''ute to &or*)9
Cenato Cuggiero, Director &eneral of "orld trade 2rganization.
Impro!ed information processing and communication allow firms to ha!e better
information about distant mar#ets and coordinate acti!ities worldwide. %he
e-plosi!e growth of the "orld "ide "eb and the Internet pro!ide a means to
rapid communication of information and the ability of firms and indi!iduals to
find out about what is going on worldwide for a fraction of the cost and hassle
as was re1uired only a couple of years ago.
5icro+rocessor and teeco''unications: %he single most important
inno!ation has been the de!elopment of the microprocessor, which enabled the
e-plosi!e growth of high power, low cost computing, increasing the amount of
information that can be processed by indi!iduals and firms. 2!er the past 58
years, global communications ha!e been re!olutionized by the de!elopments in
satellites, optical fiber, and wireless technology, and internet and "orld "ide
"eb. $ll these technologies rely on the microprocessor to encode, transmit and
decode the !ast amount of information that flows along these electronic
highways.
A +heno'enon *no&n as 5oore7s a&, which predicts that the power of
microprocessor technology doubles and its cost of production falls in half of
e!ery 4> months. %hat means the cost of coordinating and controlling a global
organization will reduce phenomenally.
%he Internet and "orld "ide "eb' this is the latest e-pression of this
de!elopment. %here are more than 478 million users of the Internet. %his will
de!elop into the information bac#bone of tomorrow*s global economy. Ceal time
!ideo conferencing and commercial transactions can be transmitted through
""". """ will reduce the costs of global communications and it will create a
truly global electronic mar#et place of all #inds of goods and ser!ices. ,uch as
the soft wares and bulldozers, and this will ma#e it easier for firms of all sizes to
enter the global mar#etplace.
Trans+ortation technoog(' Impro!ements in transportation technology,
including +et transport, temperature controlled containerized shipping, and
coordinated ship(rail(truc# systems ha!e made firms better able to respond to
international customer demands.
$s a conse1uence of these trends, a manager in today*s firm operates in an
en!ironment that offers more opportunities, but is also more comple- and
5
competiti!e than that faced a generation ago. /eople now wor# with indi!iduals
and companies from many countries, and while communications technology,
with the uni!ersality of .nglish as the language of business, has decreased the
absolute le!el of cultural difficulties indi!iduals face, the fre1uency with which
they face inter(cultural and international challenges has increased.
The changing de'ogra+hics o% the go!a econo'(:
In 4=D8*s there were four facts described in the demographics of the global
economy.
%he U., dominance in the worlds economy and world trade.
U., dominance in the world Foreign Direct In!estment picture.
%he dominance of large multinational U., firms in the international
business scene.
Coughly half of the globe ;communist world<, was una!ailable to
"estern International Business.
$ll these four facts either ha!e changed or now changing rapidly. %he changing
demographics has four facets.
The changing &ord out+ut and &ord trade +icture
A changing &ord 2oreign $irect In,est'ent +icture
The changing nature o% the 5utinationa Enter+rise
The changing &ord order
The changing &ord out+ut and &ord trade +icture:
%he U.,. share of world output has declined dramatically in the past 58 years
and a much more balanced picture is now de!eloping among industrialized
countries. )oo#ing ahead into the ne-t century, the share of world output of
what are now referred to as Ede!eloping countriesF is e-pected to greatly
surpass that of the current Eindustrialized countries.F For e-ample, :apan*s
share of world manufacturing output increased their share of world output
included China, ,outh @orea, and %aiwan.
The changing +attern o% Word out+ut and trade
Country ,hare of world ,hare of world ,hare of world
6
output
4=D5 ;G<
output
4=>7 ;G<
output
4==7 ;G<
United
,tates
98.5 64.= 46.6
:apan 7.7 >.6 =.9
&ermany =.3 9.5 48.4
France D.5 5.7 7.D
United
#ingdom
D.7 5.9 9.=
Italy 5.9 5.6 9.7
Canada 5.8 6.4 5.=
By the end of 4=>8s, the U., position as the world*s leading e-porter was
threatened. 2!er the last 58 years, U., dominance in e-port mar#ets has
reduced as :apan, &ermany and a large number of newly industrialized
countries such as ,outh @orea, and %aiwan has ta#en a large share of the world
e-ports. During the 4=D8s, the U., accounted for 68G of world e-ports of
manufactured goods. 0owe!er, this reduced to 46.6G by 4==7. Despite the fall
the United ,tates remain the world*s largest e-porter, flowed closely b &ermany
and :apan.
Capid economic growth rates now being e-perienced by countries such as,
China, %hailand and Indonesia, further relati!e decline in the U., share of world
output and world e-ports. %he "orld Ban# predicts more future growth by
de!eloping nations in .ast and ,outh .ast $sia, which includes China, India, and
,outh @orea.
A changing &ord 2oreign $irect In,est'ent +icture'
%he source and destinations of FDI has also dramatically changed o!er recent
years, with the U, and industrialized countries becoming less important
;although still dominant< as de!eloping countries are becoming increasingly
considered as an attracti!e and stable location for in!estment.
%he U., firms accounted for DD.5G of the worldwide FDI flow in 4=D8s. British
firms were
second, accounting for 48.7 G while :apanese firms were a distant third, with
only 6G.
7
0owe!er, with the barriers to the free flow of goods and capital fell, and as
other countries
increased their shares of world output, non U., firms increasingly began to
in!est across national
borders.
%he share of FDI accounted by U., firms declined substantially form around 99
percent in 4=>8 to 67 percent in 4==9. Meanwhile the share accounted by
:apanese, France, other de!eloped nations and the world*s de!eloping nations
reflects a small but growing trend in FDI.
$nother trend shows an increasing tendency for cross border in!estments to be
directed at de!eloping rather than rich industrialized nations. ;the %o& o%
2oreign direct in,est'ent re%ers to the a'ounts in,ested across
nationa !orders each (ear)<
$mong the de!eloping nations China has recei!ed the greatest !olume of
inward FDI in recent years. 2ther de!eloping nations recei!ing a large amount o
of FDI included Indonesia, Malaysia, the /hilippines, and %hailand, ;?49 billion
dollars.<.
The changing nature o% the 5utinationa Enter+rise:
$e%inition: A 'utinationa enter+rise is an( !usiness that has
+roducti,e acti,ities in to& or 'ore countries)
%he ma+or trends in MCs are the rise of non:;8 5NCs particularly :apanese
Multinationals. %he second is the growth 'ini 'utinationas.
$ number of large multinationals are now non(U.,. based, and many are
recognizable brand names in the worldwide ;e.g. ,ony, /hilips, %oshiba, 0onda,
and BM"<. %he new large multinationals are not only are originating in other
de!eloped countries, but there are an increasing number of multinationals
based in de!eloping countries. %he country focus on @orea*s new multinationals
clearly illustrates the growth of de!eloping country multinationals.
$n increasing number of small firms are becoming global leaders in their field,
gi!ing rise to the mini(multinationals. $lthough most international trade and
in!estment are still conducted by large firms, many medium sized and small
businesses are increasingly in!ol!ed in international trade and in!estment.
..g.' &." Barth, manufacturer of cocoa beans roasting machinery based in
&ermany, employing +ust D7 people has captured 38 percent of the global
mar#et for cocoa bean roasting machines.
The changing &ord order'
8
Between 4=>= and 4==4 a series of remar#able democratic re!olutions swept
the communist world. In country after country throughout .astern .urope and
e!entually in the ,o!iet Union communist go!ernments collapsed. %he ,o!iet
Union is now history, which is replaced by 47 independent republics.
Czechoslo!a#ia has di!ided itself into two states, while Hugosla!ia has dissol!ed
into a bloody ci!il war among its successor states.
For about half a century, these countries were closed for western international
business. %he fall of communism and the de!elopment of free mar#ets in
.astern .urope and the former ,o!iet Union create profound opportunities,
challenges, and potential threats for firms.
%he economic de!elopment of China presents huge opportunities and ris#s, in
spite of its continued Communist control. China seems to be mo!ing
progressi!ely toward greater free mar#et reforms. %he southern China pro!ince
called E&uangongF now has become the fastest growing economy in the world.
Between 4=>5 and 4==7, FDI in China increased from leas than ?6 Billion dollars
to o!er ?5> Billion dollars.
For orth $merican firms, the growth and mar#et reforms in Me-ico and )atin
$merica also present tremendous new opportunities both as mar#ets and
sources of materials and production.
%he path to full economic liberalization and open mar#ets is not without
obstruction. .conomic crises in )atin $merica, ,outh .ast $sia, and Cussia all
caused difficulties in 4==3 and 4==>. In response, much trade was reduced, and
some countries imposed new controls. Malaysia, for e-ample, suspended
foreigners from trading in its e1uity and currency mar#ets to Epre!ent
destabilizing influences.F "hile firms must be prepared to ta#e ad!antage of
an e!er more integrated global economy, they must also prepare for political
and economic disruptions that may throw their plans into confusion.
The go!ai"ation de!ate: +ros+erit( or i'+o,erish'ent#
Is the shi%t to&ard a 'ore integrated and interde+endent go!a
econo'( a good thing#
There are three 'a4or criticis' against go!ai"ations) These are:
Reduced 4o!s and inco'es
It encourages +oor a!or +ractices and en,iron'enta +oicies
9
Nationa so,ereignt( o% the countries are getting i'ited
"hile many economists, politicians and business leaders seem to thin# so,
globalization is not without its critics. &lobalization stimulates economic growth,
raises the incomes of consumers, and helps to create +obs in all countries that
choose to participate in the global economy. ,ome of this growth, howe!er,
creates EsweatshopF +obs, increases pollution, and draws people from the
countryside into e!er more crowded cities and slums.
Go!ai"ation< 4o!s and inco'es'
2ne ma+or criticism against globalization is that compared to creating +obs it
actually destroys manufacturing +obs in the wealthy ad!anced countries li#e U,.
%hese critics argue that, falling trade barriers allow the firms to mo!e their
manufacturing acti!ities to countries where wage rates are much lower.
In de!eloped countries, labor leaders lament the loss of good paying +obs to low
wage countries. "hen the $F%$ agreement was signed, some politicians
warned of a hearing a Egiant suc#ing soundF as +obs left U,$ for Me-ico. .!en if
the +obs are not lost, it creates downward pressure on wages in industries
where o!erseas production is a !iable option. %he a!ailability of +obs for
uns#illed wor#ers is clearly threatened when those +obs can be more efficiently
performed elsewhere. 2ne solution to this problem is to increase the education
and training of wor#ers in de!eloped countries to maintain employment, and
simply let the uns#illed +obs go to locations where uns#illed wor#ers will accept
lower wages.
Bartlett and ,teele, two +ournalists form /hiladelphia In1uirer ews paper, cite
the case of 0arwood industries, a U, clothing manufacturer that closed U,
operations, where it paid wor#ers ?= per hour, and shifted manufacturing to
0onduras, where wor#ers recei!e 9> cents per hour. %hey argue because of free
trade, the wage rates of poorer $mericans ha!e fallen significantly o!er the
years.
,upporters of globalization reply that these critics miss the essential point
about free trade( the benefits outweigh the costs. %hey argue that free trade
results in countries specializing in the production of those goods and ser!ices
that hey can produce more efficiently from other countries. .!en though there
is dislocation of +obs but the whole economy is better off as a result.
$ccording to this !iew, it ma#es little sense for the U, to produce te-tiles at
home when they can produce te-tiles at la lower cost in 0onduras or China.
Importing te-tiles from China leads to lowering costs for cloths in U,, which
results in U, consumers spend less on te-tiles and more on other items.
10
$t the same time, the increased income generated in China, from te-tile
e-ports increases income le!els in that country, which helps the Chinese to
purchase more products produced in U, li#e, Boeing :ets, Intel Computers,
Microsoft ,oftware and Motorola cellular phones.
%herefore, supporter of global trade, argue that free trade benefits all countries.
La!or +oices and go!ai"ation
2ne of the criticisms against globalization is that free trade encourages
de!eloped nations to mo!e manufacturing facilities offshore to less de!eloped
countries that lac# ade1uate regulations to protect labor and the en!ironment.
%hey feel that free trade can lead to an increase in pollution and e-ploitation of
labor of less de!eloped nations.
)ower labor costs are only one of the reasons why a firm may see# to e-pand in
de!eloping countries. %hese countries may also ha!e lower standards on
en!ironmental controls and wor#place safety. e!ertheless, since in!estment
typically leads to higher li!ing standards, there is often pressure to increase
safety regulations to international le!els. o country wants to be #nown for its
poor record on health and human safety. %hus, supporters of globalization
argue that foreign in!estment often helps a country to raise its standards.
%here is also political and economic pressure on firms not to e-ploit labor or the
en!ironment in o!erseas operations. "estern firms ha!e been the sub+ects of
consumer boycotts when it has been re!ealed that they, or their independent
suppliers, operate at standards below that in de!eloped countries.
Nationa so,ereignt( and go!ai"ation'
"ith the de!elopment of the WTO .Word Trade Organi"ation0 and other
multilateral organizations such as the E; .Euro+ean ;nion0 and NA2TA
.North A'erican 2ree trade Agree'ent0, countries and localities
necessarily gi!e up some authority o!er their actions. If the U,$ wanted to
Eprotect its domestic lumber industryF by pre!enting imports of lumber from
Canada, the dispute would li#ely be settled by an international arbitration panel
set up by the $F%$ agreement or the "%2. Because of its trade agreements,
the U,$ would li#ely be forced to open its mar#ets to importation of lower cost,
higher 1uality Canadian lumber. "hile this would clearly be good for
consumers, the domestic lumber industry would protest. "hile clearly some
so!ereignty ;independence< has been surrendered, it has been done to protect
the best interests of consumers. If a nation wanted to retreat into a more
protectionist position, it could clearly choose to withdraw from its international
agreements.
11
3;nder the ne& s(ste'/ 'an( decisions/ &hich a%%ect !iions o%
+eo+e/ are no onger 'ade !( oca or nationa Go,ern'ent/ !ut
instead/ i% chaenged !( an( WTO 'e'!er nation/ &oud !e de%erred
to a grou+ o% uneected !ureaucrats sitting !ehind cosed doors in
Gene,a/ .H=s o% WTO0> at ris* is the ,er( !asis o% de'ocrac( and
accounta!e decision 'a*ing)9
Ra+h Nader/ ;8 en,iron'entaist and consu'er rights ad,ocate)
5anaging in the go!a 'ar*et+ace:
$e%inition: An Internationa !usiness is an( %ir' that engages in
internationa trade or in,est'ent)
$ firm does not ha!e to be a MC in!esting directly in operations in other
countries to engage in International Business. $ll a firm has to do is to start
e-porting products or importing products from other countries. $s the world
shift toward a truly integrated global economy, more firms, both the large and
small, are becoming intentional businesses.
$s their organizations increasingly engage in cross(border trade and
in!estment, it means managers need to recognize that the tas# of managing an
international business differs from that of managing a purely domestic business
in many ways. Countries differ in their cultures, political systems, economic
systems, legal systems, and le!els of economic de!elopment.
%hese differences re1uire that business people !ary their practices country by
country, recognizing what changes are re1uired to operate effecti!ely. It is
necessary to stri#e a balance between adaptation and maintaining global
consistency, howe!er. Coca(Cola would not be as successful, nor would Co#e be
Co#e, if it tasted li#e ginseng in one country, lemon in another, and rhubarb in a
third. Clearly, some adaptations need to be made to correspond with local
regulations and distribution systems, but some things need also remain
consistent in order to benefit from economies of scale in ad!ertising and
production.
$s a result of ma#ing local adaptations, the comple-ity of international business
is clearly greater than that of a purely domestic firm. Firms need to decide
which countries to enter, what mode of entry to use, and which countries to
a!oid. Cules and regulations also differ, as do currencies and languages.
Managing an international business is different from managing a purely
domestic business for at least four reasons' ;a< countries differ, ;b< the range of
problems and manager faces is greater and more comple-, ;c< an international
business must find ways to wor# within the limits imposed by go!ernmental
12
inter!ention and the global trading system, and ;d< international transactions
re1uire con!erting funds and being susceptible to e-change rate changes.
=uestion !an* %ro' 5odue 1:
4. "hat is globalizationI
2. Discuss the changing demographics of the global economy.;48 mar#s<
5. Define International business.
4. Discuss the forces dri!ing companies towards International business.;48
mar#s<
7. "hat are the dri!ers of globalizationI ;:uneJ:uly 6885<;5 mar#s<
D. Is globalization prosperity or impo!erishmentI ;:uneJ:uly 6885<;48 mar#s<
Additiona notes %ro' 5odue 1:
The go!ai"ation +rocess:
$e%inition' %he globalization process is the structural and managerial changes
and challenges e-perienced by a firm as it mo!es from domestic to global in
operations.
%his process happens in three phases.
$o'estic o+erations
Internationa trade +hase
5utinationa +hase
%a#e an e-ample of %rident Corporation, a U., based company, which
transforms itself from being domestic to global company. %he first phase is
called do'estic +hase.
Phase One: Domestic Operations
13
All payments in US dollars;
All credit risk under U.S. law

%rident may not be global or international itself, yet its competitors, suppliers
and buyers may be wor#ing across borders. %his is often a #ey dri!er to push a
firm li#e %rident into first phase of globalization A international trade
%he second half of this phase is the internationa trade +hase
Phase 2: International trade phase
All payments in US dollars;
All credit risk under U.S. law

%rident responds to globalization factors by importing inputs from Me-ican
suppliers and ma#ing e-ports sales to Canadian buyers. %his stage is called the
international trade phase.
.-porting and importing products increases the demands and
re1uirements of a domestic business.
%he first is direct forein e!chane risks borne by %rident.
%rident may ha!e to 1uote prices and recei!e payments in foreign
14
U.S suppliers
(Domestic)
U.S buyers
(Domestic)
Trident
Corporation
Mexican suppliers
Canadian buyers
Trident
Corporation
currencies.
%rident will now e-perience significant ris#s from the daily !olatility
in e-change rates.
%rident also faces ris#s associated with credit 1uality and e!aluation
of international counterparts.
%his credit risk manaement tas# is much more difficult in
international business as buyers and suppliers are new and sub+ect
to differing business practices and legal systems.
Phase ?: 'utinationa +hase
If %rident is successful in international trade then the time will come for the ne-t
step in the globalization process, which is the mo!e from the international trade
phase to the 'utinationa +hase)
%rident will e!entually need to establish foreign sales and
ser!ices affiliates
%his step is followed by the establishment of manufacturing
operations or licensing agreements abroad
%rident*s continued globalization will re1uire it to identify the
sources of it competiti!e ad!antages
%his !ariety of strategic alternati!es a!ailable to %rident is
called the forein direct in"estment se#uence.
%hese alternati!es include the creation of foreign sales
offices, licensing agreements, manufacturing, etc.
2nce %rident owns assets and enterprises in foreign countries it has entered the
multinational phase of globalization.
Go!ai"ation @se-uence'
15
Trident and its
Competitive Advantage
Change
Competitive Advantage
Production at Home:
Exporting
Exploit Existing Competitive
Advantage Abroad
Production Abroad
G
r
e
a
t
e
r

F
o
r
e
i
g
n

I
n
v
e
s
t
m
e
n
t
Greater Foreign
Presence
M
o
d
e
s
o
f
e
n
t
Green %ied in,est'ent' $ long(term physical in!estment in producti!e
capability in that country. ;referred as new pro+ects<
Ac-uisition' Identification, !aluation, tender, and post(ac1uisition,
management of an e-isting, going(concern.
Aoint ,enture' Combining in!estment, capital and managerial #now(how to
reach specific opportunities
Wa(s to enter the ne& 'ar*et: 'odes o% go!ai"ation
,imple e-port of the product
De!elop a +oint !enture to sell through an e-isting company in similar
business
,ell license to foreign company and collect royalties, or franchising, turn#ey
pro+ects etc.
Contract a foreign company to do the business for a G of the sales
2!erseas office and subsidiary company set up.
5O$;LE B: THE INTERNATIONAL B;8INE88
EN6IRON5ENT
Contents: the in%uence o% countr(7s di%%erences in +oitica s(ste's/
econo'ic s(ste's/ ega s(ste's and cutura attitudes on
internationa !usiness and ethica issues in IB5)
16
Joint Venture Wholly Owned
Subsidiary
Control Assets
Abroad
Greenfield
Investment
Licensing
Management Contract
Acquisition of a
Foreign Enterprise
Understand how the political systems of countries differ.
Understand how the economic systems of countries differ.
Understand how the legal systems of countries differ.
Understand how political, economic, and legal systems collecti!ely
influence a country*s ability to achie!e meaningful economic
progress.
Be familiar with the changes that are currently reshaping the
political, economic and legal systems of countries.
.thical issues while doing international business.
Introduction
%he issues that face international businesses are entirely different from those
that face domestic firms. "hether the sub+ect is political differences, cultural
differences, trade and tariff issues or e!en corporate ma#eup, the ma+or issues
of international business are issues that simply do not occur in domestic
businesses. 2ne cannot e-pect to understand international business by learning
the tenants of domestic business and then superimposing them on an
international scene. Differences between countries are profound, and they ha!e
a powerful affect on how managers and firms wor# and act internationally. %his
chapter loo#s at the political, economic, and legal infrastructures of different
countries.
%he political economy of India shows the difficulty nations may e-perience when
they attempt to mo!e from a largely state(dri!en economy to one of
pri!atization. .!en when change appears to be merited, the results of a
particular change can be mi-ed and inconclusi!e. Changing political !iews on
the ownership of business enterprises can ha!e dramatic effects on economic
efficiency and foreign in!estment.
Poitica 8(ste's
$e%inition: Poitica s(ste' re%ers to the s(ste' +% Go,ern'ent in a
nation) The econo'ic and ega s(ste's o% the countr( are o%ten
sha+ed !( its +oitica s(ste')
There are t&o se+arate +oarities to consider &hen discussing +oitica
s(ste's: coecti,is' ,s) indi,iduais' and de'ocrac( ,s)
totaitarianis')
/olitical systems are assessed according two the two related dimensions. %he
first is the degree to which they emphasize coecti,is' as o++osed to
indi,iduais'. %he second dimension is the degree to which they are
17
de'ocratic or totaitarian.
%hese two dimensions are interrelated, systems that emphasize collecti!ism
tend to be totalitarian while, systems, that pace a high !alue on indi!idualism
tend to be democratic. 0owe!er, there might be e-ceptions also.
Democracy and totalitarianism are at different ends of a political dimension.
%he democratic !s. totalitarian dimension is not independent of the collecti!ism
!s. indi!idualism dimension. Democracy and indi!idualism go hand in hand, as
do the communist !ersion of collecti!ism and totalitarianism. 0owe!er, gray
areas also e-istK it is possible to ha!e a democratic state where collecti!e
!alues predominate, and it is possible to ha!e a totalitarian state that is hostile
to collecti!ism and in which some degree of indi!idualism (( particularly in the
economic sphere (( is encouraged.
Coecti,is' ,s) indi,iduais'
Coecti,is':
$e%inition: +oitica s(ste' that stresses the +ri'ac( o% coecti,e
goas o,er indi,idua goas)
0ere the needs of a society as a whole are generally !iewed as being more
important than indi!idual freedoms. In this condition, an indi!idual*s right to do
something may be restricted because it runs against, the good of societyF or
Ethe common goodF.
%his concept originates from the &ree# /hilosopher /lato ;963(593(BC<, who in
his boo#F the CepublicF argued that indi!idual rights should be sacrificed fro the
good of the ma+ority and that property should be owned in common.
The s(ste'/ &hich ad,ocates Coecti,is'/ is caed sociais' and
these acti,ists are caed sociaists)
8ociais':
,ocialism roots from the intellectual lessons from Car 5ar1 ;4>4>(4>>5<.
Mar-*s basic argument is that in a capitalist society where indi!idual freedom is
not restricted, the few benefit at the e-pense of many. Mar- ad!ocated state
ownership of the basic means of production, distribution and e-change
;business<. 0is point is that if the state owned the means of production, the
states could ensure that the wor#ers were fully compensated for their labor.
%hus, the idea is to manage state owned enterprise to benefit the society as
whole, rather than indi!idual capitalists.
18
%he general premise of collecti!ism is that the state must manage enterprises if
they are to benefit society. Democratic ,ocialism sees itself as part of the
historical trend toward democracy and uni!ersal enfranchisement that has
ta#en place worldwide since the 4388s. In fact, it sees socialism as the ultimate
democracy (( putting faith in the common person*s ability not only to !ote on
.lection Day, but also to go!ern his and her wor#place and community.
In the early 68
th
century, socialist ideology split into two broad camps.
2n the one hand, there were the co''unists, &ho !eie,ed that sociais'
coud !e achie,ed on( through ,ioent re,oution and totaitarian
dictatorshi+)
2n the other hand, there were socia de'ocrats &ho co''itted
the'se,es/ to achie,e sociais' !( de'ocratic 'eans, and who
disagreed on !iolent re!olution and dictatorship.
The co''unist ,ersion o% sociais' reached at the pea# in the late 4=38*s,
when the ma+ority of the world*s population li!ed in communist states. %he
countries under communist rule included'
%he former ,o!iet Union
Its eastern .uropean client nations ;/oland, Czechoslo!a#ia,
0ungary<
China
%he ,outheast $sian nations of Cambodia, )aos and Bietnam
Barious $frican nations ;$ngola, Mozambi1ue<
)atin $merican nations;Cuba and icaragua<
By mid 4==8*s, howe!er communism collapsed worldwide. %he ,o!iet Union had
collapsed and had been replaced by a collection of 47 republics. Communism
was swept out of .astern .urope by large bloodless re!olutions of 4=>=. China
remains the only ma+or country in the world today under communist rule.
0owe!er, China has recently mo!ed significantly away from strict adherence to
communist ideology and gi!es substantial limits to indi!idual political freedom.
8ocia $e'ocratic nations include ,weden, &ermany, France, and orway,
although ,ocial Democratic parties ha!e not always held power in these
nations.
,ocial democracy had its great influence in a number of democratic western
nations, including, $ustralia, Britain, France, &ermany. orway, ,pain and
,weden, where social democratic parties ha!e from time to time held political
19
power. 2ther countries where social democracy has had an important influence
include India and Brazil.
Many social democratic go!ernments ha!e nationalized pri!ate companies in
certain industries, transforming them into state owned enterprises to be run for
Epublic good rather than pri!ate profit.F In Britain for e-ample, by 4=38*s state
owned companies had a monopoly in industries li#e telecommunications,
electricity, gas coal, railway and shipbuilding and ha!e substantial shares in oil,
airline, auto and steel industries.
%he ,tate owned firms promoting the public interest ha!e had a poor record of
accomplishment. %he reasons are often ob!ious' state owned firms are often
protected from competition and are poorly moti!ated to achie!e any financial
self(sufficiency. 2ften their ma+or purpose is to carry on their e-istence, rather
than bringing anything positi!e to the country they are supposed to ser!e.
%hus, both former communist and "estern .uropean countries ha!e pri!atized
enterprises that were pre!iously state owned. In a number of "estern
democracies, many social democratic parties were !oted out of office in late
4=38*s and early 4=>8*s. in Britain, this was replaced by, conser!ati!e party of
Margaret %hatcher, sold the state*s interests in telecommunications, electricity,
gas, shipbuilding, oil, airlines, autos, and steel to pri!ate in!estors. ,elling sate
owned enterprises to pri!ate in!estors is #nown as pri!atization.
Many indi!iduals are shoc#ed to belie!e 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 e-change of electronic information, the concept of a
go!ernment trying to create physical barriers to control the flow of information
is often difficult to grasp.
Indi,iduais':
%his is the opposite of collecti!ism. Indi,iduais' re%ers to a +hioso+h(
that an indi,idua shoud ha,e the %reedo' in his or her econo'ic and
+oitica +ursuits)
In contrast to collecti!ism, indi!idualism stresses that the interests of the
indi!idual should ta#e precedence o!er the interests of the state. "hile
ad!ocated by Aristote, indi!idualism, in modern days was encouraged by
$a,id Hu'e/ Ada' 8'ith .Boo*: Weath o% Nations0/ Aohn 8tuart 5i/
and most recently/ 2rederich 6on Ha(e* and 5iton 2ried'an .No!e
Pri"e &inning econo'ists0.
Indi!idualism focuses on ;4< guaranteeing indi!idual freedom and self(
e-pression, and ;6< letting people pursue their own economic self(interest in
order to achie!e the best o!erall good for society.
20
%he U, Declaration of Independence and the Bill of Cights embody the spirit of
indi!idualism, but more familiar today are forces li#e M%B, which encourage
people the world o!er to !ote for their fa!orite !ideo (( e!en in countries where
!oting in elections is impossible and the concept of !oting is not understood.
Collecti!ism ad!ocates the primacy of the collecti!e group o!er the indi!idualK
indi!idualism asserts the opposite. %his ideological difference shapes much of
recent history and especially the Cold "ar. a war between collecti!ism
championed by the now defunct ,o!iet Union and indi!idualism, championed by
U.,.
In practical terms, indi!idualism translates into an ad!ocacy for democratic
political systems and free mar#et economies. ,o!iet Union, .astern .urope etc
ha!e mo!ed toward a greater indi!idualism. ow as guiding political philosophy
there is no doubt that indi!idualism is currently rising o!er collecti!ism. %his
represents good news for international business since this creates a more
fa!orable en!ironment fro business and free trade.
$n interesting de!iation is en!ironmentalism (( in the conte-t of collecti!ism !s.
indi!idualism. "hile one might e-pect that countries with a collecti!ist
approach would ha!e much higher en!ironmental standards Efor the common
goodF than indi!idualist countries where Eanyone can do what they want on
their own land,F the record is less clear. "hile the ,ocial Democratic countries
of orway and ,weden ha!e some of the best o!erall en!ironmental records,
the pollution problems in many of the former communist states are unbearable.
%he U,$ has an en!ironmental record that seems to lag behind many other
social democratic countries in "estern .urope. In fact, as we will see in later
discussions on &$%% and $F%$, different countries* en!ironmental standards
are becoming an increasingly important issue in international trade
negotiations.
$e'ocrac( 6s) totaitarianis'
$e'ocrac(:
$e%inition: $e'ocrac( re%ers to a+oitica s(ste' in &hich the
go,ern'ent is !( the +eo+e/ e1ercised either direct( or through
eected re+resentati,es)
Democracy in its pure state, with each indi!idual !oting on e!ery issue, has
generally been replaced by representati!e democracy, where elected
representati!es !ote on behalf of constituents. Het, in ,witzerland, many issues
are decided by referendum, and in many U, states, referendums decided
directly by !oters on .lection Day are becoming increasingly common.
Democracy, in its pure from was originally practiced by se!eral states in ancient
&reece. In comple- danced societies with millions of people, this is impractical.
21
Most of the modern democratic states practice which is commonly #nown as
Dre+resentati,e de'ocrac(9 in this system, the citizens periodically elect
indi!iduals to represent them these elected representati!es then form a
go!ernment, whose function is to ma#e decisions on behalf of the electorate. $
representati!e democracy rests on the assumptions that if elected represnti!es
fail to perform this +ob ade1uatelyK they can and will be !oted down at the ne-t
election. Democratic system guarantees constitutionally, a number safeguards
to its citizens. %hese are'
$n indi!idual*s right to freedom of e-pression, opinion, and organization, a free
media, regular elections in which call eligible citizens are allowed to !ote,
uni!ersal adult suffrage, limited terms for elected representati!es, a fair court
system that is independent for the political system, a nonpolitical state
bureaucracy, a non political police force and armed forces an relati!ely free
access to state information etc. are some of these rights.
Totaitarianis':
$e%inition: Totaitarianis' is a %or' o% Go,ern'ent in &hich one
+erson or +oitica +art( e1ercises a!soute contro o,er a s+heres o%
hu'an i%e/ and o++osing +oitica +arties are +rohi!ited)
Under totalitarianism, a single political party, indi!idual, or group of indi!iduals
monopolize the political power and do not permit opposition. There are %our
'a4or %or's o% totaitarianis': co''unist/ theocratic/ tri!a/ right
&ing .o%ten 'iitar(0)
Co''unist totaitarianis'' this is a %or' o% totaitarianis' that
ad,ocates achie,ing sociais' through totaitarian dictatorshi+)
Communism is in decline worldwide. %he ma+or e-ceptions to this trend are
China, Bietnam, orth @orea and Cuba. 0owe!er, e!en these states show a
decline in the communist party*s monopoly.
Theocratic totaitarianis'' this is a %or' o% totaitarianis' in &hich
+oitica +o&er is 'ono+oi"ed !( a +art(/ grou+ or indi,idua that
go,erns according to reigious +rinci+es. %he most common theocratic
totalitarianism is that based on Islam. It pre!ails in Iran, ,audi $rabia etc. in
these states not only is freedom of political e-pression is restricted, but also is
the freedom of religious e-pression, while the laws of the state are based on
Islamic principles.
Tri!a totaitarianis': this is a %or' o% totaitarianis' %ound 'ain( in
A%rica/ in &hich a +oitica +art( that re+resents the interests o% a
+articuar tri!e 'ono+oi"es the +o&er) %his is found in $frican countries
li#e Limbabwe, %anzania, Uganda and @enya. ,uch one party states are found
throughout $frica where a political party that represents the interests of
particular tribe;not necessarily, ma+ority tribe< monopolizes the power.
Right &ing totaitarianis': this is a %or' o% totaitarianis' in &hich
22
indi,idua econo'ic %reedo' is ao&ed !ut indi,idua +oitica %reedo'
is restricted in the !eie% that coud eads to co''unis'.
Many right wing dictatorships are bac#ed by military and in some cases the
go!ernment is made up of military officers. Many of the military dictatorship
were common in )atin $merica. %hey were also found in south @orea, %aiwan,
,ingapore, Indonesia, /a#istan and the /hilippines.
%here has been a general trend away from communist and right wing
totalitarianism and towards democracy in the 4=>8s and 4==8s. Issues relating
to theocratic and tribal totalitarianism are presently at the root of some unrest
in $sia and $frica.
Econo'ic s(ste':
$ good way to understand countries* relati!e political and economic freedom is
to draw a diagram with political freedom on one dimension and economic
freedom on the other. ;Cefer map 6.4 ;page 9D< in &lobal Business by Charles
0ill< %hen identify the relati!e position different countries on the dimensions of
economic and political freedom.
%he political en!ironment of a country matters because' ;4< when economic
freedoms are restricted so may be the ability of an international business to
operate in the most efficient manner, and ;6< when political freedoms are
restricted there are both ethical and legal ris#s concerns that ha!e to be
considered.
Econo'ic 8(ste's:
There are %our !road t(+es o% econo'ic s(ste's: 'ar*et/ co''and/
'i1ed/ and state:directed.
In reality almost all are mi-ed to some e-tent, for e!en the most mar#et
oriented systems ha!e some go!ernmental controls on business and e!en the
most command based systems either e-plicitly allow some free mar#ets to e-ist
or ha!e blac# mar#ets for some goods and ser!ices. Het, all countries can be
considered to be at some point on a continuum between pure mar#et and pure
command.
5ar*et econo'('
In a +ure 'ar*et econo'(/ the goods and ser,ices that a countr(
+roduces/ as &e as the -uantit( in &hich the( are +roduced/ is not
+anned !( an(one) Rather +rice and -uantit( are deter'ined !(
su++( and de'and)
For a mar#et economy to wor#, there must be no restrictions on either supply or
23
demand (( no monopolistic sellers or buyers. %he recent legal battle with the
federal go!ernment and Microsoft is an e-ample of an attempt by go!ernment
to remo!e from Microsoft what it percei!ed to be business restrictions that
resulted in monopolistic operations.
Co''and econo'('
In a +ure co''and econo'(/ the go,ern'ent +ans &hat goods and
ser,ices a countr( +roduces/ the -uantit( in &hich the( are +roduced/
and the +rice at &hich the( are sod. Cesources are allocated Efor the good
of society.F %he go!ernment owns most, if not all, businesses, including e!en
small businesses li#e the bread ba#ery and the local farm.
Command economies are found in communist countries where collecti!ist goals
are gi!en priority o!er indi!idual goals. France and India ha!e both
e-perimented with e-tensi!e go!ernment planning and state ownership,
although in both countries go!ernment planning has recently fallen into
disfa!or. In this system, state owned enterprises show little interest to control
costs and be efficient. %here is a general lac# of dynamism and inno!ation in
command economies are !isible, since there is no incenti!es for indi!iduals to
loo# for better ways of ser!ing customers.
5i1ed econo'('
$ mi-ed economy includes some elements of each. In Canada, for e-ample,
while most business is pri!ately owned and operated under mar#et principles,
health care, electrical power, and li1uor distribution are run by state owned
enterprises in most pro!inces.
In a state(directed economy, the go!ernment plays a significant role in directing
the in!estment acti!ities of pri!ate enterprises through Eindustrial policy.F Both
:apan and ,outh @orea are often cited as e-amples of state(directed economies.
In both situations, the go!ernment has played a significant role in directing
in!estment. %his direction has helped in the creation of some leading
international firms. For a state(directed economy to wor# well, state
bureaucrats must ma#e better decisions than capital mar#ets on the allocation
of resources. "hile state bureaucrats may be able to ta#e a longer(term
perspecti!e than capital mar#ets, they may also pro!e to be intransigent and
resistant to ma#ing necessary changes. %he difficulties many ,outh .ast $sian
countries faced in 4==3(=> highlight some of the limitations of a state(directed
economy. Cesisting whims of the mar#et has both its good and bad points.
Lega 8(ste's
The ega s(ste's o% a countr( re%ers to the rues/ or a&s that
reguate !eha,ior/ aong &ith the +rocesses !( &hich the a&s o% a
24
countr( are en%orced and through &hich redress %or grie,ances is
o!tained)
%he legal en!ironment of a country is of immense importance to international
business. $ country*s laws regulate business practice, define the manner in
which business transactions are to be e-ecuted, and set down the rights and
obligations of those in!ol!ed in business transactions. Differences in the
structure of law can ha!e an important impact upon the attracti!eness of a
country as an in!estment site andJor mar#et.
Lega s(ste's and +ro+ert( rights' there are three aspects of legal systems
that affect international business, i.e., a&s o% +ro+ert( rights/ inteectua
+ro+ert( rights/ +roduct sa%et( and +roduct ia!iit( a&s and contract
a&s)
Pro+ert( rights' is the bundle of legal rights addressing the use to which a
resource is put and the use made of any income that may be deri!ed from that
ser!ice.
Control o!er property rights are !ery important for the functioning of business.
/roperty rights can be !iolated by either +ri,ate action ;theft, piracy,
blac#mail, Mafia< or +u!ic action ;go!ernmental bribery and corruption,
nationalization<. )ac# of confidence in a country*s fair treatment of property
rights significantly increases the costs and ris#s of doing business.
%he Country Focus on Corruption in igeria shows how a country that has huge
natural resources can still remain poor when its political leaders conspire to
damage its economic acti!ity for their personal gain. 0igh le!els of corruption
can naturally lead to a significant reduction in economic acti!ity.
Inteectua +ro+ert( rights: Pro+ert( such as co'+uter so%t&are/
screen+a(s/ 'usica scores/ or che'ica %or'uas %or ne& drugs that is
the +roduct o% inteectua acti,it() ;/atents, copyrights, and trademar#s<
are important for businesses if they are to capitalize on what they ha!e
de!eloped.
Patents: docu'ents gi,ing the in,entor o% a ne& +roduct or +rocesses
e1cusi,e rights to the 'anu%acture/ use/ or sae o% that in,ention)
Co+(rights: are the e1cusi,e ega rights o% authors/ co'+osers/
25
+a(&rights/ artists and +u!ishers to +u!ish and dis+ose their &or*s
as the( see it)
Trade'ar*s: are designs and na'es/ o%ten o%%icia( registers/ !(
&hich 'erchants or 'anu%acturers designate and di%%erentiate their
+roducts)
Firms li#e Microsoft, )e!is, Coca(Cola, or McDonald*s would ha!e little reason to
in!est o!erseas if other firms in other countries were able to use the same
name and copy their products without permission. For e-ample, consider
inno!ation in the pharmaceuticals firms an incenti!e to underta#e the
e-pensi!e, difficult and time consuming basic research re1uired to generate
new drugs; on a!erage it costs ?488 million in research and de!elopment and
ta#es 46 years to get a new drug to the mar#et.<. "ithout the guarantee
pro!ided by patents, it is unli#ely that companies would commit themsel!es to
such research.
Paris con,ention %or the +rotection o% Industria +ro+ert(' is an
international agreement signed by =D countries to protect intellectual property
rights.
.stimates suggest that the $sian !iolations of intellectual property rights cost
U., computer software companies ? D billion annually and U., pharmaceuticals
companies at least ? 788 million annually. Because of all these !iolations,
international laws are currently being strengthened. %he world trade agreement
which was signed in 4==9 by 443 countries for the first time e-tends its scope
of the &eneral $greement 2n %ariffs $nd %rade ;&$%%< to co!er intellectual
property. %hese regulations enforce "%2 members to grant and enforce
patents lasting at least 68 years and copyrights lasting 78 years.
Product sa%et( and +roduct ia!iit(:
/roduct safety laws set certain safety standards to which a product must
adhere. /roduct liability in!ol!es holding a firm and its officers responsible when
a product causes in+ury, death or damage. /roduct liability can be much greater
if the product does not confirm to re1uired safety standards. %here are both ci!il
and criminal liability laws. Ci!il laws calls for m8nuy and payment damages.
Criminal laws result in fines or imprisonment.
Different countries ha!e different product safety and liability laws. In some
cases, U, businesses must customize products to adhere to local standards if
they are to do business in a country, whether these standards are higher or +ust
different. %he most strict liability laws are found in U, and other western
nations. )iability laws are typically least e-pensi!e in less de!eloped nations.
"hen product standards are lower in other countries, firms face an important
ethical dilemma. ,hould they produce products only of the highest standards
e!en if this puts them at a competiti!e disad!antage relati!e other producers
and results in not ma-imizing !alue to shareholdersI 2n the other hand, should
they produce products that respond to local differences, e!en if that means that
26
consumers may not be assured of the same le!els of safety in different
countriesI 2ne serious e-ample in!ol!es the flame retardant nature of
children*s pa+amas. In many countries, restrictions on the le!el of flame
retardency are !ery low and e!en none-istent, thus it is legal to manufacture
that product without protecti!e standards. ,hould international firms continue
to manufacture to higher protection le!els, with resulting increased costs that
may put them at a competiti!e disad!antageI
Contract a&s'
$ contract is a document that specifies the conditions, under which an
e-change is to occur, and details the rights and obligations of the parties to a
contract. Contract law is the body of law that go!erns contract enforcement.
%he parties can resort to contract law in case of !iolations.
%here are two legal traditions that are found in world today. The co''on a&
s(ste' and the ci,i a& s(ste'.
The co''on a& s(ste' e!ol!ed in .ngland o!er hundred s of years ago. It
is now found in most of Britain*s former colonies including U,. Common law is
based on tradition, precedent and custom.
Ci,i a& s(ste' is based on !ery detailed set of laws that are organizes into
codes. %hese codes define the laws that go!ern business transactions. %his is
used in ore than >8 countries, including &ermany, France, :apan and Cussia.
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
!ariety of contingencies. Common law tends to interpret legal statutes
according to the past decisions and rulings of courts. %he United ,tates uses a
common law system. Under ci!il law systems, contracts tend to be much
shorter and less specific since many of the issues relating to contracts are
co!ered in the ci!il code of the country. Under common law, ownership is
established by useK under ci!il law, ownership is determined by registration.
%herefore, another firm may register a product first and pre!ail in a bid for
ownership, e!en though the competition had been using the product for a long
time but had failed to register it.
The $eter'inants o% Econo'ic $e,eo+'ent:
The 'a4or 'easures o% econo'ic de,eo+'ent o% courtiers are G$P/
PPP/ and H$I)
Different countries ha!e dramatically different le!els of de!elopment. &D/ is
often regarded as a good measure of economic acti!ity of a country. G$P
'easures the tota ,aue o% the goods and ser,ices +roduced annua(.
G$PEca+ita is aso a good (ardstic* o% econo'ic acti,it(/ as it
27
'easures a,erage ,aue o% the goods and ser,ices +roduced !( an
indi,idua) ;Cefer map showing &D/ J per capita<.
Countries such as ,witzerland, United ,tates, ,weden, and :apan are among the
richest with highest &D/, while the largest countries li#e China, India are the
poorest. :apan*s &D/ per head is ?6>,643, whereas China has only ?53= and
India ?583. ;4==5<. ,udan has the lowest with &D/ per head as ?77. %he world*s
richest ,witzerland has ?5D,654.
0owe!er, &D/Jcapita does not consider the differences in costs of li!ing. The
;N7s PPP inde1 :: sho&s the di%%erences in the standards o% i,ing o%
+eo+e in di%%erent countries) PPP inde1 sho&s G$P +er head %or the
cost o% i,ing) %he inde- is set e1ual to 488 for the country in which /// is the
highest, which happens to be U,. ;Cefer the graph showing /// inde- of
selected countries.< %his graph shows that an a!erage Indian citizen can afford
to consume only 7 percent of the goods and ser!ices consumed by the a!erage
U, citizen.
$ problem with both &D/Jcapita and /// is that they are static in nature. From
an international business perspecti!e, it is good to loo# at the rate of growth in
the economy as well as the status of its people. Map 6.5 shows that some of the
fastest growing countries economically are those ha!e been slower to de!elop.
$ broader approach to assessing the o!erall 1uality of life in different countries
is the Hu'an $e,eo+'ent Inde1 de,eo+ed !( ;N) This is !ased on i%e
e1+ectanc(/ iterac( rates/ and &hether .!ased on PPP indices0
inco'es are su%%icient to 'eet the !asic needs o% indi,iduas) %he map
shows the 0uman De!elopment Inde-. otice that some of the worse off
countries are hea!ily populated and ha!e rapidly e-panding populations. %he
human de!elopment inde- is scaled from 8 to 488. Countries scoring less than
78 are classified as ha!ing low human de!elopmentK scoring 78 to >8 are
classified as ha!ing medium human de!elopment while those countries that
score abo!e >8 are classified as ha!ing high human de!elopment. 2ne of the
reasons of low human de!elopment inde- is hea!y and e-panding population.
"hat is the relationship between political economy and economic progressI
%his is a difficult issue. 2ne thing that is generally accepted is that inno,ation
is the engine o% ong:run econo'ic gro&th. Inno!ation is the process
through which people create new products, new processes, mew organizations,
new management practices and new strategies. $nother thing is that a free
mar#et economy is better at stimulating inno!ation than a command economy
that does not ha!e the same types of incenti!es for indi!idual initiati!e.
Inno!ation also depends on a strong protection of property rights, as inno!ators
and entrepreneurs need some le!el of assurance that they will be able to reap
the benefits of their initiati!e.
28
"hile it is possible to ha!e inno!ation and economic growth in a totalitarian
state, many belie!e that economic growth and a free mar#et system will
e!entually lead a country to becoming more democratic.
&eography can also affect economic de!elopment. $ landloc#ed country with an
inhospitable climate, poor soil, few natural resources, and terrible diseases is
unli#ely to de!elop economically as fast as country with the opposite
characteristics on each of these attributes.
"hile it can be hard to do much about unfa!orable geography, education is
something that go!ernments can affect. umerous studies suggest that
countries that in!est more in the education of their young people de!elop faster
economically. .-amples include :apan, ,outh @orea, and many $sian countries.
8tates in Transition
,ince the late 4=>8s, there ha!e been two ma+or changes in the political
economy of many of the world*s nations. First, a wa!e of democratic re!olutions
swept the world, and many of the pre!ious totalitarian regimes collapsed.
,econdly, there has been a mo!e away from centrally planned and mi-ed
economies towards free mar#ets.
Eastern Euro+e and 8o,iet ;nion'
Following the ,econd "orld "ar, ,o!iet bac#ed Communist &o!ernments too#
power in eight .astern .uropean sates' /oland, Czechoslo!a#ia, 0ungary,
Bulgaria, $lbania, Comania, Hugosla!ia and .ast &ermany. %his set the scene
for 98 years of ideological conflict between the Communist bloc, dominated by
the ,o!iet Union and the democratic west.
%he conflict started melting in 4=>7 when Mi#hail &orbache! became &eneral
,ecretary of the ,o!iet Communist party and began his program of &lasnost
and /erestroi#a. During 4=>=, communist go!ernments fell globally. %he
biggest change occurred in 4==4 in the ,o!iet Union. By 4==4, the U,,C had
already mo!ed significantly down the road toward political freedom, but not
economic freedom. 2n :anuary 4, 4==6, the Union of ,o!iet ,ocialist Cepublics
passed into history, to be replaced by 47 independent republics, 44 of which
elected to remain associated as a commonwealth of independent states.
%he post communist history has not been easy. %he mo!e toward greater
political and economic freedom has often been accompanied by economic and
political chaos. %hese countries stated dismantling decades of price controls,
allowed pri!ate ownerships of businesses and permitted much greater
competition and pri!atization of its sate owned enterprises. But, most of these
enterprises were inefficient and the pri!ate in!estors were not interested. %he
29
new democratic go!ernments continued supporting these loss ma#ing
enterprises to sa!e from massi!e unemployment*s. the resulted subsidies
resulted in budget deficits that was balanced by Eprinting moneyF. $long with
lac# of price controls, this led to inflation. In 4==5, the inflation rate was 64
percent in 0ungary, 5> percent in /oland, >94 percent in Cussia and 48,888
percent in U#raine. &D/ also fell. 0owe!er, there is impro!ement in economic
conditions in /oland, Czech etc.
%he re!olutions in the U,,C and .astern .urope ha!e ;in general< mo!ed these
countries towards democracy ;away from totalitarianism<, towards indi!idualism
;away from collecti!ism<, and towards mi-ed economies ;away from command<.
%he transitions ha!e been difficult, howe!er, and economic progress has not
been easy. Cecent elections ha!e brought EreformedF communists bac# into
power in some countries, and the economic problems facing the people are
significant.
%here are three main reasons for the spread of democracy. First, many
totalitarian regimes failed to deli!er economic progress to the !ast bul# of their
populations. ,econdly, impro!ed information technology limited the ability of
the go!ernment to control citizens* access to information. %hirdly, increases in
wealth and the standard of li!ing ha!e encouraged citizens to push for
democratic reforms.
"hile there are general mo!ements towards democracy and open economies,
this does not mean that there is necessarily going to be a homogenization of
ci!ilization. $t the same time, we see a further definition and de!elopment of
both Islamic and Chinese ci!ilizations.
Western Euro+e'
In "estern .urope, there has been a general trend towards pri!atization of
state owned companies and deregulation of industry. In many western
.uropean countries, basic industries such as telecommunications, energy
production, airlines and railroads were often state owned, while many other
sectors were protected with hea!y sate regulations.
,tarting with Margaret %hatcher*s conser!ati!e go!ernment in Britain during the
early 4=>8*s Britain has mo!ed to pri!atization of these state owned
enterprises. ,ate owned industries ha!e been pri!atized;sold to pri!ate
in!estors< and restricti!e regulations were lifted.
Asia'
During the 4=>8*s and early 4==8*s a shift toward greater political democracy
occurred in the /hilippines, %hailand, %aiwan and ,outh @orea. In Bietnam, the
ruling communist party remo!ed many price controls and began to shift toward
a mar#et economy. In orth @orea, also situation is changing to better relations
with ,outh @orea, which was their archri!al. In India, in 4==4, under the
&o!ernment of /.B. arasimha Cao, began a reform program aiming to free
mar#et economy.
30
In China too, the communist go!ernment started the shift from a pure
command economy to a mi-ed economy. /ri!ate ownership was allowed. %he
most important of them was the creation of a number of special economic
zones in which free mar#ets were allowed to operate without any restrictions,
pri!ate ownership was allowed and foreign companies were permitted to in!est.
China*s economy as a whole has been growing at o!er 48 percent per year
during 4==8*s. :apan*s growth after ,econd "orld "ar also is phenomenal.
Latin A'erica'
During the 4=>8s, most )atin $merican countries changed from being run by
dictatorship to democratically elected go!ernments. "hile most countries
pre!iously had erected high barriers to imports and in!estment ;to #eep
multinationals from EdominatingF their economies<, they now mostly are
encouraging in!estment, lowering barriers, and pri!atizing state owned
enterprises.
%he tide began to turn in the 4=38*s in Chile, under the military dictatorship,
shifted sharply in the direction of a free mar#et economy. %he largest shift
occurred in Me-ico, then run by the ci!ilian go!ernment of /resident ,alinas,
mo!ed toward free mar#et economy. Under him, Me-ico, pri!atized many state
owned enterprises, cancelled many of the laws that limited FDI, cut import
tariffs to world le!els, and in 4==9, brought Me-ico in to North A'erican 2ree
Trade Agree'ent .NA2TA0 with the U, and Canada. %wo )atin $merican
giants, $rgentina and Brazil also followed Me-ico to +oin $F%$.
A%rica
$frica is also mo!ing toward more democratic modes of go!ernment and free
mar#et economies. Most $frican countries gained their independence from
colonial powers particularly Britain, France and /ortugal in the 4=78*s and
4=D8*s.most of them became one party sates ruled by authoritarian leaders.
%oday both socialism and totalitarianism are slowly ret9eraing form $frica.
During 4==9, ,outh $frica, Malawi, and Mozambi1ue all held their first
democratic elections and 4==D in ,ierra )eone and Uganda.
But according to the world ban#*s report, e!en of the $frican countries now
achie!e a 5 percent annual growth in &D/, it will ta#e 98 years before many
return to the le!el of economic growth they were at the early 4=38*sMM
$nother report shows that foreign in!estors who are attracted to $frica because
of cheap labor are deterred by the problem s of doing business in countries
where the rules of law is so wea# that e!en simple contracts can be difficult to
enforce and they ha!e to bribe poorly paid bureaucrats who can otherwise
ma#e business impossible.
%he great hope for $frica is that the continent*s potential economic powers,
which include igeria, @enya, and ,outh $frica which might pull the rest of
$frica along with them.
31
I'+ications %or Business
%hese transitions are creating huge opportunities for international business, as
well as creating huge ris#s. It is not clear what direction future changes will
ta#e, and if these will be entirely fa!orable for business.
%he shift toward a mar#et(based economic system typically in!ol!es at least
three distinct acti!ities' deregulation, pri!atization, and legal enforcement of
property rights. Deregulation in!ol!es remo!ing restrictions on the free
operation of mar#ets. /ri!atization transfers the ownership of state property
into the hands of pri!ate in!estors. In order to attract in!estment and protect
the interests of the pri!ate enterprise encouraged by the first two acti!ities,
changes typically need to be made to legal systems to protect the property
rights of in!estors and entrepreneurs.
Attracti,eness o% a countr(
%he political, economic, and legal en!ironment of a country clearly influences
the attracti!eness of a country. $ country*s attracti!eness can be best
e!aluated by loo#ing at the benefits, costs, and ris#s of doing business in that
country.
%he long run monetary benefits of doing business in a country are a function of
the size of the mar#et, the present wealth ;purchasing power< of consumers,
and the li#ely future wealth of consumers. By identifying and in!esting early in
a potential future economic star, firms may be able to gain %irst 'o,er
ad,antages .ad,antages that !eong to an ear( entrants into the
!usiness 'ar*et0 and establish loyalty and e-perience in a country. %wo
factors that are reasonably good predictors of a country*s future economic
prospects are its economic system and property rights regime.
Cost o% doing !usiness' $ number of political, economic, and legal factors
determine the costs o% doing !usiness in a country. Poitica costs can
in!ol!e the cost of paying bribes or lobbying for fa!orable or fair treatment.
Econo'ic costs relate primarily to the sophistication of the economic system,
including the infrastructure and supporting businesses. Cegarding ega costs,
it can be more costly to do business in countries with dramatically different
product, wor#place, and pollution standards, or where there is poor legal
protection for property rights.
Ris*s o% doing !usiness' Poitica ris* is the li#elihood that political forces
will cause drastic changes in a country*s business en!ironment that ad!ersely
affects the profits or other goals of the business. Econo'ic ris* is the
li#elihood the economic mismanagement will li#ewise affect a business. Lega
ris* is the li#elihood that a trading partner may opportunistically brea# a
32
contract or e-propriate intellectual property rights.
$s a general point, it should be noted that the costs and ris#s associated with
doing business in a foreign country are typically lower in economically ad!anced
and politically stable democratic nations, whereas the ris#s are greater in less
de!eloped and politically unstable nations. %he assessment is complicated,
howe!er, by the fact that the potential long(run benefits bear little relationship
to a nation*s current stage of economic de!elopment or political stability.
Cather, they are dependent upon li#ely future economic growth rates. In turn,
among other things, economic growth appears to be a function of a free mar#et
system and a country*s capacity for growth ;which may be greater in less
de!eloped nations<. %his leads one to the conclusion that, other things being
e1ual, the benefit, cost, and ris# tradeoff is li#ely to be most fa!orable in the
case of politically stable de!eloping nations that ha!e free mar#et systems. It is
li#ely to be least fa!orable in the case of politically unstable de!eloping nations
that operate with a mi-ed or command economy.
Ethica issues'
Country differences gi!e rise to some interesting ethical issues. ,ome of them
are discussed below.
2ne ma+or ethical dilemma facing firms from the "estern democracies us
whether they should do business in totalitarian countries that !iolates the
human rights of their citizens ;e.g.' China<
One ethica concern regards &hether %ir's shoud in,est in countries
&here the go,ern'ent re+resses its citi"ens in +oitica andEor
econo'ic %reedo') "hile some argue that in!esting in these countries is
implicitly supporting the repression, others argue that the best way to
encourage change is from within, and that increasing economic de!elopment of
the country will lead to greater political and economic freedoms.
A second ethica concern regards &hether an internationa %ir' shoud
ado+t consistent and high e,es o% +roduct sa%et(/ &or*er sa%et(/ and
en,iron'enta +rotection &ord&ide/ or &hether the( shoud %ocus
on( on 'eeting oca reguations) If they adopt high standards, and
subse1uently lose business to other competitors with lower standards, was this
an ethically correct position for it to ta#e in light its re1uirements to act in the
best interest of shareholders and pro!ide ad!ancement opportunities for its
personnelI If the 1uestion is ta#en to e-tremes, is it ethical for a company to
ma#e a decision that might ultimately put it out of business and put its
employees out of wor#I
Another ethica concern regards &hether %ir's shoud +a( !ri!es to
33
go,ern'enta o%%icias or !usiness +artners in e1change %or !usiness
access) ,hould paying bribes be completely a!oided, or are bribes +ust another
cost of doing business that Egrease the wheelsF and lead to benefits for both
the firm and consumers. If bribes are an integral part of business transactions in
a country, is a firm being culturally insensiti!e and elitist if it finds bribes
repulsi!e and refuses to pay themI 2ne answer is that bribes are illegal,
according to the regulations of the U, go!ernment. $gain, these considerations
are not faced by e-ecuti!es in domestic firms as they only occur in international
business.
%a#e for e-ample the challenges in!ol!ed in Microsoft*s entry into China.
$lthough the use of pirated software was out of control in China, the company
found little solace in the courts when its tried to stop that piracy, despite
prolonged, e-pensi!e attempts. 2ne of the ob!ious problems is that the price of
most of Microsoft*s products far e-ceeds the financial ability of Chinese. By
steadfastly adhering to its principles of intellectual ownership, Microsoft ga!e
birth to a competitorNthe )inu- operating system that appeared to be a good,
cheap alternati!e to the Chinese.
Argu'ents %or and against !ri!er(
2or against
ecessary to do
business
Common practice
$ccepted practice
Form of commission,
ta-, or compensation
"rong
Illegal
Compromise personal
beliefs
/romotes go!ernment
corruption
/rohibits ta#ing a stand
for honesty
Benefits recipient only
Creates dependence on
corruption
Decei!es stoc#holders
2our Actions %or I'+ro,ing Internationa Business Ethics
Create global codes of conduct
o &lobal codes and standards set by corporations
o &lobal Codes and standards set by international organizations
Integrate ethics into a global strategy
,uspend acti!ities in host country
34
Create ethical impact statements
Go!a Codes and 8tandards $e,eo+ed !( Internationa Organi"ations
O Cau- /rinciples
O &lobal Ceporting Initiati!e
O &lobal ,ulli!an /rinciples
O 2.CD &uidelines for Multinational .nterprises
O /rinciples for &lobal Corporate Cesponsibility' Benchmar#s
O U &lobal Compact
2unda'enta Internationa Rights'
4. %he right to physical mo!ement
6. %he right to ownership of property
5. %he right to freedom from torture
9. %he right to a fair trial
7. %he right to nondiscriminatory treatment
D. %he right to physical security
3. %he right to freedom of speech and association
>. %he right to minimal education
=. %he right to political participation
48. %he right to subsistence
8e,en 5ora Guideines %or 5NCs
Inflict no intentional or direct harm
/roduce more good than bad for the host country
Contribute to host country*s de!elopment
Cespect the human rights of their employees
/ay their fair share of ta-es
Cespect local cultural beliefs that do not !iolate moral norms
Cooperate with the go!ernment to de!elop and enforce bac#ground
institutions
Nationa di%%erences o% India:
India !e%ore the re%or's:
$fter independence, India adopted a democratic system of &o!ernment. 2ur
economic system is a mi-ed economy with a hea!y dose of state owned
enterprises, centralized planning and subsidies.
35
%his system constrained the growth of pri!ate sector, which could e-pand only
with the &o!ernment permission ;)icense Ca+<. %his resulted in long delays due
to bureaucratic hurdles or red tapism.
In 4=7D, Industrial re!olution reser!ed much of the hea!y industries li#e auto,
chemicals steel, mining etc. to state owned enterprises. /roduction 1uotas and
high tariffs on imports also stunned the growth of a healthy pri!ate sector, and
labor laws added to this.
$ccess to foreign e-change was limited. FDI was se!erely restricted. )and use
was strictly controlled. In addition, the go!ernment managed prices as opposed
to letting them set by mar#et forces.
India: the re%or':
By the early 4==8*s it was realized that this system was not capable of
deli!ering the #ind of economic progress that was anticipated due to po!erty,
illiteracy, health care problems etc. persisted. In 4==4, an ambitious economic
reforms program was initiated. Much of the industrial licensing was dismantled,
se!eral sectors are opened to pri!ate sector, and disin!estments of state owned
companies were started. FDI in se!eral sectors were allowed. 488 Gforeign
ownership allowed in some of the sectors. 74 Gin some others.
Caw materials and many industrial goods were freely imported. In addition, the
tariff on imports was reduced from 988G to D7G. %he income and corporate ta-
rates reduced.
%he responses to these reforms were impressi!e. &rowth rate increased to D4
Gin 4==*s. .-ports and corporate profits gone up. FDI increased top 5.7? billions
inn 4==3 from a meager 478Million? in 4==4.
0owe!er by the late 4==8*s economic reforms were stalled. &rowth rate
stagnated. 0igh deficit at =.DGof &D/, subsidies high at 47G of &D/.
Infrastructure de!elopment were sluggish and poor. /ri!atization slowed down
due to political opposition and trade unions.
Between 4==4 and 4==3, the go!ernment sold e1uity sta#es in about 98
companies to pri!ate sector but, still, there are 698 state owned companies in
4===. $ttempts to further reduce import tariffs were stalled by political
opposition fearing that a flood of ine-pensi!e Chinese products would enter if
the barriers came down.
%his is supported by labor laws and small sector problems. Due to these, the FDI
decreased from its pea# of
5.7 ? billion in 4==3 to 6? billion by 6888. ;China FDI is 98?billion e!ery year<
36
=uestions !an* %ro' 'odue B
4. 0ow different political systems affect the international businessI
6. .-plain the role of ethics in International business.
3. Country differences gi!e rise to contentious ;contro!ersial< issues called
ethical issues. "hat are theyI
9. "hat are the implications of political, economical and legal differences
among difference countriesI ;:une(:uly 6885(48 mar#s<
7. Differentiate between socialism and indi!idualism.;:an(Feb(6885(5 mar#s<
5odue ?
$I22ERENCE8 IN C;LT;RE
Introduction
International business is different from domestic business because countries are
different. %his is due to the differences in culture both across and within
countries, which can affect the practice of international business.

$lthough many differences in culture are ob!ious, some are subtler. Many
indi!iduals are e!en often not aware of their own culture. %he chapter describes
some of the underlying characteristics of a country that help define the !alues
and norms of a society. %his affects not only how an indi!idual from one country
must adapt to wor# in another country, but also how organizations must
recognize how cultural differences affect the way they wor# with other
organizations. %he rule of law, so common in countries of the "est, does not
wor# well in China, where personal relationships and connections are the #ey to
37
getting things done. %hat concept is difficult for $merican businesspersons to
understand because they ha!e been trained to treat e!eryone as e1ual, and to
see# the solace of the court system when problems arise.
%wo themes run through the chapter' 10 cross:cutura iterac( is critica to
success in a %oreign countr( and B0 the cuture o% a countr( can
direct( and indirect( a%%ect the costs o% doing !usiness in countr()
%he opening case helps to highlight a number of cultural blunders that ha!e
affected the success of .uro Disney. It also implies that a company that has
been so successful with similar enterprises elsewhere ;:apan, for instance< as
Disney had been, still needs to be sensiti!e to the cultures of the country in
which it is doing business. Much of the reason for Disney*s failure was its
corporate ego that belie!ed it could get things done by a E#ic#(down(the(doorF
mentality. Failure to recognize important cultural differences almost caused the
demise of .uro Disney.
What is Cuture#
$e%inition: Cuture has !een de%ined a nu'!er o% di%%erent &a(s)
Cuture is a s(ste' o% ,aues and nor's that are shared a'ong a
grou+ o% +eo+e and that &hen ta*en together constitute a design %or
i,ing)
"hile culture is a characteristic of society as a whole, it shapes indi!idual
beha!ior by identifying appropriate and inappropriate forms of human
interaction.
The %unda'enta !uiding !oc*s o% cuture are ,aues and nor's)
6aues are a!stract ideas a!out &hat a societ( !eie,es to !e good/
right/ and desira!e. $s was discussed earlier, !alues affect political and
economic systems as well as culture. Balues include attitudes towards concepts
li#e freedom, honesty, loyalty, +ustice, responsibility, and personal relations
including marriage. Balues from the bedroc# of ac culture. /eople argue, flight,
e!en die o!er !alues such as EFreedom.F
Nor's are socia rues and guideines that +rescri!e the a++ro+riate
!eha,ior in +articuar situations) orms shape the actions of people
towards one another. orms can be di!ided into fol#ways and mores.
2o*&a(s are the routine con,entions o% e,er(da( i%e/ !ut genera(
ha,e itte 'ora signi%icance. .-amples would be dress, eating habits, and
social graces. Foreigners may be easily e-cused for ma#ing a few faux pas.
;blunder< %imeliness is a good e-ample, when timeliness is critical ;test days< as
38
well as when one may be e-pected to be Pfashionably late.P $mericans tend to
arri!e a few minutes early fro business appointments. "hen in!ited fro dinner
at someone*s home it is considers polite to arri!e on time or +ust a few minutes
late. %ypically, E$mericanF indi!iduals will ha!e different concepts about
lateness. In Britain when someone saysF come fro dinner at 3 pmF he or she
means come for dinner at 3.58 at > pm. %he concept of time as a commodity is
peculiar to "estern society. %ime can be spent, sa!ed, wasted. %hat is 1uite
different from many other societies, especially some areas of )atin $merica,
where time is seen as an item to be en+oyed and sa!ored.
5ores are 'ore serious standards o% !eha,ior/ the !rea*ing o% &hich
'a( !e ,er( ina++ro+riate or e,en iega. .-amples would be theft,
adultery, murder, or use of mind(altering substances ;including alcohol,
caffeine, and mari+uana<. Mores can !ary greatly between countries' what in
one country may be !iewed, as an innocent flirt in another may constitute a
serious affront to someone*s dignity or e!en harassment. "hile it is acceptable,
and e!en e-pected, to consume alcohol with business associates in :apan,
where e!ening business contacts often border on drun#enness, such actions
would be disallowed and is punishable by imprisonment in the United $rab
.mirates.
orms and !alues are an e!olutionary product of a number of factors that are at
wor# 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.
Cuture &ithin Nation@8tates
%he nation(state is only a rough appro-imation of a culture. "ithin a nation(
state, multiple cultures can easily e-ist ;as we can only too painfully see in the
former Hugosla!ia<, and cultures can also cut across national borders. %hat can
often be easily illustrated by describing the differences that e-ist between
people in a country. It is 1uite easy to get indi!iduals in the "estern U, to
agree that the people in ew Hor# are really different and generally rude, while
people in the .astern will comment on Californians or ,outherners, etc.
)i#ewise, indi!iduals in ,toc#holm will ha!e clear opinions about how different
,wedes are from the far orth or far ,outh. In !irtually any country or state
people will easily be able to describe the differences between city(fol#s and
country(fol#s, and some will EdefendF their culture while ma#ing disparaging
remar#s about the other.
The deter'inant o% cuture' are +oitica and econo'ic +hioso+h(/ the
socia structure o% a societ(/ and the do'inant reigion/ anguage and
education)
39
8ocia 8tructure
%he social structure of a country can be described along two ma+or dimensions:
indi,iduais' ,s) grou+ and degree o% strati%ication into casses or
castes)
Indi,iduas and grou+'
A grou+ is an association o% t&o or 'ore indi,iduas &ho ha,e a shred
sense o% identit( and &ho interact &ith each other unstructured &a(s
on the !asis o% co''on set o% e1+ectations a!out each other7s
!eha,ior)
"hile groups are found in different societies, societies differ according to the
degree to which the group is !iewed as the primary means of social
organization. In some of societies indi!idual attributes and achie!ements are
!iewed as being more important than group memberships while in some the
opposite is true.
Indi,idua: $ focus on the indi!idual and indi!idual achie!ement is common in
many "estern societies. .arlier we discussed the implications of this for
political and economic systems. $n emphasis on indi!idual achie!ement has
positi!e and negati!e implications. 2n the positi!e side, the dynamism of the
U, economy owes much to people li#e ,am "alton, ,te!e :obs, and Bill &ates (
people, who too# chances, tried new things, succeeded, and encouraged others
to do li#ewise. %hey ha!e an admiration of Erugged indi!idualism and
entrepreneurshipF. 2n the other hand, indi!idualism can lead to a lac# of
company loyalty and failure to gain company(specific #nowledge, competition
between indi!iduals in a company rather than team building, and limitation of
people*s ability to de!elop a strong networ# of contacts within a firm.
"hile mo!ing from company to company may be good for indi!idual mangers it
may not be good for companies. %he lac# of loyalty and commitment to an
indi!idual company and the tendency to mo!e on when a better offer comes
can result in mangers, who ha!e good general s#ills but lac# in depth
#nowledge. %he emphasis on indi!idualism may ma#e it difficult to build within
an organization to perform collecti!e tas#s. If indi!iduals are always competing
with each other on the basis of indi!idual performance, it may pro!e difficult for
them to cooperate in group.
The grou+' In sharp contrast to the "estern emphasis on the indi!idual, in
many $sian societies the group is the primary unit of social organization. "hile
in earlier times the group was usually the family or the !illage, today the group
may be a wor# team or business organization. In a social setting, $sian
employees may often say they wor# for ,ony, while a "estern employee may
40
say heJshe is an electrical engineer. In $sia, the worth of an indi!idual is more
lin#ed to the success of the group rather than indi!idual achie!ement. %his
emphasis on the group may discourage +ob switching between firms, encourage
lifetime employment systems, and lead to cooperation in sol!ing business
problems.
,ome argue that competiti!e ad!antage of :apanese enterprises in the global
economy is based on their ability to achie!e close cooperation between
indi!iduals within a company and between companies. ;,uppliers<. )ifetime
employment is the norm is most :apanese companies, where managers and
wor#ers build up #nowledge, e-perience and a networ# of interpersonal
business contacts. $ll these things can help managers perform their +obs more
effecti!ely and achie!e cooperation with others.
2n the other hand, it tends to suppress indi!idual creati!ity and initiati!e. U,
may continue to be more successful than :apan at pioneering radically new
products and new ways of doing business.
8ocia strati%ication'
8ocia categories in a societ( de%ined in the !asis o% characteristics
such as the %a'i( !ac*ground/ occu+ation and inco'e)
$ll societies ha!e some sort of stratification, where indi!iduals in higher strata
or castes are li#ely to ha!e a better education, standard of li!ing, and wor#
opportunities. "hat matters is less what these strata are, but rather the
mobility between strata and the significance of strata le!els for business.
The ter' socia 'o!iit( re%ers to the e1tent to &hich indi,iduas
,aries signi%icant( %ro' societ( to societ() A caste s(ste' is cosed
s(ste' o% strati%ication in &hich socia +osition is usua( is not
+ossi!e during an indi,idua7s i%eti'e) .i)e)/ socia 'o!iit( is ,er(
i'ited)0
%he mobility permitted by culture affects whether indi!iduals can mo!e up ;or
down< in strata, and can limit the types of +obs and education a!ailable. In the
U,$, indi!iduals are !ery mobile ;Panyone can become presidentP<, in Britain,
there is less mobility, and the caste system in India se!erely limits mobility.
Despite the laws against it, the effects of the caste system in India still e-ist
today, and are especially pre!alent in the practice of people in non(urban areas.
%he significance of the social strata can ha!e important implications for the
management and organization of businesses. In cultures where there is a great
deal of consciousness o!er the class of others, the way indi!iduals from
different classes wor# together ;i.e. management and labor< may be !ery
41
prescribed and strained in some cultures ;i.e. Britain<, or ha!e almost no
significance in others ;i.e. :apan<. %he class of a person may be !ery important
in some hiring and promotion decisions, particularly in sales organizations
where the person will be dealing with customers that may also come from a
particular class.
Reigious and Ethica 8(ste's
Reigion can !e de%ined as a system of shared $eliefs and rituals that
are concerned with the realm of the sacred.
.thical systems refer to a set of moral principles, or !alues, that are used to
guide and shape beha!ior. %he ethical practices of indi!iduals within a culture
are often closely intertwined with their religion. "hile there are literally
thousands of religions worldwide, four that ha!e the largest following are
discussed' Christianity, Islam, 0induism, and Buddhism. Confucianism, while not
a religion, influences beha!ior and shapes culture in many parts of $sia. Cefer
the Map to see dominant religions across the world.
Christianit( is the largest religion and is common throughout .urope, the
$mericas, and other countries settled by .uropeans. "ithin Christianity, there
are three ma+or branches' /rotestant, Coman Catholic, and .astern 2rthodo-. $t
the turn of the century Ma- "eber suggested that is was the P/rotestant wor#
ethicF, that was the dri!ing force of capitalism. %his focus on hard wor#, wealth
creation, and frugality encouraged capitalism while the Catholic promise of
sal!ation in the ne-t world did not foster the same #ind of wor# ethic. %he
/rotestant emphasis on indi!idual religious freedom, in contrast to the
hierarchical Catholic Church, was also consistent with the indi!idualist economic
and political philosophy discussed earlier.
Isa': with 378 million followers this is the second largest of the world*s ma+or
religions. Islam dates bac# to $D D48 when /rophet Mohammed began
spreading the word. Muslims constitute a ma+ority of a!er 57 countries and
inhabit a nearly continuous stretch of land from the north west coast of $frica ,
through the middle east, to china and Malaysia and far east.
Islam e-tends this to more of an all(embracing way of life that go!erns one*s
being. It also prescribes many more PlawsP on how people should act and li!e.
%hese are laws that are entirely counter to the U, Pseparation of church and
state.P In Islam, people do not own property, but only act as stewards for &od
and thus must ta#e care of that with which they ha!e been entrusted. %hey
must use property in a righteous, socially beneficial, and prudent mannerK not
e-ploit others for their own benefitK and they ha!e obligations to help the
disad!antaged. %hus while Islam is supporti!e of business, the way business is
42
practiced is strictly prescribed. For instance, no interest may be paid on
business loans.
Hinduis'' appro-imately 788 million followers, practiced primarily on the
Indian sub(continent, o!er 9,888 years ago, ma#ing it the world*s oldest ma+or
religion. 0induism focuses on the importance of achie!ing spiritual growth and
de!elopment, which may re1uire material and physical self(denial. ,ince 0indus
are !alued by their spiritual rather than material achie!ements, there is not the
same wor# ethic or focus on entrepreneurship found in some other religions.
)i#ewise, promotion and adding new responsibilities may not be the goal of an
employee, or may be infeasible due to the employee*s caste.
Buddhis'' Buddhists also stress spiritual growth and the afterlife, rather than
achie!ement while in this world. Buddhism, practiced mainly in ,outheast $sia,
does not support the caste system, howe!er, so indi!iduals do ha!e some
mobility not found in 0induism and can wor# with indi!iduals from different
classes. %here are around 678 million Buddhists, most of who are found in
Central and ,outheast $sia, China, @orea and :apan.
Con%ucianis'' practiced mainly in China, @orea, and :apan. %his teaches the
importance of attaining personal sal!ation through right action. Unli#e religions,
Confucianism is not concerned with the supernatural and has little to say about
the concept of a supreme being or an afterlife. %he needs for high moral and
ethical conduct and loyalty to others are central in Confucianism. %hree #ey
teachings of Confucianism ( loyalty, reciprocal obligations, and honesty ( may all
lead to a lowering of the cost of doing business in Confucian societies. %he close
ties between :apanese auto companies and their suppliers, called #eiretsus,
ha!e been an important ingredient in the :apanese success in the auto industry.
%hey ha!e facilitated loyalty, reciprocal obligations, and honesty. In countries
where these relationships are more ad!ersarial and not bound by these same
!alues, the costs of doing business are probably higher.
Language:
%he language of a society allows it to communicate but also directs the
attention of people towards certain features of the world and human
interactions. $ good e-ample is how the Inuit ;.s#imos< ha!e 69 words for
snow, but no word for the o!erall concept. ;/owder snow, falling snow, wet
snow, drifting snow etc.< )anguage helps describe how different people see the
world.
,ince language shapes the way people percei!e the world, it also helps define
the culture. In countries with more than one language, one also finds often
more than one culture. In Canada, there is .nglish spea#ing culture and a
French spea#ing culture. %ensions between the two run often high demanding
43
independence from a Canada
EDominated by .nglish spea#ers.F
"hile .nglish is clearly the language of international business, #nowing at least
some of the local language can greatly help when wor#ing in another country.
In some situations, #nowing the local language can be critical for business
success. @nowledge of the local language is often ta#en as an indication that
the businessperson is willing to meet the local firm Eon its own court.F
;ns+o*en anguage can be +ust as important for communication. Using a few
facial e-pressions and hand gestures to the class can illustrate the point. %he
fact that these can ha!e different interpretations in different cultures, and that
many of these actions may be automatic or refle-i!e, ob!iously complicates
international communication. ot only may the person you are dealing with be
unintentionally sending non(!erbal signals that you do not understand or find
misleading, you may be unconsciously sending your own signals. For e-ample,
consider different perceptions of Epersonal spaceF in communications. 0a!e a
con!ersation with an indi!idual ;about sports or the weather< standing Ea long
distance apartF and a similar con!ersation with someone else with your faces
only a few inches apart. Most indi!iduals find both of these e-treme, although a
few reser!ed Midwesterners will find the long distance 1uite acceptable. /eople
from different countries will also comment on their perceptions, and how
distance !aries with familiarity with the person.
Education
,chools, as a part of the social structure of a society, and one that indi!iduals
are e-posed to in their formati!e years, con!ey many cultural !alues and
norms. .ducation plays an important role as determinant of national business
competiti!e ad!antage. %he a!ailability of a pool of s#illed and educated human
resources seems to be ma+or determinant for the economical success of a
country.
%he #nowledge base, training, and educational opportunities a!ailable to a
country*s citizens can also gi!e it a competiti!e ad!antage in the mar#et and
ma#e it a more or less attracti!e place for e-panding business. In nations that
ha!e a ready trained wor#force for particular types of +obs, it is easier to start
operations than in nations where an in!estor will also ha!e to underta#e time(
consuming and costly training.
Michael /orter notes that :apan*s e-cellent education system was an important
factor e-plaining the country*s post war economic success.
%he general education le!el of a country is also a good inde- of the #ind of
products that might sell in a country and of the type of promotional material
that should be used.
44
$lthough there is not a perfect correspondence between educational spending
and literacy rates, a relation does e-ist, and spending on education does gi!e
an indication of a country*s commitment to education.
Cuture and the Wor*+ace
For an international business with operations in different countries, it is
important to understand how a society*s culture impacts on the !alues found in
the wor#place. %he opening and closing cases both pro!ide e-amples of culture
affecting the wor#place.
Ho%stede7s 'ode'
%he most famous study of how culture relates to !alues in the wor#place was
underta#en by &eert 0ofstede. $s part of his +ob as a psychologist wor#ing for
IBM, from 4=D3 to 4=35, 0ofstede collected data on employee attitudes and
!alues for o!er 4, 88,888 indi!iduals. %his data enabled him to compare
dimensions of culture across 98 countries.
Geert Ho%stede made a study of IBM employees worldwide, and identified four
dimensions that summarize different cultures' power distance, indi!idualism
!s. collecti!ism, uncertainty a!oidance, and masculinity !s. femininity.
Po&er distance dimension focused on how a society deals with the fact
that the people are une1ual in physical and intellectual capabilities.
$ccording got 0ofstede, high power distance cultures were found in
countries that let ine1ualities grow o!er time into ine1ualities of power
and wealth. )ow power distance cultures were found in societies that tried
to play down such ine1ualities as much as possible.
The indi,iduais' ,ersus coecti,is' dimension focused on the
relationship between indi!iduals and his or her fellows. In indi!idualistic
societies, the ties between indi!iduals were loose and indi!iduals
achie!ement and freedom were highly !alued. In societies where
collecti!ism was emphasized the ties between indi!iduals were tight. In
such societies people were born into collecti!ists, such as e-tended
families and e!eryone was supposed to loo# after the interests of his or
her near ones.
45
;ncertaint( a,oidance dimension measured the e-tent to which
different cultures socialized their members into accepting ambiguous
situations and tolerating uncertainty. Members of high uncertainty
a!oidance cultures placed a premium on +ib security, career patterns, and
retirement benefits and so on. %hey also had a strong need for rules and
regulations, the manager was e-pected to issue clearer instructions, and
subordinates initiati!es were highly controlled. )ower uncertainty
a!oidance cultures were characterized by greater readiness to ta#e ris#s
and less emotional resistance to change.
5ascuinit( 6s %e'ininit( dimension loo#ed at the relationship
between the gender roles and wor# roles. In masculine cultures, se- roles
were sharply differentiated and traditional masculine !alues such as
achie!ement and the effecti!e e-ercise of power, determined cultural
ideals. In feminine cultures se- roles were less sharply distinguished and
little differentiation was made between men and women in the same +ob.
0ofstede created an inde- score for each of four dimensions that range from 8
to 488 and scored high for high indi!idualism, high power distance, high
uncertainty a!oidance and high masculinity. 0e a!eraged the score of all
employees from a gi!en country and plotted the result scores of each country
on series of graphs.
46

Power
Distance
Uncertainty
Avoidance
Individualism Masculinity
Argentina 49 86 46 56
Brazil 69 6 !8 49
"rance 68 86 # 4!
India 4$ 48 56
%a&an 54 9' 46 95
Me(ico 8# 8' !$ 69
)et*erlands !8 5! 8$ #4
U+,+A+ 4$ 46 9# 6'

Cefer Charles 0ill for indi!idual dimensions.;Figure 5.7 and 5.D.<
Criticis's against the stud('
First 0ofstede assumes that there is a one to one correspondence between
culture and the states of a country, many countries ha!e more that one
culture.
,econd, the research tem was composed of .uropeans and $mericans.
%he 1uestions and answers may ha!e been shaped by their own cultural
biases.
%hird, his research wor#ed only within a single industry, the computer
industry, but also within a single company, IBM. It is possible that the
!alues of IBM employees are different in important respects from the
cultures of the countries they originally come from.
Fourth, the study, which is conducted between 4=D8s and 4=38, may not
be reasonable today, and may be outdated.
"hile critics ha!e concerns about 0ofstede*s methodology, and it is important
not to ta#e it all too seriously, the study does suggest what indi!iduals should
consider when doing business from indi!iduals from another country.
Cultural Change
Culture is not a constant, but does e!ol!e o!er time. "hat was acceptable
beha!ior in the U, in the 4=D8s is now considered Einsensiti!eF or e!en
harassment. )anguage and sensuality that was not allowed on Indian %B in the
4=D8s is now commonplace. Changes are ta#ing place all the time. $s countries
become economically stronger and increase in the globalization of products
bought and sold, cultural change is particularly common.
Countries are so different because of cultural changes. %wo important
implications of international business flow from these differences. %he first is to
appreciate not only that cultural differences e-ist, but also what such
differences mean for the practice of international business. %he second is due to
the cultural differences, the cost of doing the business in a country, and
national competiti!e ad!antage may !ary.
47
Cross cutura iterac('
Indi!iduals and firms must de!elop cross(cultural literacy. International
businesses that are ill informed about the practices of another culture are
unli#ely to succeed in that culture. 2ne way to de!elop cross(cultural literacy is
to regularly rotate and transfer people internationally.
2ne must also beware of ethnocentric !eha,ior/ or a !eie% in the
su+eriorit( o% one7s o&n cuture. $long with this superiority, they may
de!elop contempt for all the other cultures. ,ome people ha!e been unable to
find some of the ob!ious wea#nesses in our own culture and strengths of other
cultures. ,ome people are unaware of the uni1ueness of the culture. 2ne good
e-ample on the uni1ueness of $merican culture is the second free cup of
coffee. It is so common in $merican restaurants, yet is unheard of in many
.uropean or $sian countries. /eople who ha!e tra!eled internationally can often
identify many other e-amples.
Cuture and co'+etiti,e ad,antage'
Cultural !alues can influence the costs of doing business in different countries,
and ultimately the competiti!e ad!antage of the country. %he te-t suggests
some positi!e and negati!e aspects of U, and :apanese culture than may ha!e
contributed to the economic success of these countries. Understanding what
countries may ha!e a competiti!e ad!antage has implications both for loo#ing
for potential competitors in world mar#ets and for deciding where to underta#e
international e-pansion.
4. Discuss the implications of international business arising out of cultural
differences between countriesI ;:une(:uly 6885(48 mar#s<
6. Discuss and e!aluate &eert 0ofstede*s model of culture at wor# placeI ;:une(
:uly 6885( 3 mar#s<
5. "hat is social mobility and how does it affect international businessI ; 5
mar#s<
$dditional notes'
48
The de!ate o% go!ai"ation 68 anti:go!ai"ation
5odue F:
REGIONAL ECONO5IC INTEGRATION
I
5
P
A
C
T
O
N
Go!aists Antigo!aists
Consu'er
s
Free trade promotes lower
costs and 1uality products.
Benefits the wealth at
the e-pense of the
poor
E'+o(ee
s
Faster economic growth
promotes
0igher wages, etc.
/laces profits abo!e
people
En,iron'
ent
Creates resources needed
to address the issue
.-ploits and destroys
ecosystems
$e,eo+in
g
Nations
/romotes national
economic de!elopment,
higher standard of li!ing,
etc.
"orld financial
institutions conspire to
#eep poor nations in
debt
Hu'an
Rights
Creates cultures that
support law and free
e-pression
Corporations pursing
profits ignore human
rights !iolations
49
Contents: regiona integration and go!a trading +ositions:trading
!oc*s:Euro+ean ;nion .E;0/ A8EAN/APEC/ NA2TA and other 'a4or
regiona grou+s
Introduction
$e%inition: Regiona Econo'ic Integration means agreements between
groups of countries in a geographic region to reduce and ultimately remo!e
tariff and non(tariff barriers tot eh free flow of goods, ser!ices and factors of
production between each other.
&$%% and "%2 are the biggest association of more than 498 member countries,
which stri!e to reduce the barriers. 0owe!er, more than regional, "%2 has a
global perspecti!e.
By entering into regional agreements, groups of countries aim to reduce trade
barriers more rapidly than can be achie!ed under "%2. "hile there ha!e been
decreases in the global barriers to trade and in!estment, the greatest progress
had been made on a regional basis.
%here are many e-amples in the current popular push on the Euro+ean ;nion
.E;0 and the effects the .U ha!e on a particular business or industry that
illustrates this point.
/erhaps the best e-ample of the benefits of economic integration and political
union is the U,$. Before the current constitution was written, the thirteen
colonies had erected significant barriers to trade between each other and had
separate currencies. ,eeing that this was not wor#ing well, and wanting a better
system for their citizens, the founding fathers agreed to combine their separate
states into a United ,tates. "hether the .U, with its significant cultural and
language differences in neighboring countries, can achie!e similar benefits
remains to be seen. e!ertheless, ma+or gains ha!e already been made.
%he notion of regional economic integration is becoming increasingly important
as countries stri!e to wor# together better and become more producti!e. "hile
integration ta#es place at a much broader le!el under the "%2, it is within local
regions (( with fewer countries (( that ha!e the ability to ma#e much greater
steps.
Integration creates both winners and losers, howe!er. $n important challenge
facing many firms and go!ernments is what should be done to minimize the
costs of transition to freer mar#ets regionally as well as internationally.
Le,es o% Econo'ic Integration
50
2ree Trade Area' $ll barriers to trade among members are remo!ed, but each
member can determine its own trade policies with non(members. %heoretically
free trade are
Custo's ;nion' $ll barriers to trade among members are remo!ed and a
common e-ternal trade policy is adopted.
Co''on 5ar*et' $ll barriers to trade among members are remo!ed, a
common e-ternal trade policy is adopted, and factors of production allow
mobility between countries.
Econo'ic ;nion' $ll barriers to trade among members are remo!ed, a
common e-ternal trade policy is adopted, factors of production allow mobility
between countries, a common currency is established, ta- rates are
harmonized, and a common monetary and fiscal policy is established.
Poitica ;nion' ,eparate nations are essentially combined to form a single
nation. %he establishment of the .uropean /arliament suggests that .urope is
mo!ing towards political union. &i!ing up this last bit of so!ereignty, howe!er,
is a big step psychologically and philosophically.
Figure shows the increasing le!els of integration.
The argu'ents %or Regiona Integration
%he economic case for integration has been largely presented in the pre!ious
chapters. Free trade and mo!ement of goods, ser!ices, capital, and factors of
production allow for the most efficient use of resources. %hat is positi!e sum
game, as all countries can benefit.
Cegional economic integration is an attempt to go beyond the limitations of
"%2. "hile it is hard for 488 countries to agree on something, ;e.g. the United
ations< it is much more li#ely that only a few countries with close pro-imity
and common interests will be able to agree to e!en fewer restrictions on the
flows between their countries.
%he political case for integration has two main points' ;4< by lin#ing countries
together, ma#ing them more dependent on each other, and forming a structure
where they regularly ha!e to interact, the li#elihood of !iolent conflict and war
will decrease. ;6< By lin#ing countries together, they ha!e greater influence and
are politically much stronger in dealing with other nations.
In the case of the .U, both a desire to decrease the li#elihood of another world
war and an interest in being strong enough to stand up to the U, and U,,C
51
were factors in its creation.
%here are t&o 'ain i'+edi'ents.o!staces0 to integration'
;4< there are always painful ad+ustments, and groups that are li#ely to be
directly hurt by integration will lobby hard to pre!ent losses,
;6< concerns about loss of so!ereignty and control o!er domestic interests.
For e-ample, Canada has always been concerned about being dominated by its
southern neighbor, and Britain is !ery hesitant to gi!e much control to .uropean
bureaucrats ;it still has not adopted the euro<
%he case on $F%$ and the U, %e-tile Industry shows that although the effects
of $F%$ ha!e hurt employment in the U, te-tile industry, the o!erall effect has
actually been positi!e. %he reason' clothing prices ha!e fallen, e-ports ha!e
increased, and sales to apparel factories ha!e surged. %hose factors more than
compensate for the loss of +obs.
The argu'ents against Regiona Integration
Many groups within a country do not accept the case for integration, especially
those that are li#ely to be hurt or those that feel that so!ereignty and indi!idual
discretion will be reduced. %hus, it is not surprising that most attempts to
achie!e integration ha!e progressed slowly and with hesitation.
"hether regional integration is in the economic interests of the participants
depends upon the e-tent of trade creation as opposed to trade di,ersion.
Trade creation occurs &hen o& cost +roducers &ithin the %ree trade
area re+ace high cost do'estic +roducers)
Trade di,ersion occurs &hen higher cost su++iers &ithin the %ree
trade area re+ace o&er cost e1terna su++iers)
$ regional free trade agreement will only ma#e the world better off if the
amount of trade it creates e-ceeds the amount it di!erts.
Regiona Econo'ic Integration in Euro+e
Cefer Map to identify the member countries of the .U. %he .U is large
economically and politically, and many of the independent countries that were
under the influence of the former U,,C ha!e sought to +oin the .U.
52
$ustria
Belgium
Czech
Cepublic
Cyprus
0ungary
Ireland
Italy
)at!ia
)ithuania
.stonia
Finland
France
&ermany
&reece
5e'!er countries o% Euro+ean ;nion
%he forerunner of the .U was the .uropean Coal and ,teel Community, which
had the goal of remo!ing barriers to trade in coal, iron, steel, and scrap metal
formed in 4=74. %he %reaty of Come formed the ..C in 4=73. "hile the original
goal was for a common mar#et, progress was generally !ery slow.
2!er the years, the .U e-panded in spurts, as well as mo!ed towards e!er(
greater integration.
Many countries that are now members of the .U were initially members of .F%$
who felt either that the .U were pushing for too much integration too fast, or
were denied entry by other member states. Nor&a(, while always a member of
.F%$, has twice had its citizens !ote down membership in the .U because they
felt they would lose too much control to their much bigger neighbors to the
south. Being a small country, they felt they would ha!e little say in policies, and
would be forced to adopt policies that were unfa!orable to their prospering oil
and fisheries industries. ;$nd it is generally true that the .U would li#e to ha!e
the benefits from these industries spread around.< e!ertheless, since most of
orway*s trade is with .U member countries, it has chosen to adopt many .U
regulations (( and is in fact in greater compliance with .U regulations than some
of the .U member states.
%he economic policies of the .U are formulated and implemented by a comple-
and still e!ol!ing political structure. The %i,e 'ain institutions are the
Euro+ean Counci/ the Counci o% 5inisters/ the Euro+ean Co''ission/
the Euro+ean Paria'ent/ and the Court o% Austice)
%he problems with lac# of progress on the ob+ecti!es of the .U resulted in a
number of problems for firms and go!ernments, and led to adoption of the
8inge Euro+ean Act in 4=>3. %he ,ingle .uropean $ct called for the remo!al
of border controls, mutual recognition of standards, open public procurement, a
barrier free financial ser!ices industry, no currency e-change controls, free and
53
)u-embourg
Malta
etherlands
/oland
/ortugal
,lo!a#ia
,lo!enia
,pain
,weden
United
open freight transport, and freer and more open competition.
%he Management Focus on the .U and the media industry mergers shows the
power that the .U has ac1uired in controlling and regulating mergers of
international companies. %hrough the use of concessions, the .U has been able
to dramatically change the shape of an entire industry.
%he Treat( o% 5aastricht too# the .U one step further, by specially spelling
out the steps to economic union and partial political union. In addition to simply
spelling out the steps needed, the %reaty also laid out the future outlines of a
common foreign policy, economic policy, defense policy, citizenship, and
currency, as well as strengthened the role of the .uropean /arliament. %he
single currency will eliminate e-change costs and reduce ris#, ma#ing .C firms
more efficient.
%he Euro &as o%%icia( aunched on Aanuar( 1/ 1GGG. It became into full
use 2n :anuary 4, 6886. Member states that ha!e entered into monetary union
ha!e fi-ed e-change rates with the .uro, and hence with each other. %he .uro
reduces both e-change rate costs and ris#s, and has been used for many
business transactions. %he use of national currencies was discontinued in 6886
in fa!or of the euro, although many member ban#s will accept their national
currency in e-change for the euro. $doption of the .uro will help citizens more
easily compare prices, should increase cross border competition, and lead to
lower costs for consumers.
Britain, Denmar#, and ,weden ha!e chosen to opt out of +oining .MU for now.
2ne reason is a concern o!er losing control o!er monetary policy to the
.uropean Central Ban#. ,ome belie!e that currency union should only ta#e
place after political union.
$ number of countries ha!e applied for membership in the .U, particularly from
.astern .urope. &i!en the profound differences in income, de!elopment, and
systems, howe!er, ma#es near term integration of these countries into the .U
difficult.
Many firms and countries ;including the .F%$ countries< are concerned that the
.U will result in a Efortress .urope,F where insiders will be gi!en preferential
treatment o!er outsiders. %hat clearly already e-ists in agriculture, although
whether it will be e-tended to other areas is a matter of debate.
Regiona Econo'ic Integration in the A'ericas
Cefer map to see the primary areas of integration in the $mericas.
%hese are'
54
The North A'erican 2ree Trade Agree'ent .NA2TA0
The Andean Pact
5ERCO8;R
Other Latin A'erican trade +acts i*e Centra A'erican co''on
'ar*et/ CARICO5 etc)
The North A'erican 2ree Trade Agree'ent .NA2TA0
In 4=>>, the ;8A and Canada agreed to form a free trade area, with the goal
of gradually eliminating all barriers to the trade of goods and ser!ices between
the countries. In 4==4 the ;8/ Canada/ and 5e1ico signed an agreement
aimed at forming a free trade area between all three countries #nown as
$F%$.
%he agreement became law in :anuary 4, 4==9. it contains the flowing actions.
$bolishes within 48 years tariffs on == percent goods traded between
Me-ico, Canada and United ,tates.
Cemo!es barriers on cross border flow of ser!ices, e.g., allowing financial
institutions unrestricted access to Me-ican mar#ets by 6888.
/rotects intellectual property rights.
Cemo!es restrictions on FDI between three member countries
$llow each country to apply its own en!ironmental standards, lowering of
standards to lure in!estments is described as inappropriate and establish
twocommissions with the power to impose fines to protect these standards.
In all three countries the political and economic conse1uences of the agreement
are still being felt, and politicians in all countries are able to stri#e a cord with
wor#ers who percei!e that they lost their +obs as a result of the agreement.
Argu'ents %or NA2TA
/roponents of $F%$ argue that it will pro!ide economic gains to all countries'
Me-ico will benefit from increased +obs as low cost production mo!es south, and
will attain more rapid economic growth as a result. %he U, and Canada will
benefit from the access to a large and increasingly prosperous mar#et and from
the lower prices for consumers from goods produced in Me-ico. In addition, U,
and Canadian firms that ha!e production sites in Me-ico will be more
competiti!e on world mar#ets.
Argu'ents against NA2TA
2pponents of $F%$ argue that +obs will be lost and wage le!els will decline in
55
the U, and Canada, Me-ican wor#ers will emigrate north, pollution will increase
due to Me-ico*s more la- standards, and Me-ico will lose its so!ereignty.
,ince $F%$ is an ongoing process, and the implications are still unclear, it
li#ely will be another decade before the true costs and benefits are #nown.
e!ertheless, recent articles in the popular press help illustrate many
opportunities and some concerns.
The Andean Pact:
%he $ndean /act, originally formed in 4=D=, when Boi,ia/ Chie/ Ecuador/
Coo'!ia and Peru signed the Cartagena agree'ent. %he $ndean pact was
largely based on .C model, and reformed and renegotiated se!eral times, has
made little progress due political and economic turmoil in most of the countries.
%he integration steps begun in 4=D= included an internal tariff reduction
program, a common tariff, a transportation policy, ac common industrial policy
and special concessions for the smallest members Boli!ia and .cuador.
0owe!er, by the mid 4=>8*s the $ndean pact had collapsed. It has failed to
achie!e any of its stated ob+ecti!es. In 4==8, the heads of %i,e current
'e'!ers o% the Andean grou+:Boi,ia/ Ecuador/ Peru/ Coo'!ia and
6ene"uea met in &alapagos Islands. %he resulting &alapagos declaration
effecti!ely relaunched the $ndean group.
%he countries are ma#ing another strong attempt again, and their initial
progress on remo!ing trade barriers is promising. 0owe!er, the tremendous
differences between the countries will ma#e agreement on many issues
difficult.
5ERCO8;R
M.CC2,UC originated in 4=>> as a free trade pact between Bra"i and
Argentina. In 4==8, it was e-panded to include Paragua( and ;rugua(.
M.CC2,UC has been ma#ing progress on reducing trade barriers between
member states. %oday, most goods go tariff free within M.CC2,UC, e-cept
sugar and cars. %rade among M.CC2,UC*s four core members grew from ?9
billion in 4==8 to ?49.7 billion in 4==7.
&i!en some high tariffs for goods from other countries, it would appear that in
some industries M.CC2,UC is trade di!erting rather than trade creating, and
local firms are in!esting in industries that are not competiti!e on a worldwide
basis.
56
Other Latin A'ericans trade +acts
%he countries of Central $merica are trying to re!i!e their trade pact. In the
early 4=D8*s Costa Cica, .l ,al!ador, &uatemala, 0onduras and icaragua
attempted to set up Centra A'erican co''on 'ar*et. it collapsed in 4=D=
when the war bro#e out between 0onduras and .l ,al!ador. ow fi!e countries
are trying to re!i!e their agreement.
$ Customs Union was to ha!e been created in 4==4 between .nglish spea#ing
Caribbean countries under the name of Caribbean community. %his is refereed
to as CARICO5, was established in 4=35.
$ttempts at the creation of trade pacts between Central $merican and
Caribbean countries ha!e not been particularly successful thus far. %here has
been a goal to create a Free %rade $rea of the $mericas that would encompass
most nations in orth and ,outh $merica. %hus far, there has been little
progress.
Regiona Econo'ic Integration Ese&here
"hile there was clearly economic integration with C2M.C2, the EagreementF
between the U,,C and most of .astern .urope, had little rational economic
basis and has collapsed with the collapse of the central planning system.
Association o% 8outheast Asian Nations .A8EAN0
Formed in 4=D3, $,.$ currently include Brunei, Indonesia, Malaysia,
/hilippines, ,ingapore, %hailand and Bietnam. %hese countries are characterized
by an abundance of natural resources, large international trade sectors most
successful economic policies.
%he basic ob+ecti!es of $,.$ are to foster free trade between member
countries and to achie!e some cooperation in their industrial policies.
%he $,.$ pact has had little impact on trade and integration, although most of
the countries ha!e grown !ery 1uic#ly.
Asia Paci%ic Econo'ic Coo+eration .APEC0
$/.C is a broader /acific organization that meets yearly and includes the U,,
:apan, China, and 47 other countries. %hese 4> countries account for half of the
world*s &D/, 9D percent of world trade and most of the growth in the world
economy. %he stated aim of $/.C is to increase multilateral cooperation in !iew
of the economic rise of the pacific nations and the growing interdependence
within the region. %hus far, the goals of $/.C and the photo opportunities for
the leaders ha!e been far loftier than the success.
57
.conomic integration creates a number of significant opportunities for business.
)arger mar#ets can now be ser!ed, additional countries open to trade, and
greater economies of scale achie!ed.
%he greatest implication for M.s is that the free mo!ement of goods across
borders, the harmonization of product standards, and the simplification of ta-
regimes, ma#es it possible for them to realize potentially enormous cost
economies by centralizing production in those locations where the mi- of factor
costs and s#ills is optimal. By specialization and shipping of goods between
locations, a much more efficient web of operations can be created.
%he lowering of barriers to trade and in!estment between countries will be
followed by increased price competition, re1uiring firms to rationalize
production and reduce costs if they are to remain competiti!e.
$s other firms become more competiti!e in their home mar#ets ;now
e-panded<, they may be able to enter additional mar#ets and threaten local
firms* positions.
Firms also must be concerned that they may be Eloc#ed outF of Efortress
.uropeF or Efortress orth $merica,F and thus may need to establish operations
with a region if they are to remain an acti!e player in the mar#et.
Question ban#'
"hat are the different le!els of economic integrationI ;5 mar#sJ :uneJ :uly
6885<
"hat is $F%$I "ho are the partnersI "hat are the contents of the
agreementI ;3 mar#sJ :uneJ :uly 6885<
Discuss .uropean monetary union, its costs, benefits and road towards a
single currencyI ;48 mar#sJ :uneJ :uly 6885<
58
5odue H:
5utinationa cor+oration @ Organi"ation/ design and
structures @ Head -uarters and su!sidiar( reation in
5NCs)
THE 8TRATEGI O2 INTERNATIONAL B;8INE88
Contents: ho& %ir's can increase their +ro%ita!iit( !( e1+anding their
o+erations in %oreign 'ar*ets/ di%%erent strategies that %ir's can
+ursue &hen co'+eting internationa(/ and the +ros and cross o%
these strategies) In addition/ ,arious %actors a%%ecting the %ir's7 choice
o% strateg()
Introduction
"hen we thin# of international businesses, we often focus on the big M.s
;Multinational .nterprises<. 0owe!er, all of these were once small firms +ust
beginning to e-pand internationally. ,mall firms underta#e a great deal of
international business.
%he boo# to this point has loo#ed primarily at the en!ironment in which
international business ta#es place, and suggested some implications for
business. "ith this chapter, it mo!es into loo#ing more specifically at firms, and
the actions that they can ta#e to both respond to and shape their en!ironment.
59
8trateg( and the 2ir'
Firms are in the business of ma#ing profits by !alue creation (( being able to sell
what they ma#e for more than it costs to ma#e it. %hus, they create !alue by
either lowering the costs of production or raising the !alue so that consumers
will pay more. $ firm can add more !alue to a product when it impro!es the
product*s 1uality, pro!ides a ser!ice to the consumer or customize the product
to consumer needs in such away that the consumers will pay more for it.
Firms can lower the costs of !alue creation when they find ways to perform
!alue creation
acti!ities more efficiently. %hus, there are ttwo basic strategies for impro!ing a
firm*s profitability( a di%%erentiation strateg( and a o& cost strateg(.
%o e-tend this, it is useful to use the !alue creation approach, as shown in
Figure.
,upport acti!ities
Primary activities
2ir' as ,aue chain
Firm is !alue chain composed of a series of distinct !alue creation acti!ities,
including production, mar#eting, materials management, CRD, human
resources information systems and the firmsK* infrastructure.
%hese !alue creation acti!ities are classified into primary acti!ities and support
acti!ities.
Pri'ar( acti,ities' these ha!e to do with creating the +roduct/ 'ar*eting
and dei,ering the +roduct to !u(ers and +ro,iding su++ort and a%ter
saes ser,ice to the !u(ers of the product. .fficient production can reduce
the costs of crating !alue ;by realizing scale economies< and can add !alue by
Infrastructure ;structure and
leadership<
0uman resources
Cesearch R de!elopment
Material management
Manufacturing Marketing &service
Sales
60
increasing product 1uality ;by reducing the number of defecti!e products<
8u++ort acti,ities' these pro!ide the inputs that allow the primary acti!ities
of production and mar#eting to occur. The 'ateria 'anage'ent function
controls the transmission of physical materials through the !alue chain from
procurement through production into distribution. It also can monitor the 1uality
of inputs into the production process.
The RJ$ function de!elops new products and process technologies, which can
reduce production costs and can result in the creation of more useful and more
attracti!e products than can demand a premium price. $n effecti!e hu'an
resources %unction ensures that the firm has an optimal mi- of people to
perform the primary function efficiently. In%or'ation s(ste's helps in getting
the information it needs to ma-imize the efficiency of it !alue chain and to
e-ploit information based competiti!e ad!antages. 2ir'7s in%rastructure with
factors such as organizational structure, general management, planning,
finance and legal en!ironment also help the firm achie!e more !alue in the
primary acti!ities.
The roe o% strateg('
8trateg( can !e de%ined as the actions that 'anagers ta*e to attain
the goas o% the %ir'.
%o be profitable in a competiti!e en!ironment, affirm must pay continual
attention to both reducing the costs of !alue creation and to differentiating its
product offering in such a manner that consumers are willing to pay more for
the product than it costs to produce it.
,trategy is about identifying how best a firm can go about creating !alue. It is
often helpful for a firm to base each !alue creation acti!ity at the location
where factors are most conduci!e to the performance of that acti!ity.
Pro%iting %ro' Go!a E1+ansion
.-panding globally allows firms both large and small to increase their
profitability in a number of ways not a!ailable to purely domestic enterprises.
Firms that operate internationally ha!e the ability to ;4< earn a greater return
from their distincti!e s#ills or core competencies, ;6< realize location economies
by dispersing indi!idual !alue creation acti!ities to those locations were they
can be performed most efficiently, and ;5< realize greater e-perience cur!e
economies, thereby lowering the costs of !alue creation.
For some companies international e-pansion represents a way of earning
61
greater returns by transferring the s#ills and product offerings deri!ed from
their core competencies to mar#ets where indigenous competitors lac# those
s#ills.
$e%inition: Core co'+etence re%ers to s*is &ithin the %ir' that
co'+etitors cannot easi( 'atch or i'itate)
%hese s#ills may e-ist in any of the !alue creation acti!ities of the firm.
/roduction, mar#eting, CRD, human resources, general management etc. ..g.
Mc Donald*s ahs a core competency in managing fast food operations, %oyota
can produce high 1uality, well designed cats at a lower deli!ery costs than any
other firm*s in the world. For such firms* global e-pansions is a ay f further
e-ploiting the !alue potential of their s#ills and the product offerings by
applying those s#ills and the product s in larger mar#et.
Location econo'ies'
Due to national differences, it pays a firm to base each !alue creation acti!ity it
performs at that location where economic, political, and cultural conditions,
including relati!e factor costs, are most conduci!e to the performance of that
acti!ity ;transportation costs and trade barriers permitting<. %his strategy is
referred as focusing upon the attainment of location economies. M.s that ta#e
ad!antage of different locational economies around the world create a lo$al
we$ o% acti,ities. In the worldwide mar#et, a local economy may ha!e some
specific locational ad!antages. For e-ample, ,ilicon Balley may ha!e a location
specific ad!antage in a technological wor# force. &al!eston, %e-as has a port
location that ser!es the U.,. southwest, ;although it lost much of its shipping
trade when the city of 0ouston deepened its shipping channel.<
$e%inition: ocationa econo'ies are the econo'ies that arise %ro'
+er%or'ing a ,aue creation acti,it( in the o+ti'a ocation %or that
acti,it(/ &here,er in the &ord that 'ight !e)
..g.' &eneral Motors*s /ontiac is mar#eted widely in United ,tates, the car was
designed in &ermany, #ey components were manufactured in :apan, %aiwan,
,ingapore, the assembly operations was performed in ,outh @orea, and the
ad!ertising strategy was formulated in &reat Britain.
%he management focus on McDonald*s shows how a successful U.,. firm could
e-port its core competency in managing fast(food operations into far reaching
areas of the world.
Other i'+ications: ew Lealand may ha!e a competiti!e ad!antage for
automobile assembly operations but due to high transportation costs would
ma#e it an uneconomical location for them. U., firms are now shifting their
62
production form $sia to Me-ico due to less transportation costs and trade
barriers. Me-ico has three distinct ad!antages o!er many $sian nations such as
low labor costsK its pro-imity to large U, mar#et reduces its transportation
costsK $F%$ has remo!ed many trade barriers among Me-ico, U, and the
Canada.
E1+erience cur,e econo'ies:
$e%inition: e1+erience cur,e is the s(ste'atic reductions in the
+roduction costs that occur o,er i%e o% a +roduct)
$ number of studies show that a product*s production costs decline by some
characteristics about each time accumulated output doubles. ..g. in aircraft
industry, where each time accumulated output f airframes was doubled, unit
costs typically declined to >8 percent of their pre!ious le!el. %hat is the
production costs of the fourth airframe would be >8 percent less of the
production costs for the second airframe, the eighth airframe*s production costs
is >8 percent less of he fourth*s, the si-teenth*s airframe costs is >8 percent
less of the eighth*s and so on.
Unit costs
$ccumulated output

The e1+erience cur,e
%he Figure shows the e-perience cur!e that normally allows costs to be reduced
with additional output.
This is due to t&o reasons: earning e%%ects and econo'ies o% scae)
Learning e%%ects' refers to the cost sa!ings that come from learning by doing.
)abor producti!ity increases as indi!iduals learn the most efficient ways to
perform particular tas#s. Management also typically learns how to mange the
new operation costs efficiently o!er time. But it has been suggested that
learning effects are important only during the start up period of a new process
and that they cease after two or three years. $fter that, any decline in the
e-perience cur!e is due to economies of scale.
63
Econo'ies o% scae' refers to the reduction in unit cost achie!ed by producing
a large !olume of a product. %his is mainly due to the ability to spreads fi-ed
costs o!er large !olume.
By building sales !olume more rapidly, international e-pansion can assist a firm
in the process of mo!ing down the e-perience cur!e. By lowering the costs of
!alue creation, experience economies can help a firm to build barriers to new
competition.
Pressures %or Cost Reductions and Loca Res+onsi,eness
Firms that compete globally typically face two types of competiti!e pressures'
pressures for cost reductions, and the pressures for local responsi!eness in the
industry in which it competes.
%hese competiti!e pressures place conflicting demands on firms.
Pressures %or cost reductions'
Cesponding to cost pressures re1uires that a firm try to lower the costs of !alue
creation by mass(producing a standard product at the optimal locations
worldwide. /ressures for cost reductions are greatest in industries producing
commodity type products where price is the main competiti!e weapon.
/ressures for cost reductions are also intense when ma+or competitors are
based in low cost locations, where there is persistent e-cess capacity, and
where consumers are powerful and face low switching costs.
Pressures %or oca res+onsi,eness'
/ressures for local responsi!eness arise from differences in consumer tastes
and preferences, differences in national infrastructure and traditional practices,
differences in distribution channels, and host go!ernment demands. /ressures
for local responsi!eness imply that it may not be possible for a firm to realize
the full benefits from e-perience cur!e and location economies.
%he management focus on tailoring cars to the U,$ mar#et reflects how foreign
automoti!e producers ha!e had to change their product offerings to appeal to
the $merican mar#et. But, %heodore )e!itt ;0ar!ard Business school professor<
has predicted emergence of enormous global mar#ets for standardized
consumer products. )e!itt cites the worldwide acceptance of mc Donald*s
hamburgers, Coca(Cola, )e!i*s ,trauss blue +eans and ,ony tele!isions, which
are sold as standardized products as e!idence of increasing similarity of global
mar#etplace.
8trategic Choice
64
2ir's use %our !asic strategies to enter and co'+ete in the
internationa en,iron'ent: an internationa strateg(/ a 'uti do'estic
strateg(/ a go!a strateg(/ and a transnationa strateg() Figure
illustrates when each of these strategies is most appropriate.
0igh
Cost
/ressures
)ow
)ow /ressures for local responsi!eness 0igh
An internationa strateg('
Firms pursuing an international strategy transfer the s#ills and products deri!ed
from core competencies to foreign mar#ets, while underta#ing some limited
local customization.
Most international firms ha!e created !alue by transferring differentiated
products de!eloped at home to new mar#et o!erseas. $ccordingly, they tend to
centralize product de!elopment functions at home ;CRD<. %hey also tend to
establish manufacturing and mar#eting functions in each ma+or country in
which they do the business.
0owe!er, they may suffer from a lac# of e-tensi!e local responsi!eness and
from an inability to e-ploit e-perience cur!e and location economies.
International firms include %oys C Us, McDonald*s, IBM, @ellogg*s and /rocter
R&amble.
%his strategy ma#es sense if the firm has !aluable core competency that
indigenous competitors in foreign mar#ets lac# and if the firm face relati!ely
wea# pressures for local responsi!eness and cost reductions.
$n international strategy ma#es sense if a firm has !aluable core competency
that indigenous competitors in foreign mar#ets lac# and if the firm faces
relati!ely less pressures for local responsi!eness and cost reductions. %hese
firms tend to suffer from high operating costs due to duplications of
manufacturing facilities. %hey may alos loose out to firms that place high
emphasis on customizing the product offerings according to local needs.
65
Global
strateg
y
Inter
nationa
l
strateg
y
Multi
domesti
c
strategy
Trans-
national
strategy
5utido'estic strateg('
Firms pursuing a multidomestic strategy customize their product offering,
mar#eting strategy, and business strategy to national conditions. %hey tend to
transfer s#ills and products de!eloped at home to foreign mar#ets. %hey ha!e
the tendency to establish a complete set of each ma+or !alue creation acti!ities
including productions, mar#eting and CRD in each ma+or national mar#ets in
which they do business. Most of the multidomestic firms ha!e a high cost
structure. 0owe!er, they may suffer from an inability to transfer s#ills and
products between countries, and from an inability to e-ploit e-perience cur!e
and location economies.
%his strategy ma#es sense when there are high pressures for local
responsi!eness and low pressures for cost reductions. %he high cost is due to
the duplications of production facilities.
Go!a strateg('
Firms pursuing a global strategy focus on reaping the cost reductions that come
from e-perience cur!e and location economies. %hat is they are pursuing a low
cost strategy. %he production, mar#eting and CRD acti!ities of firms pursuing
global strategy are concentrated in a few fa!oured locations. %hey tend not to
customize their product offerings and mar#et strategy to local conditions.
0owe!er, they may suffer from a lac# of local responsi!eness. %hey tend to
mar#et a standardized product worldwide so that they can reap ma-imum
benefits from economies of scales.
%his strategy ma#es sense where there are strong pressures for cost reductions
and where demands for local responsi!eness are minimal. Intel, %e-as
Instruments, Motorola etc follow global strategy.
Transnationa strateg('
In a transnational strategy, firms must e-ploit e-perience cur!e cost economies
and location economies, transfer distincti!e competencies within the firm, and
pay attention to pressures for localization. %o do this, there need to be flows of
#nowledge from the parent to subsidiaries, flows from foreign subsidiary to
home country, and from foreign subsidiary to foreign subsidiary (( a process
called Ego!a earning9.
%his strategy ma#es sense when a firm has high pressures for cost reductions
and high pressures for local responsi!eness. ..g.K Caterpillar, Unile!er etc.
%he approach of the transnational is not appropriate in all situations, nor is it
66
without costs. "here demands for local responsi!eness is low, a global strategy
may still be the most appropriate. %he coordination and management
challenges of a transnational also create higher costs ;and sometimes benefits<
than with one of the more traditional strategies.
8trateg( Ad,antages $isad,antages
Go!a
.-ploit e-perience cur!e
effects
.-ploit location economies
)ac# of local
responsi!eness
Internation
a
%ransfer distincti!e
competencies to foreign
mar#ets
)ac# of local
responsi!eness
Inability to realize location
economies
Failure to e-ploit
e-perience cur!e effects
5utido'es
tic
Customize product offerings
and mar#et accordance with
local responsi!eness.
Inability to realize location
economies
Failure to e-ploit
e-perience cur!e effects
Failure to transfer
distincti!e competencies to
foreign mar#ets
Transnatio
na
.-ploit e-perience cur!e
effects
.-ploit location economies
Customize product offerings
and mar#eting in accordance
with local responsi!eness
Difficult to implement due
to organizational problems.
%he abo!e table outlines the ad!antages and disad!antages of each of the four
strategies. $ll are !iable types of strategies for international firms, but each has
particular features that ma#e it more appropriate in some circumstances than
others. It is also true that sometimes competitors and conditions ma#e mo!es
and changes that ma#e once successful strategies less than optimal. %he world
is dynamic and no strategy may necessarily be appropriate for a long period.
67
5odue H .Contd0
THE ORGANIZATION O2 INTERNATIONAL B;8INE88
Introduction
%he theme of this chapter is that in order to succeed an international business
must ha!e the appropriate formal and informal organizational structure and
control mechanisms.
Organi"ationa architecture: this ter' re%ers to the totait( o% %ir'7s
organi"ation incuding the %or'a organi"ation structure/ contro
s(ste's and incenti,es/ organi"ationa cuture/ +rocess and +eo+e)
"hat is appropriate depends upon the strategy of the firm, which as we saw in
the last chapter is inter(related with the demands of the industry en!ironment.
The organi"ation structure 'eans three things' the formal di!ision of the
organization into sub units such as product di!isions, national operations and
functions. ;2rganizational charts<, the location of decision ma#ing
responsibilities within that structure ;e.g., centralized or decentralized etc< and
the establishment of integrating mechanisms to coordinate the acti!ities of sub
units including cross functional terms or regional committees.
Contro s(ste's' are the metrics used to measure the performance of sub
units and ma#e +udgments about how will the mangers are running the sub
units. Unile!er measured the performance of its subsidiary companies according
to profitability. /rofitability was the control systems.
Incenti,es' are the de!ices used to reward the appropriate managerial
beha!ior. Incenti!es are !ery ties to performance metrics. ..g. a bonus for
e-ceeding performance targets.
Process' are the manners in which the decisions are made and wor# is
performed within an organization. .-amples are the processes for formulating
strategy, for deciding how to allocate the resources within the firm, or for
e!aluating the performance of managers and gi!ing feedbac#.
Origination cuture' $re the norms and !alue systems that are shared among
the employees of an organization. :ust are societies ha!ing distinct patterns of
culture and sub couture. %he organizational culture can ha!e a profound impact
on how a firm performs.
68
Peo+e' means nor +ust the employees of the organization but also the strategy
used to recruit, compensate and retain those indi!iduals and the types of
people that they are in terms of their s#ills !alues and orientation.
Orgn architecture:totait(
:ust as there were trade(offs between different strategies, there are trade(offs
between different organizational choices (( ad!antages and disad!antages to
different approaches.
8tructure:
Bertical differentiation is principally about the centralization and
decentralization of decision(ma#ing responsibilities. It is concerned with
identifying where in a hierarchy decision ma#ing power should be concentrated.
There are %our 'ain argu'ents %or centrai"ation'
;4< Facilitating coordination,
;6< .nsuring consistency between decisions and organizational ob+ecti!es,
;5< /ro!iding top managers the means to push through ma+or changes, and
;9< $!oiding duplication of acti!ities.
There are %i,e 'ain argu'ents %or decentrai"ation'
;4< 2!erburdened and hence poor decision(ma#ing at the top of the
organization,
;6< Increased moti!ation at lower le!els,
;5< &reater fle-ibility,
;9< Better decisions on the spot by the people directly in!ol!ed, and
;7< Increased accountability and control.
%he choice between centralization and decentralization is not an absolute one.
Fre1uently it ma#es sense to centralize some decisions and decentralize others
depending upon the type of decision and the strategy of the firm.
For firms pursuing a global strategy, there is clearly more of a need for
centralized decision ma#ing than for firms pursuing a multidomestic strategy.
For transnational, it is less clear, as some decisions should perhaps be
69
Structure
People
Culture
Process
Control and
incentives
centralized while others are decentralized.
Hori"onta $i%%erentiation
0orizontal differentiation is concerned with how the firm decides to di!ide into
sub(units. %he decision is typically made upon the basis of functions, business
areas, or geographical areas.
In many firms, +ust one of these is predominant, while in others there are
difficult trade(offs to be made. %he management focus on Dow Chemicals helps
illustrate how different demands can pull a firm in different directions.
Most firms start out with no formal structure. $fter growth, a functional
orientation usually de!elops as shown in Figure. %hese functions reflect the
firm*s !alue creation capti!ities. %hese functions are controlled and coordinated
by the management. %he decision(ma#ing is centralized.
2unctiona organi"ation
Product organi"ation'
$s firms di!ersify into multiple product lines, a product di!ision structure that
allows autonomy responsibility in the operating units is usually chosen as shown
in Figure. %hen each di!ision is responsible for a distinct product line.
Top
management
Purchasing Manufacturing Marketing
Buying units Buying units Plants Plants
Branch sales
units
Branch sales
units
Finance
Accounting
units
Accounting
units
70
Internationa di,ision .%unctiona0
0istorically, when many firms began to e-pand abroad they typically grouped
their international acti!ities into an international di!ision. %his tended to be the
case whether the firm was organized on a functional basis or based on product
di!isions. o matter whether the domestic structure of the firm was based
primarily upon functions or upon product di!isions, the international di!ision
tends to be organized on geographical lines. %his is illustrated in Figure for a
firm whose domestic organization is based on product di!isions.
Internationa di,ision .+roduct0
Note: G5: genera 'anager
%his structure rarely lasts due to the inherent potential for conflict and
coordination problems between domestic and foreign operations. Firms then
switch to one of two structures (( a worldwide area structure ;undi!ersified
firms< and a worldwide product di!ision structure ;di!ersified firms<. %hat is
reflected in Figures

Word&ide area structure
Head quarters
Division product line A Division product line B Division product line C
Purchasing department
Manufacturing
department
Finance
Buying units Plants Accounting units
Head quarters
Domestic division
GM product line A
Domestic division
GM product line B
Domestic division
GM product line C
International division
GM area line
Country 2 General
Manager Product
ABC
Country 1 General
Manager Product
ABC
Product
Division 1
71
$ worldwide area structure tends to be fa!ored by firms that ha!e a low degree
of di!ersification and domestic structure based on functions as illustrated in
Figure. .ach area tends to ha!e a self contained largely autonomous entity with
tits own set of !alue creation acti!ities. 2perations authority and strategic
decisions relating to each of these acti!ities are typically decentralized to each
area. %his structure facilitates local responsi!eness and is consistent with a
multidomestic strategy.
Word&ide area structure
Word&ide +roduct di,ision structure:
$ worldwide product di!ision structure tends to be adopted by firms that are
reasonably di!ersified and accordingly, originally had a domestic structure that
was based on product di!isions as illustrated in Figure. %he great strength of
such a structure is that it pro!ides an organizational conte-t within which it is
easier to pursue the rationalization of !alue creation acti!ities necessary to
realize location and e-perience cur!e economies. %hus, it is consistent with a
global strategy.
The Go!a 5atri1 8tructure
,ince neither of these structures achie!es a balance between the need to be
both locally responsi!e and to achie!e location and e-perience cur!e
economies, many multinationals adopt matri- type structures. 0owe!er, global
matri- structures ha!e typically failed to wor# well, primarily due to
bureaucratic problems.
The Go!a 5atri1 8tructure contains simultaneous, intersecting
differentiation bases, with employees
reporting to a functional and a product manager simultaneously
Head quarters
North American
area
Latin American area European area
Middle East African
area
Product
Division 1
72
Go!a 5atri1 8tructure
%ransnational firms attempt to o!ercome the problems inherent in the matri-
structure by being more fle-ible and wor#ing to create networ#s of indi!iduals
and a shared culture.
The 5i1ed 8tructure is most common in the Multinational .nterprises. It uses
localization in product de!elopment, mar#eting, sales, and ser!ice. $t the same
time functions that benefit from scale ad!antages, li#e purchasing, are
centralized
8u!sidiar( Roes and I'+erati,es
Corporations commonly ha!e subsidiaries that operate in host en!ironments.
%hey play a #ey part in balancing integration and local responsi!eness through
playing an autono'ous roe/ a rece+ti,e roe/ or an acti,e roe)
The Autono'ous Roe has a subsidiary performing most acti!ities of the
!alue chain independently of 0Q, selling output in a local mar#et or in mar#ets
the autonomous subsidiary can arrange. %his role is commonly used with Multi(
Domestic ,trategy.
The Rece+ti,e Roe has subsidiary functions that are integrated with 0Q for
other units. $n e-ample is where the subsidiary imports or e-ports components
to other subsidiaries for redistribution or final assembly. Commonly used with
&lobal ,trategy.
The Acti,e Roe has many acti!ities performed locally, but coordinated with
subsidiaries. Commonly used with %ransnational ,trategy, with mandate from
0Q, and fle-ibility for adaptation.
Asia Europe
Product
Division 1
Product
Division
2
:apan manager here
belongs to $sia
Di!ision
and /roduct Di!ision
4
73
Headquarter
s
Integrating 5echanis's
Both formal and informal mechanisms can be used to help achie!e
coordination.
%he need for coordination ;and hence integrating mechanisms< !aries
systematically with the strategy of the firm. It is lowest in multidomestic firms,
higher in international firms, higher still in global firms, and highest of all in
transnational firms.
Integration is inhibited by a number of impediments to coordination, particularly
different sub(unit orientations. %o the e-tent that different sub(units ha!e
different ob+ecti!es and ways of operating, integration becomes more difficult.
Integration can be achie!ed through formal integrating mechanisms. Formal
integrating mechanisms !ary in comple-ity from direct contact and simple
liaison roles, through teams, to a matri- structure. 0owe!er, formal integrating
mechanisms can become bureaucratic.
%o o!ercome the bureaucracy associated with formal integrating mechanisms,
firms often use informal mechanisms. %hese include management networ#s and
organization culture.
For a networ# to function effecti!ely it must embrace as many managers within
the organization as possible. Information systems and management
de!elopment policies ;including +ob rotation and management education
programs< can be used to establish firm wide networ#s.
For a networ# to function properly, managers in different sub(units must be
committed to the same goals. 2ne way of achie!ing this is to foster the
de!elopment of a common organization culture. )eadership by e-ample,
management de!elopment programs, and human relations policies are all(
important considerations in building a common culture.
%a#en together, managerial networ#s and a common culture can ser!e as
!aluable coordination mechanisms in international firms that can help o!ercome
the deficiencies of formal mechanisms.
Contro 8(ste's
2ne of the ma+or tas#s of a firm*s head1uarters is to control the !arious sub(
units of the firm to ensure consistency with strategic goals. %he head1uarters
can achie!e this through its use of control systems. %here are four main types
of controls (( personal controls, bureaucratic controls, output controls, and
74
cultural controls. In most firms, all four are used, but the relati!e emphasis
tends to !ary with the strategy of the firm.
/ersonal control in!ol!es control by personal contact with subordinates. %his
type of control system tends to be most widely used within small firms where it
finds e-pression in the direct super!ision of the actions of subordinates, but is
also applicable in large international firms.
Bureaucratic control in!ol!es control through the establishment of a system of
rules and procedures that are used to direct the actions of sub(units. "ith
regard to head1uarters control of sub(units within multinational firms, the most
important form of bureaucratic controls are sub(unit budgets and capital
spending rules.
2utput controls in!ol!e setting goals for sub(units to achie!e, e-pressing those
goals in terms of relati!ely ob+ecti!e criteria such as profitability, producti!ity,
growth, mar#et share, or 1uality, and then +udging the performance of sub(unit
management by their ability to achie!e these goals.
Cultural controls e-ist when employees buy into the norms and !alue systems
of the firm. "hen this occurs, employees tend to control their own beha!ior,
which reduces the need for direct management super!ision. Cultural controls
re1uire substantial in!estments of time and money by the firm in building
organization wide norms and !alue systems.
%he #ey to understanding the relationship between international strategy and
control systems is the concept of performance ambiguity. /erformance
ambiguity arises when the causes of poor performance by a sub(unit are
ambiguous (( when there is a high degree of interdependence between sub(
units within the organization.
%he degree of interdependence, and hence performance ambiguity and the
costs of control, is a function of the international strategy of the firm. It is lowest
in multidomestic firms, higher in international firms, higher still in global firms,
and highest of all in transnational.
%he costs of control can be defined as the amount of time that top management
has to de!ote to monitoring and e!aluating the performance of sub(units. %his
will be greater the greater the amount of performance ambiguity.
8(nthesis: 8trateg( and 8tructure
%he #ey point of this chapter, and how it relates to the pre!ious chapter, is
summarized in %able 45.6. %he implications of the four main strategies on
organizational structure and control systems are identified.
75
%o underline the scheme is the notion that a fit between strategy and structure
is necessary if the firm is going to achie!e high performance. For a firm to
succeed two conditions must be fulfilled. First, the strategy of the firm must be
consistent with the en!ironment in which the firm operates. ;,ee Chapter for
strategy< ,econd, the organizational structure and control systems of the firm
must be consistent with its strategy.
What is a strategic alliance in International business?
What are the factors to be considered in designing an organization structure of a MNC?
What is global management?
Discuss the different strategic choices available to compete in the international business.
5odue H .Contd0
5ar*et Entr( 8trategies and 8trategic Aiances
Contents:
%he decisions of which foreign mar#ets to enter, when to enter them and on
what sale
%he choice of entry mode
%he mechanics of e-porting.
Which %oreign 'ar*ets to enter#
%he choice between foreign mar#ets must be made on an assessment of their
long(term profit potential. %his is a function of a large number of factors, many
of which we ha!e already discussed earlier li#e political, economic, legal and
cultural differences. %he attracti!eness of a country as potential mar#et for an
international business depends on balancing the benefits, costs and ris#s
associated with doing business in that country.
%he most attracti!e foreign mar#ets tend to be found in politically stable
de!eloped and de!eloping nations that ha!e free mar#et systems and where
there is not a dramatic upsurge in either inflation rates or pri!ate sector debt.
2ther mar#ets that do not fit this description may be attracti!e for other
reasons. %he size of the Chinese mar#et certainly ma#es it attracti!e to firms
with a long(term perspecti!e.
76
Ti'ing o% entr(:
2nce attracti!e mar#ets ha!e been identified, it is important to consider the
timing of entry.
%here are se!eral ad!antages associated with entering a national mar#et early,
before other international businesses ha!e established themsel!es. %hese
ad!antages are called 3%irst 'o,er ad,antages)9 %hese ad!antages must be
balanced against the pioneering costs that early entrants often ha!e to bear
including the greater ris# of business failure.
%here can also be disad!antages associated with entering a foreign mar#et
before other international business #nown as 3%irst 'o,er disad,antagesF.
%hese disad!antages may gi!e rise to E+ioneering costs9/ or costs that an
ear( entrant has to !ear that a ater entrant can a,oid)
8cae o% entr('
)arge(scale entry into a national mar#et constitutes a ma+or strategic
co''it'ent .a decision that has a ong:ter' i'+act and is di%%icut to
re,erse0. %hat is li#ely to change the nature of competition in that mar#et and
limit the entrant*s future strategic fle-ibility. $ firm needs to thin# through the
implications of such a commitment before embar#ing on a large(scale entry.
Introduction and Basic Entr( $ecisions
"hen a firm that wishes to enter a foreign mar#et, it has se!eral options,
including e-porting, licensing or franchising to host country firms, setting up a
+oint !enture with a host country firm, or setting up a wholly owned subsidiary
in the host country to ser!e that mar#et. .ach of these options has its
ad!antages and each has its disad!antages.
%he magnitude of the ad!antages and disad!antages associated with each
entry mode are determined by a number of different factors, including transport
costs and trade barriers, political and economic ris#s, and firm strategy. %he
optimal choice of entry mode !aries from situation to situation depending upon
these !arious factors. %hus, while it may ma#e sense for some firms to ser!e a
gi!en mar#et by e-porting, other firms might ser!e the same mar#et by setting
up a wholly owned subsidiary in that mar#et, or by utilizing some other entry
mode.
"e can define strategic alliances as cooperati!e agreements between actual or
potential competitors. %he term Estrategic alliancesF is often used rather loosely
77
to embrace a wide range of arrangements between firms, including cross(share
holding deals, licensing arrangements, formal +oint !entures, and informal
cooperati!e deals.
,trategic alliances ha!e both ad!antages and disad!antages, and re1uire
significant effort if they are to wor# successfully.
Entr( 5odes
;%he management focuses on the Fu+i(Sero- merger show how two foreign
competitors could successfully merge and deli!er product de!elopment and
mar#eting inroads that neither alone would ha!e been able to achie!e. ;Cead
case study in Charles 0ill<
The ,arious 'odes o% entr( are:
E1+orting
Turn*e( +ro4ects
Licensing
2ranchising
Aoint ,entures
Who( o&ned su!sidiaries
E1+orting'
Many manufacturers begin their global e-pansion as e-porters and later switch
to another mode for ser!ing a foreign mar#et. Manufacturing in e-isting
locations and transporting into new mar#ets is called e-porting.
Ad,antages:
$!oid costs of in!esting in new location.
Cealize e-perience cur!e and location economies. By manufacturing the
product in a centralized location and e-porting it to other national
mar#ets, the firm may be able to realize substantial sale economies from
its global sales !olume.
$isad,antages'
new locations may ha!e lower manufacturing costs
0igh transport costs can ma#e e-porting uneconomical, particularly for
bul# products.
%ariff and non(tariff barriers by the host country go!ernment can ma#e it
78
ris#y and costly.
$gents in the foreign country may not act in e-porter*s best interest.
Turn*e( Pro4ects'
$ pro+ect in which contractor handles e!ery detail of the pro+ect for a foreign
client, including the training of operating personnel, and then hands o!er the
foreign clients the E#eyF to a plant that is ready for operation. ;,etting up a new
plant ready for operation<. %urn#ey pro+ects are most common in the chemical,
pharmaceutical, petroleum refining and metal refining industries, all of which
use comple-, e-pensi!e production technologies.
Ad,antages'
%his is the best way of earning greater economic returns from that
asset. 2btain returns from #now(how about a comple- process.
&o!ernment restrictions may limit other options thereforeK this strategy
is best in case where FDI is limited by go!ernment. ;Middle .ast
countries and petroleum refining.<
)ower ris# if unstable economicJpolitical situation in country
$isad,antages'
%he firm that enters into the turn#ey deal will ha!e no long(term interest
in the foreign country. )ess potential to profit from success of plant.
Creating a competitor by transferring the technical #now(how to a
foreign firm.
&i!e away technological #now(how to potential competitor
Licensing'
)icensing agreement is an arrangement whereby a licensor grants the rights to
intangible property to the licensee for specified time in e-change for royalties.
Foreign licensee buys rights to manufacture a firm*s product. Intangible
property includes patents, in!entions, formulations, processes, designs,
copyrights and trademar#s. 2riginally, Fu+i(Sero- +oint !enture started as
licensing agreement with Sero-. )icensed its -erographic #now(how to Fu+i(
Sero-. In return, Fu+i(Sero- paid Sero- a royalty fee e1ual to 7 percent of the
net sales re!enue that Fu+i(Sero- earned from the sales of photocopiers based
on Sero-*s patented #now(how.
Ad,antages'
%he firm does not ha!e to bear the costs and ris#s of in!estment, it is an
79
attracti!e option for firms lac#ing capital to de!elop operations o!erseas.
$!oid politicalJeconomic problems or restrictions in a country. %his is
used when a firm wishes to participate in a foreign mar#et but is
prohibited from doing so by barriers to in!estment.
$isad,antages:
)icensing does not gi!e a firm tight control o!er manufacturing,
mar#eting and strategy that is re1uired for realizing e-perience cur!e
and location economies. )oss of control o!er operations ;mar#eting,
manufacturing, strategy<
Unable to realize e-perience cur!e and locational economies
)imited in coordinating international strategy against competitors
)oss of technological #now(how
Cross icensing can minimize some of the disad!antages of direct licensing if
there is a potential for two(way licensingK it creates interdependencies between
the parties.
5eaning: Cross icensing, is an arrangement whereby a company grants the
rights to intangible property to another firm for a special time in e-change for
royalties and a license from the foreign partners for some of its technological
#now(how.
2ranchising'
Franchising is similar to licensing. %his tends to in!ol!e a longer(term
commitments than licensing. ,elling limited rights to use of a brand name and
ser!ice #now(how.
5eaning: %ranchising is a specialized form of licensing in which the franchiser
not only sells intangible property to the franchisee ;normally trademar#< but
also insists that the franchisee agree to abide strict rules as to how to do the
business. %he franchiser will assist the franchisee to run the business on an
ongoing basis. %he franchiser in turn recei!es a royalty payment, which
amounts to some percentage of the franchise*s re!enues.
Ad,antages:
Franchisor do not bear the costs and ris#s of in!estment
$!oid politicalJeconomic problems and restrictions in a country
Quic#er international e-pansion possible
$isad,antages'
)imited in coordinating international strategy against competitors
80
)oss of control o!er 1uality and ser!ice
Aoint 6entures'
$ +oint !enture is an establishment of a firm that is +ointly owned by tow or
more otherwise independent firms. "or# with a local partner and share in the
costsJprofits of an operation. %he most typical +oint !enture is a 78J78 !enture,
in which there are tow parties, each of which holds a 78 percent ownership
sta#e and contributes a team of managers to share operating control, howe!er,
there are +oint !entures in which tone from has a ma+ority share and thus
tighter control.
Ad,antages:
Benefit from local firm*s #nowledge about the host country*s competiti!e
conditions, culture, language, political systems and business systems.
shared costsJris#s of de!elopment
political constraints on other options
$isad,antages'
)oss of control o!er technology to its partner.
:Bs do not gi!e the firm the tight control o!er subsidiaries that it might
need to relisse e-perience cur!e or location economies. )imited ability to
realize e-perience cur!e and location economies
limited ability to coordinate international strategy against competitors
conflicts between partners o!er goals and ob+ecti!es of the :B.
Who( O&ned 8u!sidiaries'
In wholly owned subsidiary, the firm owns 488 percent of the stoc#. .stablishing
a wholly owned subsidiary in a foreign mar#et can be done in two ways. %he
firm can either set up a new operation in that country or it can ac1uire an
established firm and use that firm to promote its products in the country*s
mar#et.
Ad,antages'
Control o!er technological #now(how ensured, especially when a firm*
competiti!e ad!antage is based on technological competence. Many high
tech firms prefer this entry mode for o!erseas e-pansion.;firms in
semiconductor, electronics and pharmaceuticals<.
control o!er ability to coordinate international strategy
81
ability to realize location and e-perience economies
ability to coordinate with other subsidiaries
$isad,antages'
Most costly method of ser!ing a foreign mar#et.
%he firm entering through this mode must bear the full costs and ris#s of
setting up o!erseas operations.
8eecting an Entr( 5odes
$ brief summary of the ad!antages and disad!antages of each of the modes is
shown.
Mode of
.ntry
$d!antages Disad!antages
.-porting
.conomies of scale
)ower foreign
e-penses
o low cost sales
0igh transportation costs
/otential tariffs
%urn#ey
/ro+ect
$ccess to closed
mar#ets
Competition from local
client
)oss of competiti!e
ad!antage
)icensing
Quic# e-pansion
)ower e-penses
and ris#s
)ower political ris#
)oss of competiti!e
ad!antage
)imited ability to use
profits in one country to
increase competition in
another country
Franchising
Quic# e-pansion
)ower de!elopment
costs and ris#s
)ower political ris#
)oss of competiti!e
ad!antage
/otential 1uality control
problems
)imited ability to use
profits in one country to
increase competition in
another country
:oint Benture
@nowledge of local
mar#ets
)ower de!elopment
costs and ris#
$ccess to closed
mar#ets
/otential for conflict of
interest
)oss of competiti!e
ad!antage
82
"holly
2wned
,ubsidiary
Ma-imum control
o!er proprietary
#nowledge J
technology
&reater strategic
fle-ibility
.fficiencies of
global production
system
)arge capital outlay
)ac# of local #nowledge
Increased ris#
,trategic
$lliance
$ccess to closed
mar#ets
/ooled resources
increase partner*s
capabilities
Complementary
s#ills R assets
)oss of competiti!e
ad!antage
/otential o!erestimation
of partner*s capabilities

%he optimal choice of entry mode for firms pursuing a multinational strategy
depends to some degree on the nature of their core competency.
If a firm*s competiti!e ad!antage ;its core competence< is based upon control
o!er proprietary technological #now(how, licensing and +oint !enture
arrangements should be a!oided if possible in order to minimize the ris# of
losing control o!er that technology, unless the arrangement can be structured
in a way where these ris#s can be reduced significantly.
"hen a firm percei!es its technological ad!antage as being only transitory, or
the firm may be able to establish its technology as the dominant design in the
industry, then licensing may be appropriate e!en if it does in!ol!e the loss of
#now(how. By licensing its technology to competitors, a firm may also deter
them from de!eloping their own, possibly superior, technology.
%he competiti!e ad!antage of many ser!ice firms is based upon management
#now(how. For such firms, the ris# of loosing control o!er their management
s#ills to franchisees or +oint !enture partners is not that great, and the benefits
from getting greater use of their brand names can be significant.
%he greater the pressures for cost reductions, the more li#ely it is that a firm
will want to pursue some combination of e-porting and wholly owned
subsidiaries. %his will allow it to achie!e location and scale economies as well as
retain some degree of control o!er its worldwide product manufacturing and
distribution.
8trategic Aiances
83
The ter' strategic aiances re%ers to coo+erati,e agree'ents !et&een
+otentia or actua co'+etitors
%he ad!antages of alliances are that they facilitate entry into foreign mar#ets,
enable partners to share the fi-ed costs and ris#s associated with new products
and processes, facilitate the transfer of complementary s#ills between
companies, and help firms to establish technical standards.
%he disad!antage of a strategic alliance is that the firm ris#s gi!ing away
technological #now(how and mar#et access to its alliance partner, while getting
!ery little in return.
5a*ing Aiances Wor*
"hen considering the selection of a partner, a firm must be certain that the
partner is one that can help the firm achie!e its goals, share the firm*s !ision for
the purpose of the alliances, and not act opportunistically to e-ploit the alliance
for purely its own ends. /artner selection can be critical to success, and re1uires
a significant in!estment in researching the s#ills and traits of potential partners.
$ firm should structure the alliance to a!oid unintended transfers of #now(how.
%his can be done by walling(off ;wall(off< sensiti!e technologies, by writing
contractual safeguards into alliance agreements, by agreeing in ad!ance to
engage in reciprocal swaps of technological #now(how, and by see#ing credible
commitments from alliance partners.
%wo of the #eys to ma#ing alliances wor# seem to be ;4< building trust and
informal communications networ#s between partners, and ;6< ta#ing proacti!e
steps to learn from alliance partners.
2!erall, strategic alliances tend to ha!e 1uite high failure rates. Many times this
failure is a result of unrealistic e-pectations and conflicts between the partners.
It should be noted, howe!er, that +ust because an alliance is terminated it may
not ha!e necessarily failed (( some perfectly acceptable alliances can ser!e
mutual interests for short periods of time where both parties benefit, and then
end when the benefits no longer e-ceed the costs. Hou can draw analogies
between alliances and the dating practices of people to help illustrate the
benefits, costs, ris#s, as well as the long !s. short(term nature of the
EalliancesFM
EKPORTING/ I5PORTING/ AN$ CO;NTERTRA$E
Introduction
84
%he pre!ious chapter presented e-porting as +ust one of a range of strategic
options for profiting from international mar#ets. %his chapter loo#s more at how
to e-port.
.-porting is not +ust an acti!ity of large multinationals to obtain scale and
location economies, but is also an acti!ity for small firms. $lmost all large
multinationals today started their e-pansion o!erseas !ia e-porting.
.-porting can be a !ery challenging acti!ity for many firms (( unfortunately, it
usually ta#es more effort than +ust placing goods in a bo- and slapping on
foreign shipping label as we will see, although sometimes, it is almost that easy.
The Pro'ise and Pit%as o% E1+orting
%he potential benefits from e-porting can be great. Cegardless of the country in
which a firm has its base. %he rest of the world is a much larger mar#et than the
domestic mar#et. "hile larger firms may be proacti!e in see#ing out new e-port
opportunities, many smaller firms are reacti!e and only pursue international
opportunities when the customer calls or #noc#s on the door.
Many new e-porters ha!e run into significant problems when first trying to do
business abroad, souring them on following up on subse1uent opportunities.
Common pitfalls include poor mar#et analysis, poor understanding of
competiti!e conditions, lac# of customization for local mar#ets, poor distribution
arrangements, bad promotional campaigns, as well as a general
underestimation of the differences and e-pertise re1uired for foreign mar#et
penetration.
If basic business issues were not enough, the tremendous paperwor# and
formalities that must be dealt with can be o!erwhelming to small firms.
I'+ro,ing E1+ort Per%or'ance
ational differences in the go!ernmental and business infrastructure a!ailable
for supporting e-porting !ary considerably. &erman and :apanese firms ha!e
relati!ely easy access to information and assistance. "hile U, firms are not left
totally to their own de!ices, the amount of direct and indirect assistance to
them is much less de!eloped.
2ne of the biggest impediments to e-porting is ignorance of foreign mar#et
opportunities.
%he best way of o!ercoming ignorance is to collect more information. In the
U,$, there are a number of institutions, most importantly the U, Department of
85
Commerce, which can assist firms in the information gathering and
matchma#ing process.
Business and trade associations can also pro!ide !aluable assistance to firms.
2ne way for first(time e-porters to identify opportunities and help a!oid pitfalls
is to hire an .-port Management Company. $ good .MC will ha!e a networ# of
contacts in potential mar#ets, will ha!e multilingual employees, will ha!e
#nowledge of different business mores, and will be fully con!ersant with the ins
and outs of the e-porting process and with local business regulations.
2ne drawbac# of relying on .MCs is that the company fails to de!elop its own
e-porting capabilities.
%he probability of e-porting successfully can be impro!ed by utilizing an .MC or
e-port consultants, focusing on only one or a few mar#ets at first and get them
wor#ing effecti!ely, starting out on a small scale, ha!ing realistic e-pectations
about the time and commitment re1uired, de!eloping good relations with local
distributors, and hiring local personnel. %he e-ample of 5M helps illustrate one
firm*s approach.
E1+ort and I'+ort 2inancing: Procedure:
Firms engaged in international trade face a problem (( they ha!e to trust
someone who may be !ery difficult to trac# down if they default on an
obligation.
Due to the ac* o% trust, each party to an international transaction has a
different set of preferences regarding the configuration of the transaction.
Firms can sol!e the problems arising from a lac# of trust between e-porters and
importers by using a third party who is trusted by both ( normally a reputable
ban#.
$ ban# issues a etter o% credit/ a!!re,iated as LEC at the re1uest of an
importer. It states that the ban# promises to pay a beneficiary, normally the
e-porter, upon presentation of documents specified in the letter of credit.
A dra%t ;!i o% e1change< is the instrument normally used in international
commerce to effect payment. It is an order written by an e-porter instructing an
importer, or an importer*s agent, to pay a specified amount of money at a
specified time. Drafts fall into two categories (( sight drafts and time drafts.
%ime drafts are negotiable instruments.
The !i o% ading is issued to the e-porter by the common carrier transporting
86
the merchandise. It ser!es three purposesK it is a receipt, a contract, and a
document of title.
The entire 1L:ste+ +rocess for conducting an e-port transaction is
summarized. %a#e for e-ample an Indian importer and U, e-porter.
8te+1' %he Indian importer places an order with the U, e-porter and as#s the
$merican if he would be willing to ship under a letter of credit.
8te+ B' the U, e-porter agrees to ship under a letter of credit and specifies
rele!ant information such as price and deli!ery terms.
8te+ ?' the Indian importer applies to ;e.g.< ,tate ban# of India for a letter of
credit to be issued in fa!or of the U, e-porter fro the merchandise the importer
wishes to buy.
8te+ L' the state ban# of India issues a letter of credit in the Indian importer*s
fa!or and sends it to the U, e-porter*s ban#, the ban# of ew Hor#.
8te+ F' the ban# of ew Hor# ad!ices the U, e-porter of the opening of a letter
of credit in his fa!our.
8te+ H: the U, e-porter ships the goods to the Indian importer on a common
carrier. $n official of the carrier gi!es the e-porter a bill of lading.
8te+ M' the U, e-porter presents a =8 day(time draft ;bill of e-change< drawn
on the ,tate Ban# of India, in accordance with its letter of credit and the bill of
lading to the ban# of ew Hor#. %he U, e-porter endorses the bill of lading so
title of goods is transferred to the Ban# of ew Hor#.
8te+ N' the ban# of ew Hor# sends the draft and the bill of lading to the ,tate
Ban# of India. %he ,tate Ban# of India accepts the draft, ta#ing possession of
the documents and promising to pay the now accepted draft in =8 days.
8te+ G' ,tate Ban# of India returns the accepted draft to the ban# of ew Hor#.
8te+ 1O' the ban# of ew Hor# tells the U, e-porter that it has recei!ed the
accepted ban# draft, which is payable in =8 days.
8te+ 11' the e-porter sells the draft to the ban# of ew Hor# at a discount from
its face !alue and recei!es the discounted cash !alue of the daft in return.
8te+ 1B' ,tate Ban# of India notifies the Indian importer of the arri!al of the
documents. 0e agrees to pay the ,tate Ban# of India in =8 days. ,tate Ban# of
India releases the documents so the importer can ta#e possessions of the
shipment.
8te+ 1?' in =8 days, the ,tate Ban# of India recei!es the importer*s payment,
so it has funds to pay the maturing draft.
8te+ 1L' in =8 days the holder of the matured acceptance ie, ban# of ew Hor#
presents it to the ,tate Ban# of India fro payment. %he ,tate Ban# of India pays.
E1+ort Assistance
.-porters in the India can draw upon two types of go!ernment(bac#ed
assistance to help finance their e-portsK the E1+ort:I'+ort !an* and E1+ort
Credit Guarantee Cor+oration .ECGC0
87
The E1+ort:I'+ort Ban* .EKI5 BANC0 is a public sector financial institution
established in :anuary 4, 4=>6. it was established by an act of parliament fro
the purpose of financing, facilitating, and promoting foreign trade in India.
E1+ort Credit Guarantee Cor+oration .ECGC0: this institution co!ers the
e-porter against !arious ris#s. It also pro!ides guarantees to the financing
ban#s to enable them to pro!ide ade1uate finances to e-porters.
Counter trade
Counter trade is a term that co!ers a whole range of barter li#e agreements. It
is primarily used when the firm is e-porting to countries whose currency is not
freely con!ertible, and who may lac# the foreign e-change reser!es re1uired to
purchase the imports. By some estimates, counter trade accounted for 68G of
world trade by !olume in 4==>%here are fi!e distinct types of countertrade ((
barter, counter purchase, offset, switch trading, and buy bac#.
=uestion !an*:
"hat is a turn#ey pro+ectI
.-plain the different modes of carrying out International business.
"hat is a strategic alliance in International businessI
"hat is counter tradeI .-plain with an e-ample.
5odue L
THE GLOBAL TRA$ING 8I8TE5
;%0. /2)I%IC$) .C22MH 2F I%.C$%I2$) %C$D.<
Contents: The go!a trading s(ste': introduction/ instru'ents o%
trade +oic(.tari%%s and non tari%% !arreires0/ WTO/ the %uture o% WTO)
Introduction
"hile earlier Chapter discussed the economicJtrade theories of international
trade and outlined the case free trade, it was mostly silent on the political
aspects of trade policy. %his chapter focuses on the political systems and tools
of trade policy.
%he ma+or ob+ecti!e of this chapter is to describe how political realities ha!e
shaped, and continue to shape, the international trading system.
"hile in theory, many countries adhere to the free trade ideal outlined in
Chapter 9, in practice most ha!e been reluctant to engage in unrestricted free
88
trade.
2ree trade en,iron'ent in which a go!ernment does not attempt to restrict
what its citizens can buy from another country or that they can sell to another
country. 0owe!er, in reality this does not happen due to political interferences
#nown as trade policies formed by go!ernment.
For e-ample, the U,$ continues to restrict trade in te-tiles, sugar, and other
basic products in response to domestic political pressures, in addition to
technological and militarily sensiti!e products.
Instru'ents o% Trade Poic(
Tari%%s and
Non:tari%% !arriers:
o 8u!sidies
o I'+ort -uotas
o 6ountar( e1+ort restraints .6ER0
o Antidu'+ing +oicies and/
o Ad'inistrati,e +oicies)
Tari%%s are one of the oldest and easiest to recognize and regulate, and
simplest forms of trade policy.
$e%inition: a tari%% is a ta1 e,ied on i'+orts) Tari%%s %a into to&
categories) 8+eci%ic tari%%s and ad: ,aore' tari%%s)
8+eci%ic tari%%s specify an amount that will be le!ied on each unit of imported
good. ;?48Jton of tea or ?7 on a barrel of oil.< Ad ,aore' tariffs are based on
a percentage of the !alue of the imported good ;7G of the import !alue<.
$nyone who pays property ta-es has seen the tern ad !alorem ;an amount
based on the !alue of the property<. %ariffs raise the cost of foreign goods
relati!e to domestic goods, ma#ing the consumer pay more.
%ariffs benefit the go!ernment due to the re!enue raised, benefit domestic
producers since they can charge higher prices, and hurt domestic consumers.
%ariffs are unambiguously pro(producer and anti(consumer. %hey reduce the
o!erall efficiency of the world economy (( a protecti!e tariff encourages
domestic firms to produce products at home that in theory could be produced
more efficiently abroad.
A su!sid(: de%inition: is a go,ern'ent +a('ent to a do'estic
+roducer. ,ubsidies ta#e many forms including cash grants, low interest rate
loans, ta- brea#s, and go!ernment e1uity participation in domestic firms.
89
,ubsidies help domestic producers in two ways' 4< subsidies help domestic
producers compete against low cost foreign imports, and 6< subsidies help
domestic producers gain e-port mar#ets.
,ubsidies clearly benefit domestic producers, and damage foreign producers.
Domestic consumers, howe!er, must pay for subsidies, usually through ta-es.
"hen subsidies are in the form of price supports ;i.e. often in agriculture<,
domestic consumers may also pay directly. ,ubsidies generally help support
inefficient industries and #eep producti!e assets employed in industries that do
not ma#e most effecti!e use of these assets.
$ccording to official figures, the go!ernment subsidies to industry in most
industrialized countries amount to between 6 percent and 5.7 percent to the
!alue of industrialized output.
An i'+ort -uota: $e%inition: is a direct restriction on the -uantit( o%
so'e good that can !e i'+orted into a countr(. Usually, go!ernments
regulate import 1uotas by issuing import licenses for the import of some
specific 1uantity of goods to a group of indi!iduals or firms.
A ,ountar( e1+ort restraint .6ER0 may ha!e the same effect as a 1uota.
$e%inition: 6ER is the -uota on trade i'+osed !( the e1+orting
countr(/ t(+ica( at the re-uest o% the i'+orting countr()
In a B.C, another country or countries agree not to e-port more than a certain
1uantity to another country or countries. B.Cs is usually only enacted when it is
feared that a more restricti!e tariff or 1uota will be le!ied unless e-ports are
E!oluntarilyF reduced. In other words, the threat of retaliation encourages
compliance.
Import 1uotas and B.Cs benefit domestic producers and harm domestic
consumers. %hey can also e!en help foreign producers, as foreign producers
can raise the price they charge for the limited supply they can sell, and ta#e the
difference as additional profit.
Loca content re-uire'ents s+eci%( that %ir's 'ust +roduce so'e
+ortion o% a good do'estica(. %he purpose of a local content re1uirement
is usually to aid the formation of domestic industries, to #eep manufacturers
from switching to foreign suppliers, or to #eep foreign firms from setting up
Escrewdri!er plants.F where imported manufactured components undergo
simple assembly in order to a!oid some other trade restriction on the
importation of the fully assembled product. Domestic suppliers benefit, and
domestic consumers must bear the costs. )ocal content regulation may mean
the formation of strange bedfellows in certain mar#ets. For e-ample, the
mar#et for automobiles in $rgentina is too small to support local production by
all the competing firms. %herefore, the firms agreed to let one of them build
90
engines in $rgentina for all the !ehicles assembled there.
Antidu'+ing +oices: $u'+ing occurs &hen a countr( ses goods
in another countr( !eo& cost or !eo& %air 'ar*et ,aue) Dumping is a
way firms can unload e-cess production into foreign mar#ets. "hen plants
must operate at a certain le!el regardless of domestic demand, the producer
may find it appropriate to e-port some portion of the factory*s output abroad.
$t times dumping may also be done for predatory reasons, hoping to dri!e
other producers out of the mar#et, and subsidizing foreign sales with higher
domestic prices.
Antidu'+ing +oicies are assigned to punish foreign firms that engage in
dumping. %hese are designed to pre!ent dumping from occurring, or by
instituting import ta-es in order to bring prices of EdumpedF goods bac# up to
fair le!els. %he ultimate ob+ecti!e is to protect domestic producers from unfair
foreign competitors.
Ad'inistrati,e +oicies' these are bureaucratic rules that are designed to
ma#e it difficult for imports to enter a country. $ wide range of administrati!e
barriers can be enacted. ,ome say the :apanese are the masters of this trade
barrier. In recent years :apan*s formal tariff and non tariff barriers ha!e been he
lowest in the world. 0owe!er, critics charge that their informal administrati!e
barriers to importsmore than compensate fro this. %a#ing so much time to
inspect goods that they spoil or setting down specific regulations on Eproduct
standardsF that are !ery e-pensi!e to meet.
The argu'ents %or Go,ern'ent Inter,ention
3Protecting 4o!s and industries)9
%he most common political reason for trade restrictions is 3+rotecting 4o!s
and industries)9 Usually this results from political pressures by unions or
industries that are EthreatenedF by more efficient foreign producers, and ha!e
more political clout than the consumers that will e!entually pay the costs.
36ita %or nationa securit(9
@eeping industries 3,ita %or nationa securit(9 !iable is an oft used
argument for trade restrictions. "hile this may be reasonable for industries li#e
steel, aerospace, and electronicsK in the U,$ the shoe industry has regularly
lobbied that soldiers need boots. %hus, the U,$ needs to ha!e a !iable shoe
industry in order to be able to pro!ide shoes during a time of war.
3Retaiation9
&o!ernment inter!ention in trade can be used as part of a Eget toughF policy to
open foreign mar#ets. By ta#ing, or threatening to ta#e, specific actions, other
91
countries may remo!e trade barriers. 0owe!er, when threatened go!ernments
do not bac# down, tensions can escalate and new trade barriers may be
enacted.
3Protecting Consu'er9
Consu'er +rotection can also be an argument for restricting imports. %he
opening case suggests that the .U*s concern o!er bananas was, in part, due to
an interest in protecting consumers. ,ince different countries do ha!e different
health and safety standards, what may be acceptable in one country, may be
unacceptable in others.
3Protecting hu'an rights9
Concern o!er human rights in other countries plays an important role in foreign
policy. &o!ernments sometimes use trade policy to impro!e the human rights
policies of trading partners. &o!ernments also use trade policies to put pressure
on go!ernments to ma#e other changes. In recent years, the U,$ has had trade
restrictions against )ibya, Iran, Ira1, orth @orea, Cuba, and other countries
whose go!ernments were pursuing policies that were not !iewed fa!orably by
the U, go!ernment. Unless a large number of countries choose to ta#e such
action, howe!er, it is unli#ely to pro!e successful.
3In%ant industr(9
%he 3in%ant industr(9 argument suggests that an industry should be
protected until it can de!elop and be !iable and competiti!e internationally.
Unless an industry is allowed to de!elop and achie!e minimal economies of
scale, foreign competitors may undercut prices and pre!ent a domestic industry
from de!eloping. %he infant industry argument has been accepted as a
+ustification for temporary trade restrictions under the "%2.
$ problem with the infant industry argument is determining when an industry
Egrows up.F ,ome industries that are +ust plain inefficient and uncompetiti!e
ha!e argued they are still infants after 78 years. %he other problem is that gi!en
the e-istence of global capital mar#ets, if the country has the potential to
de!elop a !iable competiti!e position, its firms should be capable of raising the
necessary funds without additional support from the go!ernment.
8trategic trade +oic( suggests that in cases where there may be important
first mo!er ad!antages, go!ernments can help firms from their countries attain
these ad!antages.
,trategic trade policy also suggests that go!ernments can help firms o!ercome
barriers to entry into industries where foreign firms ha!e an initial ad!antage.
The Re,ised Case %or 2ree Trade
92
"hile strategic trade policy identifies conditions where restrictions on trade
may pro!ide economic benefits, there are two problems that may ma#e
restrictions inappropriate' retaliation and politics.
Inter!ening to aid domestic firms will only be successful if other countries do
not ta#e similar actions that offset the effects.
"hile it could be !ery difficult to identify situations where strategic inter!ention
in trade is economically appropriate, !arious interest groups will be certain to
lobby that particular firms should be aided. &i!en the ease with which special
interest groups seem to be able to capture the attention of the go!ernment, it is
more li#ely that consumers will be harmed more needlessly than producers will.
It is unreasonable to e-pect the go!ernment to be completely fair and ob+ecti!e
in EtargetingF industries, when different industries, lobbies, and politicians all
ha!e there own ob+ecti!es for Egetting their paws in the honey potF of
go!ernmental funds.
The $e,eo+'ent o% the Word Trading 8(ste'
Up until the &reat Depression of the 4=58s, most countries had some degree of
protectionism. &reat Britain, as a ma+or trading nation, was one of the strongest
supporters of free trade.
$lthough the world was already in a depression, in 4=58 the U,$ enacted the
,moot(0awley tariff, which created significant import tariffs on foreign goods.
$s other nations too# similar steps and the depression deepened, world trade
fell further.
$fter ""II, the U, and other nations realized the !alue of freer trade, and
established the &eneral $greement on %ariffs and %rade ;&$%%<. TCeferred to
sometimes as the &eneral $greement to %al# and %al#.U
%he approach of &$%% was to gradually eliminate barriers to trade. 2!er 488
countries became members of &$%%, and wor#ed together to further liberalize
trade. Figure 7.4 shows the different rounds of &$%% negotiations and the
resulting reductions in tariffs.
During the 4=>8s and early 4==8s, the world trading system as EmanagedF by
&$%% underwent strains. First, :apan*s economic strength and huge trade
surplus stressed what had been more e1ual trading patterns, and :apan*s
percei!ed protectionist ;neo(mercantilist< policies created intense political
pressures in other countries. ,econd, the persistent trade deficits by the U,, the
world*s largest economy, caused significant economic problems for some
industries and political problems for the go!ernment. %hirdly, many countries
found that although limited by &$%% from utilizing tariffs, there were many
93
other more subtle forms of inter!ention that had the same effects and did not
technically !iolate &$%% ;e.g. B.Cs<.
$gainst the bac#ground of rising protectionist pressures, in 4=>D &$%%
members embar#ed on their eighth round of negotiations to reduce tariffs
;called the Uruguay Cound<. %his was the most ambitious round to date, as the
goal was to e-pand beyond the regulation of manufactured goods and address
trade issues related to intellectual property, agriculture, ser!ices, and
enforcement mechanism. %able 7.4 illustrates the main features of the
agreement that was finally reached in 4==5.
%he agreement, howe!er, left se!eral important matters unaddressed' financial
ser!ices, broadcast entertainment, en!ironmental matters, wor#er*s rights, and
foreign direct in!estment. %hose items were left to further negotiations under
the auspices of the "orld %rade 2rganization.
"hen the "%2 was established, its creators hoped the "%2*s enforcement
mechanisms would ma#e it a more effecti!e policeman of the global trade rules
than the &$%% had been. %he "%2 has handed down a number of rulings that
ha!e led to changes in go!ernmental policies that restricted tradeK in other
cases, go!ernments had made changes in ad!ance of "%2 rulings.
Under the "%2, D> countries that account for more than =8G of world
telecommunications re!enues pledged to open their mar#ets to foreign
competition and to abide by common rules for fair competition in
telecommunications. %he "%2 has also made headway in liberalizing trade in
financial ser!ices, although the current agreement still includes a number of
e-ceptions.
,ubstantial wor# still remains to be done on the international trade front.
.n!ironmental policies are one area of concern, as are regulations regarding
foreign direct in!estment.
Clearly, trade barriers negati!ely impact the ability of firms to locate acti!ities
in the economically optimal location or source materials from the best
producers. %rade barriers can change the underlying costs and benefits of
different locations, and force firms to underta#e operations in specific locations
rather than import or e-port.
.!en if specific 1uotas, tariffs, local content, etc. regulations do not specifically
re1uire that certain actions be ta#en, a firm may choose to locate facilities or
buy from certain suppliers in order to reduce the threat of mandatory and more
puniti!e go!ernmental inter!ention.
94
Certain trade barriers may e!en ma#e some operations no longer !iable, and
force a firm to gi!e up particular mar#ets or production sites.
In general, international firms ha!e an incenti!e to lobby for free trade, and
#eep protectionist pressures from causing them to ha!e to change strategies.
"hile there may be short(term benefits to ha!ing go!ernmental protection in
some situations, in the long(run, these can bac# fire and other go!ernments can
retaliate.
.Re%er Ash&ini 8ir7s note %or GATT and WTO or re%er Internet0
5O$;LE L:
INTERNATIONAL TRA$E THEORI
Introduction and O,er,ie& o% Trade Theor(
%he opening case comparing &hana and ,outh @orea illustrates how ,outh
@oreaVs policy of encouraging trade fueled its economic growth, while &hanaVs
policies resulted in a reallocation of resources away from their most producti!e
uses. It is important to ac#nowledge the ob!ious' these two countries were
almost the same. %he only apparent difference was their approach to free trade.
Cefer Charles 0ill for the case.
%his chapter re!iews a number of different theories of international trade to
show why it is beneficial for a country to engage in trade and what patterns of
international trade might be e-pected. %a#e Iceland for e-ample' E"hat would
life be li#e on Iceland if it did not tradeIF Clearly there would be few if any autos
or electronic products, and the diet would consist mainly of fish ( !ery
ine-pensi!e fish. "hile it would clearly be technically possible for Iceland to
ma#e greenhouses, use heat from its abundant geothermal resources, and
supply artificial light to produce all sorts of tropical fruits, these would be !ery
e-pensi!e fruit. %hus, it ma#es sense for Iceland to trade some its abundant fish
for other goods produced at lower costs in the rest of the world.
"hile it is easy to see why it ma#es sense to trade for goods that a country
cannot easily produce, it is sometimes harder to understand why a country
should not ma#e goods that it can easily produce. %here is little reason why the
U,$ should not be able to produce all the snea#ers and +eans demanded by its
citizens. $ll of the raw materials re1uired for these goods are a!ailable in the
U,$, as is labor. e!ertheless, the U,$ imports most of the snea#ers and +eans
consumed. %his is because production is fairly labor intensi!e, and $merican
labor is much more costly than labor in other parts of the world. $merican
95
consumers would ha!e to pay a great deal more for these goods if they were
made only domestically. %hus, it is beneficial for consumers to purchase goods
from their least e-pensi!e source, and better that labor produce goods that
ta#e ad!antage of the educational le!el of most $merican wor#ers.
0a!ing completely free trade is certain to hurt some domestic industries that
are not competiti!e on a worldwide basis. "or#ers in the te-tile industry do not
li#e losing their +obs to wor#ers in other countries who are willing to wor# for
lower wages. Het, consumers want to purchase goods with the best priceJ1uality
tradeoff.
,ome patterns of trade are easy to e-plain ( it is ob!ious why ,audi $rabia
e-ports oil, the U, e-ports agricultural products, and Me-ico e-ports labor(
intensi!e goods. Het, others are not so ob!ious or easily e-plained. %he U, ships
:eep Chero#ees to ,candina!ia, while ,weden ships Bol!o ;Ford< station wagons
to the U,. Clearly, it would be technically possible for Ford*s ,wedish subsidiary
to produce durable four(wheel(dri!e ,UBs and for $merican firms to produce
EstatusF station wagons.
%here are many e-amples regarding trade issues in the news. Cecently, the U,$
and the .U were in!ol!ed in trade disputes o!er bananas and beef. %he banana
dispute re!ol!ed around the .U pro!iding preferential treatment to former
colonies. %here always seem to be election campaigns with rhetoric on
Eprotecting +obsF or industries, and the steel unions are considering public
demonstrations against steel dumping in the U,$. $s a candidate, &eorge ".
Bush promised +ob protection to coal and steel wor#ers in "est Birginia that
undoubtedly helped him in putting the state on his side in the .lectoral !oting
system. e!ertheless, a president cannot change global economic reality.
Bethlehem ,teel is in ban#ruptcy protection, citing EunfairF foreign imports as a
ma+or reason that it has not been able to be internationally competiti!e. %here
is usually some dispute between the U, and :apan, or some posturing going on
in the .U regarding its .astern neighbors or former colonies o!er trade. )ast
year, for the first time in world history, a foreign entity (( the .U (( prohibited
two $merican companies ;&eneral .lectric and 0oneywell< from merging e!en
after that merger had been appro!ed by all the go!ernmental agencies in the
U,$. Clearly, the so!ereignty of $merican businesses has become globalized.

The trade theories'
5ercantiis'
A!soute ad,antage
Co'+arati,e ad,antage
Hec*scher:Ohin theor(
Leontie% +arado1
96
The +roduct i%e c(ce theor(
The ne& trade theor(
Porter7s $ia'onds: nationa co'+etiti,e ad,antage
5ercantiis' and Ear( Cassica Thought ;c) 1FOO : c) 1MGO0
,ince gold and sil!er were !iewed as !aluable and a sign of wealth,
mercantilism suggested that countries should design policies that led to an
increase in their holdings of gold and sil!er.
5ercantiis' !eie,ed that it &as the countr(7s !est interests to
'aintain a trade sur+us/ to e1+ort 'ore than it i'+orted) B( doing so/
a countr( &oud accu'uate god and si,er and conse-uent( increase
its nationa &eath and +restige)
Countries should run a balance of trade surplus, and ha!e e-ports of greater
!alue than imports. %hus, tariffs and 1uotas limited imports, while e-ports were
subsidized.
Da!id 0ume pointed out how a persistent trade surplus would begin to affect
money supply and in the long(run close the trade surplus.
%he #ey problem with the mercantilist !iew is that it !iews trade as a zero sum
game, where if one country benefits, the other must lose.
$s an economic philosophy, mercantilism is flawed and in!alid. Het, many
political !iews today ha!e the goal of boosting e-ports while limiting imports by
see#ing only selecti!e liberalization of trade.
A!soute Ad,antage
$dam ,mith ;Weath o% Nations .1MMH<, 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.
If Britain were to specialize in te-tile production and France in wine production,
,mith argued that both Britain and France could consume more te-tiles and
wine than if each only produced for their own consumption. %hus, trade is a
positi!e sum game.
%hese gains from trade can be showed graphically by loo#ing again at &hana
and ,outh @orea.
97
"hen each country has an absolute ad!antage in one of the products, it is clear
that trade is beneficial. 0owe!er, what if one country has an absolute
ad!antage in both productsI %hen we should consider the country*s
comparati!e ad!antage.
Co'+arati,e ad,antage
Cicardo showed how it ma#es sense for a country to specialize in the production
of goods in which it simply has a comparati!e ad!antage, e!en if it can produce
both more efficiently than the other country.
%he case shows the production possibilities frontiers for &hana and ,outh @orea
when &hana has an absolute ad!antage in both cocoa and rice.
&hana has a comparati!e ad!antage in the production of cocoa since it can
produce 9 times as much cocoa as ,outh @orea, but only 4.7 times as much
rice. &hana is comparati!ely more efficient at producing cocoa than rice. ;Cefer
Charles hill for details and figures<
/oints C and @V in Figure 9.6 show a possible new production point for each
country. %able 9.6 shows how, with trade, both &hana and ,outh @orea can
increase consumption of both products.
%his simple e-ample ma#es a number of assumptions' only two countries and
two goodsK zero transportation costsK similar prices and !aluesK resources are
mobile between goods within countries, but not across countriesK constant
returns to scaleK fi-ed stoc#s of resourcesK and no effects on income distribution
within countries. "hile these are all unrealistic, the general proposition that
countries will produce and e-port those goods that they are the most efficient
at producing remains 1uite !alid.
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 re1uired to produce each additional item. If crops are grown on
increasingly less fertile land, mining is done on less producti!e ore regions, or
less s#illed personnel need to be hired to perform high s#illed +obs, production
per unit of input will decrease. Diminishing returns implies a //F that is con!e-
;as shown in Figure 9.5<. 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.
2pening an economy to trade is li#ely to generate dynamic gains of two types.
First, trade might increase a countryVs stoc# of resources as increased supplies
become a!ailable from abroad. ,econdly, free trade might increase the
efficiency of resource utilization, and free up resources for other uses. Figure
98
9.9 shows how dynamic gains can shift a countryVs //F outwards.
Hec*scher:Ohin Theor(
%he 0ec#scher(2hlin theory predicts that countries will e-port those goods that
ma#e intensi!e use of factors of production that are locally abundant, while
importing goods that ma#e intensi!e use of factors that are locally scarce. %hus,
it focuses on differences in relati!e factor endowments rather than differences
in relati!e producti!ity.
"hen we loo# at U, agricultural e-ports ;abundant fertile land<, Icelandic and
orwegian fish e-ports ;coastal waters climates conduci!e to good fish<,
Canadian lumber e-ports ;plentiful forests with few people<, ,audi oil e-ports,
and ,outh $frican gold e-ports, the 0ec#scher(2hlin theory seems to ma#e
sense.
Leontie% +arado1:
Using the 0ec#scher(2hlin theory, Wassi( Leontie% in 4=75, postulated that
the U, should be an e-porter of capital(intensi!e goods and an importer of labor
intensi!e goods. %o his surprise, howe!er, he found that U, imports were less
capital intensi!e than U, e-ports. ,ince this result was at !ariance with the
predictions of the theory, it has become #nown as the Leontie% +arado1.
0ence, while we can see some support for 0ec#scher(2hlin, other e!idence
contradicts it.
The Product Li%e C(ce Theor(
Bernon suggested that as products mature, both the location of sales and the
optimal production location would change, affecting the direction and flow of
imports and e-ports.
"hile the product life cycle theory accurately e-plains what has happened for
products li#e photocopiers and a number of other high technology products
de!eloped in the U, in the 4=D8s and 4=38s, the increasing globalization and
integration of the world economy has made this theory less !alid in todayVs
world.
The Ne& Trade Theor(
ew trade theory suggests that because of economies of scale and increasing
returns to specialization, in some industries there are li#ely to be only a few
profitable firms. %hus, firms with first mo!er ad!antages will de!elop economies
of scale and create barriers to entry for other firms. %he commercial aircraft
99
industry is an e-cellent e-ample. Boeing, established in the early 4=48s, has
long had a superior ad!antage o!er other aircraft manufacturers that ha!e not
had the ad!antage of go!ernmental subsidies ;li#e $irbus<.
/roducti!e efficiency may not be the result of factor endowments or specific
national characteristics, but instead be a result a firmVs first mo!er ad!antages.
ew trade theory does not contradict the theory of comparati!e ad!antage, but
instead identifies a source of comparati!e ad!antage.
$n ob!ious and contro!ersial e-tension of new trade theory is the implication
that go!ernments should consider strategic trade policies. ,trategic trade
policies would suggest that go!ernments should nurture and protect firms and
industries where first mo!er ad!antages and economies of scale are li#ely to be
important, as doing so can ma#e it more li#ely that a firm will build economies
of scale and e!entually end up a winner in the global competiti!e race.
Nationa Co'+etiti,e Ad,antage: PorterPs $ia'ond
/orterVs study tried to e-plain why a nation achie!es international success in a
particular industry. %his study found four broad attributes that promote or
impede the creation of competiti!e ad!antage.
2actor Endo&'ents' $ nationVs position in factors of production such as
s#illed labor or infrastructure necessary to compete in a gi!en industry can be
critical. %hese factors can be either basic ;natural resources, climate, location<
or ad!anced ;s#illed labor, infrastructure, technological #now(how<. "hile either
can be important, ad!anced factors are more li#ely to lead to competiti!e
ad!antage
$e'and Conditions' %he nature of home demand for the industries
product or ser!ice influences the de!elopment of capabilities. ,ophisticated and
demanding customers pressure firms to be competiti!e.
Reating and 8u++orting Industries' %he presence in a nation of
supplier industries and related industries that are internationally competiti!e
can spill o!er and contribute to other industries. ,uccessful industries tend to
be grouped in clusters in countries ( ha!ing world class manufacturers of semi(
conductor processing e1uipment can lead to ;and be a result of ha!ing< a
competiti!e semi(conductor industry.
2ir' 8trateg(/ 8tructure/ and Ri,ar(' %he conditions in the nation
go!erning how companies are created, organized, and managed, and the
nature of domestic ri!alry impacts firmsV competiti!eness. Firms that face
strong domestic competition will be better able to face competitors from other
international firms.
100
In addition to these four main attributes, go,ern'ent +oicies and chance
can influence any of the four. &o!ernment policy can affect demand through
product standards, influence ri!alry through regulation and antitrust laws, and
affect the a!ailability of highly educated wor#ers and ad!anced transportation
infrastructure.
%he four attributes of the diamond, go!ernment policy, and chance wor# as a
reinforcing system, complementing each other and in combination creating the
conditions appropriate for competiti!e ad!antage. %he Management Focus on
o#ia pro!ides a good e-ample of how this Finnish firm built its competiti!e
ad!antage because of factors in /orter*s diamond.
)i#e the other theories we ha!e studied in this chapter, the diamond ma#es
sense in some situations. %here is also anecdotal e!idence of its applicability in
certain situations. Het, some forms of trade are much more simply e-plained by
simple absolute ad!antage ;,audi $rabia*s oil e-ports<. Moreo!er, this, or any
theory, does not easily e-plain other trade patterns.
Most of the theories discussed ha!e implications for the location of production
acti!ities. Firms will attempt to locate different acti!ities in the location that is
optimal for the production of that good, component, or ser!ice.
Being a first mo!er can ha!e important competiti!e implications, especially if
there are economies of scale and the global industry will only support a few
competitors. Firms need to be prepared to underta#e huge in!estments and
suffer losses for se!eral years in order to reap the e!entual rewards.
&o!ernmental policies with respect to free trade or protecting domestic
industries can significantly impact global competiti!eness. %he opening case
showed how &hanaVs policies negati!ely influenced the global success of its
cocoa business. "hile new trade theory may suggest that go!ernments
subsidize specific industries, /orterVs theory focuses how policies can influence
the attributes of the diamond.
2ne of the most important implications for business is that they should wor# to
encourage go!ernmental policies that support free trade. If a business is able to
get its goods from the best sources worldwide, and compete in the sale of
products into the most competiti!e mar#ets, it has a good chance to sur!i!e
and prosper. If such openness is restricted, a business*s long(term sur!i!al will
be in greater 1uestion.
101
5odue M:
GLOBAL 5AN;2ACT;RING AN$ 5ATERIAL8
5ANAGE5ENT
Contents: Internationa +roductions and ogistics @ go!a sourcing/
+urchasing and su++ier reations
%his chapter e-amines three 1uestions'
"here in the world should producti!e acti!ities be locatedI 0ow much
production should be performed in(house, and how much outsourcedI 0ow best
to coordinate a globally dispersed supply chainI
Introduction
%he company*s decisions regarding global manufacturing and outsourcing and
globally dispersed supply chain management are important in controlling their
acti!ities to deli!er its products to customers who are dispersed all o!er the
world.
O+erations: $e%inition' the acti!ities in!ol!ed in the procurement of inputs
into production process, the creation of product and its deli!ery to customers
are called operations. Managers in an international business ha!e to ma#e a
102
number of critical decisions in the operational arena. %hey ha!e to decide where
in the world to locate producti!e acti!ities, how much production to outsource
to foreign suppliers, and how bet to coordinate globally dispersed supply and
distribution.
Production: de%inition' are the acti!ities in!ol!ed in creating a product.
5aterias 'anage'ent: de%inition' is the acti!ity that controls the
transmission of physical materials through the !alue chain, from procurement
through production and into distribution.
8trateg(/ 5anu%acturing/ and 5aterias 5anage'ent
%he ob+ecti!es of manufacturing and materials management are to lower the
costs of !alue creation and add !alue by better ser!ing customer needs. This
can !e done !( o&ering costs and increasing +roduct -uait(. %hese
two aspects are related.
%here are three ways in which impro!ed 1uality control reduces costs.
First, producti!ity increases because time is not wasted manufacturing poor
1uality products that cannot be sold. %his sa!ing leads to a direct reduction
in unit costs.
,econd, increased product 1uality means lower re(wor# and scrap costs.
%hird, greater product 1uality means lower warranty and re(wor# costs. %he
net effect is to lower the costs of !alue creation by reducing both
manufacturing and ser!ice costs.
$dded to the ob+ecti!es of lowering costs and impro!ing 1uality are two further
ob+ecti!es of manufacturing and materials management that ta#e on particular
importance for international businesses.
First, manufacturing and materials management must be able to
accommodate demands for local responsi!eness.
,econd, manufacturing and materials management must be able to
respond 1uic#ly to shifts in customer demand.
%he main management techni1ue that companies are utilizing to boost their
product 1uality is Tota =uait( 5anage'ent) %QM was de!eloped by a
number of $merican consultants such as .dward Deming, :oseph :uran etc. %QM
focuses on the need to impro!e the 1uality of a company*s products and
ser!ices.
Where to 5anu%acture
For the firm that considers international production to a feasible option, three
broadly defined %actors need to !e considered &hen 'a*ing a ocation
decision : countr( %actors/ technoogica %actors/ and +roduct %actors
etc)
103
Countr( %actors $s discussed earlier in the boo#, country factors suggest
that a firm should locate it !arious manufacturing acti!ities in those locations
where economic, political, and cultural conditions, including relati!e factor
costs, are most conduci!e to the performance of that acti!ity. 0owe!er,
regulations affecting FDI and trade can significantly affect the
appropriateness of specific countries, as can e-pectations about future
e-change rate changes.
Technoogica %actors include the fi-ed costs of setting up manufacturing
facilities, the minimum efficient scale of production, and the fle-ible
manufacturing etc. in some countries setting up of a manufacturing plant are
so high that a firm must ser!e the world mar#et from a single location or
from a !ery few locations. Minimum efficient scale is another technological
factor, which tells us that as plant output e-pands, unit costs decrease. %he
reasons for this relationship include the greater utilization of capital
e1uipment and the producti!ity gains that come from with greater
specialization f employees within the plant. Manufacturing technologies
designed to reduce setup times, increase use of indi!iduals machines
through between scheduling, and impro!e 1uality control at all stages of
manufacturing.
Product %actors' the first is the product*s !alue to weight ratio because it
influence on transportation costs. Many electronic components ha!e high
!alue to weight ratios, they are e-pensi!e and they do not weigh much. %hus
e!en if they are shipped halfway around the world, their transportation costs
account for a !ery small percentage of total costs. %he other product feature
that can influence location decisions is whether the product ser!es that can
influence location decisions all o!er the world. ;e.g. Many industrial products<
Locating 'anu%acturing %aciities:
%here are two basic strategies for locating manufacturing facilitates,
concentrating them in optimal location and ser!ing the world mar#et from
there, and decentralizing them in !arious regional or national locations that are
close to ma+or mar#ets. %he appropriate strategic choice Is determined by the
!arious country, technological and product factors.
Concentration .centrai"ation0 o% 'anu%acturing 'a*e 'ost sense
&henK
Differences in factor costs, political economy and culture ha!e substantial
impact on the costs of manufacturing in !arious countries.
%rade barriers are low.
104
Important e-change rates are e-pected to remain relati!ely high.
%he production technology has high fi-ed costs or a high minimum efficient
scale or a fle-ible manufacturing technology e-ists.
%he product*s !alue to weight ratio is high.
%he product ser!es uni!ersal needs.
Aternati,e(/ decentrai"ation o% 'anu%acturing is a++ro+riate &henK
Differences in factor costs, political economy etc do not ha!e substantial
impact on the costs of manufacturing in !arious countries.
%rade barriers are high.
Important e-change rates are e-pected to remain relati!ely low.
%he production technology has low fi-ed costs or a low minimum efficient
scale or a rigid manufacturing technology e-ists.
%he product*s !alue to weight ratio is low.
%he product does not ser!e uni!ersal needs.
In practice location decisions are seldom clear.
5a*e or !u( decisions:
8ourcing decisions' %he #ey issue in many international businesses is
identifying which component parts should be manufactured in(house, and which
should be out(sourced to independent suppliers.
The ad,antages o% 'a*ing co'+onents in:house are' ma#ing components
in house is also called ,ertica integration)
Lo&er costs' if the firm is more efficient at that production acti!ity than any
other company is, then it must ma#e the product or component in house.
In,est'ents in s+eciai"ed assets' if the company*s core competency lies
in de!eloping a high performance, high 1uality component, then it must decide
to ma#e it in house. "hen substantial in!estments in specialized assets are
re1uired to manufacture a component part, the firm will prefer to ma#e that
component internally rather than contract out to an independent supplier.
He+s the %ir' +rotect its +ro+rietar( technoog(' if it enables the firm
to produce a product containing superior features, proprietary technology can
gi!e the firm a competiti!e ad!antage. 2b!iously the firm runs the ris# of
loosing this technology if it outsource this technology. In order to maintain
control o!er its technology, a firm might prefer to ma#e component parts that
105
contain proprietary technology in(house, rather than ha!e them made by
independent suppliers.
I'+ro,es scheduing !et&een ad4acent stages in the ,aue chain' the
product cost sa!ings resulting from !ertical integration is because it ma#es the
panning, coordination and scheduling of ad+acent processes easier. %his
important in firms with 4ust in ti'e in!entory systems. "hen a firm needs to
tightly control scheduling, planning, and coordination of ad+acent production
processes, !ertical integration can be preferable to being dependent on
independent suppliers.
The ad,antages o% Bu('
%he ad!antages of buying components from independent suppliers are that it
helps preser!e strategic fle-ibility, and it helps the firm to a!oid many of the
organizational problems associated with e-tensi!e !ertical integration.
8trategic %e1i!iit(' %he great ad!antage of buying component parts from
independent suppliers is that the firm can maintain its fle-ibility, switching
orders between suppliers as circumstances dictate. %his is particularly
important in the international conte-t where changes in e-change rates and
trade barriers might alter the attracti!eness of !arious supply sources o!er
time.
Lo&er costs' outsourcing may be associated with the lowering the firm*s
cost structure.
Bertical integration into the manufacture of component parts in!ol!es an
increase in the scope of the organization. $lthough there may be ad!antages in
costs and in maintaining control of deli!ery of component parts, the resulting
increase in organizational comple-ity can be costly. %here are three reasons for
this. ;4< %he greater the numbers of sub(units within an organization, the
greater are the problems of coordinating and controlling those units. ;6< %he
firm that !ertically integrates into component part manufacture may find that
because its internal suppliers ha!e a capti!e customer in the firm, internal
suppliers lac# an incenti!e to reduce costs. ;5< )eading directly on from the
pre!ious point, !ertically integrated firms ha!e to determine the appropriate
price for goods transferred between sub(units within the firm. ,etting
appropriate transfer prices is a problem in any firm. %he firm that buys its
components from independent suppliers can a!oid all of these problems.
,e!eral firms ha!e tried to capture some of the benefits of !ertical integration,
without encountering the associated organizational problems, by entering into
long(term strategic alliances with #ey suppliers. $lthough alliances with
suppliers can help the firm to capture the benefits associated with !ertical
integration without dispensing entirely with the benefits of a mar#et
106
relationship, alliances do ha!e their drawbac#s. %he firm that enters into a
strategic alliance may find its strategic fle-ibility limited by commitments to
alliance partners.
Coordinating a Go!a 5anu%acturing 8(ste'
Materials management encompasses the acti!ities necessary to get materials
to a manufacturing facility, through the manufacturing process, and out through
a distribution system to the end user. %he materials management function is
complicated in an international business by distance, time, e-change rates,
customs barriers, and the li#e. .fficient materials management can ha!e a
ma+or impact upon a firm*s bottom line.
Aust:in:ti'e' systems generate ma+or cost sa!ings from reduced warehousing
and in!entory holding costs. In addition, :I% systems help the firm to spot
defecti!e parts and ta#e them out of the manufacturing process ( thereby
boosting product 1uality.
For a firm to establish a good materials management function it needs to
legitimize materials management within the organization. It can do this by
putting materials management on an e1ual footing with other functions in the
firm.
The roe o% in%or'ation technoog(' Information technology and particularly
electronic data interchange play a ma+or role in materials management. .DI
;electronic data interchange< facilitates the trac#ing of inputs, allows the firm to
optimize its production schedule, allows the firm and its suppliers to
communicate in real time, and eliminates the flow of paperwor# between a firm
and its suppliers.
5odue M .Contd0
GLOBAL 5ARCETING AN$ RJ$
Introduction
%he focus of this chapter is on how mar#eting and CRD can be performed in
order to ;4< lower the costs of !alue creation, and ;6< add !alue by better
ser!ing customer needs.
%he tension that e-ists in most international businesses between, on the one
hand, the need to reduce costs, and on the other hand, the need to be
responsi!e to local conditions is particularly predominant in this chapter as we
107
loo# at the de!elopment and mar#eting of products.
%he &lobalization of Mar#etsI
%his topic is not new (( it was discussed se!eral times in earlier chapters. %he
general !iew is usually that while %heodore )e!itt o!erstates the case, he does
identify a clear trend. Ea powerful force dri!es the world toward a con!erging
commonality and that force is technologyW the result is a new commercial
reality( the emergence of global mar#ets for standardized consumer products
on a pre!iously unimagined scale of magnitude.F
5ar*et 8eg'entation:
Mar#et segmentation refers to identifying distinct groups of consumers whose
purchasing beha!ior differs from others in important ways. Firms must ad+ust
their mar#eting mi- from segment to segment. In international business,
segmentation needs to consider the e-istence of segments that transcend
national borders and understand differences across countries in the structure of
segments.
For a segment to transcend national borders, consumers in that segment must
ha!e some compelling similarities that lead to similarities in purchasing
beha!ior. "here such similarities do not e-ist, there must be some
customization if the firm is to ma-imize performance in the mar#et. %his
customization may be in the product, the pac#aging, or simply the way in which
the product is mar#eted.
&lobal mar#et segments are much li#ely to e-ist in industrial products ;e.g.,
memory chips, chemical products, corporate bonds< than in consumer products.
Product Attri!utes
$ product can be !iewed as a bundle of attributes. Different customers !alue
different attributes, as well as !alue the same attributes differently. $ soccer
mom in the U,$ may !alue her automobile for its ease of use, but her )atin
$merican counterpart may !alue its durability.
/roduct attributes ha!e to be !aried from country to country to account for
differences in consumer tastes and preferences. Differences in consumer tastes
and preferences between countries are a function of differences in culture and
economic de!elopment.
Differences in product and technical standards may re1uire the firm to
customize product attributes from country to country. "ithin the .U, the need
to meet differing technical standards is being reduced ( but some of these
108
pre!ious technical standards ha!e shaped consumer preferences as well. .!en
in ad!anced products li#e cellular phones, the new EglobalF &,M standard for
digital communication ;which allows customers to tra!el in many countries and
still recei!e calls< has not been appro!ed in orth $merica.
$istri!ution 8trateg(
Distribution strategy is about choosing the best channel to deli!er a product to
the consumer. Figure 43.4 illustrates a typical distribution system.
,ignificant country differences with regard to distribution systems e-ist. In
some countries, the retail system is !ery concentrated, whereas in others it is
!ery fragmented. In some countries channel length is short, whereas in others it
is long. "hile in some countries access to distribution channels may be difficult.
In countries with concentrated retail systems, a few retailers supply most of the
mar#et. In &ermany, for e-ample, four retail chains control D7G of the food
mar#et. In nearby Italy, no chain controls more than 6G of the mar#et. ,uch
differences clearly affect how a firm gets its products to consumers.
%he longer the channel, the greater the aggregate mar#(up and the higher the
price that consumers are charged for the final product. Despite this, the
benefits of using a longer channel may outweigh the drawbac#s, particularly if
the retail mar#et is !ery fragmented. %he benefits of using a longer channel are
that longer channels may economize on selling costs and assist the firm to gain
mar#et access.
"hen there are e-clusi!e distribution channels, it can be difficult for outsiders
to obtain access to mar#ets. .-clusi!e channels are often based on long
established and successful relationships.
2ccasionally in order to gain mar#et access a firm may ha!e to de!ise an
entirely new distribution strategy. "hile costly, that may be the only way to
obtain access, and it may e!en gi!e the firm a competiti!e ad!antage.
Co''unication 8trateg(
$ critical element in the mar#eting mi- is communication strategy. %his is the
process of communicating the attributes of a product to prospecti!e customers.
$ number of different communications channels are a!ailable to a firm. %hese
include direct selling, sales promotion, direct mar#eting, and ad!ertising !ia
many different media. $ firm*s communications strategy is partly defined by its
choice of channel.
109
%he effecti!eness of international communication can be hindered by three
potentially critical !ariables ( cultural barriers, source effects, and noise le!els.
Cutura !arriers arise from the difficulty of communicating messages across
cultures. %he best way for a firm to o!ercome cultural barriers is for it to
de!elop cross(cultural literacy, although that is often difficult to achie!e.
8ource e%%ects occur when the recei!er of the message ;the potential
consumer< e!aluates the message based upon the status or image of the
sender. ,ource effects can be either positi!e or negati!e. For e-ample, thin# of
some positi!e and negati!e source effects (( such as &erman autos !s. French
wine or Italian cuisine !s. British cuisine.
Noise tends to reduce the chance of effecti!e communication. In this conte-t,
noise refers to the amount of other messages that are competing for a potential
consumer*s attention.
Push strateg( and a +u strateg(:
%he main choice with regard to communication strategy is between a push
strategy and a pull strategy. A +ush strateg( emphasizes personnel selling
which re1uires a competent sales force and is costly. "hereas a +u strateg(
emphasizes mass media ad!ertising to communicate the mar#eting message to
potential customers. %he choice between push and pull strategies depends
upon product type and consumer sophistication, channel length, and media
a!ailability.
Push strategies tend to be emphasized more in the following circumstances'
4< for industrial products andJor comple- new products, 6< when distribution
channels are short, and 5< when few print or electronic media are a!ailable.
Pu strategies tend to be emphasized more in the following circumstances' 4<
for consumer goods products, 6< when distribution channels are long, and when
5< sufficient print and electronic media are a!ailable to carry the mar#eting
message.
$ globally standardized ad!ertising campaign is one in which the same
mar#eting message is used the world o!er. %he ma+or benefits of standard
ad!ertising are lower costs of ad creation, better utilization of creati!e talent,
and the a!oidance of confusion created by differences in message. "hile a
standardized campaign has economic ad!antages, it usually fails to account for
differences in culture and ad!ertising regulations between countries.
Pricing 8trateg(: the conce+t o% strategic +ricing has to& as+ects/
&hich are re%ereed as +redator( +ricing and e1+erience cur,e +ricing)
110
Price discri'ination e-ists whene!er consumers in different countries are
charged different prices for the same product. /rice discrimination can assist a
firm in the process of ma-imizing its profits.
For price discrimination to wor#, the firm must be able to #eep national mar#ets
separate and different price elasticities of demand must e-ist in different
countries.
%he elasticity of demand is determined by a number of factors, of which income
le!el and competiti!e conditions are probably the most important. In general,
price elasticities tend to be greater in countries with lower income le!els and
greater numbers of competitors.
The conce+t o% strategic +ricing has t&o as+ects/ &hich are re%ereed as
+redator( +ricing and e1+erience cur,e +ricing)
Predator( +ricing in!ol!es using the profit gained in one mar#et to support
aggressi!e pricing in another mar#et, the ob+ecti!e being to dri!e competitors
out of the mar#et. 0ere the price is used as competiti!e weapon to dri!e
wea#er competitors out of a national mar#et by pricing !ery low. 2nce the
competitors ha!e left the mar#et, the firm can raise prices and en+oy high
profits. Many :apanese firms ha!e been accused of pursuing this strategy.
E1+erience cur,e +ricing in!ol!es aggressi!e pricing to build up accumulated
global !olume as rapidly as possible, thereby mo!ing the firm down the
e-perience cur!e as rapidly as possible. $ firm builds its accumulated
production !olume o!er time, unit costs fall due to Ee-perience effectsF due to
learning cur!es and economies of scale.
%he ability of a firm to engage in price discrimination or strategic pricing is
limited by antidu'+ing reguations and nation competition policy.
$ntidumping regulations limit firms* ability to price below cost or below the
price in its domestic mar#et. Competition regulations can limit firm*s ability to
charge monopoly prices.
Con%iguring the 5ar*eting 5i1
8tandardi"ation ,ersus custo'i"ation is not an all or nothing concept. In
reality, most firms standardize some things and customize others. "hen loo#ing
at the o!erall mar#eting mi- and message, one often finds some aspects of
standardization and some aspects of customization in all products depending on
local re1uirements and o!erall cost structures.
Ne& Product $e,eo+'ent
111
ew product de!elopment is a high ris# but high return acti!ity. In order to
build up a competency in new product de!elopment, the international business
must do two things' ;10 dis+erse RJ$ acti,ities to those countries &here
ne& +roducts are !eing +ioneered and .B0 integrate RJ$ &ith
'ar*eting.
Inno!ations can ma#e established products obsolete o!ernight. $t the same
time, inno!ations can create a host of new product possibilities. %o stay abreast
of competitors* inno!ations, as well as de!elop their own, firms should ha!e
CRD acti!ities in locations that are on the cutting edge of technology.
%he need to ade1uately commercialize new technologies poses special
problems in international businesses, since commercialization may re1uire
different !ersions of the product is produced for different countries.
$ firm*s new product de!elopment efforts need to be closely coordinated with
the mar#eting, production, and materials management functions. %his
integration is critical to ma#ing certain that customer needs are met and that
the company performs all its !alue creation acti!ities efficiently.
2ne way to achie!e cross(functional integration is to ha!e cross:%unctiona
+roduct de,eo+'ent tea's. .ffecti!e cross(functional teams should be led
by a hea!yweight pro+ect manager with status in the organization, ha!e
members from all the critical functional areas, ha!e members located together,
ha!e clear goals, and ha!e an effecti!e conflict resolution process.
%his all becomes more difficult when de!eloping products for multiple worldwide
mar#ets. Many large firms ha!e research centers in limited locations, with
product de!elopment acti!ities more dispersed.
5odue N
THE INTERNATIONAL 5ONETARI 8I8TE5
Introduction
%his chapter discusses how the international monetary system wor#s and to
point out its implications for international business. %o understand this we must
study the international monetary system*s e!olution. It all started with the gold
standards and its brea# up in 4=58*s. %hen in 4=99, Bretton Woods
conference, which established the basic framewor# fir the post world war II,
international monetary system. %his system called for %i1ed e1change rates
against the U, dollar.
112
Under this %i1ed e1change rate, system the !alue of the most currencies in
terms of the U, dollar was fi-ed for long periods and allowed to change only
under specific terms.
%he Bretton "oods conference also created two ma+or international institutions,
The Internationa 5onetar( 2und I52 and the Word Ban*)
%he Bretton woods system of fi-ed e-change rates collapsed in 4=35. ,ince
then the world has operated with a 'anaged %oat s(ste' under the
'anaged %oat s(ste' so'e currencies are ao&ed to %oat %ree(/ !ut
the 'a4orit( are either 'anaged in so'e &a( !( the go,ern'ent
inter,ention or +egged into other currenc()
2!er the past 488 years, the world has gone through eras with a gold standard,
fi-ed e-change rates, and the current managed float system, with periods of
high instability at se!eral times.
,ince ""II, the IMF and the "orld Ban# ha!e played an important role in the
world economy. %heir role going forward is currently under debate.
.-change rates are not free to mo!e in the way we assumed. %his chapter
focuses on the institutional conte-t within which e-change rates are free to
mo!e and do so.
The God 8tandard
%he gold standard has its origin in the use of gold coins as medium of
e-change, unit of account and store of !alue(a practice that stretches bac# to
ancient times. In the days when international trade was limited in !olume.
/ayments of goods purchased from another country was typically made in gold
and sil!er. 0owe!er as the !olume of international trade e-panded after the
industrial re!olution, a more con!enient means of financing international trade
was needed. ,hipping large 1uantities of gold and sil!er around the world was
impractical.
%he solution was to arrange fro pare currency and for go!ernments to agree to
con!ert the paper currency into gold on demand at a fi-ed rate.
Under the gold standard, countries pegged their currency to gold by agreeing to
e-change a particular 1uantity of money for an ounce or grain of gold. $t one
time, for e-ample, the U, go!ernment would agree to e-change one dollar for
65.66 grains of gold. British /ound was defined as containing 445 grains of fine
gold.
113
9>8 grains of gold X 4 ounce of gold
i.e., 4 ounce of gold X ?68.D3 ;9>8J65.66< or,
4 ounce of gold X 9.67 pounds ;9>8J445<
%herefore, the e-change rate for con!erting pounds into dollars X 4 pound X
?9.>3 ;?68.D3J9.67 pounds<
%he e-change rate between currencies was determined based on how much
gold a unit of each currency would buy.
%he gold standard pro!ides a powerful mechanism to pull trade imbalances
between countries bac# into e1uilibrium ( in factK this is one of the #ey reasons
why some ad!ocate returning to the gold standard. $ country is said to be in
balance of trade e1uilibrium when the income its resident earn from e-ports is
e1ual to the money its residents pay to people in other countries for imports.
%he gold standard wor#ed fairly well until the inter(war years and the great
depression. %rying to spur e-ports and domestic employment, a number of
countries started regularly de!aluing their currencies, with the end result that
people lost confidence in the system and started to demand gold for their
currency. %hat put pressure on countries* gold reser!es and forced them to
suspend gold con!ertibility.
The Bretton Woods 8(ste'
$ #ey problem with the gold standard was that there was no multinational
institution that could stop countries from engaging in competiti!e de!aluations.
During %he "orld "ar I, in 4=49, gold standard was abandoned. During the war
se!eral go!ernments financed their massi!e military e-penditures by printing
money. %his resulted in inflation and by the end of world war, 4=>, the price
le!els were higher e!erywhere. )ater the great Britain and United ,tates
returned to gold standard by pegging their currencies at a prewar gold parity
le!el of
Y 9.67 per ounce, despite substantial inflation, which priced British goods out of
foreign goods out of foreign mar#ets which pushed the country into deep
depression. %he U, also did the same. %he result was shattering of confidence
in the gold standard system.
In 4=99, at the height of "orld "ar II, representati!es of 99 countries met at
Bretton "oods, ew 0ampshire, to design a new multinational monetary
system. "ith the collapse of gold standards and the great depression these
members wanted to build economic order that facilitate growth.
%he agreement reached at Bretton "oods*s system established two
multinational institutions ( the I52 and the Word Ban*. %he tas# of IMF was
114
to maintain an order in the international monetary system and that of the "orld
Ban# was to promote general economic de!elopment. %he Bretton woods
agreement called for as system of %i1ed e1change rate that &oud !e
+oiced !( I52.
2i1ed e1change rate:
The ;8 doar &as to !e +egged and con,erti!e to god/ and other
currencies &oud set their e1change rates reati,e to the doar)
$e,auations &ere not to !e used %or co'+etiti,e +ur+oses/ and a
countr( coud not de,aue the currenc( !( 'ore than 1OQ &ithout I52
a++ro,a)
The roe o% I52'
%he main aim of IMF was do act as a custodian was to try and a!oid a repetition
of the chaos due to financial collapse, competiti!e de!aluations, trade wars,
high unemployment and hyperinflation etc.
%he fi-ed e-change rates were supposed to force countries to ha!e greater
monetary discipline through a need to maintain a fi-ed e-change rate, which
puts a bra#e on the competiti!e de!aluations and brings stability to the world
trade en!ironment. %he system also pro!ided some fle-ibility, and countries
could use short(term funds from the IMF to help support currencies during
temporary pressures for re!aluation.
IMF tried stabilize the monetary system through and disci+ine %e1i!iit(.
$isci+ine' the fi-ed e-change rate regime impose discipline in tow waysK first
the need to maintain a fi-ed e-change rate puts a bra#e on competiti!e
de!aluations and brings stability to the world. ,econd the fi-ed e-change rate
system imposes monetary discipline on countries thereby reducing price
inflation. ;,uppose if India rapidly increased its money supply by printing
rupees. %his will lead to more supply of money which would leads to increased
price. 2r price inflation. In turn fi-ed e-change rate, would ma#e Indian goods
uncompetiti!e in world ma#ers, while the prices of imports would become more
attracti!e in India. %he result would be a widening trade deficit in India, with the
country importing more than it e-ports. %o correct his trade imbalance, under a
fi-ed e-change rate regime, India would be re1uired to restrict the rate of
growth n its money supply to bring price inflation bac# under control.
2e1i!iit(' two ma+or features of I52 Artices o% Agree'ent fostered
fle-ibility' I52 ending %aciities and ad4usta!e +arities) %he IMF was
ready to lend foreign currencies to members to tide them o!er during short
periods of balance of payments deficit. "hen rapid tightening or monetary
policy would hurt domestic employment. $ pool of gold and currencies
contributed by IMF members pro!ided the resources for these lending
115
operations. By pro!iding funds would buy countries time which bring down their
inflation rates and reduce balance of payments deficit.
The s(ste' o% ad4usta!e +arities allows the de!aluation of country*s
currency by more than 48 percent, if the 2MF agrees that the country*s balance
of payments is in Efundamental dise1uilibrium.F EFundamental dise1uilibriumF
means such countries, which had suffered permanent ad!erse effect in the
demand for their products. "ithout de!aluation, such a country would
e-perience high unemployment and a persistent trade deficit until the domestic
price le!el fallen far enough to restore a balance of payment e1uilibrium. Cefer
sol!ed answers notes for information.
The roe o% Word Ban*'
%he official name of the "orld Ban# is the Internationa Ban* %or
Reconstruction and $e,eo+'ent .IBR$0. %he "orld Ban#*s ;IBCD< ma+or
purpose was to pro!ide funds to help in the reconstruction of .urope and the
de!elopment of third world economies.
%he IBCD lends money at generous interest rates, primarily for impro!ements in
a country*s infrastructure ;roads, bridges, etc<. During the 4=D8s, the IBCD also
lent money to support farming, education, population control, and urban
de!elopment.
%he "orld Ban# lends money under two schemes. Under the IBCD scheme,
money is raised through bonds sales in the international capital mar#et.
Borrowers pay what the ban# calls a mar#et of interest(the ban#*s cost of funds
plus a margin for e-penses. In fact, this mar#et rate is lower than commercial
ban#s interest rates. Under the scheme IBCD offers low interest loans to
customers whose credit rating is often poor.
$ second scheme is through resources raised through subscriptions from
wealthy members such as U,, :apan, &ermany. ;Cefer sol!ed answers notes for
information.<
The Coa+se o% the 2i1ed E1change Rate 8(ste'
%he fi-ed e-change rate system established in Bretton "oods collapsed mainly
due to the economic management of the U,$. %o understand why the system
failed one must understand the special role of the U, dollar in the system. $s
the only currency that would be con!erted into gold, and as the currency that
ser!ed as the reference pint for all others, the dollar occupied a central place in
the system. $ny pressure on the dollar to de!alue would play ha!oc with the
system and that is what it happened. Under )yndon :ohnson, the U, financed
huge increases in po!erty reduction programs, as well as the Bietnam "ar by
increasing its money supply.
116
,peculation that the dollar would ha!e to be de!alued relati!e to most other
currencies, as well as underlying economics and some forceful threats by the
U, forced other countries to increase the !alue of their currency relati!e to the
dollar.
%he #ey problem with the Bretton "oods system was that it relied on an
economically well managed U,, since the dollar was the base currency. "hen
the U, began to print e-cess amounts of money, run high trade deficits, and
e-perience high inflation, the system was strained to the brea#ing point.
The 2oating E1change Rate Regi'e
%he :amaica agreement called for floating e-change rates ;although countries
could inter!ene to smooth out speculati!e spurts<, the end of gold as a reser!e
asset, and more funds in the IMF to help countries o!ercome short(term
problems.
,ince 4=35, e-change rates ha!e been relati!ely !olatile. Figure 48.4 shows
mo!ements in e-change rates o!er the past three decades.
%he rise of the ? from 4=>8(7 is interesting, as this is a time where the
underlying fundamentals discussed in Chapter = would ha!e predicted that the
? should fall, not rise. %he subse1uent fall was both a result of go!ernmental
inter!ention and underlying mar#et forces.
%he regularity of go!ernmental inter!ention in the foreign e-change mar#ets
e-plains why the current system is sometimes referred to as a EmanagedF or
EdirtyF floating system.
2i1ed ,ersus 2oating E1change Rates
%he case for a floating e-change rates regime claims that such a system gi!es
countries autonomy regarding their monetary policy and that floating e-change
rates facilitate smooth ad+ustment of trade imbalances.
%he case for a fi-ed e-change rate regime claims that' 4< the need to maintain
a fi-ed e-change rate imposes monetary discipline on a country, 6< floating
e-change rate regimes are !ulnerable to speculati!e pressures, 5< the
uncertainty that accompanies floating e-change rates hinders the growth of
international trade and in!estment, and 9< far from correcting trade imbalances,
depreciating a currency on the foreign e-change mar#et tends to cause
inflation.
"hile we #now that the past attempts at fi-ed e-change rates ha!e not held up,
perhaps there is another new approach. %he floating system clearly wor#s, but
117
it causes great !olatility.
E1change Rate Regi'es in Practice
Under a pegged e-change rate regime, a country will peg the !alue of its
currency to that of another ma+or currency. /egged e-change rates are popular
among the world*s smaller nations, as they peg their e-change rate to that of
other, larger currencies that are presumed to be more stable.
%here is some e!idence that adopting a pegged e-change rate regime does
moderate inflationary pressures in a country.
$ country that introduces a currency board commits itself to con!erting its
domestic currency on demand into another currency at a fi-ed e-change rate.
%o ma#e this commitment credible, the currency board holds reser!es of a
foreign currency e1ual at the fi-ed e-change rate to at least 488G of the
domestic currency issued.
Euro+ean 5onetar( union:
Chapter on regional economic integration pro!ided some information on the
.uro and .uropean Monetary union. ,ome bac#ground on how the current
.uropean system de!eloped may pro!ide bac#ground rele!ant to understanding
this particular form of e-change rate stabilization.
%he ob+ecti!es of the Euro+ean 5onetar( 8(ste' ;.M,< were to 4< create a
zone of monetary stability in .urope, 6< control inflation, and 5< to coordinate
e-change rate policies with third currencies.
%he .CU was created as a bas#et of currencies that ser!ed as the unit of
account for the .M,. .ach national currency in the .M, was gi!en a central rate
!is(Z(!is the ecu. From this central rate flow a series of bilateral rates.
Currencies were not allowed to depart by more than 6.67G from their bilateral
rate with another .M, currency. Countries could borrow from each other to
defend their currency against speculati!e pressure.
%he .M, was fairly successful in stabilizing e-change and interest rates
between countries, although a clear crisis occurred in 4==6 that showed the
difficulty in maintaining the bands when pressured by the currency mar#ets.
Recent Acti,ities and the 2uture o% the I52
118
"ith the introduction of the floating rate system and the emergence of global
capital mar#ets, much of the original reason for the IMF*s e-istence has
disappeared. Financial difficulties ha!e not disappeared, howe!er, and the IMF
has found away to grow and redefine its mission.
%he IMF has gotten in!ol!ed in helping third world countries out of their debt
crises. Celatedly, the IBCD has found that economic mismanagement by !arious
nations can ma#e good pro+ects turn out to be inappropriate. Moreo!er, the line
between the role of the IBCD and the IMF has become increasingly blurred.
The Third Word de!t crisis had its roots in the OPEC oi +rice hi*es of
4=35 and 4=3=, when ban#s recycled money from 2/.C countries into debt by
de!eloping countries. "hen these countries too# on too much debt and were
unable to e!en ma#e interest payments, the IMF stepped in to help reschedule
debt.
The 5e1ican currenc( crisis of 4==7 was a result of high Me-ican debts, and
a pegged e-change rate that did not allow for a natural ad+ustment of prices. In
order to #eep Me-ico from defaulting on its debt, a ?78 billion aid pac#age was
put together. %he effect of the Me-ican currency crisis on the U, automobile
industry, described in the Management Focus bo-, was to allow the peso to float
freely, to cause the prices of imported autos to rise, and for the entire auto
industry to plummet.
Russian ru!e crisis' Between 4==6 and 4==7, the !alue of the Cussian ruble
relati!e to the dollar fell from 467 to 7458. %hat fall occurred while Cussia was
implementing an economic reform program designed to transform the country*s
crumbling centrally planned economy into a dynamic mar#et economy. %he fall
was directly related to the hyperinflation in Cussia, in line with what would be
e-pected by purchasing power parity.
The %inancia crisis that eru+ted across 8outheast Asia during the fall of
4==3 were sown in the pre!ious decade when these countries were
e-periencing unprecedented growth. 0uge increases in e-ports, and hence the
incoming funds, helped fuel a boom in commercial and residential property,
industrial assets, and infrastructure. $s the !olume of in!estments grew, the
1uality of these in!estments declined, leading to significant e-cess capacity.
%hese in!estments were often supported by dollar(based debts. "hen inflation
and increasing imports put pressure on the currencies, the resulting
de!aluations led to default on dollar denominated debts.
In helping bail out countries under financial crisis, the IMF*s policies ha!e come
under criticism. 2ne criticism is that the IMF has a Eone size fits allF policy that
does not ade1uately deal with the differences across countries. $nother is that
the IMF creates a moral hazard ( since people and go!ernments belie!e that the
119
IMF will bail them out, they underta#e o!erly ris#y in!estments. "hile it may be
that the IMF has become too big and does not ha!e enough accountability for
its actions, it has also been e-tremely helpful to many countries.
%he present floating rate system ma#es it important that firms carefully
manage their foreign e-change transactions and e-posure to changes.
&i!en that currencies can change, and that the relati!e appropriateness of
different locations for production and sales can change with changing e-change
rates, it is important that M.s ha!e strategic fle-ibility to transfer production
to locations where the e-change rates are the most fa!orable. Using contract
manufacturing from different countries can also pro!ide fle-ibility in low !alue
added manufacturing.
Firms ha!e an incenti!e to both encourage go!ernments to underta#e policies
that pro!ide fa!orable e-change rates, as well as encourage that a system of
more stable e-change rates be established. %he relati!e stability of e-change
rates in .urope has clearly helped .uropean firms in managing their cross(
border acti!ities.
5odue N .contd0
THE GLOBAL CAPITAL 5ARCET
Introduction
%here has been a dramatic growth in the international capital mar#et o!er the
past 47 years.
Companies are increasingly turning to the global capital mar#et for funds, as
the opening China Mobile case illustrates. By using international capital
mar#ets, firms can lower the costs and increase their access to funds.
In!estors are also di!ersifying their portfolios and reducing their systematic ris#
by in!esting internationally, although new ris#s are created in the process.
Bene%its o% the Go!a Ca+ita 5ar*et
In the case of international capital mar#ets, there are simply more of players
and a greater di!ersity in the players and the possible combinations.
120
Firms can obtain funds !ia both debt and e1uity. %o raise funds !ia debt, a firm
owes in!estor money ;%hey borrow<. %o raise funds !ia e1uity, a firm sells
partial ownership ;stoc#< to an in!estor.
%here are two main reasons why an international capital mar#et offers an
impro!ement o!er a purely domestic capital mar#et' ;4< from a borrower*s
perspecti!e, it increases the supply of funds a!ailable for borrowing and lowers
the cost of capitalK and ;6< from an in!estor*s perspecti!e, it pro!ides a wider
range of in!estment opportunities, thereby allowing in!estors to build a
portfolio of international in!estments that di!ersifies ris#.
If there is limited li1uidity in a purely domestic capital mar#et, the cost of
capital is higher relati!e to what would be found in an international mar#et.
"ith an increase in the choices a!ailable to an in!estor, the in!estor is able to
di!ersify holdings internationally, thereby reducing systematic ris# below what
could be achie!ed in a purely domestic mar#et. Figure 44.5 shows this
graphically.
"hile the systematic ris#s are reduced with international portfolio in!estments,
e-change rate ris#s now come into play.
Gro&th o% the Go!a Ca+ita 5ar*et
De(regulation and impro!ements in technology ha!e facilitated the growth of
the international capital mar#et.
Due to ad!ances in communications and data processing capabilities, the
international capital mar#ets are always acti!e around the globe. International
trading is an information intensi!e acti!ity that would not ha!e been possible
only a few decades ago when computing and telecommunication capabilities
were much less de!eloped.
%he deregulation of capital flows, a remo!al of limitations on the types ser!ices
that can be pro!ided by foreign financial ser!ices firms, and a reduction in the
restrictions imposed on domestic financial ser!ices firms ha!e all contributed to
the growth of the international capital mar#et.
"hile capital is generally free to mo!e internationally, e!idence to date
suggests that most in!estors choose to ma#e long term in!estments in their
home country and only ma#e short term opportunistic in!estments elsewhere.
$ lac# of information about the fundamental 1uality of foreign in!estments may
encourage speculati!e flows in the global capital mar#et.
121
%he Country Focus on Me-ico and the global capital mar#ets shows that a
country cannot count on capital inflows to finance its deficits, especially when
the money that is being in!ested is not there for the long term..
The Eurocurrenc( 5ar*et
A Eurocurrenc( is an( currenc( that is !an*ed outside o% its countr( o%
origin. .urodollars, which account for about two(thirds of all .urocurrencies,
are dollars ban#ed outside of the United ,tates.
%he .urocurrency got its origin as holders of dollars outside the U,$, initially
communist countries but later also middle eastern countries, wanted to deposit
their dollars but were afraid that they may be confiscated if deposited in the
U,$.
%he lac# of go!ernment regulation ma#es the .urocurrency mar#et attracti!e to
both depositors and borrowers. Due to the lac# of regulation, the spread
between the .urocurrency deposit rate and the .urocurrency lending rate is
less than the spread between the domestic deposit rate and the domestic
lending rate. %his gi!es .uroban#s a competiti!e ad!antage.
%he lac# of regulation is also a drawbac# of .urocurrency deposits, as the ris# of
forfeiture is greater than for domestic deposits. 0owe!er, this is not a ma+or
problem. %here is also a ris# of currency fluctuations that would not arise if
funds were held domestically in the domestic currency.
The Go!a Bond 5ar*et
%he international bond mar#et falls into two general classificationsK the foreign
bond mar#et and the .urobond mar#et. .urobonds account for the lion*s share
of international bond issues.
Foreign bonds are sold outside of the borrower*s country and are denominated
in the currency of the country in which they are issued.
$ .urobond issue is normally underwritten by an international syndicate of
ban#s and placed in countries other than the one in whose currency the bond is
denominated.
%he .urobond mar#et is an attracti!e way for companies to raise funds due to
the absence of regulatory interference, less stringent disclosure re1uirements
than in most domestic bond mar#ets, and the fa!orable ta- status of
.urobonds.
122
.CU and .uro denominated bonds became increasingly common in the 4==8s.
2ne ad!antage of these bonds is that the ris#s associated with e-change rates
are lower, since the .CU and .uro are actually a bas#et of currencies.
The Go!a E-uit( 5ar*et
%here is no international e1uity mar#et in the same sense that there are
international currency and bond mar#ets. Instead there are a number of
separate e1uity mar#ets that are lin#ed !ia specific e1uities and o!erall mar#et
fundamentals.
Foreign in!estors are increasingly in!esting in different national e1uity mar#ets,
primarily as a way of di!ersifying ris# by di!ersifying their portfolio of stoc#
holdings across nations.
$s firms are listed on multiple national e-changes and ha!e their shares owned
by an e!en greater number of shareholders from different nationalities, it is
becoming increasingly meaningless to refer to firms as E$mericanF or EDutch.F
For e-ample, the EnationalityF of DaimlerChrysler does not matter.
Companies are beginning to list their stoc# in the e1uity mar#ets of other
nations, primarily as a prelude to issuing stoc# in the mar#et to raise additional
capital. 2ther reasons for foreign listings include facilitating future stoc# swaps,
using the company*s stoc# and stoc# options to compensate local management
and employees, satisfying local ownership desires, pro!iding access to funding
for future ac1uisitions in a country, and increasing the company*s !isibility to
local employees, customers, suppliers, and ban#ers
2oreign E1change Ris* and the Cost o% Ca+ita
"hen borrowing funds from the international capital mar#et, companies must
weigh the benefits of a lower interest rate against the ris#s of an increase in the
real cost of capital due to ad!erse e-change rate mo!ements.
Using forward rates cannot typically remo!e the ris# altogether, particularly in
the case of long(term in!estments.
By utilizing international capital mar#ets, firms can often borrow funds at a
lower cost than they could domestically (( regardless of whether the funds are
in the form of cash loans, e1uity, or bonds.
123
%he minimal regulation in international capital mar#ets helps lower the cost of
capital, but also increases ris# in both currencies and security.
For in!estors, the international capital mar#et pro!ides opportunities for
portfolio di!ersification and the lowering of systematic ris#. $t the same time, it
creates new currency ris#s.
5odue N .contd0
2OREIGN $IRECT IN6E8T5ENT
Introduction
%he focus of this chapter is foreign direct in!estment ;FDI<. 2$I can ta*e the
%or' o% a %oreign %ir' !u(ing a %ir' in a di%%erent countr(/ or deciding
to in,est in a di%%erent countr( !( !uiding o+erations there)
"ith FDI, a firm has a significant ownership in a foreign operation and the
potential to affect managerial decisions of the operation.
%he goal of our co!erage of FDI is to understand the pattern of FDI that occurs
between countries, and why firms underta#e FDI and become multinational in
their operations.
%his chapter will describe some of the basic theories of FDI, and why firms
underta#e FDI rather than simply e-porting products or licensing their #now(
how.
2oreign $irect In,est'ent in the Word Econo'(
"hen discussing foreign direct in!estment, it is important to distinguish
between the %o& of FDI and the stoc* of FDI. %he flow of FDI refers to the
amount of FDI underta#en o!er a gi!en time period ;normally one year<. %he
stoc# of FDI refers to the total accumulated !alue of foreign owned assets at a
gi!en point in time.
%he significant growth in FDI during 4===(6884 has both to do with the political
economy of trade as outlined in the pre!ious chapter and the political and
economic changes that ha!e been ta#ing place in de!eloping countries. %he
globalization of the world economy is causing firms to in!est worldwide in order
to assure their presence in e!ery region of the world.
$nother important trend is has been the rise of inflows into the U,. %he stoc# of
foreign FDI in the U, increased more rapidly than U, FDI abroad.
124
%he rapid increase in FDI growth into the U, may be due to the attracti!eness of
the U, mar#et, the falling !alue of the dollar, and a belief by some foreign
corporations that they could manage U, assets and wor#ers more efficiently
than their $merican managers could.
It is difficult to say whether the increase in the FDI into the U, is good for the
country or not. %o the e-tent that foreigners are ma#ing more producti!e use of
U, assets and wor#ers, it is probably good for the country.
Figures D.6, D.5, D.9 and D.7 pro!ide some insight into the countries that ha!e
been the ma+or recipients and sources of foreign direct in!estment in recent
years.
%he management focus bo- details the techni1ues of Me-ican cement
manufacturer Ceme- for its aggressi!e international e-pansion of cement
manufacturing. Because cement is a product that is not easily e-ported due to
its low ratio of !alue to weight, Ceme- sought international e-pansion by
ac1uisition.
Hori"onta 2oreign $irect In,est'ent
Hori"onta 2$I is 2$I in the sa'e industr( a!road as a %ir' o+erates in
at ho'e. $ :apanese automobile manufacturer in :apan see#s to produce the
same product in the U,$. FDI would seem to be more e-pensi!e and ris#y than
e-porting or licensing, so there must be some other good reasons for firms to
underta#e FDI.
%ransportation costs can ma#e e-port infeasible, especially for products that
ha!e a low !alueJweight ratio ;i.e. cement, soft drin#s<, or would re1uire
refrigeration or similar controlled en!ironments. For items li#e electronics,
software, and medical e1uipment, transportation costs may not be an
impediment to e-porting.
%he most accepted reason for horizontal FDI relates to mar#et imperfections. By
imposing 1uotas, tariffs, or impediments, go!ernments can ma#e FDI and
licensing more attracti!e than e-porting.
%echnological or managerial #now(how can be difficult and dangerous to
license, howe!er, ma#ing it an infeasible alternati!e. $ firm can lose control of
critical competiti!e #now(how, may not be able to optimize the flow and
configuration of operations between countries, or simply may be unable to
codify its #nowledge in a way that would ma#e licensing a practical option.
125
Firms may choose to underta#e FDI simply to follow the lead of a competitor so
as not be left behind or loc#ed out of an opportunity.
FDI may be most li#ely to occur in certain stages of a product*s lifecycle (( when
other countries ha!e a large enough mar#et to +ustify local production or when
there is a need to locate production in a low cost location.
$ firm may choose to underta#e FDI in a particular country or region due to
location specific ad!antages. $n ob!ious e-ample occurs with respect to natural
resources, but it also applies to the ability to tap into a particular e-pertise ;e.g.
silicon !alley< or be located near customers or suppliers with uni1ue
characteristics. /orter*s diamond, as discussed in chapter 9, pro!ides a partial
e-planation why firms in certain industries may find it attracti!e to in!est in a
particular country.
6ertica 2oreign $irect In,est'ent
Bac*&ard ,ertica 2$I in,o,es in,est'ent into an industr( that
+ro,ides in+uts %or a %ir'7s do'estic +roduction +rocesses. Forward
!ertical FDI in!ol!es in!estment in an industry that utilizes the outputs of a
firm*s domestic production processes.
%he strategic beha!ior e-planation for !ertical FDI suggests that firms try to
either create new entry barriers or erode competitors* entry barriers. "hile
there certainly are some e-amples where the strategic beha!ior e-planation
seems to apply, the mar#et imperfections e-planation seems to present a more
complete e-planation.
Mar#et imperfections can result from impediments to the sale of #now(how and
the need to in!est in specialized assets.
Because specialized #now(how can be difficult to sell or license, a firm may
ha!e to integrate !ertically to be successful. %he establishment of sales and
ser!ices centers in high technology industries, or the in!estment in #nowledge
intensi!e e-tracti!e processes are two e-amples.
"hen specialized assets must be in!ested in ;i.e. the aluminum smelter<,
companies may need to secure a supply of the needed inputs to assure that
those assets can be used efficiently.
%he mar#et imperfections theory suggests that e-porting should be preferred to
licensing and horizontal FDI as long as transport costs are minor and tariff
126
barriers are tri!ial. If that is not the case, then firms should consider licensing
and FDI.
FDI is more costly than licensing, but may be the most reasonable option.
Figure D.D presents a decision tree suggesting when licensing, FDI, and
e-porting are most appropriate.
)icensing tends not to be a good option in high technology industries where
protecting firm specific #now(how is critical, in industries where a firm must
carefully coordinate and orchestrate its worldwide acti!ities, or where there are
intense cost pressures.
5odue N .contd0
THE POLITICAL ECONO5I O2 2OREIGN $IRECT
IN6E8T5ENT
Introduction
"hile the pre!ious chapter focused on the economic rationale for FDI, the role
of go!ernment was restricted to describing how trade barriers create mar#et
imperfections and decrease the feasibility of e-port. %his chapter loo#s more
directly at how host go!ernments can encourage and restrict the flow of FDI.
%he opening case on foreign in!estment in ,outh $frica underlines the
importance of political and social stability as a condition for the inflow of foreign
capital. It also points out the futility and counter producti!eness of the use of
trade sanctions as an agent of economic change.
0ome country go!ernments can also affect ability of firms to ta#e resources out
of the country for in!estment elsewhere.
In addition to understanding the e-plicit rules laid out by home and host
country go!ernments, firms must e!aluate their bargaining position and
appropriate negotiating stances when they wish to alter established rules for
FDI.
Poitica Ideoog( and 2$I
The RadicaE5ar1ist ,ie& o% 2$I suggested that FDI by M.s from ad!anced
capitalist nations #eeps the less de!eloped countries of the world relati!ely
bac#ward and dependent upon ad!anced capitalist nations for in!estment, +obs,
and technology. $ccording to this !iew, FDI is an instrument of economic
127
domination (( not economic de!elopment.
%he radical !iew was popular from ""II into the 4=>8s, and practiced in
.astern .urope, India, China, and many socialist third world countries.
By the end of the 4=>8s, the radical position was generally disregarded, due to
the collapse of communism, the abysmal economic performance of most of the
countries that practiced the radical approach, and the contrasting strong
economic performance of those de!eloping countries that had embraced a freer
mar#et approach ;i.e. ,ingapore, 0ong @ong, ,outh @orea<.
The %ree 'ar*et ,ie& sees the M. as an instrument for dispersing the
production and flow of goods and ser!ices in their most efficient manner. It is
built on the philosophy of ,mith and Cicardo and supported by the mar#et
imperfections e-planation of FDI.
"hile the free mar#et !iew is embraced by most ad!anced and de!eloping
nations, almost all countries impose some restrictions on FDI.
Most countries ha!e adopted a policy of 3+rag'atic nationais'/9 which lies
somewhere between the radical and free mar#et !iews.
The +rag'atic a++roach suggests that go!ernments should pursue policies
designed to ma-imize the national benefits and minimize the national costs of
FDI. "hereas in earlier years many countries discouraged FDI, or placed limits
on the ownership le!el held by M.s, many countries are now acti!ely courting
M.s for FDI ;as indicated in the opening case<. %hat aggressi!eness is also
consistent with a pragmatic approach, as countries are offering inducements
that would not be appropriate in a purely free mar#et approach.
.-amples of pragmatic policies are in :apan, the U,$, and se!eral .C countries.
The Bene%its o% 2$I to Host Countries
From a free mar#et !iew, the best policy would be for all countries to stop
inter!ening in the in!estment decisions of M.s. In their !iew the benefits
are generally so much greater than the costs that pragmatic nationalism will
li#ely end up creating. %hese costs include both barriers and incenti!es from
many countries, with the result that all countries are worse off than they
would be under a free mar#et approach.
Due to M.s large size and access to international capital mar#ets, they
may ha!e resources a!ailable to them that smaller nationally based firms do
not, and they may be able to bring resources into a country that would not
be brought in otherwise.
128
%echnology is critical to economic growth, and M.s may bring product and
process technology into a country. 0ence, not only is the technology
!aluable in itself, but also it may spur economic growth and the
de!elopment of new technological capabilities.
FDI may bring in managerial s#ills, increase the producti!e use of a
country*s resources, and spill o!er into impro!ing the management talent in
other firms that come into contact with the M..
FDI can lead to increased employment and the creation of new +obs. Critics
point out, howe!er, that the reported number of +obs created do not often
ta#e into account the loss of +obs that may ha!e occurred in other firms or
regions of a country. ,imply put, if &ermany has gained +obs, has France
lost +obsI
FDI can ha!e a beneficial effect on a country*s balance of payments by ;i<
the initial capital in!estment, ;ii< substituting for imports that contribute to a
current account deficit, and ;iii< the current account surplus that results
from e-porting the products produced from a facility built with the initial
FDI.
FDI can also spur competition and economic growth in a country. /re!iously
stodgy and protected firms may ha!e to impro!e their product offerings and
lower prices in order to compete on an international le!el. %here can also be
Efollow the leaderF effects, where the FDI of one firm will lead to subse1uent
FDI by other firms. %his will also lead to increased competition and more
choices for consumers.
The Costs o% 2$I to Host Countries
M.s operating in a particular country may ha!e greater economic
strength than domestic competitors and may subsidize operations in a
country in order to dri!e out domestic competitors.
Countries may want to restrict FDI in industries they wish to protect until
their own EinfantF firms ha!e the strength to compete against established
M.s.
"hen M.s repatriate profits from FDI, these outflows show up as debits to
a capital account.
129
If M.s import a great deal of components for assembly into the products
produced in a host country, it will ha!e an unfa!orable impact the trade or
current account balance.
,ome countries may feel that their national so!ereignty is threatened by
foreign M.s that ma#e decisions that affect the country from distant
locations.
The Bene%its and Costs o% 2$I to Ho'e Countries
The !ene%its o% 2$I to the ho'e countr( include an impro!ement in the
balance of payments as a result of the inward flow of foreign earnings, positi!e
employment effects when the foreign subsidiary creates demands for home
country e-ports, and benefits from a re!erse resource transfer effect.
The costs o% 2$I to the ho'e countr( include ad!erse balance of payments
effects that arise from the initial capital outflow, e-port substitution effects on
the current account, and the potential loss of +obs to foreign operations. %here
is much political rhetoric in the U, regarding lost +obs to Me-ico by U, firms that
mo!ed some assembly operations south of the border.
.!en when there are negati!e short(term employment effects, in the long term
these +obs would li#ely be lost in any case to foreign competitors. Mo!ing
production offshore can free up resources and people for other +obs where their
!alue added is greater and may pro!e a net benefit to consumers that now
ha!e access to less e-pensi!e products.
Go,ern'ent Poic( Instru'ents and 2$I
Ho'e countries can encourage 2$I !( o%%ering insurance/ 'a*ing
%unds a,aia!e/ +ressuring host go,ern'ents to re'o,e !arriers/ and
initiating ta1 incenti,es)
Ho'e countries can restrict 2$I ,ia e1+icit ca+ita %o& contros/
+uniti,e ta1 rues/ or s+eci%ic +rohi!itions %or +oitica concerns)
0ost countries are increasingly encouraging FDI by offering ta- incenti!es, low
interest rate loans, or outright grants and subsidies. Countries, and regions of
countries, compete with each other for new plants and facilities.
130
0ost countries can restrict FDI by ;4< imposing restraints on the ownership of
domestic firms and assets and ;6< setting specific performance re1uirements
relating to local content, e-port re1uirements, technology transfer, or local
management participation.
%hrough the "%2 there has been progress on liberalizing rules regarding FDI.
%hat has occurred primarily in the areas of financial ser!ices and
telecommunications. "or# on a much more wide ranging pact on liberalizing
FDI internationally has been stalled by a number of countries* hesitation to gi!e
up so!ereignty o!er the control of in!estment in their country.
$ host go!ernment*s attitude to FDI is a critical issue when considering whether
to in!est in a particular country.
%here is both an art and a science to negotiating. Figure 3.6 identifies the four
C*s to be considered when negotiating. %he #ey to most negotiating is to allow
the other part to belie!e they ha!e Ewon.F
$ number of the issues discussed in the chapter relate to the bargaining power
of both the host go!ernment and the in!esting firm. Issues li#e the potential for
technology transfer, effects on the balance of payments, and possibility of +ob
creation ;among others< all can change the relati!e bargaining power of both
parties. Figure 3.5 summarizes some of the #ey determinates of a firm*s
bargaining position.
Additiona notes'
Is India Read( %or 2u Currenc( Con,erti!iit(#
!( 8ushanta 5aic*
IndiaVs political boldness in see#ing peace with /a#istan in their half(century
twilight struggle for @ashmir may soon be matched by economic mo!es e1ually
as daring. Indeed, India is edging toward a truly bold reform' full international
con!ertibility of the rupee. 0ow it goes about this will not only effect IndiaVs
economic de!elopment, but pro!ide ob+ect lessons for China as it ponders
con!ertibility in the years ahead.
,ince 4==4 India has been tra!elling on a path from rupee de!aluation to full
con!ertibility, with the Ceser!e Ban# of India ;CBI< rela-ing a range of foreign(
e-change controls. Cesident Indians can now maintain a foreign(currency
account and in!est in shares of foreign companies, while non(resident Indians
131
can repatriate legacyJinheritance assets. Indian companies listed abroad can
buy property in foreign countries, and resident firms will be allowed to pre(pay
e-ternal commercial debt up to U,?488 million. )imits on e-portersV foreign(
currency accounts will be remo!ed, and ban#s may in!est in o!erseas money
and debt mar#ets.
Is India ready for full con!ertibilityI %he go!ernment is still lagging on its
domestic economic reforms. ,tructural reform and pri!atization ha!e slowed,
eroding in!estorsV confidence. But failure to address structural problems could
e-pose the economy to e-ternal shoc#s in the long term.
0ence it would be premature for India to open up its capital account
immediately. .-change rate stability is the #ey anchor when a countryVs reform
process is underway. %here is, howe!er, little e!idence that capital account
con!ertibility has a meaningful impact on a countryVs growth rate.
"ith capital(account con!ertibility, the rupeeVs e-change rate will be
determined more by capital flows than by inflation differentials, as IndiaVs
inflation rate remains broadly in line with the 2.CD a!erage of around 5G.
Because India is still running a trade deficit, there could be some pressure on
the rupee following any negati!e shoc#. $lthough monetary growth is more
than twice the rate of real &D/ growth, the inflationary ris# is probably low
because substantial e-cess capacity e-ists. Indeed, throughout the 4==8s,
despite rising output, deflation occurred, which means that IndiaVs potential
output is e-panding.
%he mo!es towards full capital(account con!ertibility ha!e proceeded in step
with impressi!e growth in IndiaVs foreign(currency reser!es. Indeed, IndiaVs
e-ternal li1uidity position has strengthened dramatically in the past decade. $s
a result of a current(account surplus and an interest(rate differential of 5(9G,
foreign reser!es reached ?38.5 billion by the end of 6886((enough to co!er
almost 47 months of imports((up from only U,?9 billion in 4==8.
Following the 4==4 balance of payments crisis, the rupeeVs e-change rate was
de!alued around 68G. .-porters could e-change 58G of their earnings at the
mar#et rate. %his was subse1uently replaced with a two(tier e-change(rate
system ma#ing the rupee partially con!ertible((D8G of e-port earnings could be
con!erted at the mar#et e-change rate, and the rest at the CBIVs fi-ed rate
;used by the go!ernment to finance essential imports li#e petroleum, coo#ing
oil, fertilizers, and life(sa!ing drugs<.
%he two(tier e-change(rate system acted as an e-port ta-, but it did not sur!i!e
for long, gi!ing way to a unified e-change rate on the trade account. Full
con!ertibility on the current account followed in $ugust 4==9. %he policy debate
then turned to capital(account con!ertibility, with the IMF and the "orld Ban#
132
strongly in fa!or. In May 4==3, the %arapore Committee on Capital $ccount
Con!ertibility charted a three(stage liberalization process to be completed by
4===(6888, with an accompanying emphasis on fiscal consolidation, a
mandated inflation target, and a strong financial system.
%hen the .ast $sian currency crisis put further action on hold and raised serious
1uestions about when((and whether((to proceed. %he sudden meltdown of
apparently healthy economies ser!ed as a star# reminder that strong e-ternal
li1uidity should not be the dri!ing force towards full con!ertibility. %he downside
ris# of capital(account liberalization, after all, is higher e-change(rate !olatility,
and e!en countries with sound li1uidity positions could not pre!ent a run on
their reser!es.
%he lesson for India is that, in the e!ent of a domestic or e-ternal shoc#, full
con!ertibility could pro!e to be a costly, short(li!ed e-periment. %he
fundamental 1uestion is whether full con!ertibility will encourage higher net
inflows or outflows of capital.
%he downside ris# of higher !olatility for the rupee is aggra!ated by some
serious problems, including a deficit running at DG of &D/ and the strategic
stand(off with /a#istan. ,hort(term capital outflows((which might occur should
either ris# worsen((could create greater output !olatility. ,o it is !ital for India to
increase the inward flow of long(term capital, regardless of whether the capital
account is closed or open.
In this conte-t, it is noteworthy that China, with a closed capital account, has
foreign(e-change reser!es of U,?6>D billion, four times the size of IndiaVs,
though ChinaVs economy is only double IndiaVs size. or is full con!ertibility the
#ey to attracting higher inflows of foreign direct in!estment ;FDI<. China
attracted FDI inflows of U,?76.3 billion in 6886((the largest in the world.
India needs to attract higher FDI inflows to help soa# up the economyVs e-cess
capacity. %his underscores the importance for IndiaVs financial stability of
successful management of the capital account ;monitoring inflows and
outflows< following any mo!e toward full con!ertibility. But, in the near term,
full capital account con!ertibility is not in IndiaVs interest.
Purchase Po&er Parit( Additiona Notes
What is Purchasing Po&er Parit(#
/urchasing power parity ;///< is a theory, which states that e-change rates
between currencies are in e1uilibrium when their purchasing power is the same
in each of the two countries. %his means that the e-change rate between two
countries should e1ual the ratio of the two countriesV price le!el of a fi-ed
133
bas#et of goods and ser!ices. "hen a countryVs domestic price le!el is
increasing ;i.e., a country e-periences inflation<, that countryVs e-change rate
must depreciated in order to return to ///.
La& o% one +rice'
The !asis %or PPP is the Ra& o% one +riceR: In the a!sence o%
trans+ortation and other transaction costs/ co'+etiti,e 'ar*ets &i
e-uai"e the +rice o% an identica good in t&o countries &hen the
+rices are e1+ressed in the sa'e currenc()
For e-ample, a particular %B set that sells for 378 Canadian Dollars TC$DU in
Bancou!er should cost 788 U, Dollars TU,DU in ,eattle when the e-change rate
between Canada and the U, is 4.78 C$DJU,D. If the price of the %B in
Bancou!er was only 388 C$D, consumers in ,eattle would prefer buying the %B
set in Bancou!er. If this process ;called ParbitrageP< is carried out at a large
scale, the U, consumers buying Canadian goods will bid up the !alue of the
Canadian Dollar, thus ma#ing Canadian goods more costly to them. %his
process continues until the goods ha!e again the same price. %here are three
ca!eats with this law of one price. ;4< $s mentioned abo!e, transportation costs,
barriers to trade, and other transaction costs, can be significant. ;6< %here must
be competiti!e mar#ets for the goods and ser!ices in both countries. ;5< %he
law of one price only applies to tradeable goodsK immobile goods such as
houses, and many ser!ices that are local, are of course not traded between
countries.
.conomists use t&o ,ersions o% Purchasing Po&er Parit(' a!soute PPP
and reati,e PPP)
A!soute PPP was described in the pre!ious paragraphK it re%ers to the
e-uai"ation o% +rice e,es across countries) /ut formally, the e-change
rate between Canada and the United ,tates .
C$DJU,D
is e1ual to the price le!el in
Canada /
C$
di!ided by the price le!el in the United ,tates /
U,$
. $ssume that the
price le!el ratio /
C$D
J/
U,D
implies a /// e-change rate of 4.5 C$D per 4 U,D. If
todayVs e-change rate .
C$DJU,D
is 4.7 C$D per 4 U,D, /// theory implies that the
C$D will appreciate ;get stronger< against the U,D, and the U,D will in turn
depreciate ;get wea#er< against the C$D.
Reati,e PPP re%ers to rates o% changes o% +rice e,es/ that is/ in%ation
rates) %his proposition states that the rate of appreciation of a currency is
e1ual to the difference in inflation rates between the foreign and the home
country. For e-ample, if Canada has an inflation rate of 4G and the U, has an
inflation rate of 5G, the U, Dollar will depreciate against the Canadian Dollar by
6G per year. %his proposition holds well empirically especially when the
134
inflation differences are large.
$oes PPP deter'ine e1change rates in the short ter'#
o. .-change rate mo!ements in the short term are news(dri!en.
$nnouncements about interest rate changes, changes in perception of the
growth path of economies and the li#e are all factors that dri!e e-change rates
in the short run. ///, by comparison, describes the long run beha!iour of
e-change rates. %he economic forces behind /// will e!entually e1ualize the
purchasing power of currencies. %his can ta#e many years, howe!er. $ time
horizon of 9(48 years would be typical.
Ho& is PPP cacuated#
%he simplest way to calculate purchasing power parity between two countries is
to compare the price of a PstandardP good that is in fact identical across
countries. .!ery year The Economist magazine publishes a light(hearted !ersion
of ///' it*s P0amburger Inde-P that compares the price of a McDonaldVs
hamburger around the world. More sophisticated !ersions of /// loo# at a large
number of goods and ser!ices. 2ne of the #ey problems is that people in
different countries consumer !ery different sets of goods and ser!ices, ma#ing
it difficult to compare the purchasing power between countries.
According to PPP/ !( ho& 'uch are currencies o,er,aued or
under,aued#
%he following chart compares the /// of a currency with its actual e-change
rate. %he chart is updated periodically to reflect the current e-change rate. It is
also updated about twice a year to reflect new estimates of ///. %he ///
estimates are ta#en from studies carried out by the 2rganization of .conomic
Cooperation and De!elopment ;2.CD< and othersK howe!er, they should not be
ta#en as Pdefiniti!eP. Different methods of calculation will arri!e at different ///
rates.
%he currencies listed below are compared to the U, Dollar. $ green bar
indicated that the local currency is o!er!alued by the percentage figure shown
on the a-isK the currency is thus e-pected to depreciate against the U, Dollar in
the long run. $ red bar indicates under!aluation of the local currencyK the
currency is thus e-pected to appreciate against the U, Dollar in the long run.
135
I52.Internationa 5onetar( 2und0
%he International Monetary Fund ;IMF< came into official e-istence on December
63, 4=97, when 6= countries signed its $rticles of $greement at a conference
held in Bretton "oods, ew 0ampshire, U,$, from :uly 4(66, 4=99. %he IMF
began financial operations on March 4, 4=93.
Current Membership' 4>6 countries
,taff' $ppro-imately 6,D88 from 448 countries
Managing Director' Michel Camdessus assumed office in 4=>3
&o!erning Bodies' Board of &o!ernors, Interim Committee, .-ecuti!e
Board
%otal Quotas' ,DC 497 billion ;U, ?4=7 billion<
$ccounting Unit' ,pecial Drawing Cight ;,DC<. $s of ,eptember 48,
4==>, ,DC 4 e1ualed U, ?4.5D4D5.
8tatutor( Pur+ose
%he IMF was created to promote international monetary cooperationK to
facilitate the e-pansion and balanced growth of international tradeK to promote
e-change stabilityK to assist in the establishment of a multilateral system of
paymentsK to ma#e its general resources temporarily a!ailable to its members
e-periencing balance of payments difficulties under ade1uate safeguardsK and
to shorten the duration and lessen the degree of dise1uilibrium in the
international balances of payments of members.
136
Ho& the I52 Ca'e A!out
%he International Monetary Fund ;IMF or Fund< and the International Ban# for
Ceconstruction and De!elopment ;IBCD or "orld Ban#< were both established at
the United ations Monetary and Financial Conference, held at Bretton "oods,
ew 0ampshire, on :uly 4(66, 4=99. %he two were created to o!ersee stability in
international monetary affairs and to facilitate the e-pansion of world trade.
Membership in the "orld Ban# re1uires membership in the IMF, and they are
both specialized agencies of the United ations. %he "orld Ban# was gi!en
domain o!er long(term financing for nations in need, while the IMFVs mission
was to monitor e-change rates, pro!ide short(term financing for balance of
payments ad+ustments, pro!ide a forum for discussion about international
monetary concerns, and gi!e technical assistance to member countries. %hese
functions are still generally true of both organizations, although the policies
determining how they are carried out ha!e been modified and amplified o!er
time.
%he FundVs legal authority is based on an international treaty called the $rticles
of $greement ;$rticles or the $greement< which came into force in December
4=97. %he first $rticle in the $greement outlines the purposes of the Fund and,
although the $rticles ha!e been amended three times in the course of the last
93 years prior to 4==>, the first $rticle has ne!er been altered.
%he IMF started financial operations on March 4, 4=93. Drawings on Fund
reser!es were made by 44 countries between 4=93 and 4=9>, although there
were no drawings in 4=78 and !ery few in the following years. During this time
the Fund wor#ed on its drawings policies. 2ne outcome was the stand(by
arrangements, established in 4=76, modified in 4=7D, and re!iewed periodically
since then. ,tand(by arrangements pro!ide a procedure for drawing on Fund
resources with conditions based on a structural ad+ustment program for the
borrower country. ,tand(by arrangements became the model for other lending
procedures designed by the Fund to meet the needs of its members.
By the mid(4=38s, the Fund found itself becoming more of a lending institution
than originally en!isioned. %he FundVs ability to meet the needs of its members
was tested when the 2rganization of the /etroleum .-porting Countries ;2/.C<
1uadrupled the price of crude oil in 4=35(4=39. /rices were increased again in
4=3= and in 4=>8. %his altered the international flow of funds as the 2/.C
countriesV monetary reser!es accumulated rapidly. $t the same time, the
industrial countries e-perienced strong inflationary pressures. %hese pressures
were addressed by an increase in interest rates and a reduction of imports. %his
resulted in balance of payments deficits for many of the de!eloping countries,
which were paying more for oil, paying higher interest rates on the loans from
the industrial countries, and finding reduced mar#ets for their e-ports. In
response to this situation, the IMF created an 2il Facility in 4=39, and enlarged
137
it in 4=37, to aid members in balance of payments difficulties. In addition, an 2il
Facility ,ubsidy $ccount was established for the poorest countries to alle!iate
the cost of borrowing under the 2il Facility. During the 4=38s, although the oil
price shoc#s placed more countries in balance of payments difficulties and
forced many of the de!eloping countries to borrow not only against the Fund,
but also against pri!ate ban#s which were recei!ing a surplus of 2/.C
petrodollars, it was generally percei!ed at the time that the debt cads would be
short(li!ed. It was not until Me-ico threatened to default on its loans in 4=>6
that the world monetary community realized the e-tent and depth of the crisis.
%hroughout the 4=>8s the Fund played an increasingly larger role, not only as
Plender(of(last(resort,P but also as mediator with debtor countries in relation to
creditor nations and pri!ate ban#s.
In the mid(4=>8s the FundVs lending operations increased dramatically. ,tand(
by arrangements are typically for one to three years, but the e-igency of the
debt crisis caused the Fund to de!ise programs for ad+ustment o!er longer
periods. %hese are #nown as e-tended arrangements and, with other medium(
term programs, can be arranged through the ,tructural $d+ustment Facility or
the .nhanced ,tructural $d+ustment Facility. %he terms of a structural
ad+ustment program, or stabilization program, are #nown as conditionality.
/rograms include 1uantified targets or ceilings for ban# credit, the budget
deficit, foreign borrowing, e-ternal arrears, and international reser!es. %hey
also include statements of policies that the member intends to follow.
Conditionality came under detailed scrutiny during the 4=>8s as more and more
de!eloping countries adopted structural ad+ustment programs and later were
unable to meet the terms of the agreement. %he philosophy of the Fund was
criticized as being too oriented to the industrial economies and not adapted to
de!eloping economies. During the late(4=>8s se!eral plans were put forth,
in!ol!ing not only the Fund but the creditor nations and commercial ban#s as
well, to reduce the debt and the debt ser!ice payments of the debtor nations. In
4=>= the Fund de!eloped new debt reduction guidelines, pro!iding Fund
support for commercial ban# debt and debt ser!ice(reduction operations by
member countries. %he debt strategy is still being assessed and its success or
failure has not been determined.
Training and Technica Assistance
$ssistance is e-tended to members in the form of training and technical
assistance. Beginning in 4=78, the Fund offered training courses on balance of
payments statistics and on international economics. In 4=D9 the IMF Institute
was established fortify these training acti!ities. %he IMF Institute pro!ides
training courses for officials from member countries in such sub+ects as financial
analysis and policy, balance of payments methodology, public finance, and
go!ernment finance statistics.
138
%he technical assistance program is operated through the Monetary and
.-change $ffairs Department, the Fiscal $ffairs Department, and the Bureau of
,tatistics. %he )egal Department, the Bureau of Computing ,er!ices, and the
area departments may also participate. $ssistance is pro!ided mainly through
staff missions, field assignments by staff members or outside e-perts, and
studies and recommendations prepared at head1uarters. In pro!iding technical
assistance, the IMF emphasizes training go!ernment officials in macroeconomic
management, reforming the ta- system and ta- administration de!eloping
central ban#ing and financing systems, and impro!ing statistical data. $d!ice is
also pro!ided on money and capital mar#ets, central and general ban#ing
legislation, the structure of interest rates, regional cooperation among central
ban#s, and the use of !arious instruments in monetary management. %echnical
assistance is most in e!idence in the transformation of the centrally planned
economies of .astern .urope and the states of the former ,o!iet Union to
mar#et oriented economies. %he IMF is assisting the new members in the choice
of currency, de!eloping import and e-port sectors, agreeing on ground rules for
setting interest rates, reser!e re1uirements, and credit guidelines, and in
ma#ing structural reforms.
I52 8tatistica Acti,ities
Under $rticle BIII of the $greement members are re1uired to furnish the Fund
such information as it deems necessary for its acti!ities, including national data
about their economic and financial condition. $rticle BIII also dates that the
Fund shall act as a center for the collection and e-change of information on
monetary and financial problems, thus facilitating the preparation of studies
designed to assist members in de!eloping policies which further the purposes of
the Fund. %he Fund uses these statistics, in consultation with the member, as
part of the fulfillment of the FundVs regulatory function, to assess the memberVs
1uota, and as part of the FundVs role in assessing the world economic outloo#. In
addition, the Fund has de!eloped standards for the classification and
presentation of balance of payments statistics and go!ernment finance
statistics. It is concerned with maintaining the accuracy and consistency in the
reporting of the data. %he IMF compiles and publishes these statistics in a
!ariety of publications.
=;E8TION BANC
4. Define absolute and comparati!e ad!antage.
6. "hat are the different instruments of trade policies that affect
International businessI .-plain.
5. Discuss the foreign e-change determination process.
139
9. Distinguish between mar#et economy and command economyI
7. Discuss the distribution strategy in International business.
D. 0ow the companies increase their profitability by e-panding globally in
ways not a!ailable to purely domestic enterprisesI
3. Differentiate patent and copyrights.
>. Discuss the different strategic choices a!ailable to compete in the
international business.
=. "hat are the costs and benefits of foreign direct in!estments to a host
countryI .-plain.
48. "hat is globalizationI
44. Describe the porter*s Diamond theory of ational Competiti!e
$d!antage.
46. Discuss the changing demographics of the global economy.
45. "hat is balance of paymentI
49. .-plain the nature and functions of foreign e-change mar#et.
47. Discuss the salient features of .uropean union and $,.$.
4D. .-plain the !arious le!els of economic integration. &i!e suitable
e-amples.
43. "hich are factors to be considered to locate its manufacturing
acti!ity of an international firm so as to minimize the costs and impro!ing
the product 1uality.
4>. "hat is a turn#ey pro+ectI
4=. "hat are the implications for international business from the
floating e-change rate system.
68. 0ow different political systems affect the international businessI
64. Define International business.
66. .-plain the different modes of carrying out International business.
65. Discuss the forces dri!ing companies towards International
business.
69. "hat is a strategic alliance in International businessI
67. Distinguish between foreign direct in!estment and portfolio
in!estments.
6D. "hat is a totalitarian systemI
63. .-plain the arguments for regional economic integration.
6>. "rite a note on the deliberations at the recently held Cancun
,ummit of "%2.
6=. "hat do you mean by dumpingI
58. Discuss the ob+ecti!es and achie!ements of .uropean Union.
54. "hat is global managementI
56. "hat are the factors to be considered in designing an organization
structure of a MCI
55. .-plain the role of ethics in International business.
59. "hat is .-change rateI
57. .-plain the nature and functions of foreign e-change mar#et.
5D. Discuss the funding strategies and facilities of International
140
Monetary Fund.
53. Discuss the implications of &o!ernment policy on currency
con!ertibility on International business.
5>. "rite note on $F%$.
5=. "rite notes on ' a< &$%% b< "%2
98. .-plain the )eontief parado-.
94. "hat is eo mercantilismI
96. "hat is counter tradeI .-plain with an e-ample.
95. "hat is meant by purchasing power parityI
141

International Business Management

Загружено:

Сведения о документе

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

International Business Management

Загружено:

Авторское право:

Доступные форматы

CHAPTER 1: GLOBALIZATION

Вам также может понравиться