ISM ASSIGNMENT

PROBLEMS IN INTERNATIONAL TRADE

SUBMITTD BY SURABHI PALIWAL A1802010080

WHAT IS INTRNATIONAL TRADE International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders. International trade is, in principle, not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture. Another difference between domestic and international trade is that factors of production such as capital and labor are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Trade in goods and services can serve as a substitute for trade in factors of production. Instead of importing a factor of production, a country can import goods that make intensive use of that factor of production and thus embody it. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor, the United States imports goods that were produced with Chinese labor. One report in 2010 suggested that international trade was increased when a country hosted a network of immigrants, but the trade effect was weakened when the immigrants became assimilated into their new country. International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.

Risk in international trade

Companies doing business across international borders face many of the same risks as would normally be evident in strictly domestic transactions. For example,

Buyer insolvency (purchaser cannot pay); Non-acceptance (buyer rejects goods as different from the agreed upon specifications); Credit risk (allowing the buyer to take possession of goods prior to payment); Regulatory risk (e.g., a change in rules that prevents the transaction); Intervention (governmental action to prevent a transaction being completed); Political risk (change in leadership interfering with transactions or prices); and

War, piracy and civil unrest or turmoil; Natural catastrophes, freak weather and other uncontrollable and unpredictable events,

In addition, international trade also faces the risk of unfavorable exchange rate movements (and, the potential benefit of favorable movements) Free Trade vs. Protectionism As with other theories, there are opposing views. International trade has two contrasting views regarding the level of control placed on trade: free trade and protectionism. Free trade is the simpler of the two theories: a laissez-faire approach, with no restrictions on trade. The main idea is that supply and demand factors, operating on a global scale, will ensure that production happens efficiently. Therefore, nothing needs to be done to protect or promote trade and growth because market forces will do so automatically. In contrast, protectionism holds that regulation of international trade is important to ensure that markets function properly. Advocates of this theory believe that market inefficiencies may hamper the benefits of international trade and they aim to guide the market accordingly. Protectionism exists in many different forms, but the most common are tariffs, subsidies and quotas. These strategies attempt to correct any inefficiency in the international market. Conclusion As it opens up the opportunity for specialization and therefore more efficient use of resources, international trade has potential to maximize a country's capacity to produce and acquire goods. Opponents of global free trade have argued, however, that international trade still allows for inefficiencies that leave developing nations compromised. What is certain is that the global economy is in a state of continual change and, as it develops, so too must all of its participants.

Problems in International Trade

Cultural Issues: The issue of cultural multiplicity in the international business scenario is continuously on the up rise owing to the factor of rapid globalization. As the developed countries spread their wings across the globe, the third world talent finds more employment opportunities in their lap. Managing the differences of languages, cultures, religions and traditions under one umbrella are some of the main obstacles faced by the international businesses, and are more complex than they seems to be on the out front. People coming from multiple backgrounds not only have differences of social setup, in fact, the cultural impact influences the psychological side of the personality as well. The business culture of a country is not very dissimilar to its social norms. However, being defensive and confining our horizons pertaining to these obstacles would be child-like. Instead we need to be solution-oriented and device methods and strategies to tackle ethnic multiplicity in the workplace. More focus needs to be given to the positive sides of globalization, as the prospects of business success are much higher and beneficial around the globe. The international business strategies should be realistic and free of all bias based on religion, culture, race or ethnicity. With this constructive and realistic approach, firms can hop into the international market and extend their sphere. Deficient Infrastructure: Inadequacy in infrastructure can be another factor that deters business expansion. According to a survey by MIGA 2002, the reliability and quality of infrastructure and utilities was the fourth most important factor in choosing a country location to invest. In general, poor infrastructure will increase overall capital and operating costs for firms for the reason that poor infrastructure increases the uncertainty risk and requires firms to hold higher levels of inventory in order to reduce the risks of production being interrupted. In some cases, a company has to incorporate its own electricity generators, water filtration units and communication facilities to reimburse the deficiencies of local infrastructure. The access to roads and utility also further increases the company investment cost. McDonald is one of the examples. McDonald as the global fast food giant was having expansion problems in India. Based on an article from India, McDonald as the global fast food giant has 600 stores in China but in contrast it has just 50 outlets in India. The major issue here is the shortage of infrastructure, especially highway roads that link to smaller towns in India. According to the survey by global consulting major KPMG and Economist Intelligence Unit, 66 percent of the total executives stated that existing transportation infrastructure in India highly increases the operating cost for their company, 62 percent of Indian executives said the existing energy and power supply infrastructure has substantially increased the company operating cost. However, companies can consider joint venture as market entry strategy to reduce the risk. Through joint venture, companies can share the financial risk, secure access to resources, gain local management knowledge and obtain access to market or distribution. Policy barriers: Macroeconomic policies are another problem that deter foreign firm from entering a market, increase cost and increase the business risks that foreign firm have to deal. The major macroeconomic policies that could deter a business expansion

are: (a) Fiscal policies: the stability of fiscal policy can influence the level and growth of tax revenues which directly influence the trade taxes and corporate revenue tax. (b)Monetary policies: the control of money supply by central bank can influence domestic interest and inflation rates, and indirectly on the stability of domestic currency values. (c) Debt management policies: the government internal and external debt and comfort levels for repaying loans. High debt country tends to repay public debt by printing domestic currency and caused inflation and deprecation of currency. In short, bad macroeconomic policies management will cause economic instability and increase the risk of future taxation, currency risk and currency convertibility risk which affects company profits. Euro Disney is one of the examples to illustrate the problem. The financial plans for Euro Disneyland first year operation anticipated total revenues of FF 5,482 million and a net profit after taxation of FF 204 million. However, in reality they didn't meet the plans. European recession caused Euro Disney to fall into serious financial problem. In November 1992 the management announced a loss of FF 188 million. The second year was even worse; they faced a loss of FF 5,337 million whereas total turnover was FF 5,725 million due to the failure of unforeseen European recession. Managing global business is equal to managing the complexity; decision that made on today may be not appropriate tomorrow. Thus, it is important to gather all information to create a basis for plan decision making. All plans include uncertainty and risk because the nature of future planning requires estimation. Technology: Technology is the key to provide businesses with the competitive edge that can lead to greater profitability and growth. Indeed, technological factors can lower the barrier to entry and reduce the minimum efficient production levels, reduce capital costs and labor costs, and influence outsourcing decisions. For instance, although outsourcing can help companies to influence the latest and the most sophisticated workflow technologies, International Business Machines Corporation (IBM), the world's largest supplier of technology services had failed due to increase labor. IBM set up global centers for tasks like software development and maintenance and employing 53,000 workers in India, and employing 200,000 people worldwide in its services business with spending on $11.8 billion on 54 acquisitions (36 software and 18 services companies). This growth means that they had to add more people, the IBM's business is in trouble for its labor represents 70 to 80 percent of the cost in traditional technology service contracts, and the traditional work of maintaining and updating software and data centers for corporate customers is still a large part of IBM.'s services business. In order to avoid such pitfalls in outsourcing, a company like IBM can integrate the business strategy that focus on the technological advances to substitute software automation for its labor force. This case of IBM illustrates that the key strategy for multinational companies in expanding business overseas is to use global teams to take advantage of greater performance to create competitive edge as well as continually investing in R&D activities in growth opportunities to ensure to compete on the basis of innovation and technology. Entry Strategies: When entering a foreign market, a company must decide on the appropriate entry strategy and ownership forms; while at the same time considering the legal structure, the amount of capital, resources invested, and managerial involvement

required in the host country. The management of joint ventures, for instance, is one of the key entry strategies a company can consider when expanding business overseas. International Business Machines Corporation (IBM), developers and manufacturers of information technology products and services worldwide, though underestimated the costs associated with the joint ventures that recently formed with PC maker Lenovo resulting reduction in its profit margins. Having manufactured an IBM's product in its entirety, Lenovo was privy to an IBM's intellectual property, and thus enabling to build its own brand expanded also designing and engineering custom electronic components and forge its own relationships with retailers and distributors including those of the IBM. From this case, selecting the appropriate entry strategies are the key factor in the success under different circumstances. IBM found itself facing not only more dangerous vendors, Lenovo, but also a new competitor that once underestimated. Multinational corporations and their manufacturing partners in foreign market need to rethink how they manage their relationships with each other. For companies like IBM and the other multinational companies, partnership problems are one of the leading causes of joint ventures failure. To avoid such pitfall, a company should focus on investing in the personal relationships that must be built to create a successful joint venture and commit the necessary time and effort, even thought the tangible inputs of the decision such as legal function of the structure, the financial considerations of ownership, the market analysis, and end result and desired outcome are all critical concerns. Strategy changes that arise from this growth that will affect business practices and profitability in the future. In clearly define and stress test your strategy countries such as China and India, population growth what are the implications of international expansion is accompanied by increasing affluence and a growing for your existing business operations? middle class consumer base. Therefore, the traditional characterisation and perception of emerging markets Very few organisations can afford to ignore the as predominantly low cost manufacturing centres is increasing trend towards globalisation. Entrepreneurial quickly changing. Emerging markets are also becoming organisations that are the first to move often have strong consumer driven societies where the demand for the most startling success stories. However, those products and services is increasing faster than in more organisations that do not stress test the financial and established and mature markets. operational impact on their existing business, may lose more than their dream of becoming a global player. The implications for your business are clear. You can become a participant in these markets and tap into before expanding internationally, you should have an ever increasing consumer base to help secure clear picture of what you are trying to achieve. Are you your future profitability, or you can watch others fill searching for a new and cheaper source of capital, that space. Those business leaders that do not act market leading talent, more cost effective production, risk watching others reap the benefits and may be new markets, or all of the above? Market research: what research is available to provide you with information on market and industry conditions? Is this information up-to-date and what is the future outlook? Create a short list of new and emerging markets, tap into existing networks, talk to your advisors and visit your short listed locations. Market research is very important but can be costly; however there are numerous resources available free of charge to help you

uncover useful information about the strengths and challenges of global markets The world is moving and changing fast. What may have been a good investment location historically, may not present the same opportunities in the future. Tap into existing networks via chambers of industry and commerce or other organizations representing an investment location, visit trade fairs, talk to your advisors, visit your target locations and meet the local people. This will greatly assist you to make an educated and informed decision about whether that market is right for your business. Choosing the location (Political and social climate): an assessment of your target locations political environment, including the potential for social unrest or Is the political system stable? How do you regional instability is relevant for determining the risk of assess sovereign risk? Any potential investment. This has been an important Does the country suffer under high levels of issue in South East Asia, where various countries sovereign debt? Have been affected by social unrest in recent years. Importance investors place on political stability in the pace of change of the global political landscape assessing emerging market locations. Almost 60% of is accelerating due to globalization. Political decisions respondents rated political stability as the most important in one country may have far reaching implications for government-related factor to consider when deploying trading partners or the globalised business community FDI. Before entering a new market, you should evaluate at large. Local tax and regulatory environment does not rule out the possibility of government support for certain industries to protect domestic markets against Is the tax regime business friendly and/or competitive? Foreign competition, through subsidies or other forms of protection. An extensive double tax treaty network may Does the country have free trade agreements likewise look impressive; however it is necessary to look or double tax treaties? beyond withholding tax rates and test how the treaties Does the regulatory regime set the scene for deal with mutual agreement procedures and arbitration a sound corporate governance framework? Around transfer pricing, permanent establishment issues a low headline corporate tax rate is always appealing and a global work force. Not all double tax treaties are Legal system: Is it a common law system? If not, are you should you develop your products in emerging sure you understand the outcomes? or fast growth markets? Do the laws and the legal and judicial should you have a presence at global system provide support for and protection innovation clusters of commercial activities? Are generous grants and incentives available for innovative organizations? An effective legal system that provides a balance between protecting the commercial interests of maintaining an environment that supports innovation business, whilst also protecting the consumer, can is critical for future business growth. Innovation can provide you with a level of confidence that you can be centralised, or decentralised and driven locally. Labour law will regulate employment matters For many businesses, the decision to relocate research There is real estate, planning and construction and development activities to an emerging market will law to consider. be influenced by a number of strategic and business drivers. These may include using the target location as a strategic hub for market expansion into that region

Language: the importance of language cannot be overstated, as it will underpin everything the business What is the availability, skill-set and cost structure does in the target location. Effective communication of the local work force? (or the lack thereof) has the ability to make or break the business. It is a key foundation upon which the success when expanding into a global market, your human of the business may be built. Your management team resources can mean the difference between successes will need the language skills to communicate effectively and failure. As your organization grows offshore, with those who will interact with your business including getting the right people in the right location can government, regulators, financiers, suppliers, staff and provide a vital competitive advantage. Even in countries where English is commonly the local workforce may often be the deciding factor spoken or is the language of business, regional nuances in determining whether to expand your business to can be a source of misunderstanding and can lead to that location and also in determining how successful more serious problems. Such an expansion will be. Language barriers in weekends and public holidays and there may also foreign markets be local customs or practices that will impact on the Tolerance of foreign business operation and activities of your workforce. In addition influence in host markets you will need to consider your global remuneration Cultural similarity to approach and whether short term and long term home market incentive programs will be offered to your overseas Degree to which advertising and cultural imagery can be employees, as well as the tax and regulatory implications understood internationally associated with this. Press and media freedom in foreign markets Openness to foreign cultural influence (e.g. through television, cinema etc.) 0% 10% 20% 30% 40% 50% Global management team: Will some members of your management team be required to spend a lot of personal time in the Who will negotiate with government, customers, new location? Suppliers and business partners? How should you manage risks such as bribery and corruption? Will Australian expatriates be sent to run the business or can the services of local managers who will be responsible for the recruitment of staff? be relied upon? Do you have an international management team or do you need to build one? To be prepared, you must consider the challenges your business will face during the start-up phase, and who Commencing business operations in a new market can from a management perspective is best placed to deal involve significant risks, and therefore it is important to with those challenges. In determining this, consider have a strong management team that understands the any potential negotiations with the government or other challenges ahead. Having established the business in local officials in the host country. Negotiations might be new country; a variety of issues may present themselves required over issues such as licensing arrangements, tax such as: concessions, labour conditions and local joint venture Financing: What are the cash flow needs of your business? What is your projected revenue growth? Are your How you manage your ongoing finance raises significant financial models sound or overly optimistic? Taxation considerations both in Australia and your target Do you need strong partners to finance your country. You should test your assumptions by using expansion? Have you considered Islamic finance financial modeling to determine if you can achieve the as a source of funds? Desired debt to equity

ratio recommended by your financial What is the debt equity mix of funding? What are advisors? You should confirm that your treasury function the tax consequences? is permitted under local and Australian law to ensure that the terms of your finance arrangements do not breach the It is important to stress test your financial models and transfer pricing rules or thin capitalization thresholds. Hybrid revenue targets to ensure you can service your debt. Financing arrangements, changes to the non-portfolio this testing should involve hypothetical parameters such dividend exemption and withholding tax implications, as an interest rate hike, currency Choosing the operating structure and Foreign exchange management: Are you looking for slow organic growth? Currency risk/controls Will you start out with a sales office or are you Is the local currency stable or volatile? looking for a green field development? Is currency hedging available at a reasonable cost? Are you looking to establish an immediate local Could currency restrictions inhibit or even prohibit presence? If so, will you set up a joint venture the flow of international funds? or will you acquire an existing local business? Organizations generally can hedge international internal There are a number of factors that will determine the transactions effectively without adverse outcomes, method of entry into your chosen location. The market although the tax and accounting treatment can be conditions and the opportunities to capture immediate complicated. The risk and commercial exposure rises market share will impact the design of your initial exponentially where transactions with external suppliers business model and structure. Supply chain, transfer pricing: have you identified all possible supply may allow you to take better advantage of chain efficiencies? Efficiencies overseas? Have you considered potential Australian tax How will profits be taxed in your target location? issues as you move functions, intellectual What is the treatment of losses? property and risk offshore? Is your intellectual property and data protected? Consider how tax is assessed and paid in the host country. The timing and quantum of tax payments The development of an effective supply chain process will impact your cash flow. Ensure that start up losses is vital to establishing efficient operations and achieving can be carried forward to reduce future tax liabilities. maximum profitability. You should consider local and Payment of withholding taxes will typically be required international commercial contracts, the adequacy of local on cross-border payments of interest, dividends and physical infrastructure beyond that which was assessed royalties. In certain jurisdictions, taxes will be triggered during start-up and the reliability of associated services on the payment of technical services fees and other on which the business will rely. payments to nonresidents. Double taxation agreements You could also explore the possibility of vertical may operate to allocate taxing rights between the host integration such as the acquisition of key suppliers or country and Australia. Detailed tax due diligence is distributors. However in doing this, you should give recommended if you are acquiring a foreign business. Consideration to any potential infrastructure, regulatory or other constraints that may hinder such an expansion. If you have operations in multiple countries, you may