Drivers of Globalization

The term Globalization refers to

the process of international integration
arising from the interchange of
world
views, products, ideas, and other aspects
of culture.
Advances in transportation and
Telecommunications,
infrastructure,
including the rise of the telegraph and its
posterity the Internet, are major factors in
globalization,
generating further interdependence of
economic and cultural activities.
Drivers of Globalization
The media and almost every book on
globalization and international business
speak about different drivers of globalization
and they can basically be separated into
five different groups:
1) Technological drivers
Technology shaped and set the foundation
for modern globalization. Innovations the
in transportation technology
revolutionized
industry. Inventions in the area ofthe
microprocessors and telecommunications
enabled highly effective computing and
communication at a low-cost level. Finally the
rapid growth of the is the latest
Internet technological drivercreated
that
business and e-commerce. global
2) Political drivers
Liberalized rules
deregulated
trading markets lead to and lowered
t̀ariffs and allowed
investments in foreign
almost all over the world.
direct
The institution of GATT (General
Agreement on Tariffs and Trade) 1947
and the WTO (World Trade Organization)
1995 as well as the ongoing opening and
privatization in Eastern Europe are only
some examples of latest developments.
3) Market drivers
Markets become more saturated, the
opportunities for growth are limited and
global expanding is a way most
organizations choose to overcome this
situation. Common customer needs and
the opportunity to use global marketing
channels and transfer marketing to some
extent are also incentives to choose
internationalization.
4) Cost drivers

Sourcing efficiency and costs vary

from country to country and global firms
can take advantage of this fact. Other
cost to globalization are the
drivers
opportunity to build global scale
economies and the high
development costs nowadays. product
5) Competitive drivers
with the global market, global
firm inter-
among competition and
countries and high two-way trades and FDI actions also support this driver.
increases
organizations are forced to “play”
Strong interdependences
international.
 Globalization, Labor Policies and the
Environment
 Critics argue that firms avoid costly efforts to
adhere to labor and environmental regulations by
moving production to countries where such
regulations do not exist, or are not enforced
 Supporters claim that tougher environmental and
labor standards are associated with economic
progress
 as countries get richer from free trade, they
implement tougher environmental and labor
regulations
Globalization & the World’s Poor
 Is the gap between rich nations and poor nations
is getting wider?
 Critics believe that if globalization was beneficial
there should not be a divergence between rich and
poor nations
 Supporters claim that the best way for the poor
nations to improve their situation is to
 reduce barriers to trade and investment
 implement economic policies based on free market
economies
 receive debt forgiveness for debts incurred under
totalitarian regimes
 Managing in the Global
Marketplace

 Managing IB differs from managing a

domestic business because
countries are different
 the range of problems confronted in IB is wider
and the problems more complex than those in a
domestic business
 firms have to find ways to work within the
limits imposed by government intervention in
the international trade and investment system
International Trade
 Mercantilism
Why do Nations Trade?
(i) Nations are different
- Unequal distribution of natural resources
- Difference in Technology
- Cost Advantages: Cost of production for the same product
differs among different locations
- Different Preferences: Americans prefer Basmati rice grown
in India (taste differences) Due to different income levels (ii)
To achieve economies of scale in production
 Mercantilism
Mercantilism the first theory of international trade, is an economic concept for
the purpose of building a wealthy and powerful state, which believes that the
wealth of a nation could only be achieved through government controls and
regulation of trade, commerce and economic activities.

It involves wealth accumulation, establishment of favorable trade with other

countries, and development of internal resources in the manufacturing and
agriculture sectors. The economic policies that pursued by the Mercantilists, such
as Governmental control of the use and exchange of precious metals, which is
often referred to as Bullionism.
 Features of a Mercantilist Economy:
1) Import prohibition of certain goods using imposition of high tariffs, government legislation or
very high taxes/import duties.
2) A wide range of government subsidies on export industries to promote the country’s export-
based policy.
3) Policies of nationalism.
4) Accumulation of assets in gold and silver, and prohibition of private accumulation, use or
export of these items.
5) One-way trade with colonies, and importation of gold and raw materials from these sources.
 ADAM SMITH coined the term “mercantile system” to describe the system of
political economy that sought to enrich the country by restraining imports and
encouraging exports. This system dominated Western European economic
thought and policies, including Portugal, France, Spain, and Great Britain
from the sixteenth to the late eighteenth centuries. Its use was favored by
writers such as JeanBaptiste Colbert, who at a time served as the French
Finance Minister.
 The basic concepts of mercantilism in terms of trading are: • This approach
assumes the wealth of a nation depends primarily on the possession of
precious metals such as gold and silver. • During 16th to 18th century, gold
and silver were the currency of trade between countries. • By exporting
goods, countries could earn and therefore maximize the amount of gold and
silver. Conversely, importing goods from other countries resulted in an
outflow of gold and silver to those countries.
 The basic concept of mercantilism in terms of trading is to make sure that the
country’s own resources are exported to other countries in higher volumes or
amounts compared to the goods imported, which are kept to a minimum
level. Trading is said to be “balanced” if a country exports more than it
imports. Through this system, resources will increase and there will be a
surplus on gold and silver reserves. • In the words of the English mercantilist
writer Thomas Mun, “The ordinary means therefore to increase our wealth
and treasure is by foreign trade, wherein we must ever observe this rule” to
sell more to strangers yearly than we consume of theirs in value”. • This
theory suggests that the government should play an active role in the
economy by encouraging exports and discouraging imports, especially through
the use of tariffs.
 Assumpition: Three Assumptions of Mercantilism: 1) There is a finite amount
of wealth in the world. 2) A nation can only grow rich at the expense of other
nations. 3) Therefore, a nation should try to achieve and maintain a favorable
trade balance, exporting more than it imports. The Use of Colonies to Achieve
a Favorable Trade Balance: 1) The economy of the colonies is always
secondary to the economy of the mother country.
 The colonies should provide cheap raw materials to the mother country and
market the manufactured goods of the mother country. 3) In return, the
mother country provides military security and political administration to the
colonies. 4) The overriding goal is national monopoly, meaning that a nation’s
colonies should be restricted to trading only with each other or with the
mother country.
 The Austrian lawyer and scholar Philipp Wilhelm von Hornick, in his Austria
Over All, If She Only Will of 1684, detailed a nine-point program of what he
deemed effective national economy, which sums up the tenets of
mercantilism comprehensively: • That every inch of a country's soil be
utilized for agriculture, mining or manufacturing. • All raw materials found in
a country should be used in domestic manufacture, since finished goods have
a higher value than raw materials. • A large, working population should be
encouraged. • All export of gold and silver should be prohibited and all
domestic money be kept in circulation.
 That all imports of foreign goods should be discouraged as much as possible. •
Where certain imports are indispensable they should be obtained at first
hand, in exchange for other domestic goods instead of gold and silver. • As
much as possible, imports should be confined to raw materials that can be
finished [in the home country]. • Those opportunities should be constantly
sought for selling a country's surplus manufactures to foreigners, so far as
necessary, for gold and silver. • That no importation should be allowed if such
goods are sufficiently and suitably supplied at home.
 Example of Mercantilism: Mercantilist doctrine is by no means dead; Neo-
Mercantilists equate political power with economic power with a balance of
trade surplus. Critics argue that many nations have adopted a neo-
mercantilist approach to boost exports and minimize or limit imports. For
example, China has recently been criticized for using the mercantilist system,
deliberately keeping its currency value low against the U.S. dollar in order to
sell more goods to the U.S. China for many years has been successful at
distributing their goods and services to other countries, and severely limiting
the imports they take in return. This has allowed China to amass considerable
wealth in foreign currencies. Economists point out, that like European
countries who eventually had to abandon mercantilism, China may be at that
point as well, if they want to continue to develop their wealth.
 Criticism: Adam Smith and David Hume were the founding fathers of
antimercantilist thought; This practice was strongly attacked by Adam Smith
in his 1776 work “The Wealth of Nations”. The criticisms of mercantilism are
given elaborately- • Mercantilists viewed the economic system as a “zero-sum
game”, in which a gain by one country results in a loss by other. Adam Smith
& David Ricardo argued that, trade should be a positive-sum game, or a
situation in which all countries can benefit. • Mercantilism unduly
emphasized the importance of money and over-emphasized the importance of
gold and silver. So Mercantilist ideas about wealth were nonsensical and
untenable.
 The mercantilists unduly emphasized the importance of a favorable balance
of trade. For the attainment of this objective they discouraged imports by
imposing heavy and prohibitive duties on foreign goods and provided every
possible ways to minimize exports. • The mercantilist assumption that the
colonies existed for the benefit of the mother was not a sound economic
proposition. • Mercantilism was a cause of frequent European wars in that
time and motivated colonial expansion. • The mercantilist policies were
designed to benefit the government and the commercial class, rather than
the entire population.
 The mercantilism over-emphasized the importance of commerce and greatly
undermined the importance of agriculture and other branches of human industry. •
It does not promote free enterprise and free movement of goods and people. And
instead it allowed colonialism and monopoly of businesses and trade practices.
Objectives were simply to generate wealth for the upper class and merchant class.
The working people were exploited and were even made as slaves with very low
wages. • Finally, Smith argued that the collusive relationship between government
and industry was harmful to the general population. He criticized mercantilist trade
policy of intervening and monopolizing trade business. Conclusion: Mercantilist
regulations were steadily removed over the course of the Eighteenth Century in
Britain, and during the 19th century the British government fully embraced free
trade and Smith's laissezfaire economics. In France, economic control remained in
the hands of the royal family and mercantilism continued until the French
Revolution. The continued pressure resulted in the implementation of laissez faire
economics in the nineteenth century.
 The Scottish economist Adam Smith developed the
trade theory of absolute advantage in 1776
 A country that has an absolute advantage produces
greater output of a good or service than other
countries using the same amount of
resources.
 Smith stated that tariffs and quotas should not
restrict international trade

Contrary to mercantilism Smith argued that a
country should concentrate on production of goods
in which it holds an absolute advantage.
No country would then need to produce all the
goods it consumed
 Trade is between two countries
 Only two commodities are traded
 Free trade exists between the countries

 They only element of cost of production is

labour.
 Country A can produce 1,000 parts per hour
with 200 workers.
 Country B can produce 2,500 parts per

hour with 200 workers.

 Country C can produce 10,000 parts per

hour with 200 workers.

 has the absolute advantage.
 According to the absolute advantage theory,
international trade is a positive- sum game,
because there are gains for both countries to
an exchange.
 Unlike mercantilism this theory measures the
nation's wealth by the living standards of its
people and not by gold and silver.
 If there is one country that does not have an
absolute advantage in the production of any
product, will there still be benefit to trade,
and will trade even occur?

The answer may be found in the
extension of absolute advantage, the
theory of comparative advantage.
 law of comparative advantage refers to the
ability of a country to produce a particular
good or service at a lower opportunity cost
than another party.
 The most basic concept in the whole of international trade
theory is the principle of comparative advantage, first
introduced by David Ricardo in 1817.
 The principle of comparative advantage states that a country
should specialize in producing and exporting those products
in which is has a comparative, or relative cost, advantage
compared with other countries and should import those goods
in which it has a comparative disadvantage.
 The cost of passing up the next best choice
when making a decision
 Eg:
you have Rs.100. u can use this to buy
either
 The assumption that countries are driven only by
the maximization of production and consumption,
and not by issues out of concern for workers or
consumers is a mistake.
History of Bertil ohlin:Between 1944 and 1967, Bertil Ohlin
was the leader of the Swedish Liberal Party, and between
1944 and 1945 he was also the Secretary of Trade of the
Swedish Government. Bertil Ohlin died in 1979.
 The countries differ with respect to the
availability of the factors of production.
 They differ if one country, for example, has
many machines (capital) but few workers,
while another country has a lot of workers but
few machines.
 According to the Heckscher-Ohlin theory, a
country specializes in the production of goods that
it is particularly suited to produce
 Countries in which capital is abundant and
workers are few production of goods in
particular, require capital.
MACHINES AND
WORKERS

 The production of goods and services requires capital

and workers. Some goods require more capital -
technical equipment and machinery - and are called
capital intensive. Examples of these goods are cars,
computers, and cell phones.
 Other goods require less equipment to produce and rely
mostly on the efforts of the workers. These goods are
called labor intensive. Examples of these goods are
shoes and textile products such as jeans.
PORTER'S DIAMOND
OF NATIONAL
ADVANTAGE
WHAT IS THE DIAMOND
MODEL?
 The Diamond Model of Michael Porter for the
competitive advantage of Nations offers a model that
can help understand the comparative position of a
nation in global competition.
TRADITIONAL COUNTRY ADVANTAGES

Traditionally,economic theory mentions the following factors for comparative advantage f

regions or countries:

1. Land
2. Location
3. Natural resources (minerals, energy)
4. Labor, and
5. Local population size.

Because these 5 factors can hardly influence…..

 Porter says that sustained industrial growth has hardly
ever been built on above mentioned basic inherited
factors
 According to Porter, as a rule competitive advantage of
nations is the outcome of 4 interlinked advanced factors and
activities in and between companies
 PORTER used a diamond shaped diagram as a basis
of a framework
to illustrate the determinants of national
advantage.
 The points of the diamond are described as
follows ……..
1.FACTOR
CONDITIONS
 Classical factors – land, labour, capital and entrep.
 Porter emphasize education level of labour,
quality of country infrastructure
2.DEMAND CONDITIONS
 Nature and size of domestic demand
-Creates capabilities
-Creates sophisticated and demanding consumer
 3.RELATED AND SUPPORTED INDUSTRIES
 Suppliers of raw mtls, market intermediaries,
financial companies, consulting agencies, ancillary
industries etc….
 It competes and come with high input quality pdts
4. FIRM STG, STRUCTURE
AND RIVALRY
 Continuouslyv improve pdt design, invest in R & D,
HRD, Tech …
 High quality; low cost = export internationally

 Japan – electronic goods

 The product life-cycle theory is an
economic theory that was developed by
Raymond Vernon
 The intent of his International Product Life
Cycle model (IPLC) was to advance trade
theory beyond David Ricardo’s static
framework of comparative advantages.
 the product life cycle - explain how trade
patterns change overtime.
 Introduction Early Late Decline
and Growth Maturity: Maturity
Stages:
Developing
MNC MNC Moves Country Developing Country
Manufactures Production to Competitor Markets Remain Viable
Product in Developing Exports Target Markets for MNC;
Product
Developed Country; MNC Home
To MNC Home
Countries; Begins Country; Country Market Is
Exports to Importing to Competes Diminishing
Developing Home with MNC
Countries Country Imports

Sales

Time
 The theory suggests that early in a product's life-
cycle all the parts and labor associated with that
product come from the area in which it was
invented
 After the product becomes adopted and used
in the world markets, production gradually
moves away from the point of origin.
 In some situations, the product becomes an
item that is imported by its original country of
invention
• Stage 1: Introduction
• Stage 2: Growth
• Stage 3: Maturity
• Stage 4: Decline
 New products are introduced to meet local
(i.e., national) needs, and new products are
first exported to similar countries, countries
with similar needs, preferences, and
incomes.
 (E.g., the IBM PCs were produced in the US
and spread quickly throughout the
industrialized countries.)
 Increase in sale of new pdt attracts
competitors.
 Increase of demand in advanced
countries; exports – increase

further innovation in pdt, cost reduction,
mkt process takes place (tech equipped)
 Shift manufacturing to foreign countries
 World wide pdtn;Export decline.
 Large scale of pdtn
 Low cost pdtn – shift manufacturing to
developing countries
 Tech become standard
 Mks for the pdt concentrate in less developed
countries as the customers in advanced
countries shift their demand to further new
pdts –thus pdtn in developing countries
 Original innovator becomes importer
 The Leontief
• Paradox
H-O theory, one of the most influential theoretical
ideas in international economics
• Makes few simplifying assumptions than Ricardo’s
theory
• H-O theory has been subject to many empirical tests
and most raised questions about its validity
• Most famous is by Wassily Leontief in 1953 for the
US
 The Leontief
Paradox
• Since US was relatively abundant in capital
compared to other nations, the US would be an
exporter of capital-intensive goods and an importer
of labour intensive goods
• However, Leontief found that US exports were less
capital intensive than US imports
• This has become known as Leontief paradox
 The Leontief
Why it is so?Paradox
1. US has a special advantage in producing new and
innovative products
Such products may be less capital intensive and
heavily use skilled labour and innovative
entrepreneurship
Ex: Computer software
2. May be due to the assumption of uniform
technology across countries
 The Leontief
• Differences Paradox
in technology may lead to differences in
productivity, which in turn drives international trade
patterns
• New research shows that once differences in
technology across countries are controlled for,
countries do indeed exports goods that make
intensive use of factors that are locally abundant
• That is, the H-O model has predictive power once the
impact of differences of technology on productivity is
controlled for
The New Trade Theory
Economies of Scale,
Imperfect Competition and
International Trade
 Base of International Trade Theories –
Why countries trade?
Reasons for Trade
Classical Theories New Trade Theory
Differences in Resource
availability or Economies of Scale
Resource Productivity

Comparative advantage Imperfect Competition

assuming Perfect (monopolistic competition or
Competition oligopoly market structure)

Constant/Diminishing
Returns to Scale Increasing Returns to Scale
 The New Trade Theory
• Emerged in the 1970s by a number of economists
• Countries do not necessarily specialize and trade solely
to take advantage of their differences in resource
endowments or technology
• They also trade because of increasing returns that makes
specialization advantageous in some industries
• New trade theorists introduce industrial organization
view into trade theory and include real-life imperfect
competition in international trade
• Argue that because of economies of scale, there are
increasing returns to specialization in many industries
Economies of Scale and
International Trade: The New
Trade Theory
Definitions:

• Economies of Scale: Reduction of average cost as a result

of increasing the output
• Increasing Returns: a unit increase in inputs results in
more than one unit increase in output
• Economies of scale is an important source of
increasing returns to specialization
• New Trade Theory supports the Comparative Advantage
theory by identifying economies of scale as an
important source of comparative advantage
• Domestic market may not be big enough to realize
economies of scale for certain products
Ex: the aerospace industry dominated by Boeing and
Airbus
How do they achieve economies of scale?
• First-mover Advantage: New Trade Theory suggests that a
country may predominate in the export of a good simply
because it was lucky enough to have one or more firms
among the first to produce that good
• First mover’s ability to benefit from increasing returns
creates a barrier to entry
Ex: Microsoft operating systems, Google, etc.
 Economies of Scale and Market
Structure
How international trade take place?
• When there is economies of scale, large firms have cost
advantage over small ones and lead to imperfectly
competitive market structure (ACLarge < ACSmall)
• Each country specializes in producing a restricted range
of goods taking advantage of economies of scale
• Helps them to produce these goods more efficiently than
if tried to produce everything by itself
• Specialized economies trade with each other, making
possible to consume the full range of goods (variety of
consumption)
 Theory of Imperfect
Competition
Characteristics
• A few major producers
• Differentiated products
• Firm is a ‘price setter’ not ‘price taker’
• Firms can sell more only by reducing their prices
(downward slopping demand curve)
 Monopolistic Competition and Trade
• Variety of goods and scale of production are
constrained by size of the market
• Trade increases market size
• Each country specializes in a narrower range of
products
• Trade offers mutual gain when countries do not differ in
resources or technologies
• Trade makes available variety of goods to the consumers
of each country
 Economies of Scale and Comparative
Advantage
What will be the pattern of trade that results from the
economies of scale?
• Two countries – Japan and India
• Japan capital abundant
• Two products – Steel and Rice
• Suppose Steel is a monopolistic competitive sector (each
firm’s product is differentiated from others)
• Japan will be still the net exporter of Steel and importer
of Rice
 Intra and Inter Industry
• Trade
Suppose, Steel producers in India produces product
different from that of Japan’s Steel producers
• Some Japan consumers prefer Indian varieties
• So, Japan import as well as export within Steel
sector
• Trade in monopolistic competition model consists of
two parts:-
– Intra-industry trade – two-way trade within a
sector
– Inter-industry trade – trade between two sectors
Pattern of Trade
– Inter-industry trade: (Steel for Rice) reflects
comparative advantage or H-O Theorem
– Intra-industry trade (Steel for Steel) depends on
economies of scale creating increasing returns due to
specialization within the industry
– The pattern of intra-industry trade is unpredictable
– The relative importance of intra-industry and inter-
industry trade depends on how similar countries are
China exports textiles to India, but also imports
textiles which can be produced only using the skills in
India. Is it comparative advantage or advantage due
to economies of scale?
 Why Intra-industry trade
matters?
• About ¼ of world trade consists of intra-industry trade
• Countries are becoming increasingly similar in their level
of technology and availability of capital and skilled labour
• Allows countries to benefit from larger markets
• More prevalent between countries that are similar in
relative factor supplies (capital-labour ratios), skill levels
and so on.
 Dumpin
•
g
An important consequence
international trade
of imperfect competition on

• Firms do not necessarily charge the same price for goods

that are exported and those that are sold to domestic
buyers – known as price discrimination
• Dumping – the most common form of price discrimination
in international trade
• A pricing practice in which a firm charges a lower price for
exported goods than for the same goods sold domestically
• Major reason: differences in the responsiveness (elasticity)
of sales to price in the export and domestic markets
 New Trade Theory:
Summary
• Suggests that nations may benefit from trade even when
they do not differ in resource endowments or technology
• Assumes economies of scale due to increasing returns
• Trade helps nations to specialize in products in which they
have economies of scale
• In autarky, size of the market limits the variety of goods
that a country can produce and the scale of production
 New Trade Theory:
• Summary
By trade, each nation may able to specialize in
producing a narrower range of products than in autarky
• Yet they can increase the variety of goods for
consumption at a lower cost
• Thus, trade offers mutual gain when countries do not
differ in their resource endowments or technology
 New Trade Theory:
• Summary
Also argue that if world market offers economies of scale
with substantial proportion of world market, then only
limited number of firms based in a limited number of
countries will produce those products
• First-mover Advantage: The firm which enter first may
gain an advantage
• A country may dominate in the export of particular
product where economies of scale exist because it is the
home for first mover firm
Political Economy of International Trade
F r e e trade refers to a situation where a government does not attempt to restrict what its citizens can buy
from another country or what they can sell to another country
INSTRUMENTS OF TRADE POLICY
: How do governments intervene in international trade?

There are seven main instruments of trade policy

1. Tariffs – specific and ad valorem
2. Subsidies
3. Import quotas
4. Voluntary export restraints
5. Local content requirements
6. Antidumping policies
7. Administrative policies
7-92
The Case for Government
Intervention

Question: Why do governments intervene in trade?

Answer:
There are two types of arguments:
1. Political arguments - concerned with protecting the
interests of certain groups within a nation (normally
producers), often at the expense of other groups
(normally consumers)
2. Economic arguments - concerned with boosting the
overall wealth of a nation (to the benefit of all, both
producers and consumers)
7-93

The Case for Government Intervention

Question: What are the political arguments for
government intervention?

Political arguments include:

1. Protecting jobs
2. Protecting industries deemed important for national
security
3. Retaliating to unfair foreign competition
4. Protecting consumers from “dangerous” products
5. Furthering the goals of foreign policy
6. Protecting the human rights of individuals in exporting
countries
7-94

The Case for Government Intervention

Question: What are the economic arguments for
government intervention?

Economic arguments include:

1. The infant industry argument
2. Strategic trade policy
7-95
The Revised Case for Free Trade

N e w trade theorists believe government

intervention in international trade is justified
Classical trade theorists disagree
Some new trade theorists believe that while
strategic trade theory is appealing in theory, it
may not be workable in practice – they suggest a
revised case for free trade
T w o situations where restrictions on trade may
be inappropriate
Retaliation
Domestic policies
7-96
Development of the
World Trading System
Question: How has the world trading system
evolved?

U p until the Great Depression of the 1930s,

most countries had some degree of
protectionism
The U.S. enacted the Smoot-Hawley Act (1930) -
created significant import tariffs on foreign goods
Other nations took similar steps and as the
depression deepened, world trade fell further
7-97
Development of the
World Trading System
Since World War II, an international trading
framework has evolved to govern world trade
I n its first fifty years, the framework was
known as the General Agreement on Tariffs
and Trade (GATT)
Established in 1947 to gradually eliminate barriers
to trade
Since 1995, the framework has been known as
the World Trade Organization (WTO)
7-98
WTO: Experience to Date

Since its establishment, the WTO has emerged as

an effective advocate and facilitator of future
trade deals, particularly in such areas as services
So far, most countries have adopted WTO
recommendations for trade disputes
The WTO has brokered negotiations to
reform the
global telecommunications and financial services
industries
The 1999 meeting of the WTO in Seattle demonstrated
that issues surrounding free trade have
become mainstream, and dependent on popular
opinion
7-99
WTO: Experience to Date

The WTO is currently focusing on:

1. Anti-dumping policies - encouraging members to strengthen the regulations governing
the imposition of antidumping duties
2. Protectionism in agriculture - concerned with the high level of tariffs and subsidies in
the agricultural sector of many economies

3. Protecting intellectual property - members believe that the protection of intellectual

property rights is essential to the international trading system

 TRIPS obliges WTO members to grant and enforce patents

lasting at least 20 years and copyrights lasting 50 years
 WTO: Experience to Date

4. Market access for nonagricultural goods and

services - bring down tariff rates on
nonagricultural goods and services, and
reduce the scope for the selective use of high
tariff rates
5. A new round of talks: Doha - launched in
2001 to focus on:
 Cutting tariffs on industrial goods and
services
 Phasing out subsidies to agricultural
producers
 Reducing barriers to cross-border
investment
 Limiting the use of anti-dumping laws
7-101
Implications for Managers

Question: Why should international managers

care about the political economy of
free trade or about the relative merits
of arguments for free trade and
protectionism?

• Trade barriers impact firm strategy

• Firms can play a role in promoting free trade
or trade barriers
FOREIGN DIRECT INVESTMENT
WHAT IS FDI?
 Foreign direct investment is an investment in a
business by an investor from anther country for
which the foreign investor has control over the
company purchased.
 It is also defined as cross border investment made
by a resident in one economy in an enterprise in
another company.
 FDI is direct investment into production in a country
by a company located in another country ,either by
buying a company in the target country or by
expanding operations of an existing business in that
country.
TYPES OF
FDI

BY
BY MOTIVE
DIRECTION

BY ENTRY
BY TARGET MODES
 BY TARGET
 Horizontal foreign direct investment
Refers to the overseas manufacturing of products and services
similar to those the company produces and manufactures in its home
market.
VERTICAL FDI:-
 Vertical foreign direct investment occurs when firms
establish manufacturing facilities in multiple countries,
each producing a different input to, or stage of, the
company’s production process.
 Where the FDI takes the firm nearer to the
market is called Forward vertical FDI.(for
example toyota acquiring a car
distributorship in america)
 Where international integration moves back
towards raw materials is called Backward vertical
FDI.(for example toyota acquiring a tyre
manufacturers)
BY
MOTIVE
 Resource seeking:-looking for resources at a
lower real cost.
 Market seeking:-secure market share and sales
growth in target foregion market.
 Efficiency seeking:-seeks to establish efficient
structure through useful factors ,cultures, policies or
markets.
 Strategic asset seeking:-seeks to acquire assets
in foreign farms that promote corporate long term
objectives.
BY
DIRECTION
 INWARD FDI:-
 An inward investment involves an foreign entity
either investing in or purchasing the goods of
a local company.
 OUTWARD FDI:-

 An outward investment is a business strategy

where a domestic firm expands its operations to a
foreign country either via acquisition or
expansion of an existing foreign facility.
BY ENTRY
MODES
 GREENFIELD INVESTMENT:-
 Greenfield investment is the investment in a
manufacturing ,office,etc.
 BROWNFIELD:

 MERGERS AND ACQUISITIONS:-

 A merger is a combination of two companies to

form a new company, while an acquisition is the
purchase of one company by another company in
which a new company is formed.
 THEORIES OF FDI
Mac Dougall-Kemp Hypothesis.
FDI moves from capital abundant economy to capital
scarce economy till the marginal production is equal
in both countries. This leads to improvement in
efficiency in utilization of resources in which leads to
ultimate increase in welfare .According to this theory,
foreing direct investment is a result of differences in
capital abundance between economies. This theory
was developed by MacDougal(1958) and was later
elaborated by Kemp(1964)
 Cont…
Industrial Organization Theory.
According to this theory, MNC with superior technology
moves to different countries to supply innovated
products making in turn ample gains .Krugman
(1989) points out that it was technological advantage
possessed byEuropean countries which led to massive
investment in USA .According to this
theory, technological superiority is the main driving
force for foreign direct investment rather that
capital abundance.
 Cont…
Currency Based Approaches.
A firm moves from strong currency country to weak
currency country. Aliber(1971)postulates that firms from
strong currency countries move out to weak currency
countries.
Froot and Stain(1989)holds that, depreciation in real value of
currency of a country lowers the wealth of a domestic
residents visa avis the wealth of the foreign residents
,thus being cheaper for foreign firms to acquire assets
in such countries. Therefore, foreign direct investments
will move from countries with strong currencies to those
with weak or depreciating currencies.
 Cont…
Location –Specific Theory.
Hood and Young(1979) stress on the location factor.
According to them, FDI moves to a countries with
abundant raw materials and cheap labor force. Since
real wage cost varies among countries, firms with low-
cost technology move to low wage countries.
Abundance of raw materials and cheap labor force are
the main factors for FDI.Countries with cheap labor
and abundant raw material will tend to attract FDI.
 Cont…
Product Cycle Theory.
FDI takes place only when the product in question
achieve specific stage in its life cycle(Vernon
1966)introduction ,growth, maturity and decline stage.
At maturity stage, the demand for new product in
developed countries grow substantially and rival
firms begin to emerge producing similar products at
lower price.
So in order to compete with rivals, innovators decide
to set up production in the host country so as to
beat up the cost of transportation and tariffs.
 cont…
Political –Economic Theories.
They concentrate on the political risks. Political
stability in the host country leads to FDI(Fatehi-
Sedah and Safizeha 1989).Similarly, political
instability in the home country encourages FDI in
other countries(Tallman 1988).
BENEFITS OF
FDI
 Improve foreign exchange position of the country.
 Employment generation and increase in production.

 Help in capital formation by bringing fresh capital.

 Helps in transfer of new technologies and

management skill.
 Helps in increase exports.

 Increases tax revenues.

DISADVANTAGES OF
FDI
 Domestic companies fear that they may lose their
ownership.
 Small companies fear that they may not be able to compete
with world class large companies.
 Foreign companies invest more in machinery and
intellectual property than in wages of the local people.
 Government has less control over the functioning of such
companies as they usually work as wholly owned
subsidiary of an overseas company.
Module 5

The Strategy of International

Business
 What Is Strategy?

A firm’s strategy refers to the actions that

managers take to attain the goals of the
firm
 Firms need to pursue strategies that
increase profitability and profit growth
 Profitability is the rate of return the firm makes
on its invested capital
 Profit growth is the percentage increase in net
profits over time
13-121

What Is Strategy?

 To increase profitability and profit growth,

firms can
 add value

lower costs

 sell more in existing markets

expand internationally
13-122

What Is Strategy?
Determinants of Enterprise Value
13-123

How Is Value Created?

 To increase profitability, firms need

to create more value
 The firm’s value creation is the
difference between V (the price that the
firm can charge for that product given
competitive pressures) and C (the costs of
producing that product)
 a firm has high profits when it creates more
value for its customers and does so at a lower
cost
How Is Value Created?
Value Creation
13-125

How Is Value Created?

 Profits can be increased by

1. Using a differentiation strategy
 adding value to a product so that customers
are willing to pay more for it
2. Using a low cost strategy
 lowering costs
13-126

How Are A Firm’s Operations

Configured?
 Value creation activities can be categorized as
1. Primary activities
R&D
 Production
 marketing and sales
 customer service
2. Support activities
 information systems
 logistics
 human resources
 How Are A Firm’s Operations
13-127

Configured?
The Value Chain
13-128

How Can Firms Increase Profits

Through International
Expansion?
 International firms can
1. Expand their market
 sell in international markets
2. Realize location economies
 disperse value creation activities to locations
where they can be performed most
efficiently and effectively
13-129

How Can Firms Increase Profits

Through International
Expansion?
3. Realize greater cost economies from
experience effects
serve an expanded global market from a
central location
3. Earn a greater return
leverage skills developed in foreign
operations and transfer them elsewhere in
the firm
13-130
What Types Of Competitive
Pressures Exist In The Global
Marketplace?
 Two competitive pressures:
1. Pressures for cost reductions
 force the firm to lower unit costs
2. Pressures to be locally responsive
 require the firm to adapt its product to meet
local demands in each market
 but, this strategy can raise costs
13-131

When Are Pressures For Cost

Reductions Greatest?
 Pressures for cost reductions are greatest
1. In industries producing commodity type products that fill
universal needs (needs that exist when the tastes and
preferences of consumers in different nations are
similar if not identical) where price is the main
competitive weapon
2. When major competitors are based in low cost
locations
3. Where there is persistent excess capacity
4. Where consumers are powerful and face low switching
costs
13-132
When Are Pressures For
Local Responsiveness
Greatest?
 Pressures for local responsiveness arise
from
1. Differences

in consumer tastes and
preferences
strong pressure emerges when consumer tastes and
preferences differ significantly between countries
2. Differences in traditional practices and

infrastructure
strong pressure emerges when there are significant
differences in infrastructure and/or traditional
practices between countries
13-133
When Are Pressures For
Local Responsiveness
Greatest?

3. Differences in distribution channels
need to be responsive to differences in
distribution channels between countries
4. 
Host government demands
economic and political demands imposed by
host country governments may require local
responsiveness
13-134

Which Strategy Should A Firm

Choose?
  There are four basic strategies to
compete in international markets
 the appropriateness of each strategy
depends on the pressures for cost
reduction and local responsiveness in
the industry
 Which Strategy Should
13-135

A Firm Choose?
Four Basic Strategies
13-136

Which Strategy Should A Firm

Choose?
1. Global standardization - increase
profitability and profit growth by reaping
the cost reductions from economies of
scale, learning effects, and location
economies
goal is to pursue a low-cost strategy on a
 global scale
This strategy makes sense when
there are strong pressures for cost
reductions and demands for local
responsiveness are minimal
 Which Strategy Should A Firm
Choose? - increase profitability by
2. Localization
customizing goods or services so that
they match tastes and preferences in
different national markets
 This strategy makes sense when
 there are substantial differences across
nations with regard to consumer tastes and
preferences and cost pressures are not
too intense

13-34
13-138

Which Strategy Should A Firm

Choose? - tries to simultaneously achieve
3. Transnational
low costs through location economies,
economies of scale, and learning effects
 firms differentiate their product across geographic
markets to account for local differences and foster a
multidirectional flow of skills between different
subsidiaries in the firm’s global network of
operations
 This strategy makes sense when
 both cost pressures and pressures for local
responsiveness are intense
13-139

Which Strategy Should A Firm

Choose? – take products first
4. International
produced for the domestic market and
sell them internationally with only
minimal local customization
 This strategy makes sense when
 there are low cost pressures and low
pressures for local responsiveness
13-140

How Does Strategy Evolve?

 An international strategy may not be viable in the

long term
 to survive, firms may need to shift to a global
standardization strategy or a transnational strategy in
advance of competitors
 Localization may give a firm a competitive edge,
but if the firm is simultaneously facing
aggressive competitors, the company will also
have to reduce its cost structures
 would require a shift toward a transnational strategy
13-141

How Does Strategy Evolve?

Changes in Strategy over Time